Britain’s recent descent into a coronavirus ‘second wave’ with the UK government succumbing to scientific and political pressure to enforce another national lockdown in England, will blunt the momentum of any short-term economic recovery. Early predictions of the cost in lost GDP in the fourth quarter is forecast to be shallower than the 25% plunge in the second quarter. Prime Minister Boris Johnson said the stricter month-long restrictions across England – including travel restrictions as well as the closure of pubs and restaurants – were necessary to stem an alarming pick-up in new infections. More than 20,000 people are catching the virus every day, according to UK government data.
Although the Treasury swiftly reinstated the furlough scheme for employers at the original 80% of salaries, the second lockdown has undoubtedly damaged the anticipated third-quarter recovery. UK gross domestic product (GDP) rebounded by a record-setting 15.5% in the third quarter, as the economy recovered from lockdown measures imposed in the Spring, according to the Office for National Statistics. The recovery reversed 55% of the 20.4% plunge in economic activity in the prior quarter. But the massive increase in UK GDP will provide little solace to the UK government, corporates or households, with the financial strain accumulating. UK companies fell into significant distress at the fastest pace in three years in the third quarter, jumping by 30,000 to 557,000, according to Begbies Traynor’s Red Flag Alert, with food and drug retailers, construction, and the leisure and hospitality sectors among the hardest hit. Almost certainly, more pain will follow in the coming two quarters, ensuring a sobering environment for SMEs, typically defined as employing fewer than 100 employees. Boards must now update liquidity forecasting scenarios, which will include assessment of existing debt covenants with an eye on refinancing, broader restructuring and possible new financing requirements with their traditional banking partners. However, the fallout of the global pandemic and subsequent economic disruption is also, inevitably, becoming ever more critical for the banks. The stampede of demand for government-backed loans has exposed the UK taxpayer to potential losses of up to 80% due to defaults and fraud, according to the National Audit Office’s worst-case scenario estimate. UK Finance, the industry lobby group, and the state-owned British Business Bank are in talks to establish industry-wide debt collection standards. Some banks have stopped opening new business account to prioritise existing customers.
The environment for the UK clearing banks is critically different in at least two ways, compared to the 2008 financial crisis. First, the low-interest-rate environment has entrenched a decade-long search for yield by pension, annuity, sovereign wealth and endowment funds. These pools of private capital have backed debt funds across the risk spectrum launched by private equity, hedge funds, fund managers and insurance companies. SMEs today, navigating their financing options in the teeth of a pandemic-induced economic crisis, have the luxury of the diversified financing market which simply did not exist a decade ago. This context is essential for SMEs now be assessing access to refinancing and new lending from their traditional banking partners.
Banks are focused on the immediate and near-term economic fallout from the pandemic with their bandwidth focused on existing loan book exposures to struggling sectors and companies. The priority will be to maximise defaulted loan recoveries – those issued before and during the pandemic – including tens of billions in bad debt from expected under the government’s light-touch coronavirus Bounce Back Loan Scheme (BBLS), which are 100% state guaranteed.
Last month the National Audit Office, the parliament’s spending watchdog, reported up to £26bn of the £43bn in bounce back loans so far issued by banks could be lost in defaults and fraud, hurting both taxpayers and the banks. Given the 100% state guarantees, banks may prefer to write off loans quickly than play the role of debt collector to thousands of SMEs which collapsed under the pandemic. Banks have requested to hand over the defaulting loans to a UK finance entity because normal recovery channels would severely clog the UK funding arteries.
But to entirely abdicate responsibility for recovery would increase the bill to taxpayers. Thus, banks must balance their resources and attention between managing in-house loan books, and mitigate loan provisions, and in a fiduciary role to the government, and ultimately the UK taxpayer, in the recovering defaulted debt under the government’s three coronavirus loan schemes. Talks with the Treasury are ongoing to determine how banks need to act in government loan recovery collection. The Office for Budget Responsibility (OBR) reported in late October that its central scenario is that these schemes will raise public sector net borrowing (PSNB) in 2020–21 by £18.3bn on gross lending of £76.4bn. It is safe to assume the Treasury will put pressure on the banks to maximise recoveries to reduce this net debt burden as much as possible. This context makes plain the bandwidth constraints the UK clearers will be under for at least the next six months.
In the near term, banks will possibly, therefore, only have sufficient bandwidth to support non-urgent refinancing and new lending for its most pandemic-resilient and dynamic borrowers. For example, those who can offer fee-based mandates, such as M&A, IPO, capital markets book-running, corporate finance advisory, hedging and currency exchange. Simply put, banks’ ability to generate returns on credit, priced off the Bank of England’s (BoE) primary interest rate of 0.1%, remains low with the headwinds on interest margins strengthening. Last month, the Bank of England wrote to UK banks enquiring as to their ability to operate in a zero or negative bank rate environment. While “not indicative” of intended future policy, banks would be wise to prepare appropriately.
The UK banks will, therefore, clearly stretched. But for growth-focused SMEs which require refinancing and new lending to support sustainable investment have an alternative: a deep pool of non-bank lenders that are able and ready to support ambitious SMEs with a compelling investment story to tell.
If you would like to discuss your liquidity and financing options, contact one of our team today, and we will help you navigate your corporate survival.