SME lending for diversified and stable cash flows

31 Oct 2018

Why is the market for alternative lending expanding?

Traditional sources of return, i.e. stocks and bonds, face a number of headwinds, with bond yields being generally low, and there being concerns about equity valuations and possible further spikes in market volatility, mainly over trade tensions. Returns from traditional portfolios have been modest and for institutional investors such as pension funds they have been insufficient to meet their liabilities. So the search for yield goes on.

In that context, demand for alternative sources of yield has picked up, which has helped generate investor interest in alternative lending. In this market, investors can earn an illiquidity premium. The sources of return in this market are typically well-diversified, so the returns are often uncorrelated to the traditional asset classes, which represents an attraction for institutional investors.

What will this market look like in five years’ time? Which players’ influence do you think will grow over the coming years, and which do you see declining? How will the role of traditional banks evolve?

The role of traditional banks is already shrinking. Capital requirements have made it uneconomical for them to be active in this market: financing riskier borrowers tends to be a drain on their balance sheet. This has opened up the market to new entrants including peer-to-peer lenders and crowdfunding platforms.

However, these newer players typically handle modest-sized loans and usually target micro-businesses and small start-ups. At the other end of the market, private equity and hedge funds are lending to mid-tier companies, leaving the centre ground – small and medium-sized enterprises (SMEs) with turnovers of EUR 2 million to EUR 50 million – open. That gap is being filled by institutional investors and asset managers that are offering SME lending funds, such as BNP Paribas Asset Management.

Looking ahead, we expect this market to see more and more standardisation and automation when it comes to the credit approval and investment process. To this end, BNP Paribas Asset Management is partnering with Caple, an SME credit specialist, which operates a web-based credit approval interface.

Given the large volumes of financial and company data used in the approval process, we are also working with big data specialists to build a web-based quantitative approval model to pre-screen loans and speed the selection process. This type of investment, also in terms of time and effort, will play a key role in making the issuance of SME loans economically sustainable and keeping this business viable in the longer run.


What is your added value in the alternative lending chain?

Unlike other lenders, we believe it is important, if not critical, for companies to retain control of their businesses and for lenders to steer clear of company strategy. Allowing each party to operate in their own area of competence builds trust between the parties and ultimately heightens performance.

In a similar vein, we believe in charging a fair rate on the loans rather than seeking maximum returns, so that the borrower can continue to invest in the business and turn a profit. We want to act in a responsible way towards all stakeholders and we expect the companies that we lend to – and invest in – to do the same.

That is why we apply environmental, social and governance (ESG) criteria to all loan recipients. These cover the ESG standards that we expect the borrowers to meet. We believe that imposing our strict criteria will help reduce investment risk. So that is our added value: a hands-off approach, fair pricing and a strict application of ESG selection criteria.


What is the benefit for the end-customer of investing in SME credit?

The SME segment is underserved, so there should be plenty of opportunities. It is diverse, covering a wide range of often innovative and growth-oriented industries, niches and products, which leaves us with many promising businesses to lend to and to put together a well-diversified portfolio.

As said, in the SME segment, there are many sources of return, which are typically uncorrelated, while the investment performance of the segment as a whole is uncorrelated to the traditional asset classes. If as an investor you are looking for predictable, diversified, stable and long-term cash flows, then we believe an SME fund is the place to be.