I keep reading about how viable, high quality small medium enterprises (SMEs) find it difficult to secure debt financing from banks. An OECD study of SME sector lending conditions found that credit was still constrained following the GFC. This is covered in the press from time to time, for example, see this article in the Financial Times. The situation also seems to occur in Australia according to this article in the Sydney Morning Herald. If high quality SMEs struggle to get debt funding, then surely this is a sweet spot waiting to be exploited. A SME loan fund can exploit this demand. Australia’s burgeoning superannuation sector could participate.
SME loan funds basically pool money from investors, then lend these out to SME’s who meet the eligibility criteria. The fund can operate as a revolving loan fund. This is where new loans are made using the repayments from existing and maturing loans. Many SME loan funds are funded or backed by governments to support policy objectives.
For SMEs, debt financing is an attractive alternative to raising equity. This sector is unable to access other sources such as public offerings. SMEs are also less likely to use trade finance.
However returns on SME loans can be volatile, due to high rate of defaults. The OECD study shows the trend of bankruptcies between 2007 to 2011. The UK for example saw bankruptcies increase by 23 to 51%. In the US, the variability is even greater.
The sector of the debt market requires more administration relative to the size of typical loans. The lender needs to be able to make credit decisions with less information. Carrying out a full financial analysis in each case is not feasible given the size of loan.
A possibility is a new operating model which can streamline the underwriting, and administration of these loans. Ideally an SME loan fund manager has experience in lending to this sector and has access to data, in particular, default data. I can across this article on a SME loan fund managed by BlueBay Asset Management. This particular fund surpassed its target of EUR 500m, raising instead EUR 800m. Blue Bay is a subsidiary of RBS and manages several fixed income and alternative asset funds. So certainly there are operating models out there.
I don’t believe these challenges are insurmountable. Where credit spreads to the larger end are tight, the returns on SME debt can be attractive. So why would we not see more of these funds around. Is this not an attractive outlet for Australia’s superannuation pool?