With growing regulatory pressure to monitor risk management and solvency, Basel III standards will further restrain the ability of banks to lend to small and medium-size enterprises (SMEs). Traditional bank loans represent about 70% of corporate financing in France, according to Marie-Anne Barbat-Layani, CEO of Fédération Bancaire Française, the French Banking Federation, and if nothing else is done, French SMEs could be starved of credit.
Outstanding corporate loans total about €660bn in France. Large listed companies account for only €80bn of the total, as they mostly rely on bond financing, rather than bank loans. But medium-size companies – with fewer than 5,000 employees and revenues under €50m, known as etablissements de taille intermédiaire, or ETI – rely on banks for €240bn of credit outstanding, while the smallest companies are the most dependent on banks, accounting for €340bn of corporate loans.
Finding new ways to finance SMEs is crucial. Both Caisse des Dépôts (CDC) and Banque de France have recently launched complementary initiatives.
CDC made a bold move last year, launching its Novo fund series – a new type of vehicle helping institutions to invest in SME bonds. “The idea emerged in July 2012 during a lunch with French insurers. One year later, it was officially launched and we had the first closing early October 2013, with €1.015bn,” recalls Thierry Giami, adviser to CDC’s executive committee and president of the corporate capital market observatory of the regulator, AMF.
The fund has 24 founders. “There were more candidates to join when they learned about what we prepared,” recalls Giami. “But we closed the fund when it reached €1bn so we could start investing.” In five months, nearly 20% of the committed assets have been invested in six bond issues. As with private equity funds, the remaining capital will be called when investments are selected, which should be within the next 18 months.
Spotlight on Novo
Novo is basically a private placement fund platform investing in mid-size firms operating in France, but which need not necessarily be French, which have an annual turnover of at least €50m, and operate in industries or services – excluding financial activities, real estate or leveraged buyouts – and which have a growth project, internal or external, national or international, to finance with a bond issue of between €10m and €50m.
Some of these specifications deserve explanation. The idea of private placements is relatively new in France as the corporate bond market is not as developed as in neighbouring countries, like the UK or Germany, where privately placed Schuldschein structures are common investments for institutions. “[German] SMEs issue €8-12bn in bonds each year on the Schuldschein market,” notes Renaud Tourmente, head of corporate debt at AXA IM.
Giami adds: “There has been an initiative to develop initial bond offerings to the public in France. But it did not take off – not because of a lack of investor interest, but because issuers prefer private placements, as they prove cheaper and easier and are more confidential than a public offering.”
Bond private placements – also called Euro PP – are taking off, however. “They started in France in 2012 and raised more than €3bn for their first year, and more than €4bn in 2013,” adds Tourmente. The problem is that a private placement requires a minimum size of €100m, and no investor would take more than 10% of the issue – nor would they commit less than €10m to each issue. The Novo funds solve this problem, as they can be the sole subscriber to smaller bond issues.
“We dealt with the dispersion ratio through investor pooling,” says Giami, who notes that, with 24 investors in the fund, none is exposed to more than 12% of any selected bond issue. The Novo funds’ exposure is also limited to 5% in a single company and 20% in any sector.
Another specification for target investments is that they are plain vanilla at fixed rate with no convertibles or warrants, with five to seven years maturity, and amortisation at redemption date – unlike most bank loans, which are redeemable over a three to five-year period. Companies get competitive financing conditions that they would not receive from their bank, such as the €50m, seven-year 4.4% bond issued by Altrad, a mid-sized construction equipment company.
No politics, please
On the buy side, details have been carefully weighed and crafted to avoid the pitfalls of ‘public investment bias’ and the Novo funds are designed to be sheltered from any political interference.
“The Novo funds have been built with and for institutional investors, and they asked us to select good quality companies,” Giami explains. The investment pool is split into two funds, Novo1 with €660m managed by BNP Investment Partners, and Novo2 with €355m managed by Tikehau IM. Strict fund rules also require managers to select companies with a creditworthiness equivalent to at least BB-plus on a typical credit-rating scale. International rating agencies will not usually rate small companies as investment grade, because of their size, so alternative rating models and financial analysis are used.
“Analysing corporate debt has been our job for years,” says Bruno de Pampelonne, a former investment banker with Merrill Lynch and Goldman Sachs, who founded Tikehau IM seven years ago and grew it into a business with assets under management of €2.3bn. The firm received 100 requests to finance mid-sized companies through the Novo2 fund; some 25% of those were excluded because of the investment rules and Tikehau IM undertook the process of selecting investments from the remaining applicants. “[We] approved five investments and 10 more are in the pipeline,” de Pampelonne notes.
Each investment takes time as many of the companies have not previously been analysed from a debt-investment point of view. Although each target company already has a good bank scoring, as required by Novo investment rules, Tikehau undertakes further analysis. “Analysing a company takes between one and two months; we meet the management, inspect factories and so on,” de Pampelonne continues. The firm also uses RiskCalc, a private rating software tool developed by Moody’s.
To further secure the investment process, each fund’s investment committee includes an independent adviser, Daniel Rondeau, a former banker with industrial experience mandated by Novo investors to oversee their interests. Also, when an investment decision requires more discussion or falls just outside the investment rules for technical reasons, the case is brought to an investors’ sub-committee consisting of the five Novo founders – CDC, FRR, HSBC, ACM (the insurance entity of Crédit Mutuel) and Sogecap (SocGen’s life insurance entity).
Institutional investors participating in the Novo funds seem satisfied with their parameters. The funds’ duration is 10 years and redeemed bonds of shorter maturity (five to seven years) will be replaced by others. The 0.5% management fee might seem high compared with a typical sovereign bond fund but it compares well against private equity funds given the comparable level of due diligence. The Novo funds target a net return of 2% above French government bonds over 10 years (a 4.15% yield versus 2.15% for the French OAT as of mid-March).
The Novo funds not only help cash-starved SMEs: they also provide insurers and pension funds with relatively safe income assets in a low-yield environment. “The financial crisis and low interest rates have pushed us to concentrate our investments on the largest and safest borrowers, but at the same time we needed to diversify to find less risky complementary income sources,” says Stéphane Baudin, CIO at HSBC Assurance, the bank’s French life insurance business. As one of the founders and largest participants in the Novo funds, HSBC Assurance plans to commit 1.5% of its €16bn assets to this new asset class over the next 12-24 months, dependent on the opportunities available.
Banks, borrowers, investors and public authorities all want to enhance SMEs’ access to credit but regulatory hurdles have prevented growth in SME lending until recently. The French accounting standards setter (ANC) has had to adapt its rules to allow hold-to-maturity instruments and several articles in the French Insurance code have had to be changed. Article R332-2, which covers SME debt as eligible assets on insurers’ balance sheets, has been rewritten.
Article R331-5-1 on risk provision, covering what happens when amortisable debt assets fall in price – listed bonds directly held on the balance sheet were always out of the scope of this article – makes an exception for insurers declaring their will and capacity to hold such debt securities to maturity. Insurers usually want to hold their SME debt investments to maturity, in any case, for reasons of illiquidity.
If Euro PP and other mid-sized company bond platforms such as the Novo funds look ready to run, they do not solve the financing equation for small and micro-cap enterprises. Such companies, with revenue of less than €50m, and often employing fewer than 10 people, must rely on banks for credit. And most institutional investors are not equipped to do the banks’ job of serving such borrowers directly.
But another financing route is under construction. “We are working to create a refinancing vehicle for SME loans that would stay on banks’ balance sheets,” said Christian Noyer, governor of the Banque de France, on 29 January 2014. “This is a way to attract savings directly, which lets banks do their job, with creditworthiness controlled on the basis of Banque de France enterprise scoring.”
This very interesting project consists of securitising small loans with a creditworthiness comparable to BBB, according to the Banque de France credit score system based on its proprietary FIBEN (Fichier bancaire des entreprises) system. These loans, with a default probability of less than 1% on 12-month maturity, are already eligible as collateral for banking liquidity when brought in guarantee to the Banque de France or other Eurosystem central banks.
The idea is to extend this collateral mechanism into a securitisation scheme, as secure for investors as it is already for central banks. Loans stay on the bank’s balance sheet and they return the provided liquidity if and when the collateral assets lose their creditworthiness.
Article L211-38 of the financial and monetary code has been adapted to allow such a mechanism to be created by selected operators – EuroTitrisation, Gide, BNP Securities Services. A group of banks – BNP, SocGen, HSBC and BPCE – have declared their interest in funding the first issue and Crédit Agricole is to join the next one. As securitisation is a faster process than originating each participating loan, amounts are likely to grow bigger and faster, probably by the billions.
All participating banks would enter the capital of the issuing Société Anonyme de Titrisation. The securities would be asset-backed by short-term loans, but not tranched, as lessons from the ABS headache have been learnt. They would carry three to five-year maturities with yields in the 3-4% range. They would be dedicated to banks in the first place, but could be open to institutional investors later. No precise target has already been set for this form of SME collateralisation and securitisation, but experts expect them to raise a few billion euros.
Of course, it will be faster and easier to progress this route by packaging existing loans on the bank balance sheets rather than originating them one by one as the Novo funds do. But together the two approaches nevertheless carry big hopes for fresh financing to save SMEs from the credit drought.