Most mature markets in most mature economies seem to consolidate, sooner or later, into a small handful of large players who between them have the vast majority of market share. Think the Big Four accountancy firms; the dominance of Boeing and Airbus in the airliner market; the Big Three credit rating agencies (S&P, Moody’s and Fitch).
This trend towards oligopoly had been in evidence in the debt market, but since the financial crisis of 2007 it has gone into reverse. Borrowers can take advantage of this, but only if they are able to compare across the wealth of choice they are now faced with.
It is not so long ago that debt markets seemed to be following the well-trodden path towards oligopoly. If we take the UK as an example, the share of new lending accounted for by the largest 12 lenders was almost 80% in the immediate aftermath of the GFC, up from 70% or so in the late 1990s, according to De Montfort University research. This proportion has fallen by a quarter, to around 60% today. In other words, twice as much new lending (40% of the total) is now done by entities outside the largest 12 firms than was the case a decade ago, as shown in the chart below: this is a market that is rapidly fragmenting into one made up of a range of diverse lenders with varying goals, rather than consolidating into a small homogenous set of larger outfits with similar strategies.
UK Market Share of Originations by Lenders Outside the Top 12
Source: De Montfort University
For borrowers, a move away from oligarchy is to be welcomed; such markets can be anti-competitive with dominant firms being price setters and consumers price takers. In a situation of pure(r) competition, the reverse is true; consumers, in this case borrowers, have more choice and are thus more likely to be in a more dominant position, meaning that it is the suppliers, in this case lenders, who are more likely to be price takers.
So far so good, but in practice, it may not be so easy for borrowers to establish a strong position. Choice is a curse as well as a blessing: to secure the best terms available, borrowers have now to scour across a huge number of potential lending partners. Data from Preqin shows that over the three years from 2014-16, 40 different managers raised a combined €40bn for deployment in European debt markets. Added to incumbent banks and existing alternative lenders, we estimate that there are now more than 200 active lenders across Europe. So while such competition will deliver rewarding terms for borrowers prepared to sift through all available options, it is practically impossible for all of the thousands of individual borrowers out there to dedicate the time to doing just that.
In order to monetise the benefits of a fragmented market where price discovery remains challenging therefore, borrowers may need to employ someone to undertake price discovery on their behalf. They need a window on the market through which they will be able to see the most competitive financing – both in pricing and structure terms. Figure 2 shows the potential impact on IRR of different debt terms. A base case of total cost of debt of 2.5% and 55% LTV (broadly where our European Debt Map suggests benchmark pricing was for London office investment at Q2 2017) produces an IRR of 8.9% (given assumptions around capital growth). This IRR may be improved to 9.2% given 25bps cheaper debt, 9.7% given an additional 5% of leverage, or 10.1% with both. This – as well as the decrease in IRR from securing debt on poor terms – shows the value a borrower will gain in having a debt advisor with deep market knowledge fighting in their corner.
IRR Under Different Cost of Debt and LTV Scenarios
Source: CBRE. Assumes 3.75% yield and 10% capital growth over five year term
Ultimately, it comes down to transparency. The debt market has never been the most open of places, and is in many ways decades behind even the property market, which although opaque by the standards of say equities at least has public databases of deals and an embedded culture of sharing of performance data and benchmarking.
We hope that publications like our European Debt Map, which compares debt pricing terms and key property metrics across 20 European countries, are a step in the right direction towards providing borrowers and lenders with greater clarity, sharing the knowledge we have gained through our network of professionals operating across the continent.
By Richard Dakin, Managing Director, EMEA, Capital Advisors, CBRE.