Lipstick on a pig: the revisions to CBILS do not work
7 April 2020: The revisions announced by the Chancellor last Friday to the CBILS SME loan programme do not work. In this note, Philip Young of CYK explains why.
A week ago, in an article entitled “The Treasury’s Optical Illusion” I welcomed the concept of the Coronavirus Business Interruption Loan Scheme (CBILS) but I vigorously criticised its implementation and said, as presently formulated, it won’t work.
I pointed out that one of the key flaws in CBILS was mandating that borrowers had to go through banks to access the scheme. Whilst one can understand, conceptually at least, why the British Business Bank (BBB) needs to outsource the administration of lending to other institutions, the structure and process outlined were too slow, too cumbersome, too dis-incentivising to SMEs (and their owners) and too ripe for abuse. So it has already transpired.
I said many banks’ concept of “normal commercial terms” in the present climate would be high interest rates and substantial security, if indeed banks wanted to lend at all. I said banks would not want to expand their balance sheets. Behold: there have already been plenty of complaints from SMEs that banks have been seeking to charge very high rates of interest and have been reluctant to lend.
I said many banks would require personal guarantees (PGs) as security for loans. I said any borrower in this climate would be foolhardy to agree to that and criticised this as creating, perversely, a strong disincentive to borrow. Behold: there have already been plenty of complaints that banks are demanding PGs. Twitter is full of anguished SME business owners complaining about this.
I said many banks would be unable to deal with the volume of enquiries and applications and the complexity of the concept would defeat the key requirement of speed, even before credit approval processes had to be undertaken. Also, I pointed out different lenders would offer different kinds of finance and many SMEs would struggle to navigate the options. Behold: there have already been plenty of complaints that banks’ branches are closed, that relationship managers are unavailable (because they are self-isolating) or have not been briefed on the scheme and/or do not know whether it is available and that lending decisions are expected to take weeks and months, not days. This has led to an unedifying squabble between the banking sector and the Government in which the Government has complained the banking sector has not done enough and the banking sector has said the Government’s rules are unclear.
On Friday last week, in recognition of all of this, the Chancellor outlined revisions to CBILS.
Unfortunately, they don’t work either. They are lipstick on a pig. I will explain why.
First, nothing has been done to address the root cause of the administrative problems, namely putting the obligation on banks to operate the scheme, to make decisions and to require SMEs to navigate their credit approval processes. Regrettably, the existence of these delays and problems is even recognised, if not addressed, on the BBB’s own website. It says: “Phone lines are likely to be busy and branches may not be able to handle enquiries in person.”
Secondly, it has been much touted in the press that lenders have been forbidden from demanding PGs. Yet, this is an inaccurate and misleading summary. The detail on the BBB website (https://www.british-business-bank.co.uk/ourpartners/coronavirus-business-interruption-loan-scheme-cbils-2/for-businesses-and-advisors/ ) discloses that it is only facilities under £250k for which a PG cannot be required by a lender. Yet this is a scheme that is intended to lend up to £5m for businesses with an annual turnover of up to £45m so, in practice, SME borrowers for most loans under this scheme are still going to be required by lenders to provide PGs.
The revision to the scheme seeks to ameliorate this, somewhat cryptically, by saying for that for loans above £250k whilst PGs can be required “they exclude the Principal Private Residence” and “recoveries under these are capped at a maximum of 20% of the outstanding balance of the CBILS facility after the proceeds of business assets have been applied.”
The devil will be in the detail and it will be interesting to see what is meant by both of these apparent conditions. But we can make some educated guesses.
The first condition is curiously worded. “Principal Private Residence” is not language that is usually found in bank guarantees. This language is more commonly associated with a form of tax relief and thereby perhaps betrays its genesis within HM Treasury. Its usage in this context appears to mean that lenders are not allowed to obtain charges over the SME owners’ matrimonial home as security for the PG. If so, this is essentially a fiction. If the PG is called by the lender, the SME owner is going to have to find and pay a lot of money to the lender. Not many SME owners have that kind of money freely available. Either that will require the owner having to sell the matrimonial home to realise the money or, alternatively, even if the owner has sufficient other assets, the owner will no longer have the business (which in most cases is ordinarily the source of the owner’s income) and the owner’s other assets will have been depleted, and so the owner will probably still have to sell their matrimonial home to realise money to live on, in any event.
So far as the second condition is concerned, this appears to envisage a “worst case” maximum liability of £1m under a PG. I say that because the maximum CBILS loan is intended to be £5m and if one assumes a disaster scenario of the business becoming worthless and none of the CBILS loan being repaid that presupposes in the case of a maximum loan a £1m liability. This is, at least, of some assistance as it reduces (but does not negate) the prospective liability a SME owner may face. However, it still begs questions. The first is the same question that I outlined in my earlier note, namely why in the present circumstances would any prudent SME owner wish to run this substantial personal risk rather than try to hoard cash in the business and hunker down? The second question is what is the priority of creditors? If the facility ranks in priority after existing bank facilities, which is likely (as they are probably secured), then the probability of this liability being crystallised for the SME owner is much greater and, hence, the likelihood of any SME owner wishing to take this risk much lower. So this second condition maintains an incentive for a SME owner not to take advantage of the scheme but rather to hoard cash.
Thirdly, even the apparently reassuring statement that lenders are not allowed to require PGs for facilities under £250k may hide hidden traps for the unwary SME owner. Consider the SME owner who had previously given a PG for existing bank facilities. That SME owner may have that existing liability covered. However, many PGs are drafted very widely and capture any and all liabilities owed to the lender, no matter when incurred. The further £250k lent under CBILS would not require a new PG – the lender would already have the existing PG to cover it. How many SME owners will be astute enough to realise this and seek legally binding comfort from the lender?
Fourthly, in my original note, I strongly criticised the fact lenders are given the power to decide whether the SME’s borrowing proposal would be viable, were it not for the current pandemic. I said this gives too much power to institutions that have historically shown themselves unworthy of this trust. No attempt at all has been made to alter this requirement.
Fifthly, black humour has been injected unintentionally into the scheme. The BBB now says that SMEs will have to present evidence that they can afford to repay the loan and that this is likely to include a cash flow forecast and a business plan. Pause and consider this for a moment. The only reason this scheme exists is because there has been a crash stop to the economy and many SMEs have either zero revenue or, at most, greatly reduced revenue. The Government has yet to articulate any compelling exit plan. The duration of the crisis is unknown. The state of the economy after the crisis looks increasingly bleak. As a consequence many listed companies have spent the past week telling the markets that they are unable to offer any meaningful forward looking guidance. In these circumstances how is any SME supposed to present a sensible business plan? For a SME with zero revenue, what will the cash flow forecast show, if not zero?
Sixthly, not only does CBILS contain perverse incentives that discourage SMEs from borrowing but it is not consistent with the other schemes announced by the Government, and this creates yet further perverse incentives. For example, the Coronavirus Job Retention Scheme (CJRS) is free to access. Why should any SME try to take a loan at an expensive rate from a bank under CBILS and the SME owner take the risk of the PG, all without any reward, and keep people in jobs, when they can access the CJRS? SMEs will rationally opt for CJRS and ignore CBILS. Thus, SMEs will furlough staff and hoard cash, as the experience of the past two weeks shows they have been doing. Rather than incentivise the maintaining of employment and the flow of money between businesses, the Government’s schemes actually encourage furloughing and the hoarding of cash. This is worse than merely perverse, it is foolish.
Stepping back from all this, the critical time in any crisis is the beginning. Good decision making at the outset is crucial to mitigate harm down the track. Two vital weeks have now been lost and the result has been exemplified all too clearly in businesses furloughing, in some cases firing, staff, and in the already significant leaps seen in people claiming unemployment benefit. The press has already been reporting on businesses going to the wall. The Government has sought to make some play of the fact that £90m has been lent under CBILS so far but, as CBILS was supposed to be a key plank of the £330bn support for UK businesses, this is paltry – roughly about than 0.02% of the total amount. This statistic does not praise the scheme, it condemns it.
As my original note said, and as I have said above, the objective of any loan scheme should be to maintain employment and to keep money flowing between businesses. Fideres proposed a much better scheme than CBILS (https://fideres.com/news/press-release-fideres-s-commentary-on-the-coronavirus-business-interruption-loan-scheme) with those as the key goals. Since Fideres’ proposal was published, the US government has itself launched a scheme (its equivalent to CBILS) that has these as its goals. It is called the “Paycheck Protection Program” and is a low interest unsecured loan to SME businesses in the United States that intentionally incentivises businesses to keep their workforce and to keep trade flowing. If you want to read more about it, you can read about it here: https://home.treasury.gov/system/files/136/PPP–Fact-Sheet.pdf. The objective of the US scheme is laudable but the mechanism it uses to incentivise employment is loan forgiveness. This advantages employment and business at the expense of taxpayers. This can be contrasted with the incentive mechanism used in Fideres’ scheme, being increases to the amount of the principal of the loan (plus a back-ended increased interest rate). Of the two schemes, in my view, the Fideres’ scheme strikes a better and fairer balance between the interests of employees, business and the taxpayer, and is the more optimal solution.
Returning to the UK, many SME businessmen are beginning to say that the SME sector is on its own and the Government cannot be counted on. If the Government genuinely wants to arrest the ongoing economic calamity in the SME sector, it has to stop mucking about, it has to act effectively, and it has to act fast. It should scrap CBILS in its current guise and immediately adopt a loan scheme similar to that proposed by Fideres. As valuable time has been lost, what is now required is a two stage programme, with the first stage being an immediate injection of money into SMEs, by way of a simple unsecured loan, in order to buy time to fix CBILS. Fideres and we have outlined how this could be accomplished here: CYK/Fideres Press Release