Does anyone remember when the Chancellor used to present a budget once (or twice) a year then rarely be seen again? The only picture of a Chancellor used to be an extended arm holding a red box, followed an hour later by petrol, beer and wine costing you more at 6pm?
How times have changed.
What Bounce Back Loans Mean
Let’s try and understand what is happening here.
100% Guarantee. This is, in broad terms, the Government borrowing a bank’s money to support small business. The banks can earn interest knowing that their borrowing is pretty much gold plated. Or is it?
Other Government guaranteed business lending (think EFG) has seen the Government give the lender a guarantee of 75% of the loan amount in the event of total default. The big caveat in the background that the borrower never saw was that the Government would cap total claims and would refuse a claim on their guarantee if the cap was breached or they considered the original lending decision to be incorrect or poorly applied.
This meant that the lender had a guarantee that may, or may not, be honoured. Needless to say the lenders never really liked the scheme and played at liking it to show that they had tried.
With the Bounce Back Loans, the Government appear to be offering a guarantee without the caveat of putting a cap in place. Allowing borrowers to (almost) self-certify the viability of their own businesses takes the assessment away from the lender.
I would expect there to be a declaration or certification from the borrower allowing recourse in the event of information being, let’s say ’embellished’, but that shouldn’t impact the lender.
The reason the Government are doing this is that in previous guaranteed loan schemes there was a level of reliance on the borrower’s future income, meaning that they didn’t have to be viable now to borrow but could be going forward. This time that is reversed, the business needs to be viable now and potentially be viable going forward. In lending terms this means;
- Proven track record
- Proven management ability
- Proven affordability based on any ‘normal day’
For a lender the first four priorities of a borrower are;
- The person (or business)
- The amount being borrowed
- The repayment source
- The security (what happens if it all goes a little Pete Tong)
Compare both lists, add in the Government guarantee and you have a near-perfect borrower profile.
The risk to the Government is in the level of default. It is a big unknown and something I can only wish Rishi Sunak well in trying to calculate.
Ordinarily, loans without a personal guarantee have a much higher rate of default, which is why almost every lender wants a personal guarantee regardless of what assets the director has.
The genius part here may be in who the money is being lent to. Let’s think about this;
- Proven business who want to return to trading
- Small loan amounts spread across a larger number of borrowers
- Viable businesses who in any normal day would be doing OK
- As a smaller business, the success of the business is about paying personal expenses, the home mortgage, school fees etc. It is emotive and personal
That considered it may be the default rate is lower than would otherwise be expected for borrowing where the borrower is 100% risk-free.
The lack of any credible underwriting is interesting. There is a model that shows the level of default on home mortgages back in the days of self-certification and fairly relaxed underwriting, versus the level of default on home mortgages in the new heavily regulated era. The rate is almost the same (yellow line 2000 through to 2014).
Where the borrower has something valuable to lose they work harder to keep it.
It may be that there is a level of genius to this new loan scheme. I hope so. It certainly offers the everyday business that was doing well a genuine helping hand.
By Dave Farmer