Monday, 27 May 2013
Commercial lending has been a significant contributor to the downfall of a number of financial services organisations. This was the primary reason that HBoS failed and subsequently took Lloyds Banking Group down with it. It was also the principle cause of the failure of Bradford & Bingley who made a major play into the buy-to-let market. Alliance & Leicester kept out of that market until the temptation of high margins and growth became too great to resist and paid the ultimate price by, like Bradford & Bingley, having to be 'rescued' by Santander. Britannia Building Society, which the Co-op acquired, aggressively entered the commercial lending market prior to its acquistion. Indeed it is the size and the problems within the Britannia Building Society commercial lending book that has fundamentally caused the huge capital gap and the down grading of the Co-op's credit rating.
A question has to be why so many safe building societies/mutuals have been tempted into commercial lending and got it so wrong?
There is no doubt that in the good times that commercial lending is highly attractive with guaranteed rents and better margins than for residential lending. The size of deals are far larger than for residential lending and for those who are motivated by numbers signing a deal measured in millions rather than hundreds of thousands is very attractive.
There is also no doubt that market for commercial lending is very much more volatile than for residential lending. Up until 2008 it was always the perceived belief that the only direction for residential housing prices to go was up - the expression 'as safe as houses' was for good reason.
The residential housing market is also more homogenous than commercial lending. Commercial lending has a wide variety of segments such as hotels, offices, retail and industrial. These segments operate in different ways, have different cycles and require specialist knowledge.
Commercial lending requires high amounts of capital, has a far broader range of risks than residential lending and requires having a large diversified portfolio to be successful in the long term.
For residential lending there is a lot of data about the market available, the amount of capital for each individual deal is a lot less, there is a huge amount of historical data, so making fact based decisions is relatively straigh forward.
The same cannot be said for commercial lending. What is critical for success in commercial lending is both internal and external data on what is going on in the market. This includes knowing and understanding what the competitors are doing. If a bank is winning all the commercial lending deals and others are withdrawing from the market then the executive need to be asking why. A question is whether the banks that failed had the data and the analytics in place and, if so, why they didn't respond to it?
For many years banks have wrestled with the decision of whether SME banking sits with the retail bank or the commercial and corporate bank. At least one lesson that should be taken from the financial crisis is that the skills, knowledge and understanding that is required to lend to consumers and the mass market is quite different from those to lend to businesses. To move from retail to commercial lending is not a continuum but to move into a totally different business. It appears that the new CEO of the Co-op gets this and has wisely decided that commercial lending is a step too far. The question outstanding is still whether the Co-op should be in banking at all?