As we pick through the detritus in the wake of the COVID-19 social and economic wreckage, it’s increasingly clear that the theoretical relief offered by government was far removed from the practical realities of so many small business owners in South Africa.
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The number of companies announcing plans to retrench staff is growing. From aviation to construction, from entertainment and leisure to hospitality, companies have indicated their intention to retrench staff because of heavy losses incurred over the past four months. In other cases, businesses are closing permanently.
National Treasury’s R200bn Loan Guarantee Scheme is a crucial centrepiece of “phase two” of the economic response to the COVID-19 crisis, and is now a few months old. Take-up, however, has been far too low.
We find ourselves in a situation where we ask ourselves why it didn’t work; why didn’t we see substantial take-up?
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“Part of the reason that is believed to be one of the stumbling blocks is that it was fairly slow to market,” says Annabel Bishop, Investec Chief Economist. “And some of the criteria as well; the businesses have to have no existing capacity to borrow and need to be in severe financial distress and if you look at the rules around it, individuals could be held personally liable extending over a substantial period.”
“From an economists’ perspective, it seems to me that the terms were not attractive enough or indeed quick enough (the scheme was rolled out seven weeks after lockdown started).”
Karl Westvig, CEO of Retail Capital, an alternative lender, has been a vocal critic of the scheme.
“We looked at the scheme in detail. First, the principle was reasonable, in that the banks carry some of the risk and Treasury guarantee 94% of the risk, but to access the guarantee, the banks had to prove that they applied reasonable criteria before they could claim that loss back from Treasury and, as a result, banks haven’t changed their criteria. Banks have traditionally always funded larger businesses, not small businesses. They’ve never been great funders of small SMEs. And the R300m cap is a pretty large business. Most of our members are doing R10 to R20m turnover, not R300m turnover. The scheme is aimed more at larger businesses.”
Westvig believes that a key flaw in the design was its utilisation of traditional credit risk criteria, which is asset-based and surety-based, not based on whether a business is likely to trade.
“The intention was to help businesses that were in distress, but banks’ criteria is not to lend to distressed businesses,” says Westvig. “Banks’ criteria is to lend to solvent businesses with good prospects. How many business owners right now can say, hand on heart, that their business is safe? We are all living in uncertain times. And, as a result, they are saying to business owners that you must now sign surety and put up collateral on a traditional facility which is meant to be for relief when you are not sure whether the business will survive, given the nature of lockdown and restrictions.”
Samantha Pokroy, founding principal of private equity firm, Sanari Capital, and SAVCA board member, has helped the private equity and venture capital industry body to draft a response to the scheme, and believes it is critically important that amendments are made so that much needed capital can start to flow to those businesses that need it most.
“I have a portfolio of six businesses, and none have been able to take it up and all would benefit from it,” says Pokroy. “We have about two-thirds that would benefit from an actual relief situation, so although they are not in distress as yet, the facilities would be put in place to ensure that they can continue to trade confidently without having to introduce cost saving initiatives that would, for example, result in pay cuts or job losses, knowing that there is a back-up plan. I think that only one will actually need the facility, but it is important to know you have it there in case the downturn is more extended, protracted and severe than we are currently seeing.”
Pokroy believes that the risk of second round effects on the economy, due to the lockdown, makes the scheme vital. Companies in the technology and the education space, business services and supplies, will face the second wave as the impact on the economy comes through and this is why it is so critical to get this programme fine-tuned and working properly.
“And then there are the rest of our companies who would benefit from stimulus in the system that triggers confidence in being able to invest in growth and focus on exports which will ultimately help the economy to recover.”
Pokroy adds that the lenders and lending criteria are far too risk-averse to be effective in saving businesses and saving jobs in this COVID-19 induced economic crisis. SAVCA surveyed its members and found that although 43% of the portfolio companies with revenues less than R300 million were in need of the COVID-19 loan facility to ensure their ongoing viability and recovery, only 28% of those that applied for funding were granted and drew down on a facility – and many did not apply at all, given the eligibility criteria.
“For the remaining 72% of companies that required funding, but have not yet been granted these facilities, the top reasons provided included the company not being profitable prior to COVID-19 due to a growth strategy, or not meeting the personal suretyship requirements for directors and shareholders.”
Although banks have extensive distribution, their inflexible credit models and conservative lending culture mean they may not be best suited to the task at hand. This has been compounded by requirements of the Reserve Bank, in which the Guarantee Scheme backing can be pulled where credit processes have not been followed by the banks in their ordinary course.
Pokroy states that “in our experience, there has been no difference between a normal loan and a COVID-19 government guaranteed loan, which defeats the object entirely. The argument for personal surety in credit application processes is to test for alignment and commitment of owner managers. The philosophy is that owner management will know better than a bank what the prospects are for their business and whether the loan can be repaid. But in these extremely uncertain times, this argument holds less water. Owner managers are unable to anticipate the market conditions any better than the rest of us, and therefore it does not provide the type of reassurance it may have under other conditions.”
“In fact, it requires individuals to decide between the risk of losing their homes and trying to keep their businesses open and staff employed. They would have to make this unenviable trade-off based on conditions that are completely out of their control.”
“Rather, the purpose of the Guarantee Scheme should be to underwrite this risk with the full knowledge of the likely costs arising from the fact that, notwithstanding best efforts by all parties, not every business will survive and not every loan will be recoverable. But jobs will be saved, families will be provided for, consumer and business expenditure will continue, and most businesses will survive and be critical role-players in the recovery of our economy”, says Pokroy.
When it comes to solutions, Westvig believes that the banks are just operating as they are intended to, to protect depositor funds. And it’s a traditional model that has legacy costs.
“From an access perspective, it tends to be quite expensive as they have branch infrastructure, they have large overheads, large levels of compliance.”
But Karl says that Retail Capital has submitted a proposal to Treasury which is being discussed at the moment, where he believes the existing rails are good enough.
“We can access between 350 and 400,000 businesses just with our own networks,” says Westvig. “So, it’s easy to distribute capital. We can see trading history on who’s trading and, on the back of that, we can make risk assessment decisions fairly quickly. Within days and weeks, you can distribute large amounts of funding to the right businesses. We saw this happen in the early stages with the Rupert scheme, managed by Business Partners. They were many times oversubscribed and distributed fairly quickly.
“The challenge is that every time we make proposals, it goes back to the Banking Association and the banks are making decisions on it, not Treasury. And the challenge we have is that the R200bn that has been earmarked, has been earmarked for the banking system, so they either have to force us into the banking structure and try and control how we distribute funding, or they have to create a separate allocation and I think that’s probably a better way to go for National Treasury.”
SAVCA recommends the following amendments to the loan guarantee scheme:
1. Dedicate a minimum amount of loan funding deployment under the guarantee scheme for companies with turnover less than R300 million and implement targets and incentives for bank deployment;
2. Include growth companies that are not yet profitable in the scheme;
3. Remove the requirement for personal suretyships/guarantees; and
4. Consider alternative lending channels and blended finance options, which may include first loss funding for private equity funding in businesses with turnover less than R300 million.
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In its latest update on the various initiatives run through the banks to provide customers with relief through this period, the Banking Association of South Africa (Basa) said that R10,6bn in loans has been provided to just under 7,500 businesses.
At the time of writing, Treasury announced sweeping changes to the Scheme including:
• Business restart loans will now be available, to assist businesses that are able to begin operating as the economy opens up.
• Clients can now access the loan over a longer period. The draw down period has been extended from three months to a maximum of six months. For example, a R6m loan can be drawn down over six months, at R1m a month if the business qualifies. The size of the loan is still calculated on operating expenses.
• The interest and capital repayment holiday has been extended from three months to a maximum of six months after the final draw down. For example, in the case of the same R6m loan, drawn down at R1m a month for six months, repayments will only be required from month 13.
• The turnover cap has been replaced with a maximum loan amount of R100m. Banks may also provide syndicated loans for loans larger than R50m.
• The test for good standing has been made easier. This has now moved back to 31 December 2019 from 29 February 2020, which will accommodate firms which were already experiencing cash-flow problems in February.
• Sole proprietorships are now explicitly included. For sole proprietorships and small companies, salary-like payments to the owners (drawings) are included in the use of proceeds. Security, suretyships or guarantees are not explicitly required. Eligible businesses should contact their primary or main banker for further information on the scheme and the qualifying criteria.
• Bank credit assessments and loan approvals will be more discretionary and less restrictive, in line with the objectives of the scheme. Banks may use their discretion on financial information required, for example bank or financial statements, where audited statements are not available. Suretyships or guarantees may also be required. The provisions of the National Credit Act and Financial Intelligence Centre Act remain applicable.
• No security, suretyships or guarantees are explicitly required in terms of the scheme. Banks may require this in terms of their individual credit risk management practices.
• Banks can consider re-applications from clients declined under Phase 1.
• Loans under the Scheme and other loans will not trigger cross default clauses and vice versa.
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Commenting on the announcement, Stuart Theobald, Chairman of Intellidex, the firm that first proposed a similar scheme to Treasury before it was announced, said it was a major improvement. However, the loss sharing arrangements still remain rather vague. And ultimately, much still hinges on whether the banks embrace the space afforded to them by the changes, to relax their lending criteria and open the taps.
South Africa needs the funds to flow urgently.