Deputy Governor of the Bank of England , Sarah Breeden is reported to be concerned 

Sarah Breeden has called for more research into non-bank lenders to stave off a “credit crunch” that could be triggered by a retreat of hedge funds, pension funds, insurers and asset managers.

We have a pension system , thirsty for liquid debt but shy of investing in solid productive capital, long on liquidity but short on real returns.

Yesterday I gave as an example of debt issued by an insurer rather than a bank, Rothesay’s loan to E&J  Estates to buy residential freeholds

The financing of Tuttiett’s property empire is helped by low-interest loans totalling £336m made by an insurance company, Rothesay Life, spun out of Goldman Sachs, in which the US investment bank remains the largest shareholder. Among the Rothesay Life loans made to E&J is one at £128m with a stated interest rate of just 0.95% a year, although it is understood the real rate paid is likely to be higher.

There is an alignment of interest between the lender and the borrower, both are interested in creating long-term “gilt-like” interest streams at rather better rates than can be achieved through gilts. But the particulars of E&J’s rent extraction are now under scrutiny as they involve practices such as the charging of unreasonable ground rents and the collection of extortionate management fees from leasehold management companies.

There is nothing productive about this kind of finance as has been identified by parliament who are this week looking to progress the freehold and leasehold bill which will put a stop to this kind of malpractice.

So why is this money being lent by an insurer and not being used to purchase the freeholds or even E&J. The answer is that insurance companies do not back their annuity books up with real assets but with corporate bonds that are issued to maximise the opportunity of the matching adjustment. These corporate bonds carry risk, credit risk and that’s what the Bank of England are worried about.

Compare this kind or lending with the long term commitment announced this week by USS in quality rental housing. This is through fund manager “Thriving Investments” and involves ownership and property management  that aims to help the community in a transparent way.

We have got used to the idea that the rate at which the Government borrows (the gilt-rate) is “risk-free” as we have got used to the idea that an insurance annuity is “gold-plated”, but corporate bonds are not gilts and insurance companies who issue debt that could go wrong are taking risks which need to be better understood.

Which brings us back to Sarah Breeden. The irony about her warning is that the Bank of England has been a great encourager of insurance companies to buy-out pension schemes.

Insurance companies, hedge funds , asset managers and pension funds themselves have been piling into debt, often creating markets which are initially attractive but carry long-term risks both for the issuers and the borrowers.

In  encouraging buy-out and a move towards self-sufficiency in pension schemes, the Bank is  encouraging the issuance of secondary debt and reducing the demand for gilts. This seems contrary to one of the Treasury’s three Mansion House golden rules (the preservation of pension fund participation in the long-term gilts market)

This private debt may be creditworthy in the long-term, but the collective rush for credit, both in the public and private markets, is reminiscent of other  herd-like behaviours. The memory of LDI is fresh in the memory. The debt is not equity, it is not a long-term asset and to my mind it is a very inferior form of investment (if it can be called investment at all).

Today is the first day of the PLSA investment conference. Private and listed  credit is the subject of a couple of sessions, I hope that somebody is going to stick their hands up from the audience and “do a Breeden”.

Pimco says “relax”

Say it again….