Insights: the debt market for SMEs

Before the financial crisis, most SMEs used their local High Street Bank for clearing services, working capital facilities and medium-term debt requirements.  In effect, Banks were one-stop shops dominating the markets they operated in and business customers were very loyal and rarely changed bank.

Fast forward to 2016 and it is clear SME Banking has changed materially – the credit process is more stringent and complex than it was.  A positive feature of the current lending environment is the increased level of choice available to SMEs when they consider accessing new borrowing – in part, this is driven by the following:

  • Recovery in appetite – traditional clearing banks have recapitalised and refocused on asset and income growth, particularly in lower-risk commercial banking areas;
  • Challenger banks – new and revitalised secondary banks have (re)entered the SME market and are keen to grow their presence and market share;
  • Credit funds – alternative and overseas lenders view the UK lower-mid market as an attractive place to deploy capital and have developed significant market shares in certain segments, e.g. funding MBOs; and
  • Asset-backed lenders – ABLs are enjoying continued success for what were once seen as last-resort lenders, but whose prominence has grown post 2009

Since 2010, we have seen a large number of credit funds (direct lenders) enter the UK Market.  To date, their focus has been on raising capital from institutional investors to lend to mid-market corporates, often supporting private equity backed transactions.  Most data and commentary suggests credit funds have cornered up to 50% of the acquisition finance market, which replicates a trend seen in the US where funds provide debt to SMEs and corporates and banks provide “safer” working capital and other banking services.

At HMT, we observe an increase in the number of credit funds now exploring the SME and lower mid-markets, with some now specifically keen to fund non-private equity owned business ( sponsorless transactions).  While banks will no doubt protect their customer base, we expect the number of new market entrants to grow and therefore choices available to SMEs to increase further.

On the supply side, institutional investors see the UK as an attractive place to invest, particularly compared to other G8/G20 countries, and are keen for credit funds to explore lending opportunities here.  In addition, we note borrowers are increasingly content to utilise what are considered “non-traditional” sources of capital, so long as its meets their funding needs.

The table below highlights some typical differences between credit funds and banks

BanksCredit Funds
·         SME & mid-market·         All debt sizes·         Debt, working capital & clearing·         Support all business types·         Sponsor & sponsorless·         Senior only·         Capital & interest across term·         Binary credit view irrespective of price·         Proven over business cycle·         Nearly always cheaper than funds·         Still relationship led·         Starting to focus on SMEs·         New entrants focusing <£10m lends·         Debt only·         Often focused on growth companies·         Increasing interest in sponsorless·         Flexible capital across balance sheet·         Interest only during term·         Bespoke risk and reward methodology·         Unproven long-term in UK·         Minimum return hurdles·         Can have very granular requirements

Whilst there are some significant differences between credit funds and banks, fundamentally both focus materially on the quality of earnings generated by a borrower along with the strength and depth of the underlying management team.  They have also developed ways of working together, which is necessary given credit funds are unable to provide working capital or clearing facilities.

Last year, we established a debt advisory business to help potential borrowers navigate the market and find the most appropriate debt provider for their business.  We are currently assisting a range of businesses (privately owned, private equity owned and listed companies) access debt funding between £2 million and £25 million from clearing and secondary banks, credit funds and asset-backed lenders.

This new offering has been welcomed by new and existing HMT Clients who appreciate:

  • our reputation in the market combined with our established contact base helps bring borrowers and lenders together efficiently;
  • our unique experience and position in the SME market enables us to offer impartial advice and guide borrowers towards their best debt funding solution;
  • our commercial excellence means we can source and negotiate the best deal delivering the optimum balance between pricing and commercial terms; and
  • partner level resource to project manage the debt raise, which can be time consuming on top of the finance team’s day job

Increased competition coupled with continued low interest rates makes for great news for SMEs.  While further choice in the future is likely, the potential of interest rate rises at some point in the future means the second half of 2016 could be an attractive year for potential borrowers.


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