Annex 1
INQUIRY INTO GOVERNMENT'S SUPPORT TO HELP
BUSINESSES ACCESS FINANCE
COMMENTS FROM THE WEST MIDLANDS REGIONAL
FINANCE FORUM
1. HISTORICAL
CONTEXT
1.1 Bank Loans
— Access to credit and bank lending is
not a new problem for SMES. It has been a concern of the West
Midlands Regional Finance Forum (RFF) since its institution in
2002 and of others before that. This "loan gap" unlike
the "equity gap" is a contentious issue to economists
but is broadly driven by same issue of profit maximisation.—
High transaction costs tend to spawn use of credit scoring rather
than individual assessment. Consequent categorisation whilst maybe
serving the banks objectives of minimising risks tends to work
by excluding groups and specific activity. Banks are, understandably,
much less concerned about missing good investments (and economic)
opportunity than failing with a debt.— It is sometimes possible
to acquire limited amounts of fluid debt by submitting personal
assets as security (overturning the basic concept of the limited
liability company) if the cash flow looks reasonable.— The
introduction of invoice discounting or factoring has enabled businesses
to grow with working capital support but made them vulnerable
to down turns.
— However, factoring is also an inadequate
replacement for overdrafts or term loans, which could be used
for intangible investments in such as product and process development,
R& D and marketing, which is particularly important to the
growing business. There is virtually no source of say 15% to 20%
money to service balanced investments such as R&D for an isolated
SME. (Parts of groups can do this through central banking.)
— This credit constraint has been in contrast
to the sloppy credit availability to other sectors such as mortgages,
personal credit cards, and private equity. commercial property,
large and mid range coporates. It is unrecognised by HM Treasury,
central financial institutions and the public. Arguably, the wish
of many SMEs to remain very small and therefore content with a
weak availability of cash has also disguised the problems for
the ambitious.
— It is particularly a problem for small
growing businesses that have no history and therefore little equity
as no retained earnings, and track record, which are fundamental
to current lending decisions.
— In addition to these opportunities, which
are potentially sound financial propositions, using a different
banking approach, resources, and cost, there is other lending
particularly to SMEs, which could be economically sound but doubtful
financially. The strength of the economic objectives may of course
vary with time as much depends on the alternative possible use
of resources.
1.2 Introduction of specialised loan instruments
— As a result of the above weakness there
has been pressure for years for other instruments.— There
has been a Small Firms Loan Guarantee Scheme (SFLG) where the
government provided some support for activities, which were potentially
economically sound but not financially supportable within tight
credit worthiness rules. There was much debate about its structure,
need and success but it was supporting lending above £300
million (and often encouraging as much again) for many years with
a net cost of about £50 million and supporting early stage
businesses. Arguably, it was extremely good value for public money,
justified also by the recognition that there was a market failure
in economist's terms. However, it has always been attacked by
economists for its intervention in our market economy, and purists
for its failure rate. Of course you would expect some failure
or the banks would clearly be doing an even worse job but the
crucial point economically is its success rate for businesses
which other wise would probably not exist.
— In the last few years there has been
a growth in CDFIs, lending a max of £50k. These were originally
established to support disadvantaged groups, social enterprise
and non-mainstream banking activity but have started to serve
a more mainstream role of small loans for business, which the
banks will not do. They charge higher rates and receive money
from public and private sources. In this region lending by CDFIs
significantly increased in the year to 31 March 2009 and in fact
loans made in the six months to 31 March 2009 were treble those
made in the corresponding period to 31 March 2008.
— More recently, across the country there
are a number of publically supported loan funds, which lend above
£50k. The West Midlands has been trying to develop a publically
supported loan fund, similar to the Advantage Transition Loan
Fund (ATBF) set up at the time of the MG Rover problem. It would
lend at EU acceptable high rates, higher than that for normal
bank lending and done by experienced lenders with discretion.
A review of the MG Rover initiative demonstrated that most of
the £5 million money will be returned to the lenders and
many jobs that otherwise would have lost have been saved. A marvellously
effective use of public money. (An independent assessment is available)
This fundamentally demonstrates the point about banking opportunities
being missed by the clearing banks, which indeed support this
Advantage West Midlands (AWM) initiative.
2. CURRENT LENDING
EXPERIENCE
2.1 Lending by CDFIs
— In the year to 31 March 2009 CDFIs in
the region made 296 loans totalling £4,820 million an increase
from 184 loans totalling £2,810 million.— The loans
made were up to £50k to businesses, which could demonstrate
they had viable business plans but which could not secure all
or any of the funding they needed from mainstream sources.—
This demonstrates that the banks will not be able to lend at the
level up to £50k to all viable businesses with to without
the EFG.
2.2 Advantage Transition Loan Fund (ATBF)
— This has been established in November
2008 from the residue of the MG Rover fund and additional money.—
In all instances the loan fund is used when the money is not available
from normal banking sources on acceptable terms, and at hard money
rates These rates are to ensure it meets state aid rule but also
so that it would not be used if bank finance were available, which
is a market pressure addition to a routine check.
— Over the period from November 2008 to
18 May 2009 the lending performance has been:
|
| Number of enquiries | 588
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| Business plans received | 167
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| Loans Offered | 51
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| Loans made | 47
|
| Value leant | £7.52 million
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| Loans approved | £8.62 million
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| Average value of loan | £169k
|
| Jobs in businesses | 3,241
|
| Loan per gross job saved | £2,661
|
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— The activity demonstrates that:
— There has been a demand outside normal bank lending.
— The ATBF has satisfied some of that demand—around
one third of serious plans presented.
— The cost per job had been extremely good value so
far. After around three months of further running the companies
will have in effect paid back the loan in taxes etc to the public
purse. Making assumptions about default, it is likely that with
current activity, 4,000 jobs, generating approximately £40
million per year for the exchequer will be saved by an expenditure
of about £2 million.
— Clearly there may have been some survival of jobs
even if businesses were allowed to collapse but the extremely
low cost described above demonstrates certain positive value.
— There would be gaps in loan provision without this
scheme, which is the major success of the region in the present
credit crunch. There is also national recognition of this position.
— The traditional banks in the region support the existence
of the scheme and often work alongside with existing lending,
sharing risk, in ways which are not otherwise possible.
— It is particularly filling sector gaps where banks
are wary, with manufacturing over 58% and automotive alone over
33%.
2.3 The new Enterprise Finance Guarantee (EFG)
(a) Current use of the EFG and ATBF— Over the country
as a whole at the beginning of April, the annual rate of eligibility
is around £1.5 billion (the intended rate and the figure
quoted publically) but for actual lending of the last four weeks
(having allowed the first two months to provide a run up) the
annual rate is around £350 million. Ie approximately the
amount lent under the old SFLG scheme. It is probable that this
rate will increase as the growth of the enquiries in the last
two months come through to lending but it needs to quadruple to
meet the objectives. Current rate of offers over the last two
months is 34% increase month on month.
— EFG average lending amount is around £80k, compared
with a limit of £1 million. Average of the ATBF is around
twice as much (compared with a potential for a quarter as much,
£250k cf £1 million).
— The lending rate for EFG in the West Midlands is the
highest in the country, compared with its business stock. This
implies that the active loan fund, ATBF, in the West Midlands
region is serving a different/additional market to EFG.
— ATBF in the West Midlands has made loans of £6
million in four months ie about £20 million a year rate.
EFG has so far done £4 million in about 10 weeks proper operation,
which is about the rate of the ATBF, and likely to be somewhat
higher as offers catch up.
2.4 The different market position of the two schemes
— The ATBF is staffed mainly with experienced bank managers
that are able to assess the businesses and its loan potential
in detail. They are also in a position to make strong comments
to management about financing, organisation and strategy. By contrast
normal bank managers tend to be shorter on that skill, experience,
and time and tend to rely more on personal guarantees, which is
a source of much aggravation. (Interesting to note that for the
EFG to date, only 30% of the offers had no personal security but
42% of the acceptances.)— The ATBF team are running a fund
and therefore are able to take a portfolio approach whereas local
bank managers have to make merely a one-off decision, which is
particularly difficult in this uncertain market. Their approach
to interest rates also enables them to cover more risk.
— As they are experienced and indeed independent old
managers, they take a more risk-assessed basis rather than a rules-based
approach, often imposed from above. Eg we know that some banks
are just refusing to do any loans connected with the vehicle industry
because of that approach.
— It has to be said also that because of the stated
terms of the guarantee scheme, by government, many bank managers
are not open to using the guarantee to cover any market risk,
which is the essence of the current problem, not just the security
risk, which the rules emphasise.
— ATBF insists that existing lending from banks remains
in place. In that way there are two institutions sharing the risk,
an option that is rarely available to SMEs in other ways for ordinary
lending and very useful in the current climate. The decisions
of ATBF also give comfort to existing bank lenders. Thus, this
is almost always a partnership with banks not a replacement.
3. IS THE
CURRENT MARKET
WELL SERVED?
— It is apparent that the banks are inadequate by themselves.—
An effective development bank operating like the ATBF which is
staffed by qualified and skilled bankers, with time, who are content
to take some sensible banking risk and are less driven to profit
maximisation will fill a gap left by the traditional clearing
banks. Some of the reasons have been described above. This has
been demonstrated by the MG Rover fund and again appears to be
so in the current market situation in 2008-09. This is in spite
of the fact that clearing banks have some form of guarantee mechanism
available to them in both of these instances.
— However there are still propositions, which will be
turned down because they are not financially viable even though
it is clear that they could possibly create real economic benefit.
This happened at the MGRover time and also now. They are just
too risky to bank with financial considerations alone.
— Under the SFLG, lending used to be about £350k
per year and under the new EGF the rate is being exceeded but
not by much at the moment. It could increase to the expected level
of about £1 million in due course although this is not yet
apparent.
4. THE USE
OF A
GUARANTEE
— It could be argued that a guarantee is a mechanism
for helping banks, which are predominantly concerned, with pure
financial decisions, to move towards more economic decisions,
with the costs covered by the institution, which benefit financially
from extra economic activity ... the state. That extra net economic
benefit of activity will of course depend on particular economic
circumstances and with rising unemployment like now will be particularly
high.— However it is clear that the terms of the guarantee
will affect its use.
4.1 The rates of guarantee
— Currently the guarantee rate is 75% as it was latterly
with the SFLG (although in the past 80% was available in some
cases). EU now allows 90% in the current climate, an increase
since November. In conversation with banks it is apparent that
holding 25% of a risky proposition is too high particularly for
higher amounts say above £200k.— The RFF argued very
strongly for closer to 90% and believes that the extra cost of
so doing (£20 million in £1.3 billion lending) would
have been well worthwhile.
4.2 The loss cap
— Traditionally SFLG had no cap on the losses that banks
could recover. Under the new EGS they are limited to 10%. Again
we know from conversations with banks that this is stopping lending
and indeed active participation by some banks. It is also of course
quite difficult, practically, for banks with many branches to
take portfolio approach, which this cap requires.
4.3 The intended scope of the guarantee
— Currently in the credit crunch the major new risk is market
risk. Are the orders going to come? And if so when? Some extra
working capital is required, hopefully temporarily. However the
EGS is generally not targeted on market risk but security risk,
as specifically stated in the BERR guidelines. "Loans where
a sound proposition may otherwise be declined due to lack of security".—
It is true that in some cases security is now less as a result
of the crisis or indeed that companies need to borrow more but
don't have market risks which make propositions unsound, so it
fulfils some purpose. However the crucial issue particularly for
manufacturing and automotive is market uncertainty and that is
not covered. These guidelines appeared to have got stricter since
the original announcements.
4.4 Security emphasis
— Arguably the guarantee is all the security support
that a bank needs.— However the guidelines on the EGS strongly
encourages the lender to take all forms of specific personal security
except principal private residence (on ministers insistence),
although the guidance seems to find ways round that exemption,
practically. It is little comfort to say security on domestic
residences will not be taken as if the guarantee is called and
cannot be paid the individual will be made bankrupt and then the
trustee in bankruptcy may well take possession of the house. The
position now is also stronger than for the SFLG as the lender
is entitled to take unsupported personal guarantees.
— By contrast, however, the government suggest that
all use of personal guarantees is at the banks discretion.
— The requirement for personal guarantees that will
be called upon before the 75% kicks in has put many directors
off.
— Industry is particularly incensed by this concentration
now on personal security as no other portion of the community
is being expected to put there personal life on the line for the
benefit of the economy| not bankers, large businesses, policy
makers, regulators. Whilst it is acknowledged that there is an
argument for directors having "skin in the game", an
expression used in early announcements, the overwhelming personal
security emphasis is looking very unreasonable and indeed unacceptable
to many business people.
4.5 In summary
— It is believed that guarantees could provide an excellent
extra mechanism for helping the banks and business come to the
right economic (rather than just financial) decision in these
difficult times. However currently:— the guarantee is too
low;
— the cap is also too low;
— the focus of risk is too restricted; and
— the government emphasis on personal security is far
too strong.
— It could be argued that all these restrictions mean
that the guarantee scheme is concentrating far too heavily on
minimising the cost to BERR rather than the benefit to the economy,
of businesses surviving.
— Although the headline figure is guarantees of £1.3
billion, the cap of 10% on claims restricts the total possible
cost to £130 million. The further emphasis of strong encouragement
to personal guarantees as well as the government one could well
bring this down towards £50 million.
— Do we really believe that only £50 million of
economic benefit (equivalent to about 5,000 increase in unemployment)
is at risk from the current credit crisis for SMES?
22 May 2009
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