On April 3rd, the OECD Financial Roundtable (FRT) dealt with SME financing beyond traditional bank loans, emphasising the role of securitisation, private placements and bonds. In today’s post, Marcus Schuller of Panthera Solutions gives us his personal view on the meeting in this article we’re co-publishing with Panthera.
The crisis saw traditional channels of credit for SMEs drying up or becoming restricted. Deleveraging became the order of the day for governments, consumers and banks. And yet, although many SME managers think that banks won’t lend to them, a recent ECB/EC SME survey suggests that nearly two-thirds of SMEs in the EU who applied for external finance got everything they applied for. The actual bottleneck comes from increasing interest rates and even more so increasing non-interest related costs (fees, charges, commissions) which make bank loans increasingly unattractive for SMEs.
Non-bank financing alternatives need to be strengthened
So what alternative financing sources are available?
In Europe, short-term options are limited due to the missing culture of direct market financing. Bank loans account for around 50% of firms’ external financing, whereas in the US, around 80% of firms’ financing comes from capital markets (equity and debt securities). Therefore SME financing in Europe via private placements or corporate bond issuances is unknown territory for many. The German Mittelstand tries to change this by placing an increasing amount of corporate bonds (Mittelstandsanleihen) especially in the retail segment. Since 2010 about 150 issuances worth EUR 7.26 billion were offered, of which EUR 5.77 billion were placed. At a first glance, it looks like a success story. However, as this market segment lacks transparency, standardisation and creditor protection, we have seen retail investors being burnt. Almost every tenth issuer has defaulted by now, although for most of the bonds, repayment will only kick in in 2015. In short, the worst is yet to come.
Which leads to a first insight into SME financing: it lacks of standardisation. SMEs are difficult to analyse due to their heterogeneous character. Small companies have different needs than medium-sized ones. Financing differs strongly between sectors and countries.
False promises of securitisation?
No wonder the large banking institutions were lobbying strongly at the FRT for an instrument they know very well how to make money with, namely securitisation. Securitisation is the practice of pooling various types of contractual debt and selling it in various forms to investors. In theory, this sounds like an elegant solution for all parties involved. But if the term “securitisation” is now known outside specialist circles, it’s because of the disreputable reputation it acquired during the Great Recession.
The representative of a large banking institution at the Roundtable didn’t see it like this, arguing that the bad reputation was due to a conspiracy of governments and regulators, driven by a “hostile sentiment”, and that securitisation did not contribute to the severity of the Great Recession.
Others may be more persuaded by what happened to subprime mortgage securitisation, or the numerous SEC mortgage fraud settlements with large banking institutions. Thanks to the settlement culture, especially in the United States, no institution had to admit any intentional wrongdoing, which makes their claim to have changed for the better not necessarily trustworthy. To be clear, securitisation is not harmful per se. It has been misused.
If we should ever again consider securitisation as part of the solution and not the problem, investors need better tools to distinguish good products from bad. In recent years, regulators and the more reasonable industry representatives have worked on those tools. Several financial regulations and other initiatives have already been implemented in the EU. Only days after the OECD FRT, the Bank of England and the ECB published their joint paper on securitisation. The paper supports strongly the value of high quality securitisation.
Could the securitisation market in Europe be large enough to solve SME financing issues? The outstanding amount of asset-backed securities (ABS) in the EU is currently about EUR 1500 billion, or around one quarter of the size of the US ABS market. Since its peak in 2009, the outstanding amount has decreased by half, to EUR 750 billion. Apart from investor-placed issuances remaining far below pre-crisis levels, secondary market activity is thin in many segments.
Residential Mortgage Backed Securities (RMBS) form by far the largest securitisation segment, accounting for 58%; SME ABS are second, but account only for 8 % of the market. The SME ABS market volume stands at EUR 120 billion. In comparison, for the EU as a whole, the aggregate volume of credit supplied to non-financial corporations was close to EUR 6 trillion in 2011. Even with the exact amount lent to SMEs remaining unknown, it is obvious that SME ABS will not be strong enough to substitute for impaired lending channels all alone.
Information is power
Instead of elaborating on available alternatives like private placements, corporate bonds or shadow banking options (crowd-investing, SME financing via hedge funds, etc.), I sensed the necessity during the FRT to highlight a prerequisite before alternative sources can be considered. In my experience SME managers and owners are experts in their field, but not in corporate finance. They don’t know the technical vocabulary and lack knowledge about available alternatives.
And although banks like to talk about servicing clients in advising them on financing, information asymmetry between the bank and an SME representative puts the latter at a disadvantage. By not asking the right questions and not knowing the limits in negotiations, the agreement automatically favours the bank. SME managers and owners need to be supported by independent advice, no matter if it is coming from the regulator or an independent market participant.
In short, educate and empower the SME entrepreneur and manager. If this succeeds, financing options will become significantly more diverse. The single offering, be it a bank loan or something more sophisticated, will have to compete with viable alternatives. Like that, market forces on relatively level playing fields would take over again. A solution that is as desirable as it is sustainable.
SMEs and the credit crunch: Current financing difficulties, policy measures and a review of literature Gert Wehinger Financial Market Trends (OECD journal), March 2014