The Bank of England released its latest figures on bank lending in the UK on Monday, revealing that £18.8 billion of new credit was extended to SMEs in the third quarter of the year – down from £20.5 billion in the second quarter, a fall of 8%.
In total, £56.1 billion of gross lending facilities have been extended to SMEs in the UK so far this year.
When Project Merlin was announced in February, Barclays, HSBC, Lloyds, RBS and Santander stated a capacity and willingness to lend £190 billion of new credit to business this year, £76 billion of which would be to SMEs. The £56.1 billion figure is therefore 75% of this target but is £1 billion short of the £57 billion target set for the third quarter.
This would suggest that things are almost going according to plan, but credit conditions in the market show little sign of improvement. “Debt finance for SMEs has never been easy,” explains Bob Press, CIO and founder of Trafalgar Capital Advisors in London. Trafalgar runs a global credit fund focused on lending to primarily listed SMEs in the UK.
“From 2004 to 2007, there was a hiatus in this trend thanks to easy credit, but the market has now reverted to how it was before – but to an extreme,” adds Press.
Citi has also emphasized the poor lending conditions in the market, casting doubt on the efficacy of Project Merlin. “This apparent achievement of the Project Merlin targets probably is not translating into any genuine overall improvement in the availability and cost of credit for small firms,” says Michael Saunders, head of Western Europe economic research at the bank. “We suspect that, in aggregate, banks are meeting their Project Merlin targets by making credit available at a high price and on tough terms that few firms can afford to meet.”
Saunders says that the cost and availability of credit for small firms will remain poor unless the government takes a far more prescriptive and forceful approach to the banks – such as running the nationalized banks on non-commercial grounds, ordering them to lend more to UK firms at low rates and, if necessary, changing the management to achieve this.
Given the unlikelihood that any of these suggestions will happen in the near future, SMEs face an extremely tough funding environment – something that Andrew Haldane, the Bank of England’s executive director of financial stability, is acutely aware of. He has called for dynamic risk weightings to be permitted, whereby banks could reduce their capital buffers in times of economic stress to free up capacity for lending.
In the meantime, sources of funding for small businesses remain scarce. “The flight to quality has seen investors focus on larger corporates and the collapse of the small cap publicly listed markets,” says Press. His firm recently launched a pre-IPO fund to provide bridge financing for firms looking to list on small cap exchanges or listing platforms in the UK, US, Ireland, Germany and Dubai.
Listing might not be top of the agenda for many small businesses that are struggling to fund themselves and Press emphasises that this is a niche solution for niche businesses.
The new fund, the cumbersomely entitled PreIpo2Ipo Fund, has been launched via strategic partnership with Marylebone Fund Management. Targeted at high net worth individuals, the fund does not invest in the companies directly but in a pre-IPO convertible note. It then walks through the listing with the company and the note converts at a private valuation rate on listing. This is a capital formation option only for companies that are cash flow positive, scalable and simple to understand, but is an example of the kind of niche solution upon which small companies are increasingly having to rely.
Bank of England data show a marginal improvement in net lending (the difference between gross lending to and gross repayments by UK private non-financial corporations) for the third quarter to 0.4 from -4.3 in the second quarter and -2.8 in the first.
At the end of November, Chancellor George Osborne is expected to announce details of a credit-easing scheme, which could see £4 billion made available for direct lending to businesses by the state – seen by some as a tacit admission that Project Merlin has not worked. The scheme is expected to stimulate a retail bond market for SMEs by providing government guarantees for issuance.
Any such intervention to stimulate capital availability will be widely welcomed if companies take advantage of it. As Press at Trafalgar points out, the most crucial factor in small business success is not necessarily availability of funding, it is management quality.
“It has been our experience that most small business failure is related to lack of management execution and systems, and while availability of capital is a contributory cause in many instances, it is generally not the primary causation,” he tells Euromoney.
