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SME Funding – The Quintessential Dilemma

10th World Islamic Economic Forum

Dubai29th October 2014

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CONTENTS

I. Introduction and ObservationsII. SMEs and UAE BanksIII. Life Cycle of SMEsIV. The 5 issues which challenge banksV. Brief on Alvarez & Marsal

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SME – A Distinct SegmentSMEs are a very distinct segment; they lie between classical retail and established corporates

My involvement ....with SMEs since 1995 and in three countries – Canada, UAE and Kenya Very similar issues in all markets

Access to fundingAccess to markets“Unbankable”Lack of corporate governance, business planning and appreciation of riskGovernment initiatives have mixed results

There is a growing demand for Sharia compliant products by SMEs in GCC, Sub Saharan Africa and Pakistan. We expect this to extend to North Africa as soon as enabling legislation is passed in Morocco, Tunisia and AlgeriaA significant number of Sharia compliant banking customers are first time borrowersAlvarez & Marsal (A&M) is a multi-disciplinary consulting firm with a team of practitioners, and is committed to helping develop & implement SME finance strategies

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Personal Observations – a Macro ViewSMEs are the most critical contributor to economic growth

No debate on SME’s importance to the economy – although contribution numbers vary in relation to contribution to GDP and employment creation

No debate on the need to “do something” or “do more”

Number of advisory initiatives at various levels with varying success

SMES cover a wide spectrum – early stage vs established SMEs

Balance between expat and locally owned SMEs

Anecdotal evidence, and discussion with bankers, indicates that SMEs fared better than corporates in the last downturn, with the exception of

o trading companies

o businesses with heavy real estate exposure

o where working capital lines for utilized for purposes other than core business activity

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Personal Observations – The SME ClientTo an SME customer, deadlines of time and excellence of service provided is as critical as it is to a very large corporate

SME customers tend to be much more passionate about their business

There is often more than one generation involved

Their lifestyle is very closely linked to the business

There tends to be a mix of personal and corporate assets

Audited information not necessarily complete or sufficiently detailed

Management is thin, decision making is centralized, business planning is not regimented

They tend to be very loyal to their bankers ((Does not usually work the other way!)

Not all successful SMEs dream of becoming large corporates

Successful SMEs tend to find niches where they have relative advantage of cost, service quality, even innovativeness

SME banking is fundamentally relationship management; close and regular contact is critical

It is not – as sometimes perceived – a high risk proposition

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CONTENTS

I. Introduction and ObservationsII. SMEs and UAE BanksIII. Life Cycle of SMEsIV. The 5 issues which challenge banksV. Brief on Alvarez & Marsal

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IMPORTANCE OF SMES SMEs contribute directly towards sustainable development and growth of a country’s economy and human capital, while being of strategic importance for the growth of commercial banks

FOR MARKET & ECONOMY

Create a knowledge-based society

Breed innovation

Diversify the economy

Promote international trade

Create new sources of employment

Form a competitive marketplace

FOR BANKSVendor financing of existing large corporates, which leads to larger wallet shareDeal flow for traditional corporate lending, as SMEs growDiversifies risk with small-ticket exposure, while providing high fee income through transaction banking and trade financeCross-sells Wealth Management products to owner-operators

Strategic & sustainable development of the human, social and economic capital of the UAE

Common SME Hurdles

Universally, particularly in developing economies, SMEs face the same issues and hurdles

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Type Observations

Social Entrepreneurship not seen as prestigious. Comfortable government jobs preferred over the hustle of entrepreneurship

Capital Limited availability of capital, especially seed & VC funding. Banks unwilling to lend to smaller enterprises and impose onerous requirements

Policy Lack of policies that are supportive of SME formation and growth (e.g. long registration & licensing times)

Labour Scarcity of skilled workforce and restrictions on importing talent is an impediment to growth

Education & Training Even for the limited capital destined for investment in private enterprise, there is an acute shortage of qualified proposals, and by extension, entrepreneurs

Essential Services Basic services (e.g. utilities) can take months to secure, burdening newly-formed companies

Business Support Costly business support services limit the ability of SMEs, especially start-ups, from availing such services

Opportunities Limited domestic market size and not enough access to international markets

Challenges Faced by UAE Banks in Lending to SMEsMajority banks in the UAE are reluctant to lend to SMEs because of the high perceived risks, particularly credit risk. The growth opportunity for banks lies in a better understanding of the SMEs and their risks

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Almost three quarter of banks in the UAE refuse to lend to SMEs because of the high perceived risk of business failure. Another major reason is a view that management of the SMEs are not competent enough to run the business.

73%

55% 45%

27% 18% 18% 18%

High risk ofbusiness failure

Managementcompetence

Insufficientcollateral

Financialfactors

Absence ofauditedfinancial

information

Absence ofviable exitstrategy

Tenure ofbusiness

Reasons for Bank's Refusal to Lend

Source: Dubai Economic Council ‘Understanding the SME financing dynamics’ 2014

Almost half of the SMEs in UAE do not have sufficient collateral for banks to feel secure to lend to them.Other reasons that cause banks to shy away from lending to SMEs is lack of sufficient working capital and lack of financial strength of SMEs.

Areas of Importance to Banks for Lending to the SME

The number 1 and 2 areas of importance to banks lending to SMEs is Collateral and Business Risk

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Collateral

Business Risk

Financial Risk

Legal & Regulatory

Collateral • Insufficient collateral• No security coverage

Business Risk

• Industry sector• Viability of business model• Operations of SME business in general

Financial Risk

• Financial stability of the SME• Quality of cash flow• Ability to withstand losses

Legal & regulatory concerns

• Absence of credit bureau in the country• Limitations with legal enforcement in case

of defaults

Source: Dubai Economic Council ‘Understanding the SME financing dynamics’ 2014

Size of Opportunity is Immense in the UAE

Despite the strong desire amongst banks to lend to SMEs, almost 40% do not have an SME business

11Source: Dubai Economic Council ‘Understanding the SME financing dynamics’ 2014

Yes61%

No39%

Percentage of Banks Lending to SMEs

0-10%46%

11-25%18%

26-50%9%

>50%18%

No Comment9%

Portion of each bank's lending to SME sector

Many SMEs initially rely on internal sources of funding but, once they are in a position to grow, they need to find other sources of capital. The challenge faced is not many banks in the UAE lend to SMEs and, of those that do, only a small portion of their book is allocated to SMEs

UAE Banking Sector & the SME SegmentThe UAE has entered a new phase of development and, recognizing the role SMEs play, some banks are gearing up to help promote a robust SME segment & further support job creation & economic activity

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Business Initiatives

Major Initiatives

Constraints

Core Business Areas

Internal capacity building to increase their SME lending portfolio

Technical assistance and training to enhance awareness for the needs of the sector

SME finance technology

SME credit risk mitigation products and systems

Development of SME finance training modules

Assistance to selected firms in development of project finance proposals

Business environment that is not prone to small-scale investments

Limited financing from the banking sector - current rejection rate stands at 75%

Insufficient regulatory support with respect to SME finance

Large number of SMEs are unaware of their being “bankable”

Quality and standardisation of business processes and services

Managerial and technical skills

IT and information support (MIS)

Research and development of under-developed business sectors

Private equity and investment climate

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CONTENTS

I. Introduction and ObservationsII. SMEs and UAE BanksIII. Life Cycle of SMEsIV. The 5 issues which challenge banksV. Brief on Alvarez & Marsal

SME Requirements Across Life StagesIn creating solutions and products for the SME segment, it is important to understand the changing needs of SMEs and how these interact with each other, as the SME evolves across life stages

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Concept Stage Initial Formation Early Stage Growth / Expansion Established / Maturity

Proof of Concept / Proof of Value Angel Venture Capital (Stage1) VC (stage 2)/ Private

Equity Private Equity

(0 – 3 years) (3 – 5 years) (5+ years)

Limited debt (e.g., physical assets)

Basic suite (e.g., factoring)

Broader suite (e.g., trade finance)

Full suite (e.g., term finance)

. Equity Programs Debt Programs

Debt products required

Equity sources

Evolving finance needs

Knowledge transferHand holding

MentoringMonitoring / Relationship ManagementBusiness services (e.g., ICT, Real estate)

Networking

KnowledgeAdvisory

InformationGlobal accessMonitoring

Business services

InformationGlobal accessMonitoring

Supporting services needed

Markets served Local Local & national National & explore exports

National, regional/ international

Life Stage

Borrowers Life Stages and the Funding GapThere is a large gap between Consumer and Wholesale banking, the customers as their business grows will change banks or

will be continued to be provided consumer banking products who now will require more sophisticated wholesale products

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Consumer Banking

• <50m borrower turnover

Emerging Corporates / SME Banking

• 50 - 250m in borrower turnover

Wholesale Banking

• >250m in borrower turnover

Typical Customer’s LifecycleCurrent GAP

Client centricity is diminished as there is a break in the clients journey

Creates a loss in revenue & clients

Cost of retaining existing customers is more cost effective than acquiring new customers

Current Gap

Consumer Banking

Wholesale Banking

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CONTENTS

I. Introduction and ObservationsII. SMEs and UAE BanksIII. Life Cycle of SMEsIV. The 5 issues which challenge banksV. Brief on Alvarez & Marsal

Borrowers Life Stages and the Funding Gap

It is important for banks to better understand the need of SMEs, as a segment rather than a sector

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The desire to force fit into Retail or Wholesale

The presumption that characteristics of SME are the same as that of top end retail or low end wholesale

Pre disposition that SME is highly risky

Non availability of granular MIS to manage the business

Lack of documented underwriting policy

Unclear procedures for handling any exceptions

Lack of a robust remedial function (as opposed to Recovery)

Not having the right skillsets in the team

Understanding the SME Segment’s NeedsA hybrid approach for the SME segment is the most effective for banks, combining the personalized touch of Retail Banking

(relationship management) with the depth of Wholesale Banking (risk management)

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Credit Extension

Credit Extension

Relationship ManagementRelationship Management

Approach to Market

Approach to Market

Product TypeProduct Type

Repayment & Collections

Repayment & Collections

Strong relationship focus – individual relationships more important than institutionalRMs must understand SMEs; be focused on finding solutions; hand hold clients; very strong on ethics – building trust is key for relationship management

Individual RM driven / Team Leader override - Previous relationship helps Service providers (accountants/lawyers) are key referral sourcesReliance on audited accounts not sufficient

Business Account Bouquet, with Overdraft & Short Term Loans (asset backed)Transaction Banking and Trade Finance (LC/TR)LBD/EBD

Zero tolerance on overdues; tolerance on reporting delays. Clarity of underwriting criteria essentialDetailed – but not heavy – analysis requiredShort form credit application plus clarity of essential information that is required

Depending on size of loan and type a mixture of Classic Retail and WholesaleHandholding may be required; Skill set of “problem solver” needed not that of recovery

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CONTENTS

I. Introduction and ObservationsII. SMEs and UAE BanksIII. Life Cycle of SMEsIV. The 5 issues which challenge banksV. Brief on Alvarez & Marsal

A&M OVERVIEWFor three decades, Alvarez & Marsal (A&M) has set the standard for working with organizations to tackle

complex business issues, boost operating performance and maximize stakeholder value

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A&M employs a hands-on approach to solving problems and creating value – with a bias toward action and results.

At Alvarez & Marsal, we:Hold ourselves accountable to delivering resultsProvide leadership by rolling up our sleeves to get the job doneBelieve in the importance of collaboration with our clients and their constituencies

Global ReachA&M has taken a measured approach to add to its service lines and geographic coverage to now offer full

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