Covid-19 hit the entire global economy hard and block discounting is no different.
In this exclusive interview, Investec’s Katherine Flannery, who leads one of the UK’s largest block discounting portfolios, explains how Investec collaborated with its clients to manage one of the biggest economic disruptions in living memory.
Before we start, let’s clarify in simple terms what ‘block discounting’ actually is.In its purest sense, block discounting is a very simple loan structure, where a “block” of underlying end-customer agreements make up the security for the loan.
The cash flow of the block loan is matched by the aggregate of the receipts under the blocked (assigned) agreements. The security in the block loan is only ever as good as the underlying agreements and their cash flows. So when those agreements become impaired, the block funder has a problem because:
a) the security loan to value (LTV) falls below agreed levels and;
b) the cash collected might be insufficient to repay the underlying block loan.
Under normal circumstances, breaches of either of these tenets would be considered an event of default – they would trigger either repayment in full or perfection of the underlying security by the block lender, who would then collect the remaining cash-flows of the underlying customers’ agreements.
What’s been outlined is clearly a huge event in its own right but, of course, nothing happens in isolation and this is especially true of the Covid-19 impact. While Investec’s own book was hit by this unprecedented shock, the business was also having to make huge operational changes to ensure that our people could work safely and efficiently from home in order to ensure continuity for our customers.
Q: How did Investec support its customers?
Firstly we spoke personally to all of our block customers and asked them what assistance they might need, conscious that it is better to offer support well ahead of when it might be needed. By getting on the front foot we were able to develop a strategy that recognised the immense challenges that the Non-Bank Finance Companies (NBFCs) were facing right from the start of the crisis.
We quickly realised that our block clients needed some immediate breathing space, and volunteered a temporary relaxation of normal terms as an exceptional response to the rapid changes to their environment. In practice this had two angles:
We extended the eligibility of Covid-19 forborne agreements to 120 days (now 180 days) so that the client didn’t have to provide new performing agreements (which is difficult when you aren’t writing any new business) or cash, which of course is ‘king’ in any business, especially at times like this.
Working closely with the clients who needed to extend the support to a cash forbearance arrangement, we agreed on plans that took into account the steps they had taken to reduce their underlying cost base (via various government schemes and their own cost containment initiatives).
It is worth noting that all this was done during a period of huge upheaval – in Investec’s case, thousands of people had to change their working practices overnight and get over some practical challenges too, quickly adapting processes so that we could work smoothly without physical signatures, for example.
Q: How did forbearance work in practice?
Our intention was to temporarily reset block repayments in a way that took into account both the clients’ need to maintain their financial obligations and the cash clients needed in order to ‘keep the lights on’ within their own businesses.
The mechanism for this took account of the shortfalls in their income, matching the temporary block repayment to Investec as a percentage of their normal receipts. Importantly, the mechanism made allowance for reasonable operating costs to be accounted for, which meant that affected clients could hold back the cash they needed to continue operating.
By implementing these measures we took a significant amount of pain ourselves in order to help our clients out of a situation which would trigger a default under normal facility terms. There are several stages to the forbearance process, with finely balanced steps to be managed in order to support the client’s survival and their longer-term viability.
We’ve liaised closely with the Finance & Leasing Association (FLA), aiming for a joined-up approach that protects the best interests of all our clients, in the hope that no individual block funder acts outside the spirit of keeping affected businesses trading throughout the crisis and beyond.
Q: It’s often said that we’re defined by what we do when our backs are against the wall. What’s your impression of the way that the industry has responded?
We’ve been reminded of the best in relationship behaviours and thank all our block clients for the way they have worked with us through the first stage of this troubling time for the UK economy.
I don’t think we could have reasonably done any more to support the NBFC’s or their underlying customers at this stage, with prompt action that has helped these businesses to continue operating through the early stages of the crisis.
The response from those businesses that we have helped has been great. They were clear about the pressing challenges they faced and we worked closely with them to recognise their individual circumstances and to provide help in a workable and timely way.
Q: What’s next in the forbearance process?
What’s really rewarding is that a number of our clients have already exited the cash forbearance period more quickly than they had expected. This is largely down to the way they have managed their portfolios (and in part assisted by underlying sectoral dynamics: they have maintained a balance between their borrowers’ best interests with their own obligations to Investec and their other block funders).
Having agreed on the cash forbearance and financial support to help keep the lights on for our worst affected clients, and having volunteered the temporary plan for relaxed eligibility criteria, we now have to work with all our block clients to manage a return to ‘normal’ engagement.
We’re formulating our plans right now for the next stage and we’re conscious that there remains a huge amount of economic and sector-specific uncertainty that might affect our block clients’ cash flows in the months ahead.
Nevertheless, we remain optimistic that by continuing to work closely together, we’ll be well placed to continue supporting the NBFCs’ vital contribution to the UK SME lending market. What’s really important is that companies continue to work with us to get through this crisis together.
Those clients who are in regular contact with us, who keep us updated on challenges and the occasional opportunity – are in much better shape when they need help because we already understand their situation and can assist more quickly.
It’s much harder to have that level of flexibility when you only hear from someone for the purpose of pricing their next block drawdown: this whole crisis has underlined the need for lenders and borrowers to work closely together and to be transparent with each other around any immediate or looming issues so that they can be fixed before they present a problem.
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