By Peter Cottrell CA(SA)
The major challenge facing most businesses is the need for liquidity, both during the lock-down period and for the subsequent reboot of the economy. On 21 April 2020, President Ramaphosa outlined further economic and social measures in response to the Covid-19 pandemic. One measure that will be of significant interest to many Small to Medium Sized Enterprises (SMEs) is the Guaranteed Loan Relief Scheme (“Loan Scheme”).
The need for liquidity
The International Monetary Fund (“IMF”) has published a report that flags the threat that Covid-19 poses to Sub-Saharan Africa and has made recommendations with regard to fiscal policy, international solidarity and monetary policy. The following guidance in respect of monetary stimulus is of interest to SMEs:
“Providing adequate liquidity: Liquidity provision by central banks can help alleviate stress in the financial system. Central banks should provide ample liquidity to banks and other financial institutions, particularly to the banks that lend to small- and medium-sized enterprises (SMEs), which may be less equipped to tackle large temporary shocks.
“Meeting credit needs of SMEs: Sub-Saharan African countries could also consider scaling
up existing initiatives to ensure credit supply for SMEs.. [S]uch measures would need to be taken in a transparent, well-targeted way that contains fiscal risks as much as possible.”
International Monteray Fund, Sub-Saharan Africa, Covid-10: An Unprecedented Threat to Development, April 2020, Page 10(A)
In announcing the unprecedented R500 billion coronavirus budget (B), President Ramaphosa outlined a R200 billion loan guarantee scheme to be implemented in partnership with major banks, National Treasury and the South African Reserve Bank, stating that the scheme is expected to support over 700,000 firms and more than 3 million employees.
The Minister of Finance provided further background to the need for this liquidity in a media briefing statement on 24 April(C), noting the risks of destruction of economic capacity on households and firms. Concerns were flagged around weak growth, global weakness, the impact of a weaker exchange rate and higher borrowing costs, together with the sustainability of South Africa’s fiscal choices. Guidance is given on the way ahead as follows:
“[I]n the month ahead, our response will be in three phases:
- Phase 1 is the phase we are currently in, which aims to PRESERVE the economy. It is designed to be a set of immediate, targeted and temporary responses.
- Phase 2 is a plan for RECOVERY from the immediate effects of the crisis. We will outline [t]his in due course.
- Phase 3 is a PIVOT to position the economy for structurally higher growth. This virus will be beaten. But we must make sure that when we beat it, we do not compromise our long-run sustainability.”
It is evident that cash liquidity will be essential to the implementation of phases 1 and 2. The existing relief measures have already provided some measure of liquidity to businesses – refer:
Further tax measures were announced as part of the R500bn stimulus package that will provide additional liquidity.
It is clear that for many businesses, further cash liquidity will be required in order to survive the lock-down and to then reopen for business on a phased basis. The R200bn Loan Scheme for SMEs is designed to provide such further liquidity. In evaluating the merits of the scheme, the following quote from the minister is relevant:
“While we are keenly aware of the need for a short-run enormous intervention, we cannot take our eye off the ball, i.e. the long-run. We must ensure that our choices do not mortgage our future.”
In the same way as the country will need to be strategic in the funding of relief measures, so too business will need to be responsible in ensuring that the measures adopted achieve the desired short term outcomes, while also focussing on the long term sustainability of the business.
Funding of the Loan Scheme
Many commentators are concerned as to how the R500bn stimulus package will be funded and the basis of funding of the Loan Scheme is therefore of interest. As stated above, the Loan Scheme represents a partnership between major banks, National Treasury and the South African Reserve Bank. Although such loan guarantee schemes are not common in our context, they have been used extensively elsewhere, with over 2,250 schemes implemented in different forms in almost 100 countries (E). The basis of the scheme is that guarantees are provided in order to enable banks to lend to SMEs with limited collateral security. Loan guarantee schemes provide a mechanism for risk transfer and diversification, enabling banks to lend with minimal restrictions.
The principle of the South African scheme is that profits and losses are shared between the partners (government and the banks). The scheme will receive all profit on the loans, representing the difference between the rate at which the banks lend the money and the cost of the funding, including a guarantee fee which will be charged to banks. Losses on the scheme (as a result of, for example, non-repayment of loans) will be absorbed as follows:
- First, losses will be offset against the profits on the scheme.
- Second, further losses up to a capped 6% of the size of any loan will be absorbed by the banks themselves.
- Thereafter, any further losses will ultimately be covered by the fiscus.
A total of R200bn has been allocated to the Loan Scheme, with R100bn being made available during the initial phase.
The key features of the loan scheme are as follows:(A)
- Covid-19 loans will be available from banks to eligible businesses with an annual turnover of less than R300 million who are in good standing with their respective banks.
- Funds borrowed through this scheme can be used for operational expenses such as salaries, rent and lease agreements, and contracts with suppliers. Loans will cover up to three months of operational costs and will be drawn down monthly.
- Banks are not obliged to extend Covid-19 loans, and those that do will use their normal risk- evaluation and credit-application processes. Business owners may be required to sign surety for the loan.
- Each business may accept only one Covid-19 loan.
- Covid-19 loans will be offered at a single, agreed lending rate by all banks participating in the scheme. The rate will track the repo rate.
- A six-month repayment holiday will commence from the first drawdown, although interest will accumulate from the date on which the first drawdown on the loan occurs.
- Repayment of interest and capital starts after six months and businesses have a maximum of 60 months to do so. Borrowers can repay the loan ahead of schedule.
Businesses will need to contact their banks for further details and to establish eligibility criteria.
Banks will provide details of the Covid-19 loans available in terms of the Loan Scheme in the weeks ahead. Nedbank have provided preliminary guidance which is useful in assessing some of the criteria that may apply(F). These criteria may assist business owners in making an initial assessment of the suitability of the scheme:
- The purpose of the Covid-19 loan is to cover up to three months’ full operating expenses, including staff costs, rentals and lease costs, utilities, supply chain and other operating expenses.
- There is no upper limit, but the amount will be driven by business needs and affordability.
- Owners will be required to sign surety.
- Businesses will be prohibited from paying dividends or repaying shareholder loans until the Covid-19 loan has been repaid in full.
- The loans may be advanced to the following businesses:
- Business operating entities, but specifically excluding individuals, state-owned entities, listed companies and companies with capital market funders or funding instruments.
- Turnover of less than R300 million per year.
- The business must be registered with SARS.
- The business must be in good standing with the bank as at 29 February 2020, being up to date on all credit agreements and with a good credit history.
- The business must be able to demonstrate a direct impact of Covid-19 on their finances.
There are some general themes that are evident from the guidance from National Treasury and the preliminary guidance from Nedbank:
- The key aspect of the Loan Scheme is a relaxation on the security requirements that would ordinarily apply.
- Businesses that were already in distress prior to Covid-19 and that are not in good standing with their banks are unlikely to qualify for a Covid-19 loan.
- Banks will introduce some form of affordability criteria as part of their regular risk and credit application process. It will be important for businesses to evaluate their cash flow requirements and to then consider how the loan repayments will be funded at the end of the six month repayment holiday. The Loan Scheme will be highly suitable to businesses that were profitable prior to Covid-19 and that will be able to resume a reasonable level of operation within 6 months. However, there are some sectors where scenarios indicate that the recovery period could be far longer than 6 months and the Loan Scheme may well not be suitable to such businesses.
- It is highly likely that business owners will be required to sign personal surety for the Covid-19 loan. This is consistent with existing banking practices where banks wish to tie the loan commitments to one or more “warm bodies” – i.e. someone who will “feel the pain” in the event of a default in the loan. Business owners will need to assess their personal risk appetite in evaluating the desirability of such funding. The surety requirement may present practical problems for businesses that trade in unincorporated entities such as Trusts.
- It is also likely that businesses will not be able to declare dividends or repay shareholder loans until such time as the Covid-19 loans have been repaid.
The Loan Scheme provides an opportunity of SMEs to access liquidity to address cash flow shortfalls arising from the Covid-19 crisis. There may be certain practical constraints to accessing this funding, including businesses that were already in distress prior to the crisis and those who will face a longer road to recovery. Business owners will need to be in contact with their own banks to determine the criteria for the Covid-19 loans.
Peter Cottrell CA(SA)
STRATEGIC BUSINESS SUPPORT
Email: firstname.lastname@example.org | Telephone: +27 31 7613400 |
(A) = National Treasury, Covid-19 Guaranteed Loan Scheme for Small and Medium Enterprises
(B) = International Monteray Fund, Sub-Saharan Africa, Covid-10: An Unprecedented Threat to Development, April 2020
(C) = Statement by President Cyril Ramaphosa on further economic and social measure sin response to the Covid-19 epidemic
(D) = Remarks by the Minister of Finance during a Media Briefing 24 April
(E) = OECD, Discussion Paper on Credit Guarantee Schemes
(F) = Nedbank preliminary guidance on Loan Scheme