The Bounce Back Loan scheme has provided a life-line for many small- and medium-sized enterprises (SMEs), but there are significant concerns about how they will be able to meet their repayment obligations. Christopher McLean looks at what this means for the lenders who are administering these schemes.
The application deadline for the government’s Bounce Back Loan Scheme (BBLS) has been extended to 30 November 2020.
It was introduced in April and has been recognised as a success providing £38 billion of cash (as at September 20)1 to stave off the initial economic shock of lockdown. But it has also built a mountain of debt for SMEs, and many companies are expected to struggle to meet repayments when they start to fall due.
The Chancellor has announced a series of measures designed to help borrowers, including extending the term of the loan from six to 10 years, allowing for interest-only payments, as well as payment holidays, but it is inevitable that many SMEs will still struggle.
High default rate expected
As well as bounce back loans, SMEs may also have additional liabilities, such as delayed tax payments, deferred rent arrears and a build-up in trade debts.
It has been predicted that UK firms will be burdened with £97-107 billion of unsustainable debt by March 20212. Some sectors are already seeing considerable strain given challenging trading conditions and accumulating operating losses. This will only continue once government support schemes wind down, including the new Jobs Support Scheme, which is due to run until April 2021.
As a result, it has been estimated by the Office for Budget Responsibility that up to 40% of Bounce Back loans could be written off as irrecoverable. The measures announced by the Chancellor in his Winter Economy Plan on 24 September3 may go some way to help, but there is no doubt write-offs will be significant.
Although the government guarantee means Bounce Back Loan scheme lenders are not taking the credit risk themselves on these failed loans, as administrators of the scheme, lenders face significant administrative costs, reputational concerns and refinancing risks.
The NAO has indicated that “lenders are required to pursue ‘appropriate recovery processes’ and the scheme terms give lenders a 12-month time limit after they have issued a formal demand on the borrower to pursue outstanding amounts …claiming on the government guarantee is not conditional on having completed the recoveries process – lenders are able to make a claim on the government guarantee “within a reasonable time period” following the first formal demand date, or sooner, if lenders believe “no further payment is likely"". However, we understand that the FCA is still discussing with HM Treasury the details of an approach to debt collection and so this area is subject to change.
Even without necessarily having to complete a full recoveries process, there is the prospect that pursuing at least partial recoveries places a significant administrative burden on lenders that will absorb considerable time and money. Do lenders have the right internal systems and expertise in place to be able to cope with that?
Lenders have argued that they would have to hire hundreds of restructuring and collection specialists, something they would rather not do at a time of squeezed earnings and high loan-loss provisions.
For newer lenders who have been offering bounce back loans, this may be a stage of the credit cycle they have not experienced before, and mindsets will need to make the significant shift from growth to recovery. This all takes time, resources and investment as processes are developed and stream-lined and staff trained.
Having to pursue SMEs for unpaid debts could lead to serious reputational damage for lenders. Many borrowers will be small, family-run businesses, which have borrowed an average of £30,000 each4. Will lenders risk pursuing them through the courts, with all the expense and reputational damage that could bring?
Lenders are particularly sensitive to this issue having been involved in a series of scandals around treatment of small borrowers after the last financial crisis.
Even the companies that do pay could still pose ‘headline risk’ for lenders. Borrowers with limited funds available have difficult choices to make: do they pay back their lender at the expense of their suppliers or tax bill? This could cause significant problems down the supply chain, as well as for HMRC.
In July, the British Business Bank (BBB) and UK Finance announced they had embarked on exploratory discussions with leading commercial banks, such as HSBC, in order to agree on a ‘code of conduct’ as to how all Bounce Back Loan scheme lenders should treat borrowers and as highlighted, we understand discussions between the FCA and HM Treasury on this point are ongoing.
Although these talks have not yet concluded, it is hoped that agreeing a standardised, automated approach to dealing with defaults could protect lenders from individual reputational damage.
One big question remains: what is going to happen to all these loans, and what role should lenders themselves play?
CityUK, an industry body representing UK-based financial and related professional services, has established the Recapitalisation Group in order to identify ways to support the recapitalisation of UK businesses who have taken on unsustainable debt in response to COVID-19. Its final report was published in July and proposes a variety of solutions including converting loans into contingent tax obligations, subordinated debt or preference shares5.
However, these options raise the thorny issue of giving preferential treatment to SMEs who took up Bounce Back loans, thereby giving an advantage over SMEs who have soldiered on without government aid. The government is unlikely to make any decisions on this in the near term, wary that proposing more generous terms will only lead to more loans being taken out opportunistically, adding to the problem.
For Bounce Back Loan scheme lenders however, the uncertainty will continue. When an existing borrower approaches its lender to refinance its government guaranteed loan, there will be difficult choices to make.
Do they refinance the loan without the benefit of the guarantee, bearing in mind the lender might have performed no previous credit checks on this borrower? Or do they push the borrower into an enforcement scenario with all the associated costs of trying to recover at least some of the debt before calling on the guarantee?
Lenders will already be feeling pressure due to the economic downturn, and this will only increase in the coming months as defaults rise and difficult decisions need to be made. They should start to prepare now.