Will bounce back loans cause SME lenders to fall flat?

The government has been fast to react to the negative economic impact of the measures they have taken in response to COVID-19. These have generally been received positively by business. However, as a result of the rapidity of the response there will be unintended consequences.

In this year’s budget, Rishi Sunak, the Chancellor of the Exchequer announced his flagship Coronavirus Business Interruption Loans Scheme (CBILS) [1]. Although the government underwrote 80% of any bad debt, banks were liable for the remaining 20%. This deterred lenders from offering loans to all but the most obviously creditworthy and viable borrowers. Interest rates were also left to the originator to set following an initial 12-month 0% rate.

Cue calls for CBILS to be amended, at least for smaller companies, with a 100% guarantee [2]. CBILS were largely left unchanged. Instead on 27 April 2020, Sunak unveiled new support for the UK’s smallest businesses [3] in the form of the Bounce Back Loans Scheme (BBLS). Under BBLS smaller businesses will be able to borrow up to 25% of their turnover to a maximum of £50,000. The government will underwrite 100% of the loan which will have a 6-year term. Furthermore, interest rates will be fixed at 2.5% following an initial 12-month 0% rate; the government will pay the interest and fees in the first year [4]. In contrast to the CBILs, lenders are not permitted to take personal guarantees or take recovery action over a borrower’s personal assets.

The move proved very popular with smaller business. As of 21 June 2020, the Treasury reported that 921,299 loans had been made available totalling £28.09bn [5], giving an average loan size of £30,500. This is in comparison to 50,482 loans being made available through CBILS totalling £10.53bn. Just over half the CBILS applications made by this date had been approved whereas for BBLS it is 82%. Currently the loans are available from 24 lenders [6].

At the start of 2019 there were 5.9m private sector businesses in the UK [7]. An increase of 3.5%, more than 200k new businesses, on the previous year. Of these 76% (4.5m) had no employees¹, 19.7% (1.2m) were micro business (1-9 employees) and 3.6% (0.2m) were small businesses (10-49 employees). The government refers to these three types of business as small businesses. Medium (50 – 249) and large (+250 employees) business made up the remaining 0.7% (0.04m) employing 52% of the work force. This not only explains the popularity of the BBLS but also the rush of new market entrants providing loans to Small and Medium Enterprises (SMEs) in recent years.

The growth in the number of SME lenders has been championed by successive governments most notably through the Banking Competitions Remedies (BCR) scheme [8]. As a condition of their bailout during the financial crisis, RBS provided £425m to smaller rivals to facilitate investment in business banking services. This is referred to as the Capability and Innovation Fund (CIF) and is operated under the BCR. Some 14 lenders have to date been awarded grants ranging from £5 million to £100million under CIF.

To safeguard their investment to date through the BCR it is reasonable to expect the government to include the 14 CIF lenders within the BBLS. This has not been the case with only 4 CIF lenders having been included and one of those had previously returned part of their CIF grant. Furthermore, the remaining BBLS lenders are made up of the large and medium established banks and building societies.

The lack of SME challenger lenders in the BBLS does nothing to increase competition and consolidates the position of traditional lenders. No small business will borrow at a higher rate when BBLS, with more favourable terms and conditions, is available. Lenders outside the BBLS are unable to lend on a comparable basis and will struggle to compete. Particularly as,

1.The majority of lenders cannot access funds at a sub 2.5% interest rate in the market.
2.The government covers the cost to lenders of administering the scheme.

Circa 10% of SMEs accessed the scheme within the first month which is likely to be extended beyond its original 4 November 2020 deadline. This means SME challenger lenders are likely to fold if they cannot become BBLS accredited. Not all will. Furthermore, with only 4 of 14 CIFS within the scheme the majority of the £425 million available through the BCR has now effectively been squandered by the government. The SME lending market becoming a casualty of the rapid government response to COVID-19.

The issues for the government don’t stop there. A recent survey by the Business Banking Resolution Service [9] found that 43%² of businesses that have made use of the government loan schemes said they do not expect to repay them. Two reasons were given; they believe they will be unable repay or that they believe that the Government will not pursue the debt. This is despite recovery being a matter for the banks. These two responses uncover some difficult truths. In the first instance loans have gone to firms that were potentially unviable pre, or have suffered catastrophic failure during, COVID-19. Otherwise, it would be reasonable to expect business recovery and subsequent loan repayment within the 6-year term. In the second instance loans where taken out with no intension of repayment. Both situations are potentially fraudulent.

The government’s dilemma will be whether to pursue recovery of any outstanding debt. If pursued the very same firms that the government was trying to save could fail as a result. However, without an effective recovery strategy the government could be writing off in excess of £10bn of taxpayers’ money. Calls are already being made in some quarters to write them off [10]. What is likely though is that the government will extend loan terms and keep interest rates low and thereby delay any decision.

If you are an SME, it is worth repeating that the BBLS is currently due to end on 4 November this year. Get it while you can.

Notes
¹ Defined as comprising sole proprietorships and partnerships with only a self-employed owner-manager(s) and companies with one employee, assumed to be an employee director.
² Although this number includes CBILS, given the relative number of loans approved and their terms, we can be confident that it reflects a potential BBLS bad debt rate.

References

[1] ‘Budget 2020: key points’ The Financial Times, 11 March 2020
[2] ‘Rishi Sunak prepares to offer 100% guarantees on small business loans’ The Financial Times, 11 March 2020
[3] ‘Small businesses boosted by bounce back loans’, HM Treasury, 27 April 2020
[4] ‘FAQs for small businesses: Bounce Back Loan Scheme’ British Business Bank, April 2020
[5] ‘HM Treasury coronavirus (COVID-19) business loan scheme statistics’ HM Treasury, 21 June 2020
[6] ‘Bounce Back Loan Scheme (BBLS) – Current accredited lenders and partners’, British Business Bank, 21 June 2020.
[7] ‘Statistical release: Business population estimates for the UK and The Regions 2019’, Department for Business, Energy & Industrial Strategy, 10 October 2019.
[8] Banking Competition Remedies Limited (BCR), 21 June 2020.
[9] ‘The impact of covid-19 loan schemes on business banking dispute resolution’ Business Banking Resolution Service, May 2020.
[10] “George Osborne urges UK to write off Covid-19 business debt”, The Financial Times, 3 June 2020