How does coronavirus impact private credit? Can SMEs look to alternative lenders for help during the COVID-19 crisis? Find out from our private credit expert
Our lives have changed with the coronavirus crisis. But have they changed forever? In Does This Change Everything? European Investment Bank Group experts examine the implications of the COVID-19 crisis for sectors from education and digitalisation to urban mobility and medicine—and for your everyday life.
To find out what coronavirus means for the private credit market, we spoke to Francesco Battazzi, head of diversified debt funds at the European Investment Fund.
Read Does This Change Everything? from the European Investment Bank, the EU bank. Subscribe to the podcast on iTunes, Acast, PlayerFM and Spotify
Does the coronavirus crisis change the future of alternative lending?
It does in the short/medium term, at least.
Alternative lenders represent an alternative to bank financing for a growing number of businesses in Europe.
Credit funds, in particular, raise money from institutional investors, like pension funds, to provide lines of credit for companies. They provide SMEs with a broader choice of financing options, as well as offering investors an asset class that links institutional savings with the growth of Europe’s real economy.
COVID-19 will have a severe economic impact across enterprises of all sizes.
Given the massive disruptions on cash-positions and supply chains for European enterprises, kick-starting the economy won’t be an easy push on the button once physical distancing is no longer needed.
In general, what I like about credit funds is that they are closed-ended. Meaning that, unlike banks, which predominantly depend on short-term deposits, closed funds have investors’ commitments that are there to stay in the long-term, until the fund’s maturity, and they can provide patient finance to SMEs [small and medium-sized businesses]. In times of crisis, investors will not rush to ask for their money back, but will rely on fund managers to do their best to keep funds performing well even in troubled waters. In such a way, credit funds have a counter-cyclical investment behaviour, and in a market downturn they keep supporting strong new business opportunities.
Now, having said that, the private credit market, which developed after the 2009 financial crisis, is being tested for the first time against an economic downturn.
Basically, the asset class is building its own performance track record as we speak.
What challenges does the market face now?
In the short- to medium-term I see three type of challenges for credit funds.
First of all, at company level, strict measures are being taken by the companies financed by these funds to maximise their cash conservation. They are applying for the deferral of taxes, for state-paid unemployment, and they are also trying to open short-term facilities, mainly with banks. So, for the time being, long-term investments have been stopped..
Second challenge is that fund managers’ investment activity has slowed down, given the uncertainty. We see at this stage a bifurcation between stronger sectors and weaker sectors.
Third challenge is that we see an important problem for credit fund managers, as they seem to miss the availability of investors’ capital. At this stage investors are not willing to invest in credit funds, since they are still trying to understand what is going on.
What new products or approaches might be needed in debt funds to cope with this future situation?
With the main issue for European enterprises being liquidity during the shutdown to compensate for lack of revenues, the immediate reaction of our fund managers has been to get in touch with their SME borrowers and help them deal with the crisis measures announced by the Member States.
It’s fair to assume that the bulk of credit lines will be provided by the banking system, with access to public guarantee schemes in certain countries and sectors.
The approach of credit fund managers in the last two weeks has been to help with the concession of payment holidays, as needed. In particular, one of our funds has granted a three months deferral of principal payments to all SMEs in their portfolio. And this has been very much appreciated by SMEs.
In the coming months, I expect private credit funds to focus on:
More short- to medium-term financing—two, maximum three years—for the purpose of helping businesses to cope with working capital issues and debt re-financing (for example, fund managers would be typically providing add-ons on top of what they already gave in the past to the same company.);
We can see the credit market developing towards special situation financing, as a way to provide support to those companies that need to address specific needs that would not be considered market standard debt financing, and where bank financing is not available.
How difficult will it be for private credit funds to adapt? To develop new solutions?
While managers of credit funds are indeed adaptable, more adaptable than traditional lenders, their main constraint is availability of capital from private investors. Existing funds with significant commitments will be best placed to engage in new business opportunities during the Covid-19 crisis, but it will be very difficult to do so for new fund managers, as they have to fundraise and convince investors that they have a strong investment case, even if they lack a track record and established network. And in the current environment, I’m afraid, this will be quite difficult.
What effect might this have on everyday life for citizens? And for the European economy?
These days most EU citizens are affected by physical distancing and are trying to cope with this.
We are affected by unavailability of certain products, due for example to issues on the supply chain of enterprises. If an enterprise cannot sell its products, it will not have the money to buy supplies from someone else, and it’s a vicious circle, unless banks or credit funds are there to provide new cash.
More broadly, as EU citizens we all strive to make our economy resilient in the long-term, to make it more sustainable and environmentally friendly.
We need to ensure employment and innovation for the current and for future generations.
Private credit funds have a key role to play in a resilient European economy, as the most innovative and fastest growing businesses often need a tailor-made finance package.
No two businesses are alike, and neither are their financing needs. A technology company, for example, with intellectual assets, may lack the collateral for a ‘plain vanilla’ bank loan.
Or, a fast-growing business investing its early profits in acquisitions might prefer to make a single repayment at the loan’s maturity rather than smaller payments throughout the life of the loan.
This is where private credit funds come into the picture, to address specific financing needs of our most innovative and fastest-growing businesses and support the employment that they create.
A particular sector of alternative lending is the crowdfunding platforms’ sector, providing modern online lending solutions. It is a completely different experience, compared to having to go to a bank branch, sit down and talk, before starting a process that could take quite some time. I would say it is actually a type of lending fully compatible with physical distancing .
Crowdfunding is more and more reliant on institutional investors’ money, and because of this, the private credit market is important to us as Europeans and for our economic environment.
What we are experiencing today, since the outbreak of COVID-19, is that credit funds do not have private investor capital to provide the cash needed by SMEs.
We need to keep strong the connection between institutional savings and Europe’s real economy.
What will the European Investment Fund’s role be in this new situation?
The European Investment Fund is supporting, even more than last year, the private credit funds; with particular attention to funds focusing on SMEs. This includes new managers or managers launching new funds in EU countries where alternative lending is less developed.
The European Investment Fund supports Europe’s growing private credit market by taking cornerstone investments in new credit funds, under a programme called EFSI Private Credit tailored for SMEs.
The goal of the EFSI Private Credit Programme is to channel private institutional investment into credit funds, to support more market-based, tailor-made funding solutions for the European economy; to increase the volume and diversity of alternative debt financing available to European SMEs; and in doing so to contribute to the development of a Capital Markets Union by supporting pan-European investment activity.
With the main issue now being availability of capital from private investors , the European Investment Fund envisages dealing with the situation by increasing the EIF’s share in certain funds, or increasing the EIF’s commitment at subsequent closing to ensure continuity in the fund-raising . Unfortunately, a few credit funds we would like very much to support will be unlikely to close their fund-raising this year, given the hostile market dynamics.
With more support from the European Investment Fund we show confidence in the market and encourage investors to continue investing in private credit funds.
Read Does This Change Everything? from the European Investment Bank, the EU bank. Subscribe to the podcast on iTunes, Acast and Spotify.
