Lending off LIBOR or base rate

When the Bank of England cut base rate to 0.5% on March 5, the spread against LIBOR stood at an eye watering 1.49%. Three weeks later three month LIBOR has only reduced to 1.70% and is moving very slowly downwards. The big hope is that quantitative easing will improve the money supply but in the short term it continues to be a dilemma for all lenders on how to fund their loan books

Lenders currently withdraw all their tracker products in both residential and buy-to-let mortgage sectors ahead of any base rate announcement. The last thing they need is base rate reducing further yet their retail or wholesale funding costs remain largely the same.

In the commercial sector many lenders have adopted a transparent offering whereby they will quote a customer both on LIBOR and base rate and over the last few months have priced any base rate loans with a premium of 0.75 %. In the last month with a variance of more than 100bp, this approach has come under renewed pressure. And following the last base rate cut the disparity will be more difficult to resolve. On larger loans lenders tend to quote off LIBOR alone and in the current market we would encourage our customers to link to LIBOR because eventually the premium will decrease and a loan linked to base rate could start to look expensive. As each lender approaches this differently, brokers have an additional complexity to factor in when advising customers on commercial transactions.

When recession really bites as it is now doing in the economy at large, lenders start to review sectors for risk and make broad judgments without regard to the strength of individual borrowers within that sector. That was understandable in the early 1990s when databases were cumbersome and fairly broadly based but it seems that old habits die hard. Always up for a good kicking by credit teams are printers and transport businesses.

The print industry is always a good target because there always seems to be an oversupply of print businesses in the UK so they operate on wafer thin margins even in a bull market and run their presses for 15 to 20 hours a day. In a recession not only do margins get thinner but reduced volumes then impact the contribution to central costs resulting in multiple business failures.

Transport companies carry not only the print materials and the printed product but also any reduction in consumer demand means less trips from factory to depot and to store. But more worryingly, trips with less than fully paid loads increase the unit cost. In the last few years UK based companies have had to pay higher fuel costs than their continental counterparts so internal to UK based transport companies suffer a cost disadvantage to their European competitors who fill their tanks to the brim before loading onto Eurotunnel.

So don’t be surprised if you get several enquiries in a row from businesses in a particular sector – some of them can be refinanced even today.