Asset finance facing emerging economic and compliance challenges

Summary

The pace of change in the asset finance sector is accelerating with economic challenges, new regulation, evolving technology, and players constantly changing in the market. Everyone in the asset finance sector needs to be ready to reorganise and adjust to a rapidly changing world.

A host of asset finance leaders came together at the Asset Finance Connect (AFC) Autumn 2023 Conference to explore the emerging economic and compliance challenges facing the evolving industry as we entered 2024.

The industry panellists discussed the findings of the AFC asset finance confidence survey H2 2023, covering an array of topics including lenders’ appetite to lend, SMEs’ appetite to borrow, growth of new business volumes, operating, compliance and technology costs, and compliance and credit risk.

AFC asset finance outlook H2 2023

We are currently living in interesting times with many complexities in the market, both global and domestic, and have witnessed some extreme shocks to the system over the past couple of years.

Ylva Oertengren, Chief Operating Officer at Simply highlighted that knowing your history is important as it helps to predict the future, but she pointed out that we are in a moment in time where old patterns no longer apply to the future. So, Asset Finance Connect asked industry players the key questions about the short-term future of the asset finance industry.

The AFC asset finance confidence survey, sponsored by FIS, asked leaders to look at the industry from September 2023 to March 2024 covering a variety of topics. Survey respondents were one-third brokers and two-thirds funders.

Conducted in September 2023, the survey findings gave us a snapshot of what the industry is thinking. The accompanying AFC asset finance outlook report (H2 2023) is available to download here.

• The survey revealed expectations on SME borrowing, with lenders expecting borrowing to grow (25%), while brokers do not expect to see growth (-17%).
• Focusing on lenders’ appetite to lend to SMEs, both lenders and brokers expect captives and independents will take the market share from banks. Brokers believe that captive appetite will increase the most. Lenders forecast that independents will have the biggest appetite going forward in the next six months.
• Growth of new business volumes is skewed to some asset classes. Both lenders and brokers agree that new business volumes for business cars, commercial vehicles and plant & machinery will go up, but see a retraction in lending to consumer cars and IT & office equipment.
• In the technology sector, brokers are much more optimistic about growth of new business volumes for technology than lenders are.
• For green assets, there is a strong consensus across both brokers and lenders that demand will be going up, providing a lot of growth for asset finance.
  
  While the survey feedback looks optimistic, there are significant challenges to face as an industry:
  
  
• Broad consensus that cost of funds will increase further (and the industry is prepared for that) but since the survey was conducted in September that picture has possibly changed slightly.
• Availability of funding (wholesale or block discounting) is slightly optimistic.
• Cost of fund increases need to be looked at against a backdrop of increasing operating costs, with technology, staff and compliance costs expected to increase. This is not surprising considering inflation and cost-of-living price rises.
• Brokers score higher than lenders on cost increases, especially on cost of compliance. Is this a consequence of Consumer Duty and more scrutiny from lenders or is it more demand for investment in technology?
• Bad debt is expected to increase.
• Brokers and lenders agree that administrations and insolvencies will go up, which we have already seen happening and this, unfortunately, hits the SME community.
• Compliance risk is expected to increase, which is not surprising, and brokers and lenders are in agreement that credit risk appetite is expected to decrease.

The survey findings paint a picture of high demand for lending amongst SMEs, particularly for green assets, but also a phase for our industry where brokers and lenders face higher cost of funds as well as increasing operating costs. The background to all of this is increasing credit risk and defaults but the industry thinks supply of credit is expected to increase.

Challenging year ahead

Looking at the market dynamics, we see a challenging year on cost and risk but also big demand for new assets to be funded. Nathan Mollett, head of asset finance at United Trust Bank (UTB) believes that the industry is ready to face these challenges in 2024.

While the panellists agreed that the survey feedback is what most people would expect to see, Mollett felt that lenders aren’t actually as optimistic as the survey shows. Lenders are a lot more cautious about the outlook on SME lending, according to Mollett, which is sensible given some of the trends in the market.

Mollett highlighted that brokers and lenders are seeing more competition for deals; a dynamic that is being played out in the market today and we’ll see further in 2024.

Competition is creating some inconsistencies in approach from lenders. Mollett highlighted that more than half of lenders are taking a sensible approach, focusing on maintaining margins, being more cautious around those they lend to, while lending about the same as the previous year or slightly more.

Another approach to the dynamic sees an increasing number of lenders who seem to be pricing at wafer-thin margins in today’s market and chasing growth aggressively.

The growth aspirations of lenders far outweigh the growth the market is going to give, against a backdrop of high interest rates and increased insolvencies.

Appetite to lend and borrow in the market

As a fresh pair of eyes to UK asset finance, Matt Roper, CEO, Commercial at Close Brothers believes that “the asset finance industry is absolutely vital to UK PLC because without it the doers and makers can’t run and grow their businesses.”

Despite a lot of negative noise in the press around economic uncertainty in the UK, Roper notes that, “at a business level, many SMEs are doing exceptionally well; they are resilient, adaptable and will find a way to succeed, but they need lenders’ help to do that, and as an industry that is what we are good at.”

After experiencing first-hand what an SME owner wants, after watching his father transition from corporate life to a small business owner, Roper observes that SMEs need flexibility, certainty, clarity and speed from lenders, whose default setting should always be to try and help the customer.

The survey, however, highlighted a gap between what brokers and lenders see when it comes to SME borrowing demand, with lenders expecting borrowing to grow (25%), unlike brokers who are not expecting to see growth (-17%).

Mark Nelson from Compass Business Finance discussed how lenders see growth and opportunity coming from other parts of the market as well as from their larger banking competitors retracting from the market.

However, brokers who work “day-to-day on the ground” are already seeing that slowdown in demand coming through and therefore have a slightly more pessimistic view.

Growth in asset classes

Close Brothers’ Matt Roper confirmed that his current experience is entirely consistent with the survey findings, showing that growth of new business volumes is skewed towards certain asset classes. Roper observed that Close Brothers are seeing strong demand across most asset classes, but stronger in some sectors including transportation.

For green assets, the survey highlighted a strong consensus across both brokers and lenders that demand will be going up, providing a lot of growth for asset finance.

However, the asset finance industry needs to figure out how to successfully harness opportunity in green and renewable finance, according to Mollett, with only large banks and Close Brothers doing it properly at the current time.

Mollett observed that the market dynamic around green assets does not make it easy for mid-size banks to enter with confidence, due to the additional risk on unknown and unproven technologies affecting the security in the asset.

Increased operating costs

With economic uncertainty alongside rising operating costs from staff, compliance and technology, it is becoming increasingly difficult to build and run a profitable business.

Operating costs are going up drastically with increased recruitment and training costs, according to Nova Everidge, Director of Asset Finance at Metro Bank.

Cost of regulation is difficult to manage cost-effectively unless you have over £1bn, noted Mollett: “As a mid-size bank or a new entrant, you have to have a certain scale or be of a certain size to be able to cope with the regulation from a profitability perspective.”

Regulation

Alongside rising compliance costs, Nathan Mollet also identified the unrealistic speed with which regulation must be implemented especially when implementing retrospectively on the back book.

An unintended consequence of increasing amounts of regulation was evidenced by a show of hands amongst the panel and audience, highlighting the dwindling numbers of lenders in the regulated space, with many moving to unregulated business to avoid the cost associated with compliance.

Despite the accompanying challenges to new regulation, Ylva Oertengren, Chief Operating Officer at Simply believes that the asset finance industry must embrace regulation and engrain it in their customer proposition in the right way: “Regulation is not a problem per se. You have to make it part of your customer proposition and embed the principles of regulation and what the intended outcomes are to drive a better business.”

Technology to drive efficiency

Many lenders and brokers are fully embracing digitalisation as a strategy for them to address rising operational, compliance and risk costs. Katrin Herrling, CEO & Co-Founder at Funding Xchange demonstrated how technology can support the industry in these challenges in a way that reduces operational costs, does not require huge investment in digital technology, and drives some of the compliance.

“With increased demands around reporting for compliance challenges like Consumer Duty, the ability to have a ready-made and delivered solution has been welcomed by all parts of the ecosystem,” observed Katrin Herrling.

Many brokers see digital as complimentary to building personal relationships with customers whilst addressing the cost challenge.

Herrling highlighted how technology can also be used for a more efficient management of existing broker and funder relationships.

Currently there is diversity in the asset finance sector as to how information is shared between brokers and lenders using technology, starting with emails and moving to funder portals, to facilitate the ability for brokers to interact seamlessly with lenders. However, portals can still cause problems for brokers, according to Herrling, and funders are starting to understand that.

While funder solutions are a step in the right direction to using digital infrastructure to enhance the broker-funder relationship, a solution is needed to create the ability for brokers to access funder information much more easily without having to log in to every single funder portal.

Smart Finance Hub is trying to tie this all together in one digital solution to support the whole ecosystem by enriching the conversations between brokers and funders, increasing efficiencies in the relationships in a “meeting of minds” and address rising challenges, including rising costs and compliance issues.

Basel III and changes to capital requirement rules

Richard Davies, CEO at Allica Bank came into 2023 with a negative mindset, expecting a medium-size recession to happen. While Davies’ predictions did not come to fruition, he believes that some things need adjustment, and the economy needs to normalise after the past decade which was an anomaly with low interest rates.

However, as highlighted in the below video, Davies is particularly concerned about Basel III reforms and changes to capital requirements that will severely impact the market.

A report published in March 2023 by Oxera Economic Consultancy and backed by the NACFB (National Association of Commercial Finance Brokers) and FSB (Federation of Small Businesses), found that there was up to £44bn of SME lending supply at risk.

Concerned that the issue does not seem to have enough prominence in people’s thinking, Davies pointed out that, “this is far bigger than the cost of funding risk, in general, and bigger than the cost of risk, because this is not a one-off thing, it’s ongoing.”

Allica are lobbying hard against this, and Richard Davies is adamant that a united industry uproar is required at a time of complete uncertainty, when SMEs are already struggling with rising base rate costs and the economy is going to grow, at best, sluggishly.

Davies commented, “This is the wrong thing at any time, but definitely the wrong thing right now. We need more champions to take a stance. We need to be brave and stand up for the SMEs we serve.”