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A new credit crunch? What’s next for bank lending to construction

In 2015, outstanding loans to construction firms stood at just over £37bn. By August this year, they had fallen to £32.6bn. Why does lending appear to be in decline and where is this trend heading? Lucy Alderson investigates.

Since 2015, the value of bank loans on the books of industry firms has broadly been on a downward trajectory.

The total sum of outstanding bank loans among construction companies stood at £37.08bn in January 2015. Since then it has steadily fallen all the way to £32.6bn by the end of August this year.

Major events have occurred over the course of these three-and-a-half years that have shaken the market.

Chief among these of course was Britain’s decision to leave the European Union in June 2016, compounded by the ongoing negotiations with Brussels that remain shrouded in uncertainty. At the same time, the industry has been hit by a number of high-profile company failures, led by the likes of Lakesmere, Lagan Construction and, of course, Carillion.

So how have these events impacted lending and what future trends can the industry expect to see?


While the decline in outstanding loans among construction firms has not been entirely constant, the overall direction has been clear according to data published by the Bank of England.

From £37.08bn in January 2015, outstanding loans held firm through to May before suddenly falling to £34.99bn in June. While the figure rallied slightly into the following year to hit £35.34bn in February 2016, decline returned during the four months leading up to the EU referendum.

By the end of June, outstanding loans to the industry stood at £32.89bn. In just a year-and-a-half from the beginning of 2015 to the end of June 2016, the value of loans on the industry’s books had therefore dropped by more than 11 per cent – some £4.19bn.

Stephen Gruneberg, a reader in construction economics at the University of Westminster, says this decline could suggest developers were “quietly shelving projects” as the EU referendum drew closer.

Discussions around the UK’s relationship with the EU stepped up a gear in 2015 as the general election loomed. In April that year the Conservative Party published its manifesto committing itself to holding an “in-out referendum on our membership of the EU before the end of 2017”. By the end of the year, the European Union Referendum Act received royal assent, giving the green light for a vote to take place the following year.

Dr Gruneberg says the decline in outstanding loans indicates that clients were “preparing for the worst” in the lead-up to the EU referendum vote. “Investors work well in advance,” he says. “Customers may have decided not to invest […] this comes into play in 2015 when the drop in lending occurs. And from 2015 right up until now, people have been, and continue to be, put off making decisions [on projects].”

Although the result of the EU referendum did not have a significant impact on lending, Dr Gruneberg says this indicates that clients had already made their decisions to pull out of projects way before the vote took place.

The aftermath

In the months following the Leave vote, the value of industry loans actually began to edge back up, getting close to late-2015 levels by March 2017, when it hit £35.16bn. Since then, however, the previous pattern of gradual overall decline has returned.

The impact this has had on sectors has varied considerably, according to Construction Products Association senior economist Rebecca Larkin. She identifies the commercial sector as one area where lending has declined significantly following the EU vote.

According to the Bank of England data, the net amount loaned to firms involved in commercial projects declined by £259m in the six months following the referendum.

Ms Larkin says this indicates that clients were pulling back from progressing commercial sector projects – particularly major office schemes in central London – due to the uncertainty that followed immediately after the Brexit vote. This also goes some way to explain the decline in new orders for office projects, Ms Larkin adds.

CPA data shows that new orders for offices – which historically account for around a third of the commercial market – halved from £1.6bn in Q1 2016 before the referendum to £800m in Q2 this year.

outstanding value owed to banks bank lending

outstanding value owed to banks bank lending

“Uncertainty has led to a lack of final approval for new projects in the commercial sector, resulting in a fall in new orders and fewer projects,” she says, and this “crucially” encompasses a fall in high-value projects too. “It follows that if there’s less in the pipeline, there’s less to finance.”

Between March and August this year, outstanding loans among industry firms dropped by £1.5bn – the longest period of sustained decline in seven years.

The figure fell from £34.26bn in March to £32.75bn by the end of August. The last time there was such a long period of decline was in 2011, when outstanding loans fell by £2.5bn in the seven months from January to July.

Ms Larkin suggests this fall is “likely” to be due to the lag in construction activity following the EU referendum. There is typically 12-18-month lag between construction order and output, she points out, suggesting we may only just be starting to see the impact the EU referendum has had on activity.

Dr Gruneberg adds that the six-month sustained decline in outstanding loans could also indicate that developers are pulling back from giving projects the go-ahead due to the slow progress the UK has made on Brexit negotiations.

Is demand that high?

However, Mike Conroy – commercial finance director at trade body UK Finance – argues that demand from the industry is simply not particularly high. “Demand for finance in the construction sector is subdued, with ongoing economic uncertainty impacting firms’ appetite to borrow and invest in the long term,” he says.

And while the value of outstanding bank loans among industry firms may have declined overall during recent years, Mr Conroy cites Bank of England data showing that the value of new loans specifically has recent edged up. Between March to August this year, new lending to construction companies totalled £9.98bn – up from £9.2bn in the same period of 2017.

“When firms do apply for bank finance they are likely to be successful: eight in 10 applications by SMEs in the sector [are] given the green light,” Mr Conroy states.

“When firms do apply for bank finance they are likely to be successful: eight in 10 applications by SMEs in the sector [are] given the green light”

Mike Conroy, UK Finance

Could one factor be an increase in firms accessing other funding streams aside from banks? EY capital and debt advisory director Michael McCartney believes this could be the case.

“One of the themes we’ve seen over the past five to six years is the significant emergence of construction companies accessing non-bank financial markets,” he says. “It’s a good news story – there are options out there and there is still liquidity in financial markets [for construction companies].”

However, relying on these alternative funding streams could come with a risk, argues Mr McCartney. Other non-bank financial markets have been “more volatile” in their interest in the sector, he says, adding that contractors could run the risk of relying on too many financial stakeholders – one of the problems that affected Carillion.

Hard lessons learned

As well as the impending departure from the EU, Mr McCartney cites another potential factor behind the fall in outstanding loans. “A whole host of banks got burnt by Carillion, so the natural reaction to that is to proceed with more caution,” he says. “Most banks have reviewed their credit processes and lending parameters in the wake of Carillion. For many lenders, there have been some pretty hard lessons learned.”

Although the bank sector’s exact exposure to Carillion has not been fully disclosed yet, the liquidated contractor’s financial debt stood at £1.5bn, according to inquiry documents.

A chief executive at one major contractor, speaking to CN  anonymously, says there is “no doubt” that banks are tightening up their approach to lending post-Carillion. “Insurance premiums have gone up as well, and people are much more cautious towards who and how much they will be lending to,” they add.

Banks have also taken financial blows from other high-profile contractor liquidations that have occurred over the course of 2017 and 2018.

drop outstanding loans

drop outstanding loans

When facade specialist Lakesmere went into administration in October last year (followed closely by its subsidiary McMullen Facades a month later in November), the company owed its secured creditor, HSBC, £23.1m. And in March this year, contractor Lagan Construction collapsed owing secured creditor Danske Bank £3.9m, according to administrator KPMG.

The impact of these events has even led Laing O’Rourke to delay filing its financial results until Christmas at the earliest. In a statement this week, the firm claimed the current environment following the collapse of several contractors had slowed its UK refinancing, leaving it unable to sign off its accounts.

Speaking to CN about the issue, chief executive Ray O’Rourke called for banks to start lending more to contractors. “We’re not seen as an attractive sector, which I find interesting because we represent 8-10 per cent of GDP,” he said. “I don’t think it’s tenable that banking institutions can say they don’t want to be involved [in construction].”

What’s in store?

Profit warnings from major contractors including Bouygues and Interserve could also be making lenders more cautious, Ms Larkin says.

EY Capital’s Mr McCartney adds that, while banks are still lending to construction companies, there will be long-term changes in the way loans are handled.

“In many respects, banks are going back to more traditional approaches to assessing credits on new lending propositions, making sure they fully understand a company’s business plan,” he says, before stressing that financial markets are still interested in investing in stable construction firms with a “good credit score and a good rationale to seek new lending and facilities”.

Dr Gruneberg agrees with Mr McCartney that more vigorous scrutiny of construction firms is here to stay, adding that firms could continue to struggle accessing loans.

“We’re not seen as an attractive sector, which I find interesting because we represent 8-10 per cent of GDP. I don’t think it’s tenable that banking institutions can say they don’t want to be involved [in construction].”

Ray O’Rourke, Laing O’Rourke

The conclusion of Brexit negotiations will leave clients with a much better understanding of how they can invest, Dr Gruneberg points out, which is when we can expect to see developers making decisions on more significant private sector projects. It will be at this point that construction firms will be looking to secure finance, he suggests; however, banks may not start lending until construction work “really gets under way”.

“Banks are scared of lending to construction, because construction is seen as being very vulnerable as demand goes down,” Dr Gruneberg says. As a result, contractors may not have sufficient funds to pay their supply chain and this in turn could lead to more high-profile company failures, he predicts. “We’re in for a period of more Carillions,” he says.

So are banks pulling back from construction, or has there simply been a decline in demand? It could well be a combination of the two.

However, Dr Gruneberg argues that it will only be possible to confidently predict future lending trends once the dust has settled on Britain’s departure from the EU.

“All is depending on Brexit,” he says. “After Brexit, people will be able to understand how they can invest in Britain.”

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