Why the Government’s Coronarvirus SME Guarantee Scheme has delivered less than 4% of the $40 Billion allocated to it…
When the federal government announced it would guarantee up to $40 Billion worth of loans to SME’s in order to keep funds flowing through the COVID-19 pandemic, business lenders cheered, but now those cheers have fallen silent. The funds have failed to flow and many people, including small business ombudsman Kate Carnell, are asking ‘why?’
So, let’s consider some of the hurdles…
- The Scheme specifically applies only to “Unsecured Loans”. Often this is one of the most expensive lending products pitched at small business, and whilst it may be one of the most flexible (the business can spend the money where they need to) many lenders charge a considerable premium compared to say equipment finance or other ‘Secured’ loans.
Somewhat confusingly the Scheme Rules [3.2(b)] state that the loans must not be secured by any Security Interest (typically the goods financed by the lender which can be repossessed if the borrower defaults) other than personal guarantees or any Security Interest so long as the lender undertakes not to enforce it!
- Lenders are instructed to “determine lending standards in accordance with their usual credit assessment process”. A lender’s normal credit process is usually quite straight forward, put simply – “lend to businesses that can prove that they can and will pay you back.” Of course, in these abnormal times the usual credit assessment process simply isn’t realistic. Many small businesses cannot show that they will have any way to repay a loan without a change in circumstances, and without support (government support, community support, and creditor support).
- The fear of AFCA (Australian Financial Complaints Authority) Even though consumer Responsible Lending regulations don’t typically apply to small businesses, AFCA still hears (and often upholds) complaints in some form of “It was obvious I couldn’t afford the loan, the lender should never have lent me the money.” Wisely, the treasurer has amended AFCA’s terms so that an AFCA Decision Maker must consider complaints on the basis that lenders are allowed to disregard the impact of COVID-19 when determining the financial situation of the borrower (of course this is in complete conflict with “normal credit process”). More relevantly though, this ‘exemption’ applies only to Unsecured Loans under this scheme.
- The final nail in the coffin – Scheme loans cannot be used to refinance any existing debt. Surely this makes sense, right? Why would the government allow lenders to convert existing loans which it hasn’t guaranteed into new ones which it does guarantee? It’s important to understand that many small businesses do not access finance directly from a bank but via a ‘finance company’ (which may in turn be funded by a bank, or through another source).
When COVID-19 hit and businesses started to miss repayments, the banks were given some relief around the treatment of impairments. However the finance companies were, and remain, at the mercy of their agreements with their wholesale funders. As bad debts increased many of these wholesale funding facilities have turned off the lights and gone home, or are simply overwhelmed trying to ‘fix’ the problem of existing customers who are behind in their payments, they have no intention of acquiring new potential problems.
What does all this mean?
Let us imagine for a moment you’re a small café struggling with limited trade due to COVID-19. You need to replace your broken coffee machine which costs $10,000.
You can apply for asset finance from your bank (it’s cheaper than an Unsecured Loan, remember) but the lender doesn’t approve it because:
- The government guarantee doesn’t apply to this type of loan.
- You’re a poor risk to repay the loan as trading is down and the future remains uncertain.
- The lender needs to show that it appropriately applied its usual lending standards and credit policies.
OK, you say, I’ll pay a bit more and get a $10,000 Unsecured Loan under the Scheme, but is the lender any more inclined to approve you?
- You’re still a bad risk to repay the loan.
- If you don’t pay the lender, it does get back $0.50 in the dollar from the government, but to get any more it has to come after you personally (assuming it has your personal guarantee) and run the risk of being the big-bad-bank that sent you bankrupt.
- The lender can’t even repossess the coffee machine as it would normally.
In either circumstance if you’re already behind in payments on some other loan the lender may not be able to lend you the money even if it wanted to!
So, how does the government fix this?
- Allow the scheme to apply to all the typical major types of finance used by small businesses including leases and loans. This means that businesses can access cheaper rates when using the loans to buy things and they can take advantage of the Treasurer’s other flagship business stimulator ‘Accelerated Asset Depreciation’.
- In allowing the Scheme to apply to leases and loans, allow lenders to take security over the assets they have financed as they normally would, but allow them to take personal guarantees only when not taking security over the assets being financed. This gives lenders confidence in their ability to recoup losses through a combination of the guarantee and sale of assets as they normally would and gives business owners comfort that their home isn’t necessarily being put on the line in these uncertain times. You could even have the draw on the guarantee only allowed once the assets have been sold (so if the assets get more than $0.50 in the dollar the government pays out less).
- Extend the scheme to any approved lender which holds the loan on its own balance sheet or assigns the benefit of loans to its wholesale funding facility. This would mean these lenders can assign the benefit of the guarantee to their wholesale funders and (hopefully) turn on the broader tap of business funding once more.
- Allow lenders to refinance a certain amount of existing customer debt within the scheme (perhaps 50% of the drawn loan amount). This could be limited to existing customers that had a facility which were up to date when COVID-19 struck. This would certainly have a significant impact in allowing lenders of all types to turn the tap back on to the customer. Yes, it means the taxpayer may be on the hook for funds which the lender had already committed, but it also means that the lender is far more likely to be comfortable extending their risk further to this customer.
Wrap all of the above in a set of simple rules that ensure lenders cannot enforce security or guarantees too soon in the process, and must be flexible around payment arrangements for COVID-19 impacted customers, particularly where circumstances change (like a renewed lockdown as we’re seeing in Victoria).