Mini-bonds for SMEs: how rating improves the market placement

Here some key data from the annual report published by the Politecnico di Milano:

• in 2018 the number of Italian issuing companies increased by 17%, of which 123 entered the market for the first time. The overall number of the issuing companies jumped to 498.
• number of mini-bonds increased by 5,3% compared to the previous year, reaching a total number of 746 issues since November 2012;
• on the other hand, the average face value of emissions decreased by 22.4 million. In 2018 the total face value collected was 4.3 billion, 2.2 billion less than the previous year. The average value of fixed-rate-coupon is 5%, 5,38% of floating-rate coupon.

Since this financing resource is constantly growing, we’ve summarized in this article the key facts to know before investing or issuing mini-bonds.

Mini-bonds have been introduced on the Italian market in 2012 by the Decree Law “Decreto Sviluppo”.

They are debt securities (bonds and commercial papers) under 500 million euros issued by non-financial companies, listed or unlisted.

In common terms, however, we refer to mini-bonds for bonds issued by small and medium-sized unlisted enterprises.

According to Italian law, mini-bonds can be issued by any SME, excluding banks and micro-enterprises (companies with less than 10 employees and a turnover under 2 million euros). On the other hand, only qualified or institutional investors can subscribe mini-bonds, such as banks, asset management companies (SICAV or SGR) or investment funds.

Like any kind of financial obligation, mini-bonds grant investors an interest rate, paid through fixed-rate or floating-rate coupons. They generally have a medium to long term maturity, 5 years on average (however never less than 36 months). The principal can be refunded at the maturity (bullet bonds) or amortized over the life of the bond.

Most contracts also have put/call options: put options give the holder the right to force the issuer to redeem the principal of the loan at any time before the maturity date (putable mini-bonds), call options on the contrary gives the issuer the right to pay back the principal before the maturity (callable bonds).

Mini-bonds are the alternative financing channel most widely used by Italian enterprises. Through this channel companies can:

• diversify the financing sources;
• reduce dependence on bank credit;
• improve bank-business relations;
• get used to the financial system for a possible launch on the stock market (IPO).

Medium to long-term financing increase a company’s liquidity, improving the overall economic and financial balance. This can lead to a better creditworthiness assessment, which helps companies access to bank credit at better conditions.

The first step is the definition of a business plan that points out the company’s capacity to generate an adequate cash flow to pay investors back. Advisors can help companies define a business strategy and bond’s general terms (value, maturity, call/put options, etc.).

At this stage, advanced risk management solutions are recommended to analyze possible risk scenarios and to forecast business performances.

Secondly, legal advisors should be consulted for the drafting of the contract and the verification of compliance requirements.

The third step is the placement of securities. Mini-bonds can be listed on the Italian stock exchange. The most "quoted" segment is Extra MOT PRO, the Italian exchange market for listing bonds, commercial papers and project bonds.

The placement can be done by contacting stock broking companies (the Italian SIM) or arrangers, who will take care of identifying potential investors.

Although not mandatory, ratings are useful at various stages of the mini-bond issuance process:

• during the definition of the business plan, a rating provides an evaluation of a company’s health and helps define an affordable financing strategy;
• by placing securities, a credit rating provides investors information on the investment’s opportunity and on the insolvency risk of the issuer.

A rating can be requested to a Credit Rating Agency either by the issuer itself (solicited rating) or by the investors interested in assessing the profile risk of the investment (unsolicited rating).

Solicited ratings can be disclosed publicly as a guarantee of reliability or conveyed privately to the applicant (undisclosed rating). In the case of unsolicited ratings, the rating will always be undisclosed.

In 2018, modefinance issued 12 new undisclosed ratings on mini-bond, 10 of which solicited and 2 unsolicited, becoming in less than a year from its entry on the market the second major Italian player.

42% of the rated companies got an investment grade, i.e. a rating equal to or higher than B1- in the rating scale used by modefinance, while the remaining 58% got a speculative grade (lower than B1-).

Regardless of the result, ratings represent the best opportunity for issuer and investors to get a transparent and independent evaluation, devoid of any commercial interest.