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Bank lending still lagging behind construction recovery

Construction firms have a major opportunity with speculative development returning, but bank lending is yet to recover to pre-crisis levels.

New work is on the rise, but financial constraints and access to finance still remain major obstacles for many firms.

As a factor limiting activity, financial constraints were second only to skills and labour shortages in the latest Construction Market Survey for Q1 2015 from the Royal Institution of Chartered Surveyors.

Factors limiting activity_RICS

Source: RICS

A total of 55 per cent of respondents reported financial constraints as stifling their activity in the first quarter.

This has consistently posed problems for firms, with 61 per cent citing it as a factor in Q4 2014 and 58 per cent in Q3 2014.

Given these difficulties, what can firms do to ensure they have access to cash?

Big vs small

Funding access has been less of a problem for major contractors – and many are not as reliant on bank or financial lenders to secure funds.

Kier issued a private placement last year – these were securities not sold through public offering, with maturities of between seven and 10 years, with a blended interest rate of around 4.5 per cent.

Through this, the contractor raised £120m, and CEO Haydn Mursell said the company had been using the US private placement market since 2003 “to diversify the sources and maturities of its debt funding”.

This week Kier announced its deal to buy infrastructure group Mouchel for £265m.

The firm will finance the deal through a £340m fully underwritten rights issue, of which £36m will be used for integration and deal costs and £40m to pay down Mouchel’s net debt.

And in December, Henry Boot was able to complete two of its nine previously announced strategic land sales. The firm undertook 11 such sales in 2014, having carried out nine in 2013 and three in 2012.

“It’s SMEs that are struggling for finance more than the larger firms”

Simon Rubinsohn, RICS

RICS chief economist Simon Rubinsohn says larger firms’ greater access to finance, particularly equity finance, makes cash generation much easier.

“Fairly predictably, looking at what our members are telling us, it’s the small and medium-sized business that are struggling more than the larger ones,” he says.

“The larger firms have recourse to other sorts of finance – they’re more able to access equity finance and debt finance.”

Lending down despite recovery

In 2014, lending from high street banks to the construction industry declined, despite the wider recovery in activity across the sector.

Between February 2014 and February 2015 – the latest available data – overall lending to construction fell 30.9 per cent from £52.14bn to £36.01bn, according to the Bank of England.

Aside from a small increase in August 2014, lending to construction firms has seen month-on-month decline since February 2014.

For housebuilders, lending has been more readily available, with lending actually increasing in the first two months of this year.

Bank lending to housebuilders grew from £3.68bn in December 2014 to £4.15bn in February 2015 – and lending to housebuilders has hovered around the £4bn mark since 2013.

With housebuilding performing well, this is understandable, but Mr Rubinsohn doubts there will be a return to lending on “out-and-out speculative developments”.

“The overall picture is one in which there is some improvement coming through; lenders are a bit more open for business in this area,” he says.

“There is evidence that the pressure is lessening – the very fact that development is taking place and that starts are increasing is consistent with the fact that there must be more money around, or [these projects] wouldn’t be happening.”

Smaller housebuilders are still struggling to raise the necessary funds through bank lending.

Federation of Master Builders chief executive Brian Berry says SME housebuilders have still found it “extremely difficult” to access development finance.

“Banks appeared to go from a position of almost indiscriminate lending to an indiscriminate refusal to lend to our sector,” he says.

“Since then, when it comes to smaller residential developments, the default position of the major lenders has been a blanket ‘no’.”

He adds that even when finance is available, it came with “steep price tags and sizeable fees attached”.

Lending to firms active in commercial construction also saw a decline over the same period, dipping from £5.33bn to £4.76bn between February 2014 and February 2015.

Rules of re-engagement

Clearly, lending from banks to the industry has been inconsistent.

What then needs to happen to make lending increase and ensure banks re-engage with construction?

Recovery in demand is the first step to increasing lending, with the London market indicative of where the industry is heading over the course of the year, according to Mr Rubinsohn.

“In London, a majority of respondents actually say that financial constraints aren’t a barrier – the percentage that says they are [a barrier] is 40 per cent,” he points out.

“It’s still a constraint but it’s less than elsewhere, and that’s indicative of where we are now.”

“Construction’s unique approach to contracts makes them a challenge for traditional funders”

Andrew Dixon, Aldermore

He also highlights that respondents to the RICS survey based in the North of England, where the recovery has yet to fully bed in, were more likely to cite financial constraints as an issue holding back growth.

While some banks may seem less willing to lend to construction firms, there are still specialists who want to encourage responsible lending to the industry.

Andrew Dixon, head of specialist finance at Aldermore, a bank formed in 2009 that specialises in SMEs, says the struggles faced by smaller firms looking to secure financing is “not a new problem”.

“Construction firms have a fairly unique approach to contracts which makes them a challenge for many traditional funders,” he says.

Behind the curve on alternatives

He argues that specialist lenders can provide a “practical” alternative to traditional lenders.

But evidence from the Asset Based Finance Association (ABFA) suggests the construction industry lags behind other sectors in using alternative finance.

Of the 43,500 businesses that used their assets to borrow money in the 12 months to Q4 2014, construction businesses accounted for fewer than 2,000 – significantly fewer than the manufacturing and services sectors.

Bibby Financial Services managing director of construction finance Helen Wheeler says ‘bad debt’ within the industry makes it even more difficult for firms to borrow money.

“Outstanding debt is a key issue for the industry”

Helen Wheeler, Bibby Financial Services

Recent research by Bibby Financial Services found that 70 per cent of SME construction firms have had to write off money owed to them over the past three years – equating to almost £2bn a year.

“Outstanding debt is a key issue for the industry,” she argues.

“These bad debts place significant strain on a business’ cashflow and ability to take on new orders.

“Turning to alternatives such as construction finance enables a business to continue to trade and win new contracts while they wait for payment.”

She adds that firms are “sorely missing out” on asset-based finance, which is “costing them dearly”.

Slow burn return of lending

As a result of these factors, lending to the industry is not expected to see a return to pre-crisis levels in the near term.

The Bank of England’s Trends in Lending report for April indicates that overall lending levels to SMEs across all sectors of the economy were largely unchanged in the three months to February 2015, while lending to large businesses fell “significantly” during the first quarter of 2015.

But despite this, respondents to the Bank’s Credit Conditions Survey indicated that demand for bank lending to small businesses would increase significantly during Q2 2015, while demand from larger firms will remain unchanged.

Mr Rubinsohn believes any increase in lending to construction is likely to be a “very slow burn”.

“The lesson we’ve learnt over the last few years is that lenders are not going to get back into the position they were pre-crisis – and in some respects that’s good,” he says.

“The scars of the last feeding frenzy are uppermost in the mind of risk managers”

Simon Rubinsohn, RICS

“But the difficulty we have in the development sector [is that] it’s a higher-risk business and, as a result, it’s not entirely surprising that dealing with it is fairly slow.”

He adds that finding funding will still be a “challenge for many businesses”.

A slow and steady shift in lending seems the likeliest pattern – with banks remaining reluctant to hit the same levels seen up to 2008.

Mr Rubinsohn for one does not expect any “major uplift” in speculative lending.

“The scars of the last feeding frenzy probably are a bit too uppermost in the mind of risk managers.”

Readers' comments (1)

  • As an owner manager of a small company we have had success in securing funding for renovation works but its been a blanket No from mainstream lenders when discussing new build property. Our business model is to move into construction of small schemes utilising MMC however we have not come across a sensible funding option. Alternative funding is expensive with heavy T&C's, not ideal for a business looking to move into an industry.
    We are like many SME's, willing and able to assist with the shortage of homes and progress the industry through MMC's etc, perhaps affordable housing is a route into the market for new starts with dedicated funding?

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