The Bounce Back Loan Scheme (BBLS) has been extended for a third time to 31 March 2021. In addition, businesses that originally borrowed less than the maximum amount available to them are now able to top up their original loan.
The BBLS was introduced in April 2020 and has been recognised as a success providing £42 billion (as at 15 November 2020) 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.
In September 2020, the chancellor 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.
The full economic impact of the pandemic has yet to hit, primarily due to the support measures such as the government-backed loan schemes, including the BBLS, as well as furlough, VAT and rent deferrals, and restrictions on statutory demands and winding up petitions.
There is hope that the vaccination programme will enable the economy to take steps to open up again. However, as government support starts to unwind in 2021, it is likely there will be a rise in defaults. As well needing to start repayments on bounce back loans, SMEs may have built up significant additional liabilities, such as delayed tax payments, deferred rent arrears and a build-up in trade debts.
The high level of fraud associated with the BBLS is also a concern. A third-party review commissioned by the British Business Bank (BBB) found that there is a ‘very high’ level of fraud risk, caused by self-certification, multiple applications, lack of legitimate business impersonation and organised crime.
As a result of both credit and fraud risks, it has been estimated by the Department for Business, Energy and Industrial Strategy and the BBB that 35-60% of borrowers may default on their bounce back loan. These levels are staggering. The measures announced by the chancellor in his Winter Economy Plan in September 2020 may go some way to help, including a replacement loan scheme which could carry a guarantee of up to 80% for loans of up to £10 million, but there is no doubt that 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 National Audit Office 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 streamlined 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 each. 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 2020, the BBB and trade association 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.
Two big questions remain: 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 that 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 shares.
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.
For support in getting ready for coming challenges, contact Christopher McLean.