In May this year we examined investor returns for lending opportunities in non-bank lending. It’s timely now to re-visit this as the sector continues to mature and establish its share of the development finance market. We examine the factors that contribute to this and how these have changed over time, if at all, and what impact they have had.
First of all, what’s the broader context:
- The fundamentals of the property sector itself as an asset class, against which commercial lending is made, have remained robust. Residential housing has been particularly strong and future growth prospects for the apartment market are underpinned by migration inflows, both temporary and permanent as borders re-open.
- Key economic indicators, such as inflation and central bank cash rates, have made plenty of headlines, particularly with a sharp uptick in annual inflation in the US. However, these overseas drivers are largely not replicated in Australia. The domestic rate is a low 2.1% p.a. and not expected to rise to 2.5% until some point in 2023. The Reserve Bank of Australia (RBA) has been vocal in committing to hold the cash rate until inflation is sustainably in the range of 2% to 3% p.a. and wage rise pressure starts to flow through but that will rely on the tightening of labour markets. Rising interest rates for borrowers have only really occurred in the longer-term, fixed rate (e.g. 3 year and 5 year) offerings from the banks. So, we are likely to see a low interest rate environment for some time and hence the investor returns on non-bank lending are likely to continue to generate alpha returns (excess returns earned on an investment above the benchmark return) e.g. appropriate return for first mortgage lending risk is 5% and investment return is 7%.
- Government measures in response to the pandemic are becoming less impactful on the economy.
In summary, market factors are favourable towards achieving strong investor returns in the non-bank lending asset class.
Secondly, what’s been happening with the non-bank lending market itself?
- The impact of Australian Prudential Regulation Authority (APRA) and other regulations on the traditional banks, particularly in terms of capital adequacy provisions, continue to create further opportunities for growth in development finance for non-banks where the traditional banks have pulled back their lending.
- Non-bank lenders continue to grow their capacity to lend as witnessed by Initial Public Offering (IPO) raisings and capital mandates from institutions.
- The asset class is maturing as a component to be included in asset portfolio allocations.
- Wealth advisory firms are increasing their clients’ exposure as the investment continues to demonstrate a track record.
What’s the message to investors from client advisers?
- Non-bank lending offers a strong value proposition in terms of return over risk compared to other assets classes.
- It is largely uncorrelated with, or counter cyclical to, the factors which impact other assets.
- The attractiveness of the product has seen capital flow into the sector and subsequent lowering of investor returns due to the greater competition chasing the pool of quality loans.
- Risk settings remain paramount. Yield should always reflect the asset class risk and it should not be a race to the bottom.
Ultimately, recent market trends have meant that investing in non-bank lending is now a much sought after commodity and a desirable asset to complement any diversified portfolio.
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