Balancing risks against sound bank principles

Date: 07/03/1996

THE European Investment Fund has to be one of the least known of the EU's institutions.

While parties in Brussels may occasionally hum to the sound of talk of the ECSC, PoCo, Coreper, and the EIB, the EIF is conspicuous by its absence from such conversations.

Yet, tucked away in a corridor of the European Investment Bank headquarters in Luxembourg, the EIF's 19 staff are busy turning EU politicians' rhetoric into reality.

While their tasks may sound dull - providing guarantees for loans to small and medium-sized enterprises (SMEs) and Trans-European Network (TENs) projects - they see it as a mission; a sentiment nurtured by the zeal of their president Georges Ugeux.

“I don't expect the EIF to be recognised,” says the 51-year-old career banker. “I think the minimum it takes is three to four years of existence to prove not only that you exist, but also that you have a raison d'être.”

The EIF was devised during the depths of the 1992 recession as part of a multi-pronged plan to channel any spare public funds into big-ticket TENs investment projects and, the current flavour of the month, SMEs.

What makes it special is that it is a unique partnership between the public and private sectors; owned 40&percent; by the EIB, 30&percent; by the European Commission and 30&percent; by a group of 76 banks.

Established in mid-1994 with 2 billion ecu of capital, the fund can provide guarantees on loans up to 5 billion ecu, with the option of rising to 16 billion ecu.

So far, it has made guarantees worth 1.3 billion ecu, of which 650 million ecu have already been used. With 19 staff, the fund has done more business in 18 months than the much-fanfared European Bank for Reconstruction and Development has in three years.

After a year in business, the EIF's shareholders were very pleased with their new baby, but felt it lacked punch - the element of mission.

After all, while Europe's biggest firms continue to shed jobs, it is the SMEs where employment is being generated. Buried among the thousands of five-person units on industrial estates throughout the Union could be the next Microsoft.

A missionary was needed and the EIB head-hunted Ugeux. After a 25-year career in banking which took in Générale de Banque, Société Générale, Morgan Stanley and Kidder Peabody, Ugeux was ready for a new challenge when he took up the reins in June last year.

“It's a true challenge,” he says. “We have to find a modus operandi for the EIB, the European Commission and 76 banks from 15 different countries, some of which are public and some of which are private. Making that partnership work is the biggest challenge.”

But finding the right balance between risk-taking and sticking to sound banking principles in financing infrastructural projects and SMEs is easier said than done.

“We have to make a very small team work and use its strength to make deals of substantial size, manage its risk and operate without creating either a bureaucracy or a free-lance approach,” he said.

Together with his two colleagues on the EIF's key financial committee, Ugeux has drawn up a new three-year business plan, which was approved by the supervisory board in January and will be presented to the EIF shareholders' general meeting on 18 June.

“I was personally very encouraged by the extremely warm reception from the shareholders to the approach, which tries to combine a sense of mission and professional standards,” he says.

The president has no plans to overhaul the management of the fund, even though the split between SME and TENs financing can make life difficult.

“At the moment, nobody has the luxury of specialising,” he admits. “But we are going to grow, and growth always requires adjustments. We all agree that issuing guarantees for SMEs and, on the other hand, issuing guarantees for major projects, are probably two very distinct businesses and I would not rule out that, as we grow, we will specialise one way or another between those two very different markets.”

But Ugeux insists this will be a natural evolution and not an imposed split. “I'm a great believer in process, I believe in evolution. I don't think management revolutions make a lot of sense.”

In cash terms, 85&percent; of the fund's guarantees go to TENs and 15&percent; to SMEs - but this only tells a small part of the story.

“In amounts, TENs will always be more important but, in the number of transactions, it's the reverse,” Ugeux points out. A typical EIF transaction for a TENs project will be around 100 million ecu, compared with less than 20 million for an SME unit, but there will be a lot more of the latter.

EIF guarantees have gone to the upgrading of Malpensa Airport in Milan and a new highway around Lyon, but it is the fund's role in SME financing that seems to inspire the visionary in Ugeux.

“The world could live without us,” he admits. “We are never going to present the fund as a panacea; we are humble enough and professional enough to know that. Our wish and our mission is to be a complement to things that exist and increase the speed, size, maturity of the growth of SMEs.”

The EIF does not lend money or provide guarantees directly to SMEs, but gets involved in banks' schemes to give a helping hand in a sector where they have traditionally failed to find the right lending formula.

“In our view, the SME financing that banks are providing is terribly conservative,” says Ugeux.

“Banks usually give the business of making loans to SMEs to their local branches - which makes eminent sense from a client management point of view, but that's not the place where you can create new structures and have new ideas.”

Moreover, lending by banks to small companies tends to be straightforward debt secured by the firm's assets, which is often the owner's house.

“I think that will have to change over time and I believe that a key value of the fund will be in being the first instrument of the Community that actually takes the risk off the SMEs,” he predicts.

For example, at the moment, the fund is negotiating with two British bluechip banks over the setting up of a specialised cash pool of around 40 million ecu, which would be used to provide unsecured loan finance to SMEs. This will be one-third equity and two-thirds debt, and half of that debt will be guaranteed by the EIF.

“That's ideal for us. By taking just one-third of the risk, we will improve the lending terms for SMEs,” says Ugeux.

This kind of experiment in lending to SMEs allows the fund to gain experience in a number of fields, giving it expertise it can pass on to other lenders. “What the fund can do for SMEs is peanuts, but if the 76 banks we have as shareholders, through their relationship with the fund, can promote these ideas internally, then the leverage effect that the fund plays justifies its existence,” he argues.

The next big step will come in June when Ugeux will ask shareholders if he can start taking equity shareholdings in SME funds. This would be for 75 million ecu over a three-year period.

Nevertheless, Ugeux is the first to admit he does not have the cure-all for SMEs. “There is nothing that is more local and specific than SME financing, so if you want to find a global solution to SME financing, you are dead from day one. But if we take the time to invest in understanding how the Mezzogiorno is different from the Jutland in Denmark or Yorkshire in Britain and how our interventions can be different, then we can achieve the objective that the Community has given us.”