Assessing the Credit Worthiness of Italian SMEs and Mini-bond Issuers

Abstract

A number of innovations have been introduced in the last five years to counter the devastating impact of credit rationing in Europe, particularly from traditional bank lending. This is a major problem for the small and medium size firms’ sector in Europe, which has also suffered from bank regulatory concerns of capital adequacy, heightened emphasis on default risk of bank counterparties and the general malfunctioning of credit extension and private sector growth. In Italy, some of these less traditional sources of funding for SMEs have started to become more popular and the development of the mini-bond market is a clear example. In this study, we develop a new innovative model to assess SMEs’ creditworthiness and we test it on the companies that have issued mini-bonds from this market’s inception in 2013 to 2015. These models are constructed not only for Italian SMEs, but specific models for four distinct industrial sectors are also provided. Furthermore, we apply, for the first time, Altman’s Mortality Rate Approach to determine the Bond Rating Equivalent and the probability of default for the SMEs that have issued mini-bonds. We review the risk/return tradeoff of the new bond market and confirm that the amount of information asymmetry is significant, potentially reducing the number of investors and small businesses that would be interested in using this new channel to fund their business growth. Last, we prove that the risk profile of the SMEs that have issued mini-bonds in the period considered is better than the average of our SME development sample. This supports the conclusion that SMEs that have chosen the new mini-bond market have done it consciously and not because they could not access bank lending.

I. Introduction

In the years following the last financial crisis, the credit transmission channel has been damaged as regards to the quantity, price, and distribution of credit. This is a major problem for the small and medium size firms’ sector in Europe, which has also suffered from bank regulatory concerns of capital adequacy, heightened emphasis on default risk of bank counterparties and the general malfunctioning of credit extension and private sector growth. New regulatory requirements have forced banks to offload inventories of corporate and mid-market debt assets, and to scale back traditional lending for the foreseeable future. Banks are mandated to simplify their businesses and shrink balance sheets. In 2012, the International Monetary Fund estimated that European banks needed to reduce their asset base by $2.6 trillion. Being heavily reliant on traditional bank lending, small and medium-sized enterprises (SMEs), are confronted with difficult financing constraints in a deleveraging environment. This has been especially true in Italy.

A number of innovations have been introduced in the last five years to counter the devastating impact of credit rationing in Europe, particularly from traditional bank lending. Both, large corporates and SMEs have started to drastically reduce their reliance on bank lending supporting the development of new alternative sources of funding.

For larger enterprises, especially in Northern Europe and the U.K., the high-yield, non- investment-grade bond market has grown from about €100 billion in 2010 to almost €500 billion by the end of 2015, with almost 700 different corporate issuers, of late. But, this market is only available to relatively large corporates. For smaller entities, and retail credit in particular, the internet-based “crowd-funding” market has shown considerable growth and promise, but still lacks regulatory scrutiny, size and sustainability issues persist in anticipation of continued tepid macroeconomic growth and a possible new economic downturn. In addition, non-bank market-based lending, or shadow-banking, from institutional lenders can improve the flow of credit to SMEs, but will not be sufficient, in our opinion, to provide wide participation to the varied types of SMEs across Europe.

Private debt is emerging as an important funding component for fast-growing, medium- sized companies, whose capital structure and competitive advantage have been seriously challenged by the new banking regulatory environment (Basle III) and the heightened globalization forces. Private debt comprises mezzanine and other forms of debt financing that comes mainly from institutional investors such as funds and insurance companies – but not from banks. In contrast to publicly listed corporate bonds, private debt instruments are generally illiquid and not regularly traded on organized markets. They originate in the UK and the USA, where they are an established form of funding and have long been used for financing growth and buyouts, but new initiatives are spreading across Europe.
In this study, we build upon several studies (Altman and Sabato, 2005, 2007; Altman et al., 2009; Ciampi and Gordini, 2013; Ciampi, 2015) to develop a new innovative set of models at industry sector level to assess SMEs’ creditworthiness and we test it on the companies that have issued mini-bonds since the market’s inception in 2013 to 2015. Our findings confirm that the amount of information asymmetry is significant in the market and is affecting the level of risk/return trade off potentially reducing the number of investors and small businesses that would be interested in using this new channel to fund their business growth. We improve upon the existing literature in various ways.

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