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Covid loan defaults could cost the Treasury up to £25bn

UK Treasury

UK companies borrowed almost £8Obn across the government’s flagship coronavirus loan schemes in the year to March, according to recently published Treasury data, costing the Treasury around £25bn in loan defaults. This figure is based upon just-published scheme utilisation levels and Covid loan default forecasts by the Office for Budget Responsibility (OBR).

The three major loan schemes provided emergency cash flow support up to the end of March to around 1.7m UK companies hit by the pandemic. By far the most popular scheme was the Bounce Back Loan Scheme (BBLS) because it was ‘light touch’ in due diligence and offered a 100% government guarantee to lenders. As a result, the vast majority of companies that drew on government loans – around 93% – did so through the BBLS, but this only equated to 61% in loan value (£48.4bn), as a small number of medium and large companies required far larger loans.

According to the new data published by the British Business Bank, the BBLS provided £47.4bn in loans to more than 1.5 million UK companies and an additional £950m in top-up facilities. By comparison, the Coronavirus Business Interruption Loan Scheme (CBILS), the original loan scheme, provided 109,877 loans (i.e. term loans, overdrafts, invoice finance and asset financing) worth £26.4bn, and the Coronavirus Large Business Interruption Loan Scheme (CLBILS) extended 753 facilities worth £5.6bn. The top two sectors which drew upon the Covid loan schemes were construction (£12.4bn or 17%) and wholesale and retail (£11.7bn or 15%). Elsewhere, the manufacturing sector secured £3.7bn, or 14%, of all CBILS loans, representing an almost three-fold increase in share relative to its business population size. The first tranche of data on the recovery loan scheme (RLS) will be published in the autumn.

Utilisation for the expired loan schemes correlated with the pandemic trajectory. The successful vaccine roll-out was offset by new variants that forced the government into further lockdowns, suppressing economic activity. Repayments were due to commence from May, but many struggling borrowers exercised the option to delay by six months, pushing out first repayments to November. Banks will remind borrowers directly of their repayment obligations next month.

The government’s flagship loan schemes – which broadly targeted companies by size and risk profile – carried widely ranging expected default rates. In March, the Office for Budget Responsibility estimated expected losses under the BBLS at 45%, equating to approximately a £21.3bn cost (excluding top-up facilities) to the Treasury. This high default rate reflected the riskiness of smaller businesses, the ‘light touch’ due diligence and the 100% guarantee to lenders. By comparison, the OBR’s expected losses under CBILS, which are individually credit assessed by the lenders, also aimed at smaller companies but with a maximum 80% government guarantee to lenders, was 17.5%, while for CLBILS, aimed at medium and large businesses typically more resilient to exogenous shocks, was 10%. These default rates equate to expected losses of £2.6bn and £980m respectively, based on the scheme utilisation data published by the British Business Bank which oversaw loan scheme delivery. Taken together, the expected losses to the Treasury are forecast at around £25bn.

In a separate default analysis, the Department for Business, Energy & Industrial Strategy (BEIS) estimated the Covid loan scheme default rates were between 35–60% for BBLS; 10–25% for CBILS; and 5–20% for CLBILS. These default rates imply a total cost to the Treasury between £19.2bn and £35.1bn. Separately, the Recovery Loan Scheme (RLS) is expected to cover loans worth £12bn in 2021­–22, leading to estimated write-offs of just under £1bn, a fiscal loss rate of around 8.3%, according to the OBR.

Of course, actual losses could be significantly different to these forecasts. They will depend upon the outlook for the economy and the steps taken by companies to position themselves in the strongest relative position, given their circumstances. At the macro level, the government will be hoping the reopening of the economy on July 19 will stimulate a recovery in consumer spending, which broadens out to improved business sentiment over time. UK gross domestic product (GDP) increased by 0.8% in May, according to new data published by the Office for National Statistics (ONS), which remains 3.1% below pre-coronavirus levels seen in February 2020. The monthly uptick is somewhat muted and comes as leading indicators also point to a slowing momentum for economic activity in June, as new Covid cases rose again due to the Delta variant. This suggests that the pace of the UK’s recovery may be slowing as we move into the summer months, which has implications for companies looking to accelerate revenues to support covid loan repayments. Economists at Capital Economics forecast that Q2 GDP will now be around 5%, rather than its 6–6.5% prior forecast, with GDP returning to pre-pandemic levels by October.

Although the three Covid loan schemes expired on March 31, the successor RLS is scheduled to run until the end of the year and is similar in design to CBILS with an 80% government guarantee to lenders. Companies are also still able to draw upon the furlough scheme and secure business rate and VAT relief. In addition, the moratorium on commercial evictions has also been extended by nine months to March 2022.

If you would like to talk to one of our team about your debt financing options, please contact David Abbott or Anthony Brennan.

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