Investing in Private Debt in 2020

Tendersetter

12:25 pm

11 November 2020

Many investors and investment funds aiming to diversify their portfolios and achieve higher returns opt to invest in private debt, the preferred financing instrument of small, unlisted companies.

 

This is why it is crucial to analyse the circumstances of Italian SMEs after the COVID-19 lockdown to evaluate whether investing in private debt is still worthwhile.

SMEs in Italy

Some important, interesting conclusions can be drawn from the Cerved SME 2019 report.

 

The momentum that characterised the universe of SMEs since 2013 lost some of its force in 2018. While turnover grew by 4.1% in nominal terms (compared to +4.4% the previous year), in real terms it remained at 2017 levels. This slowdown has affected all sectors except construction.

 

Labour costs (+5.6%) grew faster than value added (+4.1%), with negative consequences for the productivity and profit margins of SMEs. Moreover, the recovery in gross profitability has almost stopped in its tracks: gross profit margins grew by only 1.2% in 2018, compared to 3.2% in the previous year. Levels remain well below pre-crisis figures, down 20% on 2007.

 

Data on business demographics are also giving mixed signals: the number of SMEs grew by 5.5% in 2017 but only by 2.9% in 2018, stopping at 161,000.

The financial soundness of SMEs

Despite declining growth figures, the progressive strengthening of SMEs’ financial fundamentals has not been affected. Financial debt increased in 2018 for the second consecutive year and at a faster rate than in 2017 (+2.2% compared to +1.2%). At the same time, SMEs strengthened own capital at a sustained pace (+8.5%), with a consequent reduction in the percentage of financial debt out of net capital, which fell to 63% in 2018 (from 66% in 2017 and 116% in 2007). Moreover, despite the slump in profitability, the impact of financial expense on gross profit margins reached an all-time low (13%), thanks in part to the ECB’s expansive policies. In 2018, data on SME capex grew strongly, accounting for 7.1% of tangible fixed assets (compared to 6.4% in 2017).

 

One of the biggest concerns surrounding how the international economic context will evolve remains US trade policy, which has already wrought havoc on the global economy. The downwards trend in international trade has dealt the hardest blow to economies centred around manufacturing. The worst effects in Europe were seen in Germany and Italy, which slipped into phases of economic recession between 2018 and 2019.

SMEs and the effects of COVID

The effects of COVID-19 in 2020 thus far have been studied and forecast in the Regional Report Cerved-Confindustria 2020. The report stresses that “the strengthening of financial soundness in 2018-2019 will not be sufficient protection for many SMEs to withstand the impact of the economic effects of COVID-19” and that “it is necessary, on the one hand, to ensure timely financial resources for SMEs that risk cash crises and, on the other hand, to support economic recovery in the medium term, which is crucial for the sustainability of debt.”

 

The forecast model used is based on a scenario in which the impacts of COVID-19 on businesses are estimated, taking into account the lockdown and the effects of the Prime Minister’s decrees, assuming that the national and international economic context will progressively normalise. In addition, a worst-case scenario was considered assuming a second wave of infections and another “light” lockdown in the coming weeks.

 

The model predicts that the turnover of Italian SMEs will contract by 10% in 2020, rebounding by only 4.8% in 2021. This will result in a loss of between 270 and 650 billion in turnover in 2020-21. In the event of another lockdown, revenue is expected to fall by 18.1%, with losses of almost €300 billion over the current two-year period.

 

The analysis indicates that COVID-19 could push over one third of Italian SMEs into a cash crisis at the end of 2020 and that €25 to €37 billion would be needed to overcome the crisis and avert difficulties for 1.8 million workers.

 

Even in the worst-case scenario (i.e. a second wave and consequent lockdown), the allocations declared by the government in the “Cura Italia” decree (€200 billion in the Central Guarantee Fund plus additional funds for SMEs in Sace, the Italian export credit agency) should be largely sufficient to cover the needs of SMEs.

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