Of late our Conclusion has concentrated upon the global liquidity story and its continuing development. The story is key to just about everything, it is a credit expansion of unprecedented scale, which will undoubtedly end and afterwards the world won’t be the same again for a very long time!
The big question now is whether or not the sovereign wealth story will manifest itself, if so a Wall of Money amounting to $2.5 trillion will swamp the system and the price of just about everything will go past the Moon on its way to Mars. However, Walls of Money have a funny habit of disappearing and this one might well just do that. Nonetheless, we have to take on board the possibility that this could happen, in which case the shape of things will change and we will take that into account.
UK commercial property: banks to increase loans
Sovereign wealth management aside, there are some very interesting developments worth mentioning. On 25th May the Financial Times wrote about UK commercial property and that bank lending to this sector has hit a record. A survey carried out by De Montfort University, showed that banks are planning to increase their loans on commercial property, even though they have more than tripled their outstanding loans to real estate in just eight years.
Total debt secured on commercial buildings soared to £172.5 billion by the end of last year against £49.8 billion in 1999. Yields on most commercial properties are now below borrowing costs and that’s before the next rise in interest rates. The Bank of England has warned that some investors may have under-priced risk to commercial property. Of banks surveyed, 89% are seeking to lend even more in 2007 than they did in 2006. Their lending aggressiveness is encouraged because of low level of defaults but there again, as we keep saying, that is a key element of a credit expansion. Nobody knows who’s struggling because whilst credit is easily available, nobody needs to default on a loan.
Man Group embraces cov-lite loans
It has also been reported in the Financial Times that the Man Group, a London listed hedge fund group, is renegotiating its existing credit arrangements to new cov-lite loans. Harvey McGrath, Chairman of Man, said that the rise of cov-lite loans without the usual protections demanded by lenders demonstrated how loose credit conditions were and was one of the lead indicators of the top of the market. He also said that Man hoped to take advantage of the opportunity to borrow cheaply without the covenants that give banks the right to interfere in the business.
About switching Man’s existing loan facilities to cov-lite, he says “we plan to use and abuse it”. Banks in their unseemly scramble to write new business and collect outrageous fees often ignore due attention to the nature and quality of that credit and deservedly, should expect their customers to be less respectful of their banking practices. Man Group are, of course, “undoubted” but their Chairman’s language to us seems inappropriate when it concerns the borrowing of immense sums of money.
One can understand why the Chairman of the Man Group feels that he can publicly say that he is going to abuse the system because, according to experts, banks are growing so desperate to buy into booming alternative investment markets that they are taking unprecedented steps. Edmund Conway, Economics Editor at the Daily Telegraph, recently wrote of lending to the private equity and hedge fund sector at below the official UK interest rate. Experts have also warned that it underlined the extremely low risk priced into these investments – despite repeated warnings about the potential pitfalls facing some deals. David Owens, Chief European Economist at Dresdner Kleinwort, said that although the recent run of statistics only ran back to 1999, he suspected that the situation of banks lending on average beneath the base rate was unprecedented. He has never seen anything like it. “Banks are simply falling over themselves to lend to these people… It’s symptomatic of the amount of liquidity in the system.”
It is the nature of the beast that once the excesses start, they continue until they become absurd and impracticable. Suddenly great financial pain is felt because of something that goes wrong. As David Rubenstein of the Carlisle Group said “We need to prepare people for the reality that some deals will fail.” We surely must be quite close to that moment right now.
By John Robson & Andrew Selsby at RH Asset Management Limited, as published in the Onassis Newsletter, a fortnightly newsletter that gives insight into the investment markets.
For more from RHAM, visit https://www.rhasset.co.uk/