Smaller companies were the hardest hit by the retrenchment of the banks in the wake of the financial crisis and a variety of alternative lending methods have emerged to try to address this issue. Angus Grierson from LGB Corporate Finance looks at the options.
Many forms of peer-to-peer lending and crowdfunding platforms now exist to help businesses. Secured loan note programmes are also growing in popularity. Originally targeted at the lower-mid corporate market, secured loan note programmes are also now increasingly seeing interest from mid-size companies with larger borrowing requirements, and the investor base is broadening from HNWs to institutions such as family offices, which could see the market increase significantly in size and scale in the coming years to benefit a broader range of SMEs.
As challenger banks and other alternative providers have entered the market, options available to SMEs have broadened. However, the overall picture still shows that SMEs find it difficult to access finance they would historically have obtained from a bank. The British Business Bank finds that 100,000 small businesses still have applications for around £4bn of loans rejected annually by the main British lenders. Compounding this funding challenge is the fact that SMEs have been largely unable to make use of the bond or private placement markets due to their relative lack of scale.
As a result, a proliferation of alternative providers has stepped in to try to meet the funding needs of SMEs. One of the most publicised has been peer-to-peer lending platforms, many of which have done a good job of channeling private capital into businesses. Though growing fast, these platforms still only account for a small proportion of funding for businesses and tend to focus on small companies. This leaves a gap in the provision of private debt to larger SMEs those needing £2m - £20m or those with more complex capital structures.
Secured loan note programmes are well-suited to address the needs of such businesses. The instrument originates in the institutional capital markets, where massive volumes of medium term notes (MTNs) are issued. As the SME funding markets have evolved post-crisis and private investors have increasingly sought yield, secured loan note programmes have been established as an effective way for SMEs to access the private debt market.
The notes are secured, fixed-rate, medium-term debt securities. Notes can be issued on a regular basis to investors under a common suite of documents established at the outset. They carry robust security and collateral provisions, and can be flexibly structured to accommodate a borrower’s capital structure. For investors they offer regular investment opportunities to those seeking a sector-diverse, fixed-income generating portfolio. The companies best suited to issue secured loan notes are typically more established with a clear capacity to service the debt and may be operating (e.g. engineering, industrial) or financial (e.g. leasing, vehicle rental) businesses.
At LGB Corporate Finance, our estimates put the immediate addressable market for secured loan notes at around £500m. The programmes have developed to such an extent that, while originally targeted at smaller businesses, we are now seeing increasing demand from mid-sized corporates. So far, we have arranged £90m of loan note programmes for SMEs, involving the issuance of £45m of loan notes by 21 companies in a range of sectors. As we deal with larger companies and funding requirements we see no restriction on the relevance or application of secured loan note programmes.
Just as the universe of companies issuing these loan notes is broadening, so is the investor base. Investors operating in a low yield environment have increasingly seen private debt as a lucrative asset class and an opportunity for diversification, steady cash flows, a substitute for traditional fixed-income exposures and assets with lower volatility. Secured loan note programmes designed specifically for SMEs are no exception, providing investors with bespoke structures, attractive diversification from public bond markets and robust security arrangements.
High net worth individuals were the original investors in secured loan notes, but the programmes are now attracting a wider range of investors. Institutional investors including family offices and wealth managers, attracted to secured yields of 6-10% p.a., have also now started to enter the market - a trend reflective of the wider shift by institutional investors away from the yield drought in the public markets and towards the private markets. Family offices are now thought to be committing some 11% of their funds to private debt and a further 21% to private equity.
The outlook is continuing political, economic and trading uncertainty. SMEs, which form the backbone of the UK economy but which often lack resilience through global scale, will feel the ramifications of this uncertain environment the most. It is therefore critical that we continue to develop instruments and mechanisms that enable SMEs to access the capital from as many sources as possible so that they can grow and support the economy. We believe that secured loan note programmes are an important part of the emerging finance landscape.
Angus Grierson, is the Managing Director, LGB Corporate Finance