Private debt can step up to help fill 'funding gap' for SMEs

The series of crises experienced over recent months and years has had a marked impact on European SME credit markets. Each new wave of uncertainty has brought some unpleasant recollections of the 2008 global financial crisis, with additional apprehension having abounded in the last few months as the stories of Credit Suisse, Silicon Valley Bank and First Republic Bank have played out.

Over the last decade, there has been a significant retrenchment from SME lending by the traditional banking sector, and the uncertainty of recent years, brought on by Brexit, COVID-19, the war in Ukraine and inflation, has only served to amplify this trend. Uncertainty is likely to continue in years to come, whether from elections in the US or UK, the continuing geopolitical tensions between the US and China, or the effects of rising interest rates on macroeconomic conditions.

At DunPort Capital Management, we’ve seen bank retrenchment in each of the markets in which we operate, with alternative lenders increasingly filling the gap.

For example, in the Benelux region, the number of traditional credit institutions has fallen by over 60pc between 1998 and 2018 and in the last year alone, UK SME lending fell by ￡14bn to ￡195bn. In Ireland, the traditional SME lending market has narrowed significantly in recent years due to a number of banks departing the market. Between December 2010 and December 2021, the amount of bank credit outstanding with non-financial SMEs in Ireland declined from €27.1bn to €12.7bn.

The scale of this retrenchment has created a funding shortage for SMEs and lower mid-market private equity sponsors, and with that comes opportunities for private lenders to fill the void. In the UK, traditional banks have lost market share to challenger and specialist banks, who have grown to a roughly equal share of new SME lending. Across the EU, private debt as a share of SME lending grew from 34pc in 2010 to 70pc in 2021.

However, not all segments of the market are equally supplied by capital from private credit funds, with the lower mid-market being particularly underserved in recent years.

At DunPort, we’ve identified the lower mid-market as an area in which SMEs and financial sponsors are underserved, and in which there are many opportunities to deploy capital at attractive risk adjusted returns. We focus on businesses generating EBITDA between €1m-€10m and since the team formation in 2013 we have lent over €1bn to SMEs across Ireland, the UK and Benelux, providing flexible solutions for stable, cash generative businesses. We give promoters and sponsors visibility of fast execution early in the appraisal process enabling the business to focus on its growth strategy. This includes funding acquisitions, management buy outs, re-financings and other corporate activities.

This year, while uncertainty continues to abound, our pipeline remains healthy as demand for flexible debt capital in the lower mid-market remains strong. At DunPort our expectation is that the banking sector will continue to remain cautious, creating opportunities for alternative lenders to increase their share of new SME lending. Our disciplined and highly experienced investment team stands ready to deliver, for borrowers, sponsors and our investors, despite the challenging macroeconomic climate.