Getting out of the bank's shadow - alternative financing sourcesThe emergence of private debt placements provides an alternative to bank borrowing for companies without access to the capital markets and is set to bring major changes to the European refinancing system.
The amount of credit available to non-finance sector companies in the eurozone has fallen by 10% to €4.3trn since the global financial crisis. Although demand for credit decreased due to the economic downturn after the mortgage and Lehman crises, the euro crisis is the main factor on the supply side.
At the same time, the requirements of Basel III are forcing banks to either increase their capital base and/or to dilute their risk positions. The banks have been suffering from a significant loss of confidence, which has substantially increased their refinancing costs. All this has meant that financial institutions have been making huge cuts in their balance sheets and therefore reducing their supply of credit. This so-called bank deleveraging trend is still in full swing and will have far-reaching consequences in Europe, particularly for companies without direct access to the capital markets.
Strong dependence on banks in Europe
European corporations have traditionally relied on bank finance, with the banks’ share of corporate finance representing around 80% of external third party finance. This contrasts to the situation in the US where finance by bond issue (around 80%) is preferred over bank credit. The credit shortage presents a huge challenge to European corporations, potentially jeopardising future investment in growth.
According to data from the European Central Bank (ECB) there are already signs of a trend away from a bank-oriented system in Europe, in the direction of the capital markets. Between 2009 and 2013 the volume of bank credit decreased in terms of European GDP by 7.4%, while bond volumes rose by 2.4%.
Bonds – an alternative for the privileged few
Research by Deutsche Bank shows that finance through bond issue is still only a privilege enjoyed by large corporations. High issue costs and reporting duties mean that bond issue is only viable for corporations with volume above around €50m. This is an insurmountable hurdle for most SMEs in Europe, which represent 99% of all companies and around two thirds of total employees.
SME financing left behind?
Where does this leave SMEs that cannot access the capital markets? Most face tight bank lending conditions. Access to finance was the second most frequently cited problem for SMEs in the 2013 ECB opinion survey.
The trend in the volume of unsecured credit to SMEs is a good indicator of bank lending policy. Analysis of credit volumes since 2009 by size of company and business sector in Switzerland, for example, clearly shows a negative trend. From June 2009 to 2014, the volume of unsecured credit utilised by companies with up to nine staff from Cantonal banks fell by 37% to CHF6.1bn and from the large banks by 33% to CHF28.2bn. An analysis by business sector reveals that the retreat of the banks particularly affected the manufacturing sector, with a drop of 21%.
In a 2012 SECO survey, 52% of the SMEs polled felt that in general credit conditions were worse than 12 months ago. The equivalent figure in the 2010 survey was only one-third. The research shows a change in sources of funding in full swing, with banks losing market share.
Getting out of the bank’s shadow – alternative sources of funding
Alternatives to bank borrowing and market-listed bond instruments already exist in the form of private debt placements with medium to long-term durations.
This poses two major questions:
- who are these new lenders, often referred to as shadow banks, jumping in where the banks are slowly retreating?
- what can shadow banks do better than ordinary banks?
Shadow banks consist of financial intermediaries with access to investment capital, which is not subject to the strict regulations and requirements of the banking industry. This circle of capital providers includes institutional investors such as life insurers, pension funds, hedge funds and private debt funds.
According to ratings agency Moody’s, up to July 2014 over 60 new private debt funds in Europe had provided a total of US$33bn in capital and this upward trend continues. Limited access to bank funding for SMEs has made corporate lending an extremely attractive investment avenue for investors due to the very low credit-default probabilities of SMEs in certain countries in Europe, such as Switzerland. In addition, the low correlation between private loan placements and the bond and stock markets means that this low-risk investment category offers enhanced diversification and thus an improved risk-return structure for an investor's portfolio. These positive investment characteristics mean that investors are often willing to accept the lack of liquidity in such placements.
New funding models
Market regulators, as well as institutional investors, have welcomed this diversification of investment channels. However European private placement markets have a long way to go to catch up with the US however. Private placements have long been an established source of alternative funding in the US, with a market volume of US$54bn in 2013. European corporations account for roughly a quarter of this.
The growing private placement market has been the subject of a number of recent reports, including those by the European Commission, the Bank of France and a special task force set up in the UK. An International Capital Market Association (ICMA) working group published best practice guidance for the pan-European private placement market in 2014. The greatest handicap in the private debt market for European institutional investors is the lack of ratings for medium-sized corporations and of transparency in the SME market. New business models are required in order to overcome these handicaps. Early co-operation between shadow banks and traditional banks – for example BlueBay Asset Management has announced co-operation with Barclays and AXA is working with Société Générale – show that the private placement trend is not only creating competition but also new co-operation models in corporate funding.
How can SMEs benefit from this trend?
Classic private debt placement has a number of advantages for medium-sized corporations that have no direct access to the capital markets: Firstly, placement costs are lower than for public debt issues due to reduced legal and regulatory stipulations. Secondly, smaller volumes, generally starting at €10m can be placed. Finally, negotiation of loan conditions can often be relatively easily co-ordinated since the investor base consists of just a fewprofessional investors.
Small companies will often benefit from specialist advice to help them overcome the barriers mentioned above. They can obtain efficient corporate analysis, structure their credit needs for presentation to investors and cover corporate financing requirements as professional intermediaries. This requires sound credit and capital market know-how to ensure that investment proposals meet the demanding requirements of private debt investors, including transaction track record, company and sector analysis, financial models and rating details. Such specialist advisers should also be familiar with the investment profile of professional private debt investors and have direct access to decision-makers.
It’s critical that an adviser is able to build a bridge between the business model and individual situation of the company on the one hand, and the requirements of the investors as the potential source of capital on the other, in order to provide finance and security for the SME’s long-term growth possibilities.
For more information, contact:
T +41 61 206 99 66
T +41 61 319 51 88