Medium-sized European companies will struggle to meet their multi-billion financing needs in the next few years, as banks reduce their lending to the sector, according to Standard & Poor’s Ratings Services.

Mid-market companies are increasingly seeking to diversify their funding sources as banks embark on a de-leveraging process that may take many years. But the alternatives to bank funding for mid-market companies in Europe form a cluttered and incohesive landscape. In addition, most direct funding is still mainly aimed at larger companies.

S&P has launched Europe’s first credit benchmark aimed at increasing the transparency and comparability of mid-sized companies – accounting for around one third of Europe’s economy and employment – from a credit perspective, which may help facilitate access to new sources of capital market funding.

“European businesses have traditionally relied on bank funding, but deleveraging and tightening regulation are creating a scarcity of finance for European companies, and the problem is particularly acute for medium-sized businesses,” said Alexandra Dimitrijevic, managing director, Standard & Poor’s. 

“While larger corporates have easier access to finance and much smaller companies are the focus of a variety of policy proposals, medium-sized businesses or the ‘squeezed middle’ appear to be falling into the gap between them.”

The scale of the problem facing this “squeezed middle” of the corporate sector is significant. S&P estimates that European medium-sized businesses will need to raise up to €3.5tn in debt funding over the next five years. About €2.7tn of this relates to refinancing existing loans, with the remaining €800bn needed to support capital investment and expansion plans between now and 2018. This equates to about a third of total debt currently owed by non-financial companies in the region.

To ease the funding pressure facing these companies, new mechanisms are being developed in Europe to channel funding from investment and other non-bank institutions, including the nascent but growing European private placement markets and the launch of new bond exchange platforms in countries like France, the UK, Italy and Spain. 

Even a five per cent contribution to the financing requirements of these companies from various alternative funding sources would amount to a meaningful €35bn each year. However, despite a growing interest from institutional investors to invest in this new asset class, they are often deterred by the lack of transparency of the credit risk of mid-sized debt issuers.

Colin Tyler, chief executive of the Association of Corporate Treasurers, said: “Large companies have been raising significant amounts of new funding in the international bond markets but this has been more difficult for mid-sized companies where smaller issue sizes and lack of clarity on credit risk have discouraged investors. Standard & Poor’s new Mid-Market Evaluation is therefore a welcome development and one which should stimulate mid-market issuance across Europe.”