November 2023
Welcome to Neu Capital’s market insights.
These findings are to provide insights into the various key themes in the non-bank lending market.
- Non-bank equity valuations globally have been greatly impacted by the higher interest rate environment and the valuation lens this has brought. Whereas companies were previously valued on their rate of growth and a multiple of annualised revenue, valuations have returned to a traditional multiple of earnings. Unprofitable companies are trading at or below NTA.
This change is clearly visible with ASX-listed lenders. The table below highlights the amount and timing of the fall in share prices from their all-time highs.
- Some companies are now trading at valuations which are well below their accumulated losses, despite having built large lending portfolios and achieved cash flow breakeven. In many cases, these companies are trading well below replacement value.
- The impact of the material change in the valuation landscape has created an equity drought. This has drastically reduced the willingness and availability of equity to fund growth opportunities.
Where equity is available, companies are uncomfortable with the dilution impact and/or the perception of a “material down round” on existing investors.
Where equity is not available, or too expensive, companies are rightsizing their operating base to ensure OpCo solvency is assured.
Measures being undertaken include:
- Trimming growth aspirations (exiting non-performing markets and geographies)
- Reducing headcount
- Reducing marketing
- Moving up the credit curve to reduce the impact of credit losses
- In some cases, higher rates have created a margin squeeze as the originator was not required to hedge their loans or the loans were too short in duration to hedge or their product had regulatory caps in place. In these cases the ~4% rise in official interest rates has led to a $1m reduction in annual income (per $25m of portfolio size).
- Concerns about the consumer have not eventuated in 2023, but many funders are being cautious about their exposure to the consumer going into 2024.
- This environment is also exposing fintech operating models and their scalability. Investors are cautious of originators which are more “fin” than “tech” and if portfolio growth will translate to additional cash earnings.
- Due to concerns around solvency and scalability, senior bank funding is becoming harder to secure. Banks have also increased their minimum size requirements given they too are experiencing head count challenges and want to put larger amounts of money to work to meet their internal profit hurdles.
- Despite increasing interest rates, inflows to credit funds remain strong with the majority sitting on a large amount of undeployed capital. Neu Capital has an extensive reach globally and almost all funds we talk to are witnessing positive inflows from institutional, high net worth and retail investors. The increase in flow is also enabling the credit funds to participate in higher ticket size transactions.
We expect these credit fund flows to be sustained well into 2024, notably for funds offering high-single or low double-digit returns. The requirement to put these funds to work in a low credit growth environment has driven the reduction in credit spreads which has been witnessed since mid-year.
- Given the state of equity markets, we are seeing an increase in appetite for debt solutions to fund growth. This includes OpCo loans (secured by the originator seller notes and participation units), or whole loans sales. Given the likelihood of equity markets remaining challenging for the next 12 months, we see these solutions gaining greater traction.
- Finally, given the growth in credit funds and their desire to be open-ended funds, we are seeing an increase in fund NAV finance requests to provide operational and liquidity flexibility. Generally structured as a securitisation SPV, this provides funders with a low-levered exposure (sub 30%) to a range of assets where subordination is provided by the unit holders.
Please reach out if you’d like to discuss any of this paper.