iIs there such a thing as an 80:20 rule? And if there is, is it there to be broken? Those questions surrounded the Government’s Coronavirus Business Interruption Loan Scheme (CBILS) last week. Frustration at the slow distribution of funding to SME UK via the scheme led to widespread calls for the Government to underwrite the final 20%, and so increase its guarantee of the amounts funded by accredited lenders under the scheme from 80% to 100%. But would that do the trick? Or are there some companies worthy of public support for which more debt is simply not the right answer?
The 20% is a form of risk retention by the accredited lenders. Risk retention has been mandated before to encourage prudence in credit practices, most notably perhaps in the US when the Securities and Exchange Commission along with other US regulators adopted the Credit Risk Retention Rule to implement part of the Dodd-Frank Act. The Rule obliged asset securitisation vehicles to retain 5% of the risk of any assets they transferred. The Act and the Rule were a direct response to the financial crisis. Risk retention was to counter the perceived failings of the pure credit distribution model where liquidity dislocated risk and reward, and so contributed to the crisis.
By contrast, this crisis wasn’t caused by excess liquidity in the financial markets. And the wider market now needs liquidity. The CBILS medicine has been slow to reach SME Britain. Risk retention in this case is supposed to ensure that Government-backed loans do not go to companies which would have been likely to fail anyway. But after three weeks and a widening of access by the Government, CBILS is reported to have provided more than £3bn of total funding has been provided to 16,500 businesses – against 300,000 businesses apparently asking for support. It cannot be the case that the other 283,500 businesses were all likely to fail anyway. So is risk retention the right approach now? By contrast, Swiss banks were able to approve 75,000 loans worth £12.4bn in the first week alone of their equivalent scheme. The main differences: the Swiss government is guaranteeing 100% of each loan; and the Swiss scheme is administratively very simple. At least this much can be said: the 20% risk retention isn’t helping.
So far, the Government have resisted these calls. “I am not persuaded that moving to a 100% guarantee is the right thing to do” was the Chancellor’s comment last Monday. Although, on Friday the Financial Times reported that the Chancellor may be considering a new scheme for micro-businesses offering funding of up to £25,000, 100% guaranteed by the Government. Beyond the sheer pressure on the public finances, questions of moral hazard around any increase abound.
However, to some extent, the risk retention debate is obscuring a further challenge for lenders. Businesses seeking to benefit from CBILS, and arguably its bigger cousin, the Coronavirus Large Business Interruption Loan Scheme (CLBILS), can be loosely characterised as one of three types.
Firstly, businesses which were trading close to or at the limit pre-COVID-19. These are businesses which would be seen as a high credit risk and would not normally have qualified for additional borrowing pre-COVID-19. The additional debt they would take on through CBILS would make them financially unviable in normal trading conditions. There is a significant risk that additional lending through CBILS would not be sustainable. As the CBILS criteria make clear, these businesses should be ineligible for support as they do not “have a borrowing proposal which the lender would consider viable were it not for the current pandemic”. CBILS is not therefore an appropriate vehicle to support such businesses.
Secondly, businesses which were trading strongly pre-COVID-19. These are businesses which could comfortably have taken on more debt pre-COVID-19. To the extent they need additional liquidity in current circumstances, CBILS could prove an effective route. Some businesses will have a challenge providing adequate asset security to support the funding, and these businesses may be in some of the sectors hardest hit (e.g. retail, restaurants). There may be a case for additional flexibility to support borrowers in these sectors. Other governments, such as the US, have recognised particular sectors in equivalent schemes. This may be where a 100% guarantee would help.
Thirdly, businesses which were trading comfortably but whose finances were structured with no headroom pre-COVID-19. This is in many ways the most difficult category and where that further challenge lies. These are businesses which the Government would want to support and which should be good contributors to the economy after the immediate crisis is over. But their lack of headroom calls into question their ability to trade their way out of additional debt. For these companies there is a real risk that the additional debt CBILS causes them to take on, particularly once the interest-free period ends after 12 months, will cause these viable companies pre-COVID-19 to become non-viable afterwards.
A 100% guarantee may assist some businesses in this category. But if the additional borrowing is the problem, an increased Government guarantee won’t help. Indeed, it may simply facilitate the delivery of a vaccine which ultimately overwhelms the patient. Using CBILS for such companies therefore risks having the perverse effect of achieving the opposite of the Government’s aims. For this category, it may be that an alternative model of support is needed. Perhaps this is an equal challenge for the Government: both to identify that alternative, and then to justify its use.
