Shadow bank lending on the rise as big four pull back

While non-bank lenders account for a small share of the country’s total financial system – about 5 per cent or roughly $22.3 billion annually – they are gaining traction as conventional banks tighten their lending books.

IBISWorld said this sector of financing is slated to grow at an annualised 2 per cent over the next five years through to $24.6 billion.

Faced with tighter lending standards following the banking royal commission, Australia’s big four banks are opening the door for shadow banks, indirectly benefiting non-bank lenders who can offer commercial real estate borrowers easier and less onerous loans, albeit generally at higher interest rates.

Shadow lending is undertaken by registered financial corporations (RFCs), often backed by a mixture of investment funds, hedge funds, wealthy private individuals or listed real estate investment funds.

The Commonwealth Bank of Australia’s recent half-year result shows its exposure to commercial property loans has held steady at 6.7 per cent of its total loan book, worth about $94 billion. The CBA’s exposure has previously been much higher, but the bank has been reducing its commercial property loan book for the past few years.

Global property markets, particularly city offices and new developments, have been roiled by the shift to working from home and supply-chain disruptions following the pandemic.

Given uncertain market conditions, the CBA said it has imposed tighter loan-to-value ratios (LVR) for loans in the office sector, where high vacancy is an ongoing problem. Over the half-year, the bank’s lending exposure increased in Premium/A-grade offices and decreased in B-grade and lower buildings.

CBA chief executive Matt Comyn said the bank’s commercial loan growth is “primarily concentrated in sectors with better credit quality or market conditions. Exposure to REITS, industrial and Premium/A-grade office is preferred, he said.

“Office exposures are weighted toward premium/A-grade property with the weighted average LVR maintaining a buffer to the bank’s minimum requirements,” Comyn said.

One of the latest deals is by non-bank property lender Pallas Capital, which has established a new vehicle, Pallas Funding Trust No. 2 (PFT), worth up to $500 million. It is backed by a senior funding facility with funds managed by Ares Management’s Alternative Credit strategy.

Pallas will funnel the money to a mix of pre-development loans, residual stock loans and investment property loans. It will target medium-sized commercial real estate borrowers and expects that most of its loans will be between $2 million to $25 million in total.

Pallas Capital chief investment officer Dan Gallen said this market segment remains under-serviced as it falls between the very narrow lending focus of the major banks.

“Many non-bank lenders prefer to focus on either minimal CRE loans or much larger loan exposures of over $50 million,” Gallen said.

“We expect to increase lending volumes substantially given the majority of commercial properties have values up to about $35 million, which is precisely where PFT will focus its lending business.”

Pallas Capital has operated institutional lending facilities since 2021 and has loaned about $850 million across over 170 loans through such facilities.

ASX-listed Centuria has also increased its exposure to the shadow banking sector through its Bass Credit business. It has $1.6 billion of assets under management, and of that, $222 million is spread across 13 real estate finance loans.

Centuria Bass Credit is the result of a joint venture between Bass Capital Partners and Centuria Capital Group in April 2021. It provides real estate funding to mid-sized companies, entrepreneurs, property developers and investors.

Giles Borten and Nick Goh, Centuria Bass’ joint chief executives, said the lender is experiencing a surge in demand for non-bank real estate finance in the current high-interest rate environment, where many traditional lenders have tightened their loan criteria amid unprecedented demand for residential stock.

“This demand has been met with strong wholesale investor appetite for high returns across a relatively short time period of about 12 to 18 months,” they said.

“These are the fundamentals that have underpinned Centuria Bass’ 41 per cent annual increase in its funds under management to $1.6 billion. We believe these conditions will be sustained.”

Stamford Capital, another large player in the sector, said rate relief should signal a return of lender confidence, which should further open up access to capital with appetite for higher leverage.

In its latest insights report, Stamford says that while construction costs have stabilised, there is a new “normal” in terms of pricing, with construction costs almost 30 per cent higher than they were before the global pandemic.

“This will impact developers’ ability to deliver affordable stock. The housing supply and demand imbalance will help make residential developments a reasonably safe asset class for developers and investors,” the report says.

“Until rates drop, investors will still be weighing up the cost of borrowing against purchase yields.”

According to Stamford, non-bank lenders can price for risk and offer less conditionality, while banks remain conservative in the prevailing market conditions.

View article on the Sydney Morning Herald