With billions being pumped into infrastructure, energy, commodities and technology, what industries are being underserved and why? To plug the liquidity gap, the global debt market continues to see a shift from conventional bank lending to alternative forms of funding, ranging from debt funds to debt capital markets issuances – but is this trend sustainable in Africa? Development finance institutions ("DFIs") and multilaterals have historically held a solid lending track record across the continent – but to what future impact? Are commercial banks being squeezed out as a result?
Alternative lending in the corporate context can the corporate lending context and include a wide interpretation, to include: non-banking lending to, for example small and medium sized enterprises (“SMEs”), to a multi-partner approach on larger financings for corporates and to the use of the debt capital markets for both sovereigns and corporates.
Are the trends we are seeing in the alternative lending space being reflected in Africa?
From a private equity manager’s perspective, there is not enough availability of private credit investment in Africa – this creates opportunities as well as challenges. Private credit accounted for about 2% of the financings that occurred in Africa in 2017 – contrast this with Asia, which experienced investment of over $7 billion worth of private credit. With respect to domestic credit expressed as a percentage of gross domestic product (“GDP”), the figure is 21% for sub-Saharan Africa.
This figure is 192% and 134% for the United States of America and the United Kingdom respectively. It is apparent that there is limited lending in Africa on the commercial and the private credit side and the boom being experienced in the United States of America or Asia, for example, is not being reflected in Africa on a relative basis. The aim for public and private entities should be in ensuring that SMEs have alternative financing solutions apart from offering traditional equity, considered as a last resort by many smaller businesses.
There is a mismatch between businesses and banks as banks require a minimum annual turnover before committing to lend – it may be that this leads to a perception issue that influences private credit's tendency to take a cautionary approach to investing in such businesses.
Spotlight on SMEs
The SME funding gap is well documented. The World Bank Group has conducted a number of studies on this, which estimates that globally the gap for formal SMEs is as high as US$1.2 trillion, with half of formal SMEs having no access to formal credit.
Approximately 70% of all SMEs in emerging markets lack access to credit. The gap is particularly wide in sub-Saharan Africa and this has brought opportunities for alternative non-bank lenders to both lend and have a developmental impact across the continent.
According to the World Bank, formal SMEs contribute up to 60% of total employment and up to 40% of Gross Domestic Product in emerging economies and this is significantly higher when informal SMEs are included. With more access to finance SMEs can play an even bigger role in economic growth and development in the region.
The opportunities for alternative lenders in the SME space have been fuelled by attractive yields, increased bank regulation, more conservative credit risk appetites of banks and (in some instances) loosening of regulations that had restricted direct lending.
This can clearly be seen in trade and commodity finance transactions where there are a broad range of producers and traders looking to access capital quickly and flexibly on a short to medium term basis, fully collateralised, and to pay for this service.
DFIs have been able to contribute to dealing with the liquidity gap by encouraging and fostering improvement of, for example, peer-to-peer lending. The DFI focus is on facilitating medium to long-term financings, developing pension funds and investment markets and working with private equity and debt funds to increase the availability of credit.
Commercial banks are key to the reduction of the liquidity gap with the challenge being to match the relevant type of capital required with the right business. As a result, it is important to be innovative and credit houses need to have alternative fund structures which cater to the relevant businesses seeking credit.
From a sector perspective, where is the biggest liquidity gap?
There is an almost unsurmountable need for funding in commodities, mining and energy, including as a result of growth in the area. There is demand in the technology sector but the challenge in that sector is the bankability of start-ups due to, among other things, the risk of failure and bankruptcy. There is no 'one size fits all approach' as situations differ by country and sector. Instead, there should be a micro-focus on business types rather than macro-sector focus.
For certain investors, technology and education are attractive from the perspective of diversification of investment; others may take the view not to back commodities or any strongly regulated sector. In some instances, cash-flow lenders are reluctant to lend to technology businesses as these businesses do not offer the same collateral that the institutions require – the solution may be to locate the relevant guarantors who can offer such collateral.
What has driven the record corporate and sovereign issuances in the debt capital markets in 2017?
In 2017, corporate non-local currency issuances were at three-year high and sovereign issuances were at a five year high. One feature of the current markets is that the tenure of certain loans are approximately 30 years and therefore the capital advanced can be used for longer term projects. It will be interesting to see the steps that borrowers will take to arrange refinancings at the time that repayments are required for short-term loans maturing in less than 10 years.
An increased length of time or repayment period allows businesses to manage repayments in a realistic manner and there is space for amortising lending into sub-Saharan Africa. In particular, there is strong interest in the Nigerian and Kenyan technological communications sector, which may result in further Eurobonds in the near future.
Has there been a crowding out of commercial lending in the credit market?
There remains a strong demand for funding which allows room for all types of players in the market. Commercial banks are businesses that need to receive adequate comfort on how their resources are managed in any given investment. However, these banks play numerous roles including acting as collaborative vehicles working with global wholesale debt providers and linking them with the right enterprises. Moreover, some are turning their focus in the region on driving "agency banking", where each bank may have numerous agents travelling to various villages in Africa – this flexibility is to create a platform to facilitate access to alternative lending.
What are the individual unique selling points that credit funds can offer when investing in Africa?
For certain funds, the focus is on SMEs and the lower mid cap segment. The aim is to work on medium to long term financings, meaning tailored credit and quasi-equity structures.
One of the innovations is to assist businesses requiring financing with building an effective internal team, offering private equity experience and identifying the right profile for a chief operating officer so that there is a structure that can facilitate growth. By assisting with operational support and value, it improves the chance of return on investment and consequently the attraction of investment.
From the perspective of Barak Fund Management, a home-grown African fund, with the majority of capital raised outside of Africa with European, Asian and Middle Eastern investment, Jean Craven's view was that by playing a junior role in a facility, Barak Fund Management is in a niche spot where it can provide bridge financing to senior and private equity funds. The regulatory environment in Africa is a concern but similar funds can assist with creating access to the market for other institutions.
In conclusion…
While there remains a liquidity gap, alternative lenders are making significant progress in trying to plug the gap with sophisticated, targeted products and strategies at an individual institutional level and more broadly by collaborating with co-creditors. The funding needs of borrowers are unique to the types and sizes of their businesses and the differences in demand facilitate lending solutions from conventional debt providers to alternative lenders – there is no crowding out of one lender type over another – the demand for liquidity outstrips this concern.
So, who is taking the lead in lending? Conventional commercial bank debt, DFI lending, debt capital markets solutions and private credit all have a role to play. Commercial banks will however continue to take the lead at a local and regional level and, together with DFIs, act as catalysts to facilitate sustained growth in liquidity in the loan and debt capital markets. Whilst the volumes of private credit deals may not be at par with the USA or Asia, private credit is a much-needed alternative lending class in Africa and is indeed on an upward trajectory.
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