At BNP Paribas Asset Management, Stéphane Blanchoz, Head of SME Alternative Financing, focuses on loans to small and medium-sized enterprises. He has high expectations of this line of business. In his view, loans to SMEs can offer excellent returns, particularly to long-term investors such as insurance companies and pension funds, while also improving the diversification of their portfolio.
Although still largely uncharted territory, this market has enormous potential. “Of the 24 million companies in Europe, fewer than 1 000 issue listed bonds,” says Mr Blanchoz. “The rest go to the bank for finance or issue debt outside the market, which is known as private debt. Private debt is in great demand, particularly when it comes to debt issuances worth between EUR 40 and 60 million. In the current low-interest environment, parties are seeking the extra premium that private debt yields.”
But as more investors chase the large private debt issues, premiums decline. And the fact that many of the large debt issues are private equity-driven do not make this debt paper any more attractive either, in Mr Blanchoz’s opinion. He prefers to look a step lower, at loans between EUR 500 000 and EUR 5 million: amounts that are too large for the crowd funding market (which average EUR 100 000 per deal), but which banks are also no longer keen to lend.
“Stringent regulations have made banks particularly reluctant to extend long-term loans,” says Stéphane Blanchoz. “In addition, banks demand guarantees that companies cannot always provide. In particular, businesses that make their living in the services sector often lack assets that can serve as security. And time is another factor. It can take a bank three months to assess a loan application. Not every company has that much patience.”
Substantial risk premium
The companies belonging to the target group of the finance solution proposed by Mr Blanchoz and his team are the backbone of the economy. In his opinion, investing in SMEs means investing in the real economy. Scale is key to making this asset class a success in the market. Only then can the costs be reduced to a sufficiently low level. That is why the process has been automated and standardised as much as possible. Moreover, Mr Blanchoz and his team work together with partners. The target is to process loan applications within five weeks.
Stéphane Blanchoz explains: “The loans have terms of five to eight years, which is longer than is offered by banks. And, the interest rate is not variable, but fixed. In addition, the loan is repaid during the term at fixed intervals and in equal instalments. No security is put up, but we do work with covenants. Every three months, we measure whether the debt position is still within the agreed criteria. If not, the company is in technical default.
“The interest rates that SMEs pay are between 6% and 12%. We are aiming to strike the ideal balance between the return that will satisfy investors and what the companies are prepared to pay. It is definitely not our intention to make them pay too much, because that would jeopardise the repayment of the loan.”
Launch of first strategy
The first SME Alternative Financing strategy is likely to be launched in the UK early in 2019. The aim is to offer investors a net return of between 6% and 8% per year, with a default ratio below 2%. Investors will not participate on their own. BNP Paribas Asset Management will also take a minority stake. “That demonstrates our commitment, without overshadowing the other investors,” says Mr Blanchoz. “The target capital of the strategy amounts to EUR 300 million.”
The first loans have already been issued: to a specialist temporary staffing agency and a service provider for large supermarkets. Other applications are currently being processed. Mr Blanchoz sees lots of scope for growth. “The British market alone is worth tens of billions. Our aim is to lend EUR 1 billion per year across Europe. Ideally, we want to fund companies with a growing number of employees.”
Even without this motivation, there are good reasons why SME credit can be a sensible investment. It can offer additional diversification, pay a relatively high interest rate, provide income over many years, and be offered cheaply thanks to the standardised process.
And what if a new crisis is just around the corner? Or if European rates rise? Mr Blanchoz: “In case of a crisis, high-yield companies will have a tougher ride than the companies we have selected. They have stable cash flows and meet strict environmental, social and governance (ESG) criteria.
As a rule, SMEs are less cyclical than many large listed companies, which reduces the risk of default. Interest rate increases are not likely to be a problem either. The interest rate premium is so high that rising government bond rates will not become competitive any time soon.
Written on 13 November 2018.
This blog post is based on an article in IEX profs. To read the original (in Dutch only) click here >To read more on lending to small and mid caps, click here >