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Government extends Recovery Loan Scheme to support strained corporate balance sheets

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The UK government has announced a two-year extension to the Recovery Loan Scheme (RLS) to support businesses struggling under the weight of soaring prices, tighter financial conditions and the impact on demand from the cost of living squeeze.

 The extension of RLS, anticipated since May, coincides with new inflation data for June, which reveals the annual rate has climbed up from 9.1% in May to a fresh 40-year high of 9.4% according to the Office for National Statistics (ONS). Rising fuel and food prices have pushed inflation to levels last seen in 1982. The Bank of England (BoE) forecasts inflation will peak slightly above 11% towards the end of the year. Ahead of the June ONS inflation data, Andrew Bailey, Governor of the BoE, said in a speech on 19 June that “a 50 basis point [interest rate] increase will be among the choices on the table” for the Monetary Policy Committee at the next meeting, which will be in August.

 UK business confidence has notably deteriorated. Around three quarters (76%) of UK-listed companies expect a decline in UK economic conditions in the next 12 months, according to the FTSE 350 Boardroom Bellwether survey. Soaring inflation, rising costs of energy, raw materials, wages – further aggravated by staff shortages across many sectors – and continuing supply chain bottlenecks intensified by Brexit red tape are in danger of pushing many businesses to breaking point. All these headwinds are feeding into a growing recession risk in the UK, the eurozone, and the US, while China’s slowdown has significant consequences for global demand. 

 Capital Economics forecasts a 0.1% contraction in UK GDP in Q2 compared to Q1. Paul Dales, Chief UK Economist, said: “It is far too soon to conclude that the economy will be able to get through this period of unusually high inflation largely unscathed. With real household disposable incomes set to fall further in Q3, a recession is still a real risk.”

 RLS extends £4.5 billion in 15 months

The RLS scheme extended £4.51bn in government-backed funding across 20,643 facilities from April 2021 to 12 July 2022. Of which, £3.83bn is drawn through 18,338 facilities, according to the British Business Bank (BBB). More than half of combined loan facilities (53%) are concentrated in four industries:

  • the construction industry (2,776 businesses received £730.6m);
  • wholesale, retail trade and repair (3,711 businesses received £716.2m);
  • manufacturing (2,286 firms received a combined £554.8m); and
  • real estate (564 companies received £409.8m).

 “The extension of the Recovery Loan Scheme will help ensure we continue to provide much-needed finance to thousands of small businesses across the country while stimulating local communities, creating jobs and driving economic growth in the UK,” said Business Secretary Kwasi Kwarteng in a statement.

The Department for Business, Energy & Industrial Strategy stated: “The principle behind the extended RLS remains unchanged: government will underwrite 70% of lender liabilities, at the individual borrower level, in return for a lender fee. Lenders must ensure that the government guarantee benefits are passed through to businesses.” The borrower remains 100% liable for the debt. The BBB described the extension of the RLS as “a new iteration”, implying changes. The scheme is scheduled to restart in August.

 The RLS offers businesses loans of up to £2m. It was initially designed to help businesses return to financial sustainability after the pandemic, but has broadened to provide a vital lifeline to corporate balance sheets under acute stress. Businesses in industries with significant exposure to energy prices already operating under narrow profit margins, such as aviation and manufacturing, could see earnings fall by around one-third, even after assuming costs can be passed onto customers, warned the BoE in its July Financial Policy Committee report. The darkened economic outlook could expand to businesses in non-essential household goods and services (e.g. retail and leisure, tourism, consumer discretionary) if a fall in household real incomes reduces demand. Firms exposed to these headwinds will need to shift a larger share of dwindling revenues to repay the rising cost of debt servicing.  Matalan, the UK retailer, exemplifies these pressures. Last month, the Liverpool-based retailer reported that it may not be able to continue to operate if it is unable to refinance its debts by January, according to a Financial Times report.

 From the banks’ perspective, while inflation corresponds to higher net income on lending, it also prompts more judicious lending to borrowers that can demonstrate an ability to successfully pass on the burden of inflation to customers, which varies markedly. Banks’ treatment of struggling borrowers has come under renewed scrutiny in recent weeks. The Financial Conduct Authority (FCA) warned banks it will act if they fail to improve standards after a review of 11 banks found instances of unfair treatment of small business borrowers over debt repayments. The watchdog wrote to the chairs of all retail banks with small business customers earlier this month, reminding them of the standards expected by the FCA. Sheldon Mills, the FCA’s Executive Director for Consumers and Competition, said: “We were disappointed to find repeated instances of these customers not being treated fairly by banks when they’re struggling. We expect the whole sector to act quickly to improve this. We will take action if problems continue.”

 Banks suggest loan books are holding up relatively well, and the rates of default across Covid loans are still lower than modelling exercises had predicted. However, it may only be a matter of time before this trend decisively deteriorates.

 Across the original three Covid loan schemes, the government guaranteed £79.3bn in loans in 1.67 million separate facilities, including £47.4bn across 1.56 million loans under the Bounce Back Loan Scheme (BBLS), according to BBB data. Approximately 193,377 loans with an unpaid balance of £5.7bn are in some form of arrears as at 27 June 2022, representing 12.4% of all loans advanced under the BBLS, according to a Freedom of Information request to BBB by Purbeck Insurance.

 The RLS extension, which will be live from next month, was reportedly delayed due to efforts to toughen up fraud protections. According to estimates, between £3.5bn and £5bn of Covid loans were fraudulently claimed.

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