Across the UK the wheels of the economy are starting to turn again after two months of virus-imposed lockdown. As the business community returns to trading during Covid, a picture of the survivors and casualties in the asset finance space may soon become clear.
The likelihood of a V-shaped economic recovery was played down by Rishi Sunak, the chancellor of the exchequer, during an evidence-giving session before the Lords’ Economic Affairs Committee on 19 May.
Sunak, who was speaking as fears of recession and rising unemployment occupied the business news agenda, said an “immediate bounceback” was “not obvious” and the economy may show signs of ‘scarring’ once restrictions are lifted.
If that turns out to be the case, early indications suggest some of those scars could be borne by the UK community of non-bank lenders, many of whom have thrived in the asset finance space – until recently.
Like other players in the UK economy, non-bank asset finance companies and the commercial brokers on which they rely have suffered their share of setbacks since a lockdown was imposed nationally on 23 March.
‘Demand shocks’ have reverberated across the economy accompanied by calls for banks and finance companies to show forbearance to millions of consumers and businesses impacted by Covid-19.
Squeezed on borrowing
But, in the rush to pull together an SME bailout plan, non-bank executives say that poorly-conceived government schemes threaten to inflict more lasting damage on the independent leasing infrastructure that has built up around the needs of SMEs, following the withdrawal of the big banks from funding small businesses from 2008.
One of the first policy shocks for the non-bank sector came early in the coronavirus fallout when the capital markets – responding to official calls for a three-month payment holiday – raised the cost of funding sharply.
As non-deposit-taking institutions, non banks look to raise funds on the money markets or from institutional investors – such as pension funds, investment funds or bigger banks – with larger players also able to sell their loan books through securitisations, but when news broke of the Government’s calls for forbearance, affordable borrowing on the debt markets soon dried up.
In this environment, the bigger non-bank players with deeper pockets and bigger backers were less sensitive to money market costs than smaller asset finance specialists, funded from a limited source.
According to Becky Bradley (senior counsel of Wells Fargo Securities, a provider of asset-backed securities) the debt capital markets in Europe initially stopped for around two weeks as the crisis took hold.
However, issuance volumes have since returned for the issuers of securities, albeit at a cost, she told LexisNexis on 27 March.
To ease the pressure on lenders, the Bank of England (BoE) unveiled its Term Funding Scheme for SMEs (TFSME) in March, designed to make cheap funding available for lenders at very low-interest rates.
However, for non-bank lenders there was a catch, access to the ultra-cheap funds was only possible via the big banks who enjoy favoured status under the BoE scheme.
This prompted government lobbying by asset finance representatives for non banks to achieve equal borrower status with the big lenders, to allow them to secure best-rate funds directly from the BoE and avoid being at the whim of the capital markets.
In April, the Finance & Leasing Association (FLA) reported its non-bank members were experiencing “a huge cashflow drain from forbearance with Covid-related requests growing by more than 1000% in the week commencing 16 March, followed by a further 249% increase the following week.”
According to Geraldine Kilkelly, head of research and chief economist at the FLA: “The asset finance market was hit hard in March by measures taken by the Government to deal with the coronavirus crisis.
“Of particular concern is new lending to SMEs which contracted by 19% compared with March 2019, and by 10% in Q1 2020 as a whole,” she stated on 7 May.
Stephen Haddrill, managing director of the FLA told a hearing of the Treasury Select Committee on 15 April: “There is this big non-bank sector that the FLA represents. It is very keen to lend, but it is having trouble accessing the capital markets in order to take that lending forward.
“Firstly, over the last 10 years, we have seen the re-emergence of the non-bank and the independent sector, a sector that the FCA [Financial Conduct Authority] itself regards as very innovative and that is lending to people who are close to it. It is very close to the customer. Whatever can be done to support this element of the market is really important.
“Secondly, the supply of credit is so fundamental that it has to be speeded up, and the supply chain of credit has got to be shortened. At the moment you have Bank of England support going into the main banks, which might then pass it on to the non banks, and they pass it on to their customers.
“Let us short circuit that and get that Bank of England support or British Business Bank [BBB] support directly to that sector.”
Given the difficulties in accessing wholesale funding for the non banks, some say the Government needs to find a vehicle for the non banks to access affordable funds.
John Cronin, a financial analyst at Goodbody Stockbrokers, says: “For the Bank of England, the parameters are clear for who qualifies for Term Funding, the reality is the Bank of England, through the PRA [Prudential Regulation Authority], doesn’t ordinarily regulate non banks, it doesn’t have sight of their capital adequacy plans or sight of their ongoing liquidity ratios, so it doesn’t know who it is lending to.”
Meanwhile, the FCA regulatory regime that applies to non banks and independents imposes far less onerous restrictions compared to the PRA.
These various distinctions translate to different perceptions of risk in the eyes of the banks whose decision it is whether to lend to non banks or not via the TFSME.
“The indirect access to TFSME is seen as too restrictive by the non banks and they fear there could be problems when arrears begin to come in and the banks walk away from lending, so it’s up to the Government to step in to find a new or existing vehicle to fund non banks,” says Cronin.
As this article goes to press, talks between the Bank of England, HM Treasury and non-bank representatives, are continuing and a compromise solution is much speculated about within the industry.
As the UK entered its second month in lockdown, many non banks were being squeezed by high funding costs, which was accompanied by limitations to loans via government bailout schemes for micro-business in what some see as unfair taxpayer-funded competition.
While, at one level, business loans and leasing deals are different types of agreements, in the eyes of the asset-based funding community the two products are deeply interwoven, and are becoming increasingly so.
In the last 10 years, as fintech companies have entered the non-bank lending space, asset finance and leasing providers have experienced an increase in demand for business loans that have displaced asset-based lending but which also work in tandem with leasing agreements.
Squeezed on lending
The Government’s six-year micro-business loan – the Bounce Back Loan Scheme (BBLS) – caused a second major policy shock for many non-bank lessors when it was announced on 4 May.
This is because for SMEs surviving in hibernation the immediate need is for cash loans and less so for asset=based lending, which is expected to pick up once the economy improves.
In the weeks leading up to this announcement, lenders who formed part of the BBB’s other Covid-19 SME schemes were accused of failing to distribute the 80% government-backed funds fast enough, with figures showing that lenders had approved less than 50% of the 52,807 applications for the Coronavirus Business Interruption Loan Scheme (CBILS) by the beginning of May, according to UK Finance.
The BBLS – which allows small companies to borrow up to £50,000 – is novel for several reasons and not just because of its 100% government guarantee for lenders.
“When Bounce Back was announced it was quite revolutionary, one, because it is very low-cost, two, there are no repayments for the first year, and three, the application process is incredibly simple,” says Adrian Langford, managing director of Rivermore Asset Finance.
Under the terms of the scheme, loans of up to 25% of business turnover are available for up to six years at a fixed rate of 2.5% with the first year’s interest and fees paid by the Government.
Critics of the Bounce Back loans say it harms competition for business loans by excluding non-bank players from the market.
“The BBLS completely circumnavigates the broker, the introducer and the packager because the customer can only apply for BBLS through their bank. What we’ve seen is that for SMEs to properly get BBLS approved, they need to do this through their existing bank accounts.
Of the 18 lenders offering Bounce Back loans, 17 are banks and Tide (a fintech provider of business current accounts) is the sole non-bank lender on the panel.
In the rush to create an antidote to the slow-moving CBILS, leasing executives say HM Treasury has added to the woes of the non-bank sector.
One asset finance executive, who asked not to be named, says: “Whoever created CBILS was clearly very ingenious, but the person who put in place all the initial caveats and said it must be implemented via the BBB, should have seriously paused for thought.
“The BBB was specifically set up to take a slow considered approach to things, it had a sensible low-risk culture and did not have the resources to administer a high-speed emergency funding scheme, so an almighty logjam at a time of crisis was entirely predictable.
“Although some weeks and months later, BBB are adapting well, this logjam seems to be what Government were reacting to when it created BBLS – it looks like a knee-jerk reaction likely to cause more economic problems down the line than it solves, when there were simpler, faster delivery methods already available.”
A crucial objection to BBLS is the non-commercial rate of interest charged.
In a letter dated 1 May, Rishi Sunak told accredited lenders of Covid-19 emergency schemes: “As a 100% guaranteed loan scheme, the price of BBLS is critical to its success: together, we need to ensure that these loans are affordable and accessible.
“As such, and incorporating a range of data, I have come to the decision that the rate should be set at 2.5%.”
Setting the interest rate at below commercial prices has prompted much head-scratching by owners of independent financing companies and by asset finance brokers.
“This seems to undermine the existing lending industry for the next five years or so. The Government has effectively excluded brokers, small finance companies and non banks from being able to be involved in BBLS. Perhaps they should take another look at this,” says Stephen Bassett, an independent lending consultant.
He continues: “The regretful thing from the industry’s point of view is that they could have used the existing UK non-bank infrastructure to get money out to SMEs very quickly, even if gently subsidised or normal commercial rates were applied, customers would still have wanted the funds, and the whole industry would have continued to operate largely as usual. I disagree that it is all about low-interest rates, I believe it is repaying the capital element which will become the new problem.
“As it happens no one can benefit other than the end-user, which is good, but it speaks to an unfortunate lack of trust in the existing infrastructure,” says Bassett.
Covid schemes: CBILS & BBLS
Bank interest rates under CBILS – the Covid-19 scheme for SMEs with a turnover of up to £45m – were often in the range of 6% or 8% and above in some instances, prompting some executives to argue that, had the BBLS rate been set at similar levels, the Bounce Back product would have achieved much the same or similar uptake as 2.5% but, crucially, would have allowed small finance companies and brokers to get involved in the process, without opportunists and possibly fraudsters, taking the loan just because it was cheaper than anything else available.
As it is, critics say the current rate amounts to unfair competition by allowing the accredited lenders the privilege of lending at low rates guaranteed by the taxpayer, while pushing out independent lenders and brokers.
Neil Baxendale, a director of GTF Event Equipment Finance, an asset finance brokerage specialising in the events and hospitality industry, described the Bounce Back offering as “ill-thought-out”.
“CBILS was a fine idea, it offered 80% support for the lenders and allowed the non-high street institutions to get involved, which meant the broker network had at least a potential opportunity to earn income from providing solutions for customers.
“The problem with BBLS is that by only going through the high street banks and also removing any commission earning possibilities, the scheme then cuts out any opportunities for non-bank funders and the broker network to service their own customers who are likely to be candidates for the Bounce Back loans.”
Anton Scott, head of sales at Dawsongroup Finance, part of Dawsongroup Plc, welcomes the Bounce Back scheme but laments the limitations and its potential for market abuse: “The Bounce Back is a worthwhile product but the SME community has been stifled by the lack of choice on offer to access these funds.
“The applicable interest rate on Bounce Back has made it a bit of a target for those who feel they would get away with an application, even when they don’t actually need it.
“We know of businesses that don’t actually need the cash, but – for the sake of it and because of the low cost – they’ve applied and have been given the facility.
“The BB interest rate is very attractive which may lead to some businesses taking on additional financial commitments without thinking things through properly.”
A spokesperson for the Treasury says: “Our Bounce Back loans are helping thousands of small firms get finance quickly at a low, affordable rate and with a 100% government-backed guarantee.
“All lenders are welcome to apply to be accredited to the scheme. We recognise the vital role that alternative lenders and challenger banks play providing credit to SMEs, and are committed to promoting competition in the sector.”
Critics say the Bounce Bank lenders benefit on three fronts. With the Government, and not the borrower, paying 2.5% fixed interest on BBLS for the first year, each loan can be expected to bring in at least a year’s worth of interest revenue. Secondly, without much effort, the banks are earning goodwill from the customer. And lastly, after the first year, when the first actual borrower payments are due, defaults are expected to be high but, thanks to the 100% guarantee, the lender is (notwithstanding an extensive recovery process) indemnified from any losses.
A recent survey by the Business Banking Resolution Service of 500 UK SME decision-makers, found that of those who had taken out a government-backed loan, “43% say they do not expect to repay them, either because they do not think they will be able to or because they do not think that the Government will pursue the debt.”
“Why give the Bounce Back loans away like sweets?” asks Baxendale. He says that had the Government allowed BB loans to be underwritten normally this would have allowed the independent sector that specialises in funding micro-businesses to get involved, rather than the current system of allowing business owners to self-certify they can afford the loans, which causes problems and brings costs down the line for the taxpayer.
With Bounce Bank loans targeted at sole traders and partnerships, this type of lending normally falls within the scope of the Consumer Credit Act (CCA), meaning it’s up to introducers and lenders to check a borrower’s affordability before any lending can take place.
However, the Government has relaxed the application of the CCA for BBLS and says it will pass a new law retrospectively to cover this.
Langford says, because of this, “it now seems the BBLS lender has no obligation whatsoever to check affordability but is nevertheless left with the decision to offer a borrower a loan or not”.
He says this creates an unnecessary layer of confusion that the normal underwriting process would have easily addressed with no extra burden on the regulator or the taxpayer.
Not all funders agree, other’s think the Government can’t be faulted for making mistakes by not getting the SME bailout response just right.
Jason Davies, UK broker manager at Conister Finance & Leasing, whose parent is Isle of Man-based investment bank Conister Bank, says the business does the bulk of its business in the UK leisure, hospitality and retail sector and is “at the sharp end of what happened.”
He says the Government needed to act decisively to support the SME market and has largely achieved its aims.
“If the result from getting BBLS out the door quickly is that UK SMEs flourish, then everyone wins,” Davies says.
Although he welcomes the scheme, Davies thinks SMEs are not out of the woods yet.
He says: “[As a funder] our challenge at the moment is dealing with clients who we extended forbearance to – for one or two months – but who are now coming back to us asking for further assistance as the world is still a grim place for doing business.”
But he recognises the hardships for brokers. “We deal with about 35-40 brokers, the ones I’ve spoken to are experiencing a high level of frustration in actually getting deals through.
“In theory, there are more routes to market now, but in practice getting deals done is proving a challenge.”
However, Davies thinks that Bounce Back loans succeeded where CBILS struggled. “The BB facility is obviously a fantastic addition. You only have to look at the take-up rate of the BB to know it hit the nerve, it hit the sweet spot of UK businesses, a lot more than CBILS did.”
In the three weeks since BBLS was launched, around 464,393 loans worth about £14.18bn have been lent out. On average over 33,000 loans have been granted each day since the scheme launched, according to UK Finance.
As of 17 May, the BBLS approval rate was 79.8%, compared with 50% under CBILS, and the average size of BBL finance was £30,534 compared with £178,334 under CBILS, according to a report from consultancy Rangewell.
Another funder, who spoke on condition of anonymity, says he’s been approached by a number of his SME customers, who had recently had a BB loan approved, about settling their existing leasing arrangements. “And I don’t think we’re the only funder this has happened to,” he says.
The cheap government loans under the BB scheme have tempted several SMEs to borrow more money than they need in a bid to clear their outstanding asset finance debts.
“We’ve had a handful of customers already come to us, who earlier came to us about arranging forbearance, about asking for a settlement, so they can clear their existing leasing arrangements, but clearly the Government scheme is not there to be used to clear other debt on that basis,” he says.
Unfortunately for such clients, there is rarely any benefit to be gained from settling a lease agreement early, as a 2-3% rebate for early settlement is standard on lease agreements.
“We’ve seen a number of these early settlements come through at a time when so many businesses are asking for forbearance,” the funder says.
Bassett says he’s looking forward to “the next phase of Rishi Sunak’s plan, which needs to enable a staged return to commercially based lending.”
He says: “The Government could continue to offer government funding and government-backed schemes, perhaps similar in structure to CBILS, but rather than just using the BBB, it could now also channel funding or support, through the existing network of FCA-approved funders and brokers, allowing them to apply standard criteria on a case-by-case basis, thus helping the market recover faster.
He says this would allow “hundreds of brokers and scores of funders and non-bank institutions that are currently out of the loop, to start playing a real role in getting the sector back on a commercial footing.”
Given how urgently the independent leasing sector needs to get back to doing more normal levels of business, the Government could also use this as an opportunity to push through much-needed reforms, “for example ensuring funders and brokers always fully disclose any commission and fees involved where government funding or guarantees are involved. Given the circumstances, this could also help lead the way to even more open and responsible lending behaviours,” says Bassett.