Deep in the new UK government’s account of how it plans to reinvigorate UK capital markets (the sixth of its six priorities for financial services) sits a solitary mention of small and medium-sized enterprise asset-backed securitization, or SME ABS.
Specifically, the government plans to examine the potential for securitization of the British Business Bank (BBB)’s ENABLE debt guarantee programme. Of all the elements contained in the financial sector plan, the one about ABS particularly piqued my interest. Because diversifying sources and availability of finance for SMEs has been a hot topic for years both in the UK and in the European Union, where efforts to super-charge capital markets union remain high on the agenda, with securitisation at its core.
The aim of securitizing ENABLE debt programmes, according to the January 2024 publication Financing Growth: Labour’s Plans for Financial Services, is “to support more lending at scale by challenger banks and small business lenders to facilitate SME growth”.
The UK securitization market could do with a boost beyond the residential mortgage-backed securities that dominates activity. In its April 2024 report Capital Markets in the UK: Key Performance Indicators, the Association for Financial Markets in Europe pointed to the lack of a deep UK securitisation market as a structural competitive disadvantage. The rate of loan transformation in the UK lags other major European markets. Only 1.7% of outstanding UK loans were securitized in 2023 compared with 3.4% in Spain, 2.7% in France and 2.4% in the Netherlands.
When it comes to SME ABS outstandings across Europe, these amounted to €114.4 billion (US$124 billion) at the end of the Q1 2024 and the volumes are dominated by Italy (€42 billion), Netherlands (€25.3 billion) and Belgium (€24.4 billion). The UK is barely a rounding error at €200 million. There were no new European transactions in Q1 2024, incidentally.
When it comes to boosting securitization in the UK and SME ABS, in particular, ENABLE is a great place to start because it’s a rules-based government-backed scheme with clear and standardized rules of engagement. So, what is ENABLE and how does it work?
Rules of the game
It’s a guarantee programme run by the BBB, the UK state-owned development bank, under the aegis of the Department of Business and Trade. Under the programme, the BBB charges SME lenders a fee in return for government guarantees on eligible SME debt portfolios. The scheme is open to banks, providers of asset-based finance, and direct lending funds (collectively referred to as “participating originators”.
To be eligible for guarantees, underlying debt should be interest-bearing and have a stated maturity. Hence the scheme covers term lending, receivables and supply-chain financing, trade and asset finance but not hybrid or equity-like instruments. A particular focus of the BBB is getting finance to smaller SMEs, those with a trading history of less than five years, and SME growth companies.
Lenders applying for guarantees need to submit proposals involving portfolios with at least 250 borrowers and a minimum size of £25 million (US$32.14 million) – although actual submissions have involved much bigger portfolios. There are portfolio concentration limits: no single exposure above 1%, no single industry exposure above 20%, and submissions must meet the BBB’s minimum debt-origination standards, key among which is that debt must be additional and not a substitute for existing sources.
To reduce the risk elements, SMEs in financial difficulty are not eligible; nor are exposures to retail buy-to-let investors or proposals involving the acquisition of secondary assets. Applications need to specify the proposed maximum notional size of the guarantee being sought, and include information about the percentage increase this represents relative to the applicants’ existing or projected SME annual credit origination.
Applicants are viewed more favourably if they have an environmental, social and governance policy and strategy, can prove they have considered the effects of climate risk on their business, and have set targets for reducing greenhouse gas emissions, and/or actively monitor and promote diversity, equity and inclusion. Licensed banks lending under the scheme benefit from a zero (or close to zero) risk-weighted government guarantee on a percentage of credit losses on eligible debt they originate above an agreed first-loss threshold.
Leveraging securitization for small lenders
Given all of the above rules of engagement, it strikes me that the scheme is an ideal candidate for securitization. As far as I can tell, no new formal structure has emerged for ENABLE securitizations, but, broadly speaking, it will involve newly-originated receivables from multiple eligible lenders being sold to and warehoused in a multi-originator special purpose vehicle, and the receivables pool is securitized once it reaches sufficient scale.
The benefit of a multi-originator approach is that it allows smaller lenders to leverage pro rata the benefits of this effective financing tool. Originators will retain first-loss equity tranches, the BBB will hold or guarantee mezzanine tranches, and senior tranches will be placed with end investors, who will benefit in effect from credit enhancements from the support sitting beneath them in the payment hierarchy.
So, how do the numbers stack up? ENABLE Guarantee and ENABLE Build programmes (the latter for SME housebuilders) committed a record £868 million in the 2022/23 fiscal year to March 2023 (partially because lending granted under the Covid-era Recovery Loan Scheme shifted to ENABLE). At the end of Q1 2024, the BBB had done nine transactions and committed approximately £1.1 billion to smaller finance providers. Since the first transaction in September 2015, the programme has supported lending to some 86,600 businesses and facilitated more than £2.5 billion of finance, according to the BBB’s data.
The question is: how quickly can receivables ramp up to make securitisation a viable recurring option? A number of guarantee facilities have emerged in recent months to make the numbers more respectable: in July, a second increase of £100 million to a facility size of £350 million for DF Capital, the bank focused on manufacturers and dealers in the leisure, commercial and powersports sectors; and a doubling of the facility with Oxbury Bank, the specialist agricultural bank, to £200 million.
Othe transactions include a £100 million facility increase for United Trust Bank to £350 million, a £75 million transaction for Cynergy Bank, £100 million for Cambridge & Counties Bank, and a guarantee on a warehouse facility for alternative lender ThinCats with senior funding provided by Citi and Barclays to support lending of up to £696 million.
The government’s document talked about the points raised in it being starting points and that we should expect updates in 2024. Let’s see.
