Case Study: SME Loan Book

by Josh
Sep , 24

An SME lender originating secured property-backed business loans requires additional funding to meet demand and grow the book. The loan origination criteria spans $100k-$500k loan sizes, 12-36-month tenor with 14-22% interest rates based on internal risk-weighting models. All loans cash pay interest and principal on a monthly, straight line amortisation basis.

The existing loan book of $25m, contains c. 120 loans (i.e. $208k average loan balance), with a weighted average contractual IRR of 18% including establishment fees. Loss rates over the prior 4 years have held around 1.5%. The existing book is funded by $10m equity and $15m unsecured HNWI notes paying 12%.

Raising additional equity is undesirable (dilution) and the 1st and 2nd degree network of HNW’s is delivering only a fraction of the additional capital required, hence an institutional debt solution is preferred.

While the book is yielding c. $4.1m per annum in cash yield (after losses), after paying $1.8m of interest on the HNW notes, and $1.4m of operating costs, there is only $925k remaining for reinvestment or dividends. $925k on the $10m of equity capital tied up in the book is just 9.3%, less than half the 20% return on equity target.

Several steps are involved to optimise this structure and improve the bottom-line yield, including structuring of a new senior debt facility with a >$30m limit, higher advance rate and <10% interest rate. A portion of the unsecured noteholders remain in the structure via a junior note and the equity first loss is reduced from 40% ($10m of $25m) to 10%, releasing c. $8m of capital back to the company on completion and reducing the WACC from 15.2% to 11.3% overall.