Britannia Radio

The cogs are clogged

By Richard Milne

Published: February 16 2010 02:00 | Last updated: February 16 2010 02:00

T he land in front of JJ Teixeira's wood factory in northern Portugal has been cleared. Senior management huddle with sales, finance and accounting workers in a temporary office in preparation for the building of an extension to the plant on the outskirts of Porto.

They might be in for a long wait. Despite receiving record orders last year for its bespoke doors, wooden floors and furniture, JJ Teixeira cannot obtain a bank loan for the expansion. Even a project that received substantial government funding - a €2.4m ($3.3m, £2.1m) plan to make pellets out of the waste wood - foundered for lack of bank finance, according to Pedro Azevedo, the company's 31-year-old finance director.

"Operationally we are doing really well. But the company is in dire straits in financial terms. Since the credit crisis we haven't been able to roll over any debt and we've had to stop investment. This is not a good sign either for us or for Europe as a whole," he says.

Small and medium-sized enterprises such as JJ Teixeira, with its 250 emp-loyees, are the backbone of the European economy, representing 67 per cent of employment compared with 55 per cent in the US. Their fragile state, reflected in soaring bankruptcies, threatens the strength of the nascent recovery, as the larger companies dependent on the millions of small businesses as suppliers and customers are also potentially at risk. This frailty could also undermine some of Europe's proudest achievements, such as the fact that it has protected jobs better than the US in the downturn.

SMEs blame the banks for squeezing credit. Indeed, their predicament raises questions about the behaviour of the Continent's financial institutions, which have received billions of euros of government help but remain reluctant to lend. This in turn throws into doubt the future of thousands of companies such as JJ Teixeira. Eurozone bank lending to companies shrank at an annual rate of 2.3 per cent in December; research from the European Central Bank this month raises fears that this contraction will mean the eurozone is worse affected than the US in terms of growth.

"Access to finance is a big issue, and is another factor that will impact negatively on growth as banks are more risk averse," says Hans Wijers, chief executive of AkzoNobel, the world's largest paint company, and a former Dutch economics minister.

But the dependence of small European companies on bank loans also raises questions as to whether their owners should have diversified their funding and strengthened their balance sheets before the crisis, either through capital markets or by injecting profits back into the business.

Though Martin Kapp works in the most famed SME sector in Europe - the GermanMittelstand - he is just as gloomy as Mr Azevedo. As well as running his own engineering company, he is head of the organisation that represents machine toolmakers, one of the most important sectors in Europe's largest economy but also one of those hit hardest by the downturn. Though the end of the credit crisis is being hailed in nations across the world, he says: "The hardest times for SMEs are still ahead of us."

In particular, he worries about what will happen in the coming weeks and months as companies hand in their year-end results and balance sheets to banks. Because sales collapsed last year many companies will have breached their loan covenants, pushing them into default. "I see real problems - there could be more company failures," he says.

The same is true in Italy, famed like Germany for its SME sector. Giuseppe Morandini, chairman of brickmaker Fornaci Giuliane and head of small industry at Confindustria, the employers' group, shares Mr Kapp's fears. "There are real problems of access to credit," he says. "Bank demands for guarantees are increasing, spreads [the charge for loans above official interest rates] are high and the response times from banks are often incompatible with the speed with which we must make decisions in our business."

Nowhere is that more evident than in Portugal, which has more SMEs per inhabitant than any European country other than the Czech Republic. Its economic situation may be particularly desperate, with the budget deficit forecast to reach 8 per cent of gross domestic product in 2010 and public debt expected to hit almost 85 per cent, but experts say SMEs across Europe suffer similar problems.

According to credit insurer Euler Hermes, bankruptcies rose by 67 per cent in Portugal in 2008 and were expected to rise another 20 per cent last year. That is mirrored elsewhere in Europe, where corporate bankruptcies in five big countries - France, Germany, the UK, Spain and Italy - are estimated to have totalled 154,000 in 2009 compared with just 63,000 in the US and 16,000 in Japan.

Down a small, unpaved road a few kilometres north of Porto, in the heart of the country's main entrepreneurial region, stands a nondescript house. On the top level lives Fernando Silva, downstairs is his textile company, Confecções Maria de Fátima. Mr Silva entered the crisis with 42 workers; seven are left. The main room is filled with more than 30 sewing machines, most now gathering dust. Postboxes once overflowing with orders to be dispatched are largely empty.

Although Mr Silva does not blame the banks alone - he also points the finger at regulation - they play a big part in his story. Before the crisis, he was able to borrow at an interest rate of about 5 per cent; now it is 10-12 per cent. "I have a good relationship with my bank. Without that it would surely be 14-15 per cent," he says.

His complaint is common among entrepreneurs. "The banks have received money from the state to help fund companies. But we don't see any of it. It is farce. Everything is too high risk these days for banks."

Banks see things differently. They claim lending in the eurozone is contracting not just because they are pricing risk more appropriately compared with before the crisis but also because demand from companies, reluctant to invest at the moment, has fallen. "Do I think there has been some constriction of lending? I am sure there has. Are we open for business across Eu-rope? The answer is a very emphatic yes," says Alan Keir of HSBC.

Some banks have tried to address the problem head on. Deutsche Bank this month launched a €300m fund to offer capital to German companies with less than €100m in annual sales. Mr Kapp complains that the interest rates will be too high. Not that he is asking for cheap money: "What we need is some bridging help to allow businesses that have made healthy profits in the past to survive this year. It is not about subsidies but just supporting us for a small period and not being so short-sighted."

José Coelho, head of several wine companies, says Portuguese banks last year offered him a spread of 6 per cent above the normal interbank interest rate, in contrast to the 2 per cent he paid for a property deal before the crisis. "To adapt a Portuguese saying, the banks are someone who lend you an umbrella on a sunny day and then ask for it back when it rains," he says. Deutsche Bank, which was expanding in the country, gave him a spread of just 1.25 per cent, although he says rates have since increased.

Mr Silva of Confecções Maria de Fátimamaintains regulation, too, is a large part of the SME sector's problems. His 23-year-old company has had to pay compensation to fired workers according to their length of service. The system is perverse and the costs excessive, he says. "If you have a good 35-year-old worker with three to five years' service and another one aged 55 with 20 years' service but who produces half the goods, you still have to fire the younger one."

Augusto Morais, head of Portugal's main SME association, accuses Lisbon of "fiscal terrorism". "The SMEs pay the debt [of the state]," he says. He points to the fact that there were 489,000 SMEs in the country in 2005 whereas there are now just 267,000. As deputy head of the European association of SMEs, he adds that small companies all over Europe are suffering. Mr Morais points to the scale of the tax-take across the Continent, which he says "harms competitiveness".

The irony is that many SMEs have survived the recent crisis and are even starting to see a recovery but are being trapped financially. JJ Teixeira beat its previous record for orders of €18m by some distance last year: it took €25m, of which €16m came in the past six months.

But instead of celebrating, Mr Azevedo is worrying about bankruptcy. The company, due to pay creditors - mostly suppliers - €1.6m by the end of January, took until the middle of this month to find all the money it owed. "I will have to do the same juggle I've done the last few months and call suppliers and customers and ask them to pay."

Late payment is proving to be a big problem. Before the crisis, customers of JJ Teixeira took 120 days to pay; now it is 187. Mr Azevedo is delaying payments to his own suppliers. He says: "My biggest worry is that we get into a spiral with SMEs where one doesn't pay another so they go bankrupt one after another."

For many large companies, though the state of their SME suppliers became a matter of serious concern, their fears are easing. Leif Johansson, chief executive of Swedish truck company Vol-vo, says: "A large company like ours is dependent every day on thousands of small companies and we have seen the problem with access to credit. But compared with where we were, it is a much better situation now."

Indeed, there has always been a high failure rate among SMEs, which suggests the causes of their problems go beyond the behaviour of crisis-hit banks or regulation. Some 92 per cent of the Continent's businesses are "micro-companies", with fewer than 10 employees. That leads some to question whether they lack ambition. "I sometimes wonder whether there is the drive in Europe to create a company with more than, say, €5m or €20m in revenues," says one leading European industrialist.

Be that as it may, the situation for many SMEs is still desperate. Mr Morais of the Portuguese SME association frets that, caught between the demands of the state and the lack of response from banks, companies have little ability to boost their competitiveness or productivity, which lags significantly behind larger companies. "This is not just an issue of the recession for Europe, it is a structural one too," he says.

At JJ Teixeira, Mr Azevedo is taking things one day at a time. In comments that the heads of many European SMEs could make, he says: "We lack a financial bridge at the moment to get out of the crisis. We are walking on a very tight rope right now."

Equity capital

Stock markets look to restore ties with growing business

In the wood-panelled splendour of the Irish Stock Exchange's old trading floor in central Dublin, a blackboard still displays the prices chalked up on the first day trading took place there, in 1878.

It offers a snapshot of economic history showing how, during the industrial revolution, stock exchanges were where companies came to raise capital and build businesses. On the board are debentures issued by builders of the great Uruguayan and Argentinian railways of the 19th century.

Yet now, the role of a stock exchange as a place where capital can be formed is being called into question as a different type of revolution has swept the markets: electronic trading. Not only has this closed trading floors like the one in Dublin across the globe, it has also spawned so-called high-frequency traders who often hold shares for only a fraction of a second.

But some exchange heads believe small and medium-sized enterprises have been left behind. Deirdre Somers, the Irish exchange's chief executive, says many exchanges have lost their role as "national flag carrier" as they have focused on the secondary market - where shares are traded daily - as opposed to the primary listings that are crucial to smaller companies looking to raise capital.

"Because the global stock exchange environment has become so focused on delivering to the intermediary and the 'liquidity providers' and brokers in the markets, the culture has changed," she says. SMEs are becoming "more and more disenfranchised from the world of stock exchanges".

The London Stock Exchange derives just 5 per cent of its income from fees charged to companies when they list. Exchanges with a second-tier market - such as the LSE's Aim and the Irish IEX - need to focus more on the "specific, bespoke needs of midcaps", which are "under-broked and under-analysed", says Ms Somers.

Ester Levanon, who heads the Tel Aviv Stock Exchange, says Israeli SMEs tend to sell out to big US companies when they reach a certain size, rather than list. Amid a lack of local analyst coverage, the exchange is considering a scheme to fund analysts' salaries - an idea Ms Levanon says she borrowed from the Singapore stock exchange.

Xavier Rolet, LSE chief executive, agrees with Ms Somers. The LSE has cut tariffs for market-makers on Aim. "Aim is a necessary link between private companies and the full list," Mr Rolet says. "There is no doubt it feeds the senior market - it is like the junior rungs on the housing market ladder."

Job generators

Defined by the European Union as having fewer than 250 workers, small and medium-sized enterprises provide two out of every three of Europe's private sector jobs.

By 2005 they represented 58 per cent of all value added generated in the EU. In that year, the latest for which figures are available, the EU was home to some 20.4m SMEs and only 43,000 large companies. Of the SMEs, 92 per cent were designated as "micro-companies", employing fewer than 10 people (the definition of "small" applies to those with 10-49 staff).

Because they lack economies of scale, SME productivity was only 86 per cent of the European average.