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As inflation rises, SME lenders become essential

Due to COVID-19 restrictions, the SME sector has faced many challenges over the past few years.

With inflation rates at an all-time high, alternative lenders have become essential for survival.

“It’s at a critical point today. Employment costs are rising and energy costs are rising. For any business, this is going to be difficult going forward,” said Ravi Anand, managing director of alternative lending company, ThinCats.

Ravi Anand
Ravi Anand

According to additional, after a sharp drop in inflation in 2020 to 0.68%, it skyrocketed to 2.43% in 2021 within the European Union. This level remained high, with Eurostat signaling a continued increase to 5.9% in February 2022.

The main component of this development was energy, which reached 32% inflation in February.

Increased sanctions due to the Russian invasion of Ukraine have resulted in restricted access to oil and high prices as it continues.

Chart showing inflation levels

This, together with the expected inflation after the recovery from the COVID-19 pandemic, is contributing to the surge in inflation, which will continue to affect the SME sector.

ThinCats Receives Additional Funding for Pandemic Recovery

ThinCats, which primarily focuses on providing alternative financing to medium-sized SMEs, has been of significant help to their clients during the ongoing recovery from the COVID-19 pandemic. Reported for loaning out a record £318m in 2021, they recently announced they had secured a further £100m from their current investment partners, Insight Investments.

“We’ve been with Insight since 2018,” Anand said. “Their portfolio went through COVID and out the other side, and because it performed well, they decided to expand their funding line.”

ThinCats is a balance sheet lender, putting its capital at risk while receiving funding from senior lenders. They work by syndicating loans, receiving portions of a loan from different primary lenders. Diversity within the portfolios is improved and their own balance sheet risk, mainly focused on large cash flow loans not secured by assets, is managed.

Thincats SME finance statistics
ThinCats Funding Statistics

“Some challenger banks may have certain straitjackets in terms of credit, policy and industry constraints…the higher risk weighting discourages them from lending without collateral,” Anand explained.

“As you increase the size of the loan, the skill set required to understand the business increases. We have tried to create people, processes and systems to cater to this cohort (of non-asset based businesses) and fill the void left by banks for over 20 years. He continued.

Medium-sized SMEs see their growth

Between April and December 2020, SMEs increased their capital borrowing to survive the heavy restrictions of the COVID-19 pandemic.

The borrowing varied according to the size of the business. Thirty-five per cent of small businesses are receiving funding, amounting to £45billion, mostly from the government-backed Bounce Back loan scheme. Only 18% of medium-sized companies did the same.

According to them booksThinCats saw a 60% increase in net cash for midsize SMEs, indicating that borrowing has led to business growth.

They predict that the mid-sized sector will continue to thrive in the future, with insolvency returning to pre-pandemic levels and not much higher in the next few years.

The same is not true for small SMEs. Higher borrowing rates only marginally increased net cash by 5%, painting a picture of survival rather than recovery and growth.

Funding circle logo

SME loans

Although ThinCats focuses on the middle market sector, there have been many other alternative lenders supporting small and micro businesses over the past few years.

Primarily data-driven, alternative lenders for SMEs have vast portfolios of thousands of small businesses. The portfolios of lenders such as ThinCats, on the other hand, consist of a few hundred.

Funding Circle is one of the small business focused alternative lenders in the SME sector. Originally a peer-to-peer lending platform, the company offers on-demand business loans. Lending decisions are made quickly with low interest rates by connecting businesses to investors.

Although initially working with institutional and retail investors, in April 2020 the platform closed to the retail investor sector. This represents 5% of the total credits managed by the platform.

Funding Circle SME Loan Growth Charts

Globally, the firm has facilitated borrowing for 122,000 businesses, worth £13.5 billion, and has been accredited by the UK government to lend up to £350,000 through the through the Covid Recovery Loan Scheme.

By providing and managing a range of loans, from sole traders, unsecured commercial loans to small business loans, they provide customers with ease of use. Applications take 10 minutes to complete and funding within 24 hours of decision.

They have offered facilitation of various supports during Covid, including tax deferrals, future coronavirus funds, and various trade subsidies and tariffs.

High levels of defaulted loans expected

While they are functional and maintain a positive rate of return, they also predict high levels of loan defaults and reduced rates of return in the years to come.

In the retail earnings statement released in 2021, they said: “A range of measures have been introduced to support small businesses through the impact of Covid-19, including payment plans offered by Funding Circle and government stimulus.”

“As defaults reduce investor returns, the actual annualized return is higher than it would be if this support were not in place. As economic conditions return to normal through 2021, we expect that this will result in an increase in defaults and a reduction in the real annualized return.

According to their statistics, the amount remaining to be repaid at the end of the year, excluding bad debts, has continued to increase. Loans fell slightly between 2020 and 2021 after increasing by half a billion globally between 2019 and 2020.

Alternative financing essential to move forward

“There will be a lot of issues around employment in the supply chain and general inflation. I think the banks will become a lot more cautious… that plays into the hands of alternative lenders,” Anand said.

Although medium-sized SMEs recorded an increase in net cash, a sign of greater resilience to the difficult economic climate, small SMEs did not experience the same growth. Higher levels of borrowing at the height of pandemic restrictions may lead to higher levels of loans in default due to inflation and higher costs incurred.

The reduction in bank lending, given the higher risk involved, creates a ripe market for alternative lenders.

“(Alternative lenders) have been lenders where banks have struggled to take care of their customers… Coming out (of the pandemic), we are seeing that banks’ appetite is more limited, driven by many losses due to the Bounce Back Loan Scheme (BBLS). ). In general, banks tend to be more conservative when it comes to lending,” Anand said.

“What we can do is look through this and look at good companies in weak sectors and avoid bad companies in good sectors. Industry dynamics are important, but that doesn’t mean all companies are the same. Within this framework, we can finance growth.

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