Moody's: Securitisation to emerge as new non-bank driven funding source for SMEs and mid-caps in Europe

Non-banks (including insurers and funds) can add some fire-power to European policy makers' initiatives to fund small businesses by packaging their loans into structured deals, according to Moody's Investors Service in a report published today. However, information asymmetry can expose such deals to a potential misalignment of interest between investors and portfolio managers. 

"Securitisation enables investors, such as insurers and pension funds, to transform their investments into more liquid instruments and to align their risk appetite, owing to the tranching of issued notes," observes Monica Curti, a Vice President -- Senior Credit Officer at Moody's. 

In light of European policy makers' efforts to grow the non-bank lending market, Moody's expects securitisation to emerge as a new funding source for small- and medium-sized enterprises (SMEs) and mid-caps in Europe. Policymakers are supporting non-banks' SME lending activities with a view to encourage investors to support growth in the real economy. However, the rating agency says it is crucial to bear certain risks in mind. 

"Data on SME and mid-cap debt originated by non-banks is fragmented at best. This exposes the deal to risks, such as an adverse pool cut, or a potential misalignment of interest between investors and portfolio managers. With traditional bank lending to SMEs in the euro area well below pre-crisis levels, alternative investors can undertake lending directly in the case of private placements, through a fund or a special-purpose vehicle," she notes. 

Moody's says transaction governance and the alignment of interest between the investors and the portfolio manager are the key risk drivers. Borrowers that are ineligible for traditional bank financing because of a weak credit profile may look for alternative fund providers.

Moody's report says that growth in non-bank SME lending is uneven across Europe. The UK is the leading market for peer-to business lending, with growing SME debt funds and a developed private placement market. France is also a well-known private placement market (Euro Private Placement) and SME debt funds have also been established in Italy, which has a growing mini-bond market. Germany has a small, but mature SME bond market. A fixed-income alternative market (Mercado Alternativo de Renta Fija "Marf") was launched in Spain last year. 

Although Moody's expects non-bank SME deals to resemble collateralized loan obligations (CLOs) and granular balance-sheet SME securitisations, especially from a structural point of view, they will differ somewhat. Moody's has observed a strong divergence in the past performance of SME and mid-cap transactions with originate-to-distribute models