“Consideration may need to be given” to bailouts from taxpayers “to meet solvency or liquidity requirements,” but only “at the extreme end,” whatever that means.
By Nick Corbishley, for WOLF STREET:
Many struggling businesses in the UK, both large and small, will soon be sitting on debt piles they won’t be able to service as the emergency loans they’ve taken out to survive the lockdown and its aftermath begin to fall due. That’s the stark warning of an “interim report” by the Recapitalisation Group (RCG), a task force assembled by The CityUK, one of the UK’s most powerful financial lobby groups, at the “encouragement” of the Bank of England, to explore ways of recapitalizing small and medium-size enterprises (SMEs) when the inevitable debt defaults begin.
By early next year, non-financial businesses will have between £32 billion and £36 billion of additional debt they cannot repay, the RCG warns in the report. That fresh debt, on top of the distressed business debt that already existed before the crisis, will leave UK businesses with between £97 billion and £107 billion of what the RCG calls “unsustainable debt.”
Around half of that debt will belong to SMEs. Almost all of it will be owed to banks. Although the loans are ostensibly backstopped by the government, some banks, according to The Sunday Times, are beginning to fret that when companies begin to default on their debt, the government backstop will not automatically kick in, leaving the banks holding big losses on their loan books.
The UK government has set up a total of three emergency business loan programs in response to the coronavirus crisis: the Bounce Back Loan Scheme (BBLS), the Coronavirus Business Interruption Loan Scheme (CBILS), and the Coronavirus Large Business Interruption Loan Scheme (CLBILS), each of which covers different segments of the business community.
BBLS is aimed at micro and small businesses, offering facilities of up to £50,000. It is 100% backed by the government. CBILS is tailored to both small and medium sized businesses, offering facilities of up to £5 million, and is 80% backed by the government. CLBILS focuses on large businesses with facilities of up to £200 million and is 70% government guaranteed.
In addition, the Bank of England has launched the Covid Corporate Financing Facility program which provides liquidity to large corporations by exchanging commercial paper for low-interest loans. It has so far lent £16 billion to 53 companies.
But it’s the government’s three loan programs the RCG is interested in. Through these programs, lenders have provided £35 billion in emergency loans to 830,000 businesses. But the RCG expects this to rise to between £111 billion and £123 billion by the second quarter of next year.
Borrowers do not have to repay the principal or interest on those loans for the first 12 months. But in three months’ time the government’s job retention scheme is scheduled to come to an end, meaning companies will have to restart paying the wages of their formerly furloughed workers. That could be a stretch for some companies that have generated virtually no revenues for months on end and will need to use much of their working capital to reinvest to meet pent up new demand. The alternative is to lay some of their workers off, but that itself can be a costly process.
Ironically, it is when the businesses begin to reopen that the strains will probably begin to show, particularly for companies that already had debt and/or cash-flow issues before this crisis began.
“It’s the classic symptom of over-trading,” says Duncan Swift, former president of insolvency trade body R3. “If there is a significant uptake in orders but a weakened capital base, that is when insolvencies will spike. The feeling is that it is three months off.”
In a recent survey of SMEs by the British Banking Resolution Service, 45% of respondents who have taken out a loan from a government business lending scheme say they may not repay it. Some industries are likely to be more exposed than others. According to RCG, the sectors most at risk of non-payment are property (representing 24% of the total estimated unsustainable debt), accommodation & food services (16%) and construction (11%).
To reduce companies’ debt burden, RCG has a number of proposals, including exchanging troubled CBILS (the loans given to mid-sized firms) for preferred stock, which would be subordinate to all existing debt but ahead of existing shareholder loans and common equity; and swapping BBLS (“micro” business loans) for contingent tax instruments. These might function in a similar way to student loans and fall due only when certain payment thresholds are reached.
It also recommends encouraging capital providers, both institutional and retail, to invest in UK businesses, either directly through a mix of debt and equity or indirectly through a third party investment manager or fund (such as an asset manager or Private Equity fund).
It’s far from clear how PE firms, VC firms, and institutional investors would be able to “help out” heavily indebted SMEs. As the authors of the report themselves admit, huge hurdles would have to be overcome and models and regulations retooled for the proposal to have any hope of getting off the ground:
“Unlocking capital from UK insurers, pension funds and PE could present opportunities to support UK SME recapitalisation and merit further consideration. However, unlocking private capital for this purpose and on this scale has not been done before in the UK market. There are significant challenges (e.g. alignment with investors’ risk and return preferences, and regulatory and operational issues) across all investor groups. Therefore substantial changes to the current model and new approaches to overcome existing impediments will be required.”
As efforts are made to straddle those hurdles, the UK Treasury is already working on plans to make it easier for pension funds to invest in PE and VC funds. Pension funds are currently restricted from investing in PE and VC funds due to the high fees they charge.
Former Chancellor George Osborne suggested another possible option in a chat with the FT last week: just “write off some loans.”
The RCG agrees, conceding that “consideration may need to be given to grants offered by the government” — which would be free money from taxpayers — “to meet solvency or liquidity requirements,” but only “at the extreme end,” whatever that means. By Nick Corbishley, for WOLF STREET.
Foreign Companies welcome. US Tax dodgers that didn’t qualify in the US, no problem. Read... The 53 Companies Bailed Out by the Bank of England: Johnson Controls, Carnival, PACCAR, Honda, Toyota, BASF, Bayer…
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