How lending as an asset class will hold up as Brexit heats up

By Nick Rees on 10th January 2019

Alternative Credit

The Blu family office's Nick Rees explores how Brexit's endgame could affect investors across alternative lending strategies.

How lending as an asset class will hold up as Brexit heats up

How will Brexit affect investment strategies that engage in private lending? The answer is (as always): it depends.

Clearly, whether or not we have a so-called “hard” or “soft” exit from the EU will have a large bearing on this question. And for another, the type of credit you are extending, be it secured or unsecured and for how long, will also weigh heavily on the impact of privately constructed loan agreements.

Whether or not the underlying borrower is affected more than another is also a variable to consider, e.g. a company that exports to the EU will probably see its credit rating decrease, whereas an English centric business, such as pubs, should see no deterioration in their business activities.

Some may actually see an increase in revenues, as the people of the UK are either celebrating or drowning their sorrows depending on their view of the outcome of current negotiations.

So far, we have not seen private lending strategies exhibit any adverse changes in yield, other than through the risk inherent in extending credit in Sterling in of itself. This may have to do with the rather binomial state of possible outcomes, making portfolio decisions almost futile at the moment.

But we have definitely seen a decrease in overall activity and why not, if you don’t have to take risk on Brexit, why would you in such a market constellation? As part of a diversified private lending strategy, we would also not recommend only doing private lending in the UK, in any event.

But, for the sake of argument, what could we expect to happen to a UK centric portfolio of private lending strategies? Actually, not much. The “beauty” of private loans is that there is no mark to market.

Unlike bonds that are traded on exchanges, a loan agreement with a corporation is utterly unaffected by what happens in the world and the macro environment, unless of course the borrower and / or the loan defaults.

To put this bluntly, say the financial markets (including corporate bonds) drop by 30%, your investment in this loan will remain on the book at par, earn interest and experience no drop in value whatsoever.

Only if the interest payments are not met, will the loan then be marked down. How much depends on the recovery rate (and if the loan was secured or not), but these tend to be quite high.

And remember even during the great crisis of 2008, life did go on. Businesses were still operating, people were eating, and of course the government was flooding the market with liquidity. All in all, most (secured) private lending strategies did not lose money at all in 2008.

What happens if life as we know it ends (take your pick of a hard Brexit or a Corbyn-government), and the UK enters the dark ages (think the 1970’s)? Well then yes, many of your private loans will default, as businesses go bankrupt, the government can’t keep the country running and anyone who can (e.g. has money), flees to safer shores. But then again, if that happens, you are probably also better off growing your own vegetables. Something to think about as you consider the alternatives before March 2019 and decide the fate of the next generations.


 

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