Small and midsized enterprises (SMEs) are the engine room of many economies, making a significant contribution to gross domestic product and total employment. Despite their contributions to the economy, access to finance for many SMEs is often challenging, creating barriers for future expansion and growth. In recent years, the increasing presence of financial technology (often called fintechs) has opened up the SME lending landscape as financiers leverage their predictive data analytics and pervasive networks to capitalize on lending opportunities and risk monitoring to an under-served market.
The use of securitization as a funding source for the SME sector is gaining traction in Asia-Pacific, particularly in Australia and China, where the respective governments are taking measures to address ongoing funding challenges for this sector. S&P Global Ratings discusses here the unique risks of the SME sector, the variety of related securitization tools, and some of the analytical approaches that have been used to rate this asset class globally.
What Is An SME?
The definitions of an SME vary across jurisdictions but they generally benchmark to revenue or asset size, and number of employees (see table 1).
Table 1
SME Characteristics | ||
---|---|---|
Definition of SME | China* | Australia** |
Number of people employed | ||
Mid: 100-300 employees | Medium: 20-199 employees | |
Small: 10-100 | Small: <20 | |
Micro: <10 | Micro: <1-4 | |
Typical loan size | ||
Lease: <RMB 20 million | Small business lending: <A$2 million | |
Others: <RMB 5 million |
Banks are the major providers of SME finance outside of micro finance and equipment leasing in many markets. For many banks, the provision of collateral is a key determinant in setting the terms of the loans, including the loan size and interest rate payable. This in part reflects the lower bank capital charges for loans where collateral, such as residential property, is provided as security.
Unique Risks Of SMEs
Lending to SMEs is perceived as riskier than lending to larger, more established businesses. Some of the more common risks associated with the SME sector include:
- Blurred line between entrepreneurs' or small business owners' personal and business finances.
- Business cash flows are more sensitive to prevailing economic conditions, making SMEs more vulnerable to macroeconomic volatility.
- Less financial flexibility given their smaller size.
- Risk of business failure is higher given the smaller operating scale and business concentration risk.
- Heightened geographic risk as small businesses are more likely to operate in narrow geographic markets and have a greater sensitivity to local demand conditions.
- Difficulty in access to financing and the price of financing is often high particularly if lending is unsecured.
- Disruption risk is higher because business success is often tied to the performance of a few key individuals or the provision of a limited range of services.
- Performance data including default and loss history is often limited given the shorter duration of business operations and less sophisticated reporting systems of many SMEs.
The unique risks of the SME sector make debt financing a challenge. These risks also translate to significantly higher funding costs for SMEs compared with larger corporates. Emerging technologies including big data analyses, cloud computing, artificial intelligence, and blockchain are altering the financial services landscape, enabling new data sets to be incorporated into future credit and risk pricing decisions, often by new lending entrants. For instance, financing affiliates to e-commerce operators use network analysis of transactions to evaluate operation conditions of the obligors through more intimate observation of their business activities. In addition, banks are increasingly using their cross-sector knowledge and alternative operations data to assess businesses' performance trend. These advances will enrich existing data sets and facilitate greater transparency of the SME sector over time, which should ultimately improve access to finance.
Analytical Framework For Assessing Credit Risk
The framework we have adopted to analyze credit risk in SME securitizations will in part reflect the SMEs' loan purpose. The loan purpose of SME financing typically falls into two categories: working capital financing and fixed asset financing (see table 2).
Table 2
SME Loan Purpose And Financing Type | ||||||
---|---|---|---|---|---|---|
Working capital financing | Fixed asset financing | |||||
Loan types | ||||||
Trade credit finance. | Equipment leases. | |||||
Accounts receivable financing (factoring). | Small business loans backed by the proprietor's equity in the family home. | |||||
Line of credit. | Inventory finance. | |||||
Secured or unsecured | ||||||
Mostly unsecured. | Secured. | |||||
Typical financiers | ||||||
Banks or specialist lenders. | Leasing companies. | |||||
Online lenders. | Banks. | |||||
Factoring companies. | ||||||
S&P's applicable rating methodology | ||||||
Consumer Receivables Criteria. | Equipment Leasing Criteria. | |||||
Trade Receivables Criteria. | RMBS Criteria (specific assumptions may also be applied). | |||||
*Small Business Loan-Backed Securitization Criteria. | ||||||
§SME CLO Criteria. | ||||||
Note: Depending on the availability of data, concentration risk in specific pools and the transaction structure (e.g., closed or revolving), more than one rating methodology may be applied in the determination of ratings. *Small Business Loan-Backed Securitizations Criteria apply to U.S. small business loan securitizations backed by static pools. §SME collateralized loan obligations (CLO) criteria apply to CLOs backed by granular and well-diversified pools of loans to European SMEs. |
Other factors to be considered in determining the most appropriate analytical approach or combination of approaches include:
- Size of the portfolio and any inherent borrower concentration risks.
- Secured versus unsecured nature of assets being securitized.
- Revolving or closed pool structure.
- Quality and duration of performance history data including default and loss data.
- Esoteric nature of the securitized assets and the servicer transition risk.
- Uniqueness of and dependence on proprietary operating platform
S&P Global Ratings has rated a number of SME securitizations in different jurisdictions. We outline below some of these transactions including the criteria applied and unique operational risks (see table 3).
Table 3
SME Transactions Rated By S&P Global Ratings | ||||
---|---|---|---|---|
Transaction Name |
OnDeck Asset Securitization Trust II LLC |
|||
Collateral Type | Loans made to U.S. small businesses to fund their working capital needs. Loan sizes range from US$5,000 to US$500,000. Loan terms range from 3 to 36 months. | |||
Criteria Applied (Credit Analysis) | * U.S. Small Business Loan-Backed Securitizations and Asset Backed Securities Equipment Loans and Leases. | |||
Unique Operational Risks | Seller and servicer is an online platform for small business lending founded in 2006. Warm back up servicer in place to mitigate servicer transition risk. | |||
Closed or Revolving Pool | Revolving pool. Amortization triggers, eligibility criteria and concentration limits in place. | |||
Transaction Name |
CAN Capital Funding LLC |
|||
Collateral Type | Loans and merchant cash advances (MCAs) made to U.S. small businesses to fund their working capital needs. Loans and MCAs are highly diversified in terms of business sector and location. | |||
Criteria Applied (Credit Analysis) | * U.S. Small Business Loan-Backed Securitizations and Asset-Backed Securities Equipment Loans and Leases. | |||
Unique Operational Risks | Seller and servicer is an online platform for small business lending founded in 1998. Warm back up servicer in place to mitigate this risk. | |||
Closed or Revolving Pool | Revolving pool. Amortization triggers, eligibility criteria and concentration limits in place. | |||
Transaction Name |
Small Business Origination Loan Trust 2016-1 |
|||
Collateral Type | Peer-to-peer originated unsecured U.K. SME loans. Average outstanding principal balance of loans -- £48,502. Pool is highly diversified and granular. | |||
Criteria Applied (Credit Analysis) | European Consumer Finance | |||
Unique Operational Risks | Seller and servicer is an online platform for small business lending founded in 2010. Warm back up servicer in place to mitigate this risk. | |||
Closed or Revolving Pool | Closed pool. | |||
Transaction Name |
Liberty Series 2016-1 SME |
|||
Collateral Type | Fixed and floating-rate loans to commercial borrowers secured by a first registered mortgage over Australian commercial or residential properties. | |||
Criteria Applied (Credit Analysis) | § Principles of Credit Ratings. | |||
Unique Operational Risks | Higher degree of subjective assessment applied than traditional RMBS, given the limited historical data, diversity of products, security, obligors and the smaller loan pools. | |||
Closed or Revolving Pool | Closed pool. | |||
Transaction Name |
Far East Leasing 2019-1 Asset Backed Notes Trust |
|||
Collateral Type | Chinese lease receivables secured by leased equipment relating to the machinery, consumer, and retail business segments. | |||
Criteria Applied (Credit Analysis) | ABS: Equipment Leasing Criteria: Credit Risks Evaluated In Lease-Backed Securitizations. | |||
Unique Operational Risks | Lack of experience in servicing transition in China's securitization market. | |||
Closed or Revolving Pool | Closed pool. | |||
Transaction Name |
Think Tank Series 2018-1 Trust |
|||
Collateral Type | Fixed and floating-rate loans to commercial borrowers secured by a first registered mortgage over Australian commercial or residential properties. | |||
Criteria Applied (Credit Analysis) | § Principles of Credit Ratings. | |||
Unique Operational Risks | Higher degree of subjective assessment applied than traditional RMBS, given the limited historical data, diversity of products, security, obligors and the smaller loan pools. | |||
Closed or Revolving Pool | Closed pool. | |||
* Due to the revolving nature of the asset pool, small business loan securitization criteria was supplemented with the ABS Equipment Leases criteria. § Assumptions outlined in Australia RMBS criteria were also applied, where there were similar factors that affected borrower performance. |
The Data Conundrum
One of the key challenges for new entrants wanting to utilize securitization as a funding tool is the provision of historical loss data. This may be due to the availability of limited performance history or the lack of reporting systems to track default and loss data in a way that can be easily extracted.
Where we do not have the benefit of full data sets on how the loans have performed over a long horizon, or data corresponding to a stressed economic environment, we typically adjust our credit-loss assumptions accordingly.
Over time, the accumulation of more granular data sets in credit assessments may result in a better ability to estimate potential losses in a variety of economic stress scenarios. Data observations on borrowers' behavior obtained during relatively benign economic conditions might not be indicative of how borrowers are likely to behave during an economic downturn though. This may result in the use of higher range multiples or rating caps to address limited performance data for some issuers.
The stability of financiers' operation models and targeted borrowers also could be important consideration for our rating analyses. Due to the highly fragmented and diverging SME customer base, past data may be less relevant to forecast future performance if we believe their business models have yet to stabilize. These factors again could result in our use of high range multiples or rating caps.
The Fintech And The Facilitation To SME Finance
Fintech may address the risk to SME financing, because of its ability to increase the availability of alternative business performance-forecast data and the tools for credit analyses. Across the region, financiers related to e-commerce giants and traditional banks have been able to expand their footprint in SME lending in a more efficient way.
By exploiting vast amounts of data using sophisticated algorithms, fintech behemoths in China have become the new digital financiers to merchants operating on their e-commerce platforms. Their visibility to the payments and transaction data gives them access to large amounts of information that could help inform lending decisions. Traditional commercial banks are also ramping up efforts to reach their customers through e-channels, digitize their cross-industry knowledge, leverage their advantage in businesses' cash management, and employ big-data analyses. These practices address the typical difficulty of SME finance--the lack of network to reach SME borrowers, and the shortage of reliable operation data on operations to facilitate credit decisions.
Securitization transactions in China supported by SME merchant finance receivables and loans have been available since 2014, through the general micro-loan securitization or SME CLO names. Asset performance has been stable, according to market disclosure, partly due to the use of new data sets obtained through affiliated data sets and networks to estimate credit losses, which expands understanding of borrower behavior. The operational linkage to the proprietary platforms or ecosystem, however, may create performance dependence with the respective banking, e-commerce, and payment platforms.
Marketplace Lenders--The Bank For The 'Underbanked'
Following the global financial crisis, stricter regulation and capital requirements for traditional lenders led to reduced access to credit for particular consumers and businesses, including SMEs. A consequence of this was the rise in demand for alternative sources of credit. The marketplace lending (MPL) industry grew in line with these developments, benefiting from an innovative use of technology, the absence of regulatory capital requirements and legacy IT architecture, and the cost benefit of not needing brick and mortar storefronts.
The terms "P2P lending," "marketplace lending," and "alternative finance" are often used interchangeably to group together an array of originators and services in an industry that provides a diverse range of loans to both consumers and businesses. The business application could be very different across the markets, but the common denominator between all of these companies is their use of financial technology to connect borrowers with lenders and to underwrite loans using significantly automated algorithmic processes. As lending volumes have increased and their MPL platforms have increasingly diversified their investor base, particularly via the use of institutional partners, securitization of MPL assets has also become increasingly prevalent (Marketplace Lending Securitization: Operational Risk Is Declining As The Sector Evolves, June 3, 2019).
With the growing number of participants in the sector, the range of product offerings has expanded to include personal loans, consumer loans, mortgages, student loans, home improvement and SME loans.
In China, despite the relatively small scale, P2P lending provided important financing to some SMEs through business owner loans. However, this industry drew broad market attention more recently due to the number of operators that have failed and the many controversial business activities that have been revealed. China regulators increased market-cleaning efforts in recent years, and the focus includes a proper business review and registration for qualified operators, and responsible origination, and funding processes. The general expectation is further industry consolidation and more stringent risk management will prevail in the future.
In Australia, there are clear requirements for MPL platforms published by the Australian Securities and Investment Commission (ASIC). These state that under Australia's financial services and credit laws, providers of marketplace lending products and related services will generally need to hold an Australian Financial Services (AFS) license and an Australian credit license if the loans made through the platform are consumer loans (see "Marketplace Lending Securitization: Operational Risk Is Declining As The Sector Evolves," published June 3, 2019).
Distinct Operational Risks In Marketplace Lending
In addition to asset specific criteria, S&P Global Ratings considers operational risks arising from the performance of key transaction parties, including portability, disruption, and severity risk. Distinct operational risks of the broader MPL sector include:
- Business strategy and operating history: Most MPL platforms have operated only through a period of benign economic expansion in a low interest rate environment and have not been tested through a downturn. To compensate for these risks, our stressed default and multiple assumptions may be more severe than would otherwise be the case.
- Management: Length of time, experience, and strategy of the company are considered in our analysis. We have observed comparatively higher management turnover in the MPL space versus traditional lenders.
- Revenue and financial performance: Many MPL platforms' primary sources of revenue are origination and servicing fees. As such, there may be materially less "skin in the game" versus traditional lenders.
- Funding sources: We will look at the mix of institutional, retail, balance sheet, and securitization funding to determine the breadth and depth of the MPL platform's financial support. Funding diversity is important as an overreliance on one form of institution can lead to liquidity shortfalls.
- Partner bank relationship incentives: We will review the incentives in place aligning the interests of the MPL platform and partner bank.
We have observed a growing number of mitigants to these risks over the past few years, and have an increased amount of performance data from both MPL platforms and securitizations of these assets. In recent years, the maximum rating achievable from S&P Global Ratings for securitization of these assets has risen for some issuers.
Regulatory Impetus For SME Financing Is Gaining Momentum
Addressing funding challenges for SMEs has become a recent policy focus of both the Chinese and Australian governments.
Seeing the potential of a major credit dislocation in this sector, both the Australian government, and Chinese regulators have repeatedly emphasized their intention to support the sector, and encouraged financial institutions (particularly commercial banks) to increase their lending to SMEs. Various policy measures and strategies pursued by the Chinese government to help stimulate lending to the SME (including micro loans) sector include the following:
- Encouraging major banks to increase their lending to this sector by providing more liquidity support to the banking system, allowing for higher nonperforming loans (NPLs) and more favorable capital charge treatment on such lending;
- Alleviating the value-added tax for income from SME lending;
- Initiating and enhancing new/existing nationwide credit databases, to provide financiers better loan underwriting information of the targeted borrowers;
- Providing resources for risk sharing through the set-up of a national financing guarantee fund that will work with local supporting schemes to share the credit loss of SME lending; and
- Encouraging the securitization of banks' SME loans.
These measures have proven effective to date in increasing lending to the SME sector. By the end of 2018, for example, the outstanding loan amount to financial-inclusion micro and small enterprises (entities with the aggregate of outstanding loans and business loans to individuals and owners of the entities at no higher than RMB10 million) reached RMB9.36 trillion, or 21.8% higher than the year before, according to China Banking and Insurance Regulatory Commission.
The Australian government has created the Australian Business Securitization Fund (ABSF) with the mandate of aiding market development by attracting additional private sector investment to this sector.
Where To From Here?
The impetus provided by government support and the increasing penetration of fintechs will bolster the use of securitization as a funding tool for SME lending in Asia-Pacific. While the unique risks of this sector may warrant a more cautious approach to credit analysis and operational risk assessments, continued advances in technology and data analysis will enable greater understanding of credit risk. This should ultimately lead to a more accurate prediction of defaults over time and improve access to finance for SMEs from both banks and fintechs.
Related Research
- Australian Structured Finance: Credit Analysis In A Digital Ecosystem, Nov. 21, 2018.
- Marketplace Lending Securitization: Operational Risk Is Declining As The Sector Evolves, June 3, 2019
This report does not constitute a rating action.
S&P Global Ratings Australia Pty Ltd holds Australian financial services license number 337565 under the Corporations Act 2001. S&P Global Ratings' credit ratings and related research are not intended for and must not be distributed to any person in Australia other than a wholesale client (as defined in Chapter 7 of the Corporations Act).
Primary Credit Analysts: | Erin Kitson, Melbourne (61) 3-9631-2166; erin.kitson@spglobal.com |
Aaron Lei, Hong Kong (852) 2533-3567; aaron.lei@spglobal.com | |
Secondary Contact: | Kate J Thomson, Melbourne (61) 3-9631-2104; kate.thomson@spglobal.com |
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