Funding for businesses in Ireland has changed dramatically over the past eight years. That’s not to say it was perfect prior to the financial crisis, funding was so concentrated on property during 2004-2008 that many cash flow businesses without property assets also struggled to obtain support.
However, the departure or closure of several bank lenders has led to the current situation of a concentration of lending from a very limited pool. At the end of 2016, the combined market share of the three main lenders in gross new lending was 93%, evidencing the crucial importance of retail banks in the support of Irish Small and Medium Enterprises (SMEs).
Coupled with this increased reliance on a limited number of lenders, total outstanding SME credit in Ireland (excluding real estate credit) has fallen dramatically from €36 billion in 2010 to below €16.6 billion in March 2017.
This article is taken from the latest issue of Insights for Business Owners, a twice-yearly email publication which provides business owners with expert analysis of the latest economic & investment topics affecting corporates, as well as special features and profiles of leading business owners.
At Davy Corporate Finance, we work with clients throughout the country to help select and obtain the most appropriate source of debt or equity capital for their businesses. In this article, I aim to highlight how the three main banks should always be the first port of call for SMEs seeking funding and to give an insight into the changing landscape and the alternative funding that is emerging in the Irish economy.
The landscape change has been driven by necessity and in many ways the first source of alternative external capital has been friends and family. However, I will focus on institutional capital sources on the basis that their growth reflects an international evolution in SME funding whereby certain institutions have made significant businesses out of successfully targeting niche lending sectors.
Any funding requirement discussion should begin with the purpose of the funding sought, along with the urgency of the funds. Fundamentally retail banks seek to support SME growth plans but they provide loans, not equity so the competitively priced margin on retail bank lending reflects their relatively low risk appetite. Internationally that characterises the lion’s share of SME lending: relatively low risk lending at relatively low rates. The above statistic about the percentage of new lending coming from core banks reinforces this as the primary source of funding.
According to the European Central Bank President Mario Draghi, 80% of credit in the US is originated from capital markets, with just 20% from banks, whereas it is the other way around in the European Union with 80% coming from banks. Although the percentages can be disputed, the point is that specialised institutional funding is taking a larger role in commercial lending internationally and more recently in Ireland also.
Although such funds or companies often charge more, they generally provide certainty of delivery, quick response rates, specialised products, increased flexibility and higher leverage as their key selling points.
Unsurprisingly, most of the new lenders in the market target large companies and large loans, partly on the basis that the workload involved for a lender on a €100,000 loan is similar to a €10 million loan but the revenue is very different. This leads to greater difficulty for the many SMEs seeking to borrow amounts in the thousands - because of historic difficulties, they cannot obtain funding from banks. Again, the first port of call should be to the retail banks that are heavily targeting this segment of the market but there is an increasing number of finance providers that are providing valuable and competitively priced invoice discounting, asset finance and commercial loans to Irish SMEs.
Typically fund lenders concentrate on a very narrow segment of the market. Figure 1 illustrates some of the providers and products/sectors available. This is a sample of the credit providers in the market and is not fully exhaustive. We recommend that companies should seek professional assistance in selecting the appropriate financial product and provider.
Source: Davy, 2017
As outlined above, there are a myriad of products and lenders available in the Irish market, however, the challenge is often to narrow the company requirement to a select number of products and match them with the appropriate provider. Whereas all borrowers wish to borrow as cheaply as possible, some companies see merit in paying a slightly higher interest rate to reduce the annual loan amortisation (lower cash cost per annum can benefit growth companies) or indeed many companies now prefer to grant less security if possible, particularly when it comes to personal guarantees.
Another circumstance where alternative funders may become attractive is where a borrower has been frozen out by local banks either on account of historical financial problems or the requirement for a product that is not in line with the current bank policy. This may include situations where shareholders are seeking to raise capital to take money out of the business.
Private equity (PE) has been available in the Irish market for many years but is more readily available in recent years. These firms can invest in direct equity to acquire a business or to take control to fund consolidation. The main focus of PE firms is funding leveraged or management buyout-type takeovers and are a potentially interesting source of capital to a founder who is looking to sell their company and retire or move on.
Credit funds are a relatively new participant in the Irish lending scene. However, at least four different funds have already lent in excess of €100 million, with some lending in excess of €300 million in total. As such, these funds are representing an increasing proportion of new lending in the Irish market.
Typically credit funds seek to lend term loans of €5-50 million per transaction so they target the higher end of the market. Interest rates are generally higher than bank rates (although the gap is closing) and in return for those higher rates borrowers can obtain greater flexibility on other terms and higher debt levels.
By necessity, the funding landscape for Irish companies has changed significantly over the past 10 years. Changes are long term, and Irish companies will become more accustomed to dealing with non-traditional funding providers.
Many Irish companies have a degree of understandable nervousness about dealing with new lenders. However, companies with a proven ability to repay should make lenders compete for their business, while lenders should be prepared to back their success.
The refinancing and borrowing landscape in Ireland has changed and we recommend that Irish companies seek professional advice to ensure they are aware of the extent of products and providers available. If you would like to hear more about how Davy Private Clients and Davy Corporate Finance can help your business with its funding requirements, please contact a Davy adviser.
Davy Corporate Finance is regulated by the Central Bank of Ireland.