> Christopher Baines, Gulf Capital:
SME and Mid Cap Bank Lending in MENA
I
t is widely acknowledged that on a global scale commercial bank lending to SMEs is not sufficient despite rhetoric and various Governmental incentives seen in a number of countries to grow this area.
“MENA region is the place in the world where SMEs are the least likely to have access to credit lines.”
There are two primary reasons for this: many banks are seeking to rebuild their capital bases to prepare for tighter regulations (e.g. Basle III) and also protecting themselves against additional potential write-downs or other un-quantifiable adverse effects to their business in the near future. This rationale is common in many countries and is likely to prevail for the short term at least, given the broader unresolved issues in global finance and the finely poised global macro economic situation.
Within the wealthiest part of MENA - the Gulf Cooperation Council (GCC), which includes countries such as Saudi Arabia, the UAE, Qatar and Kuwait with some of the highest GDP per Capita rates in the world – bank lending to SMEs is almost negligible. In the GCC, only 2 % of bank lending is devoted to SMEs.
Both of these factors foster a cautious approach for commercial bank lending to SMEs. In geographies with more developed capital markets we have consequently seen the development of SME dedicated funds making direct lending investments and filling the gap in the market left by banks.
These numbers are extremely low but are even more surprising when compared to the importance SMEs have in the overall GCC economy, whether that is expressed through a share of employment or of GDP. Even in oil exporting countries such as the United Arab Emirates, SMEs account for 60 % of GDP and 86 % of employment.
With that in mind, what chance do the smaller mid-market borrowers have of raising loans to fund their expansion especially in a region such as the Middle-East and North Africa region (MENA)? According to a World Bank study, the MENA region is ranked as the place in the world where SMEs are the least likely to have access to credit lines from financial institutions. Only 20% of SMEs in MENA have this access, which makes them less likely to have available bank lines than their peers in Africa and half as likely to have bank facilities than their Latin American & Caribbean equivalent.
SMEs therefore represent a very important part of both the regional economy and social fabric due to their ability to rapidly create (or destroy) jobs significantly impacting sentiment. This is why Governments in the region are increasingly keen to foster the development of bank lending to SMEs. Given this situation, a number of the larger banks in the region have established dedicated SME finance teams however, while this certainly helps, it does not necessarily make an immediate difference improving access to finance in all cases.
% of Firms with a Loan/Line of Credit from Financial Institution, MENA and Other Region 80% 70% 60% 50%
Africa East Asia and Pacific East Europe & Central Asia Latin America & South Asia MEN
The typical form of security required by banks is a mortgage over assets as well as personal guarantees from the owners/main shareholders. As such, asset-light SMEs with strong cash generation that require growth capital, can often find it difficult to raise flexible debt financing.
40% 30% 20% 10% 0%
SMEs
Sources: World Bank (January 2011)
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At Gulf Capital, we believe that this new emphasis on SME bank lending will be an evolutionary rather than revolutionary process as SMEs move from being primarily financed on the basis of the assets they can pledge to lenders (on a LTV or Loan to Value approach) rather than the amount of cash flow they generate.
Large
Banks in the region are also typically very cautious when it comes to cross border transactions (even to a bordering country in the
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region) with domestic clients being the main focus. Acquisition finance is something that in our experience SMEs struggle to raise and this would be especially challenging in the case of cross-border acquisition financing. The LTV financing approach also limits Private Equity’s ability to mix debt with equity when completing an acquisition of an SME. In Western Europe, the US and certain parts of the Far East, private equity (PE) investors typically secure debt financing either via banks (senior bank loans, and/or mezzanine/subordinated loans) or via the capital markets, (high yield bonds). In some cases, both instruments are combined. In the MENA region, where there are no established sub-investment grade capital markets and only a few examples of institutional credit investors, PE investments are typically fully equitised (i.e., not supported by a combination of debt and equity). We believe that this is holding back the development of PE in MENA. Why is this the case and why does it matter? There are some peripheral reasons for this situation like the lack of need for the tax shield that debt provides in countries with higher levels of taxation, which can make debt less attractive in the MENA region. However, in our view the main constraint on SME corporate and PE-related financing is not due to the lack of demand but rather the limited supply of structured lending. When asset-light borrowers seek growth capital in the form of an acquisition or a capex loan, lenders are often required to take a view on future cash flows rather than relying mostly on the present situation of the borrower. We believe this structured lending approach is not yet widespread enough in the region. The core of structured lending, we believe, is to analyse and quantify the future financial benefits of a proposed growth plan and carry out detailed due diligence on the borrower’s financial and commercial prospects. In short, for asset-light businesses, ascertain whether the growth plan generates sufficient additional free cash flow to repay the loan or bond under a realistic scenario (cash flow approach) rather than determine whether a mortgage on assets will give the lender sufficient asset coverage (asset approach). Why does this matter? Put simply, structured cash flow lending is required to maximise regional entrepreneurs’ growth and PE investments’ profitability. For example, a strong corporate with