Trouble with CBILS
Liam McGee
Making data fit for human use. Keeping it real (ontologically). Building tools for the future of infrastructure.
“As of Tuesday (14th April), a total of 6,020 loans worth £1.1bn had been issued under the coronavirus business interruption loan scheme (CBILS)... UK finance said 21% of the 28,460 formal applications had so far been approved for the government-backed loans, which are interest-free for 12 months. However, more than 300,000 firms have reportedly made informal inquiries about seeking help from the scheme, which is part of the government’s wider business support package worth £330bn.” -- The Guardian, Thursday April 16th 2020.
The UK Government offered the Coronavirus Business Interruption Loan Scheme (CBILS) as the serious support to help businesses weather the Covid-19 storm. Operating costs such as leasing and renting costs, licences, stock purchases and manufacturing inputs all need financing to keep the wheels turning in the absence of revenue. On the face of it, a low interest, government backed loan sounds pretty good. As a good managing director I of course investigated the terms that would be on offer.
We had already discussed loan funding an expansion of the business in the Autumn) with our relationship manager at HSBC, Tom (we get our own 'relationship manager' because we are a scale-up tech company). Despite the bank horror stories I have heard from other businesses, my experience with HSBC was good. Tom was helpful and realistic. But when he told me we would need to produce a business plan with cash flow forecasts, I laughed down the phone at him. In my defence, this was the day in mid March that we’d had one of our main customers told us they would renege on their contract, refusing to pay despite the terms of the contract. When your clients are a lot bigger than you are, you can’t rely on litigation, it's too slow. Nothing seemed reliable at that point, even contracted work. The idea that HSBC could ask me to robustly predict future revenues was absurd.
Tom explained that this had to go through their normal process, which meant I had to make the best projections I could, but that the Bank would be realistic and not be beating us with a stick if we were failing to meet those projections in 6 months time. Regarding providing security for the loan, he explained that joint savings held with a partner would not be used as security, nor would my primary residence. As a good entrepreneur, I have sunk everything most of what I have into the business already. But it was comforting to know that, while I might go personally bankrupt should we fail to repay the loan, we wouldn’t lose our house.
The terms HSBC offered were, roughly, 4% above base for a 3-6 year term (3.5% above base for a 1-3 year term). No interest would be charged for the first 12 months. Minimum loan £10k, maximum of £5m.
Ok, so I now knew the terms. Interesting. And then I started to think about it some more.
Money, money everywhere.
At the start of 2020, the world was already awash in liquidity. The vibe in Venture Capital funding was getting peculiar. People were reporting a drive to pile more money into companies than they wanted. The companies would be loaded with debt to reduce tax, and have to deliver ever more unsustainable rates of growth would. This results in a lot of companies going bust under the strain, and there are plenty of VC funds which lose money. But VC fund managers are taking their 2% whatever happens to the fund performance. There is no downside risk, and plenty of upside benefit should they stumble upon a unicorn. So they ran the motors ever hotter in each of their investments, burning out most of them. And still the moneys poured in for these high risk investments. Money was piling up, sitting uninvested, desperate for a home.
So you might have expected debt funding for lower risk, steadier return companies to have been easy to come by. Yet this was not the case in the SME sector. SMEs - Small to Medium Sized Enterprises - are not tiny. They are firms with between 10 and 250 employees. It's hard to make it to 10 staff memebers without being useful and profitable. Yet despite the near-zero costs to commercial banks of raising money, the banks were not offering loans at terms SMEs could afford to take. The government tried offering a government backed loan scheme (the 'EFG' fund) to help. But despite the government guaranteeing to pick up the tab of 75% of the cost of any bad loans made, the terms available were still 6-7% above base, an very high spread. Stories of another brewing scandal rumbled in the background.
SMEs are the backbone of the ‘proper’ economy of production of goods and delivery of services. The Government wanted to get monies into it. But despite their efforts, investments were instead increasingly sucked into a giant financialised bubble of stocks, property and derivatives, a bubble so huge compared to the ‘proper’ economy that it was dragging the price of the underlying commodities around, to the point of unsustainability. Value was being sucked at an alarming rate out of the proper economy and into the financialised one through an overheating stock market and property market. I was alarmed.
Coronavirus and reboot.
And then everything changed as coronavirus hit. Economies hibernated or even shut down. But that means economies will need to be rebooted. So as part of that reboot, how do we get value invested in the productive economy? How to do so in a way that is - in response to wider concerns about the nature of capitalism - both ethical (laws and external considerations of right behaviour) and moral (the pricking of our own consciences). Is CBILS a way to do it?
The ethics of credit and debt is this: if a debtor ends up repaying far more than the inflation-adjusted value of the principal, this is unjust. Furthermore, if a debtor is placed in a situation that they must neglect the basic requirements of human dignity in order to service their debt obligations, this is also unjust.
For example, in the early 1980s global debt crisis, the possibility that highly indebted poor countries (HIPCs) might default on their debt obligations was a crisis for the creditors, in that they might no longer make their returns. However, the rates of interest on the loans (18-25%) meant that most of the money being paid to the creditors was just servicing the interest. In many cases the debtor countries had already repaid the equivalent of the original principle many times over. And when a country was required to spend almost all its wealth on servicing debt, it meant that it could not spend on critical infrastructure - roads, healthcare, education - and became trapped in an endless cycle of debt. Zambia: “During the 1990s, the country paid out approximately 20 percent of GDP in debt service, but budgeted only 2-3 percent of GDP for health and education”
It’s rather too easy to feel little solidarity with people in a far away country of whom we know nothing (to misquote Neville Chamberlain). But we should. Especially if we are going to take on debt at a rate, like those Highly Indebted Poor Countries, that stops us growing our way out of it.
CBILS: good news, bad news.
A commercial bank doesn’t need to possess any money to issue a loan. It creates money out of nothing in the very act of issuing a loan. Enter the loan on one side of the balance sheet as a debit, and enter the same amount on the other as a credit. Voila, money from nothing. Central banks can do this too (though commercial banks have created most of the money slashing around the economy). They have been doing this for ages, but it has not (mainly) ended up in the ‘proper’ economy of goods and services, instead being sucked into the ‘financialized’ economy of stocks and derivatives, and the property bubble.
CBILS, however, is money created from nothing to pump into the ‘proper’ economy - goods, services, retail, manufacture, primary industry. This may be an interesting way for Government to target resources at generating productive transactions rather than speculative ones.
Raising capital is usually used by businesses to invest in infrastructure, or in sales and marketing. For infrastructure investment, the capital assets (whether physical machinery or ‘concrete’ intangibles, such as knowledge capital) will generate value for years. For investments in sales and marketing, there should be a more immediate but shorter lifespan of operating payback (although even this depends on what we mean by marketing, brand building has a longer payback and is more like a capital investment in an intangible).
But CBILS is not like this. It’s there to cover the costs that would have been covered by revenues lost as a result of coronavirus. A typical tech business tries to maintain something like a 33% operating profit margin. Most of the retained profits are rolled into R&D in the following year. Let’s say that once furloughing support ends you still find yourself having £3m in missing revenues to replace until the economy comes back to anything like the confidence it had before, that means you will need to find £2m to cover operating costs over that period. You will also have no profits to roll into R&D, so this really is the cost of pausing the business. You now have to find EBITDA of around £2.5m over the following 5 years, or about £0.5m per year, in order to repay the principle and the interest. That’s a 25% Return On Invested Capital (ROIC). Which is too damned high, even for a tech business. It’s utterly unaffordable for most professional, manufacturing, retail, primary industry or service sector firms.
The CBILS interest rate would be ok if you could just pay the interest and then refinance at the end of the term, of course. But the financing terms are dependent on the government guaranteeing most of the debt. And then at the end of the term, they stop guaranteeing it. And you have to refinance with a changed risk and no knowledge of the likely new interest rate terms. And remember. You have invested nothing into revenue-generative assets, it was all in covering operating costs. You risk becoming a “Highly Indebted Poor Company”, forever paying your operating profits to service a loan you should never have needed.
Building a better CBILS
Does capital need to be paid back at all, as long as it’s making a good return? A McKinsey report suggests the median ROIC for non-financial companies (in other words, ‘proper economy’ companies) was a little over 9% in 2004, in the US. And it was fairly stable at that level all the way back to 1963. If we take a more modest set, at the 25th centile (i.e. where 25% of companies were below this level), this was a highly achievable 5.4%. If anyone can find me some UK figures on that I would be delighted.
Government needs to decide what it wants out of CBILS. Is it a long-term investment in the future of the SME sector using new money created to replace the value that evaporated, as transactions for goods and services ground to a halt? In which case, that’s a pretty good analogy for QE (quantitative easing) monies created by central banks and pumped into the financialised economy post 2008 to replace the value that evaporated as its shaky foundation of CDOs and exotic derivatives were exposed. The 2008 financial crisis QE didn’t drive inflation because it was money created to replace value lost. That’s pretty much what could be done for the real economy, which across the last decade has had to bear continuing austerity measures in contrast to the unimaginable largesse bestowed on the financial sector. So if such ‘proper economy’ QE just fills in the gap left by the lack of value creation from transactions for real goods and services, then they may not even risk inflation. It may just prop up the middle classes and get the economy rolling again, this time with a better spread of wealth.
Most investors would normally consider a ROIC of 7-8% pretty good for ‘safer’ bets, as long as they can get the money out again at some point. That’s not a problem for a business as long as they can refinance the loan at roughly the same rate. If the principle can simply be paid back by swapping another amount of capital in, to be repaid at roughly the same ROIC, then all is good.
For the government to facilitate this, new institutions will be required. A National Business Bank regulated by the Bank of England would be a good start, perhaps using government majority ownership of Royal Bank of Scotland as the starting point. I also suggest a new category of government-created money available to Companies: a 'Socially Responsible Fund'. This would have obligations placed on the loan recipient relative to the debt/asset ratios. These might include restricted dividends, executive salaries capped to basic wage multiples, and a ban on share buybacks.
Another approach would be the RBS method. The government could offer equity finance to now-struggling companies (this is just QE by another name where the asset purchases are shares in companies), and allow the companies to either buy that equity back over time, or simply require dividends to be paid to the government, and use this as a way of replacing lost tax revenue. A real investment in British businesses. Perhaps a little too much for a labour government to get away with, but a conservative one has more leeway on this sort of thing.
We’ll see, I guess. Good luck to you all, trying to keep the wheels turning amidst the shifting sands. Please share with anyone you think might either enjoy it or disagree vehemently with it and set me right.
Making data fit for human use. Keeping it real (ontologically). Building tools for the future of infrastructure.
4 年So, some good follow-ups from Tom at HSBC, which I will fold into the article shortly. Main things of note: No repayments in year 1. CBILS would be payable after year 1 in regular monthly payments covering both the interest and the principle, just like a repayment mortgage. An interesting wrinkle: it can be repaid in full at any time without penalty. It's worth pointing out also that longer term loans would be available from the bank (say 20 year term) but would require assets as security. IP can be used as an asset but that tends only to be for larger SMEs (£10-£250m revenue). How that IP is valued, given you have to depreciate a capitalised intangible over 4 years, is unclear. If you have a significant capital asset (property for example) you can put up against the loan, you might as well get a CBILS loan for year one, interest free, then repay it by raising another loan with a longer term. If you do not have substantial capital assets lying around to offer as security, you could go for a second tier lender who would not need security but would charge a lot more interest.