Elsevier

Global Finance Journal

Volume 43, February 2020, 100450
Global Finance Journal

Assessing the credit worthiness of Italian SMEs and mini-bond issuers

https://doi.org/10.1016/j.gfj.2018.09.003Get rights and content

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. We believe “mini-bonds” can be a success in Italy as long as the market supplies an attractive risk/return tradeoff to investors as well as affordable and flexible financing for borrowers. Assessments of credit risk must be convincing and objective, providing complements to the traditional rating agency process. 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 so far. Our findings confirm that the amount of information asymmetry is still high 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.

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. 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.

Section snippets

The emergence of mini-bonds in Italy

To answer the call for wider credit accessibility for SMEs in Europe, a few countries have experimented with bond financing. For example, in Germany, the mechanism is called “Mittlestand-Anleihen Bonds,” but its growth and impact has been mediocre, at best. In Italy, the market for SME bonds is known as “mini-bonds,” and it is this market that we address in this report and suggest a critical ingredient to its eventual success.

Mini-bond is not a technical term: it is used in Italy to refer to

Ingredients for a successful bond market

Any financial market, if it will survive and provide an important function to economic growth, must provide proper incentives to issuers, investors and market intermediaries. The latter, through its underwriting, research and secondary-market trading operations, have always been crucial to financial market development. A good example is the growth of the high-yield/non-investment grade bond market in the U.S. and, of late, in Europe. The former now comprises over 2300 firms with at least $1.6

The ZI-score SME model2

To achieve the required risk assessment transparency, we suggest strongly that models be introduced and tested, built specifically to estimate default risk on Italian SMEs. Since the Min-bond market is very new, there does not yet exist data to include recovery rates on defaults nor any long-term market default rate statistics. We suggest, therefore, to concentrate on individual issuer default probabilities, an area we have had considerable experience in and now focus upon for Italian SMEs (see

Model development

The main idea is compare the financial profiles of Italian SMEs, which have either defaulted or not in the past, in order to build a multivariate model for predicting the probability of default of those firms who have already, or could potentially, tap the mini-bond market for debt financing. The model(s) also can indicate the relative health of firms within specific sectors.

Based on a database extracted from AIDA, we assessed 15,452 active and 1000 non-active Italian SMEs.3

Variable selection

The next step in the model building process is to identify a number of variables that could be helpful indicators of firm credit worthiness. Consistent with a large number of studies, we choose five accounting ratio categories describing the main operating and financial aspects of a company's profile. As shown in Fig. 5, these include measures of liquidity, profitability, leverage, coverage and activity. In some cases, statistical transformations are performed, such as logarithms, to enhance

Model results

We utilize a logistic regression technique, whereby a forward step-wise variable selection method determined the final variable-set for each of the four sector models. The resulting models included a range of 6 to 8 variables, each subject to several transformations to enhance their predictive power. Each model was built on an original sample of 80% of the total sample, with holdout (secondary) samples for our test results on 20% of each of the defaulted and non-defaulted SME groups.

Based on

Bond rating equivalents and probabilities of default

While it is useful to assess the accuracy ratio of a Default-Non-Default statistical model, the bi-variate result does not indicate the probability of and the expected timing of the default. These dimensions are critical for investors in terms of assessing the investment risk/return tradeoff and also are extremely helpful in providing an important metric for the relative health of firms across sectors and over time.

In order to provide additional measures of credit worthiness, we introduce the

Assessing the SME ZI-score model on Italian mini-bond issuers

We assessed the credit worthiness on a sample of 102 Italian mini-bond issuers that have issued mini-bonds in the last three years. Only a few companies (5) could not be analyzed due to lack of sufficient financial data. The size of the Mini-bond issuers' sample, registered and traded in the secondary market by Borsa Italiana, were slightly larger than the SME population that we used to construct the four sectors' credit scoring models. We therefore felt it appropriate to assess this mini-bond

Conclusions

The SME ZI-Score model is a powerful tool that provides an assessment of a company's risk profile based on the last two years of financial information. Based on four separate models, each specifically developed for a major industrial sector category, the family of ZI-Score models successfully classified and predicted default or non-default on large samples of Italian SMEs. Utilizing creative transformations of standard financial ratio metrics and combining them with powerful statistical

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