NUMMER 4 / 201696 FINANCIALINVESTIGATOR

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SME DEBT DISINTERMEDIATION: INNOVATION AT WORK

In the current low interest-rate environment, allocations to private debt investments and other direct lending strategies can be attractive for institutional investors looking for yields and diversification opportunities. In this article we discuss the latest developments.

In the aftermath of the 2008 crisis, the financial industry had to undergo significant reforms, paving the way for the disintermediation of banks with strong support from regulators who were keen to reduce the overall size of banks’ balance sheets. In Europe in particular, the heavy reliance of companies on bank credit was addressed with various initiatives favouring non-bank financing of corporates, while at the same time allowing institutional investors to achieve the much sought-after diversification of their assets. Initiatives such as opening up bond markets to mid caps with an unrated or non-investment grade risk profile, the introduction of fiscal incentives for bond issuance in Italy and the launch of dedicated Euro PP funds in France focused on mid-cap companies willing to diversify their sources of funding or take a first step towards the eventual issuance of public debt. Most of these new sources of funding allow companies to maintain a high level of confidentiality if needed. To that extent, the French example is interesting. France has actively promoted Euro Private Placements for companies not large enough to tap the public fixed-income capital markets. However, since the start of this market in 2012, the bulk of issuers are companies with a turnover of more than EUR 300 million.

For an investor selecting corporate bonds, the available level of

diversification is actually fairly limited at this point. When looking at European Corporate benchmarks for investment-grade, high-yield bonds and leveraged loans, non-financial issuers do not even total 1.000. Putting this into perspective, according to Eurostat, the EU28’s business economy consisted of around 25.6 million active enterprises in 2012. And even if the overwhelming majority of companies active in the non-financial business economy of the region are micro enterprises, the number of companies which could potentially ask for non-bank financing in the context of disintermediation remains significant, in particular when it comes to small and medium-sized enterprises (SMEs).

Indeed, the SME segment has so far participated only marginally in the disintermediation trend and is still quasi-exclusively being funded through the banking system. For private investors, financing smaller companies is difficult since the time-consuming analytical resources those investors are ready to mobilise when they invest in sizeable loans would not be economically practicable when it comes to assessing investments in smaller loans.

Having said that, recent initiatives show that innovation is underway, both for investors looking for credit diversification through an exposure to SMEs and for SMEs looking to diversify their sources of funding away from the traditional banking

By Stéphane Blanchoz

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Stéphane Blanchoz is BNP Paribas Asset Management CIO for Alternative Debt Management. He joined BNP Paribas’ asset management arm in 2004 after four years as an auditor for BNP Paribas ‘Inspection Générale’. Previously, Stéphane worked as a Risk Manager in Tokyo for BNP (1997-1999) and for Pechiney (1996). He holds a Masters Degree in Finance from Lyon II University and is also a lecturer in several training programs (AFG, SFAF, Lyon II University).

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NUMMER 4 / 2016 97FINANCIALINVESTIGATOR

The European debt market has undergone a gradual, but significant transformation in recent years. The direct lending market has become both an additional funding solution for SMEs and an asset class bringing diversification to investors. The gap left by the banking industry’s retreat from lending has opened up new perspectives: according to data provider Preqin, assets under management in private debt have grown by 14% a year since 2006 to USD 523 billion as of June 2015. And in Europe only, the aggregate capital raised by private debt funds has reached USD 29.8 billion.

To conclude, in the current low rate environment where cash-rich investors have to compete with central banks for valid investment opportunities, bank disintermediation is creating new and attractive asset classes. Initially focused on mid-sized to large companies, this trend now appears to be moving in the direction of SMEs where different initiatives are being launched.

SMEs can benefit from access to different – and often flexible – types of non-bank financing, while investors, currently learning to live with negative interest rates, can smartly trade off

channel. The development of crowd-lending platforms gives SMEs the chance to obtain non-bank financing. This so-called peer-to-peer lending, originally directed at individual lenders, has started attracting institutional interest recently. The first marketplace lending securitisation in Europe, Small Business Origination Loan Trust 2016-1 (SBOLT), was announced on April 14th, 2016. Rated by both Fitch and Moody’s, SBOLT is backed by collateral made up of a pool of loans to SMEs domiciled in the UK, which were originated through Funding Circle, the operator of the leading marketplace lending platform for SMEs in the UK. As a first approach, SBOLT aggregated a modest number of about 2.500 loans totalling GBP 130 million.

However, one could easily foresee further securitisations of this type in Europe, allowing investors to access SME debt with different risk-return profiles. Indeed, volumes have kept growing and the issuance of marketplace lending ABS has benefited from the clear support of European policymakers for disintermediation.

Another relatively recent development, which we see as definitely positive for SME credit, is a regulation approved in April 2015 by the European Council and applicable from December 2015: the European Long-Term Investment Fund (ELTIF) label. Though not specifically directed at SMEs, ELTIFs are well suited to investments in long-term and illiquid assets. Moreover, these funds can grant loans directly to companies, challenging the banking monopoly in place in some European countries.

ELTIFs can encapsulate a number of SME direct lending initiatives. The shift from a concentrated portfolio of sizeable SME loans to a diversified ELTIF of smaller SME loans could well pick up pace in the coming years. However, this will require proximity to origination sources, the development of scoring methodologies and the ability to industrialise credit work through a highly-structured investment process.

liquidity for returns. And this trend is gaining momentum. «

This article was written by Stéphane Blanchoz, CIO for Alternative Debt Management at BNP Paribas Asset Management.

• In the current low yield

environment allocations to

private debt investments and

other direct lending strategies

can be attractive for

institutional investors.

• Financing European Small and

Mediumsized Enterprises

(SME) is an innovative

investment solution offering

exposure to European credit

markets with an attractive risk-

adjusted return profile.

• SMEs can benefit from access

to different – and often

flexible – types of non-bank

financing, while investors can

smartly trade off liquidity for

returns.

Figure 1: Private Debt Assets under Management, December 2006 - June 2015

Source: Preqin Private Debt Online