Three quarters of £35bn business debt is unsustainable

It is feared that up to 780,000 firms employing three million could go bust in the next year if they cannot defer repayments on government-backed loans. The figures highlight the risks if urgent action to tackle the projected £35bn of unsustainable debt from Covid-19 loans is not taken according to a new report by The CityUK.

The Recapitalisation Group, which was formed by finance industry body TheCityUK, has suggested a UK Recovery Corporation should be formed to turn risky debts into more manageable forms like tax liabilities or shares.

The 144-page report, which is being sent to the Treasury and the Bank of England, says ministers should set up a new UK Recovery Corporation to oversee schemes designed to restructure companies’ debts to make them more sustainable.

The report finds that with around three-quarters of this projected unsustainable debt held by firms outside London, a national solution is needed as soon as possible. The rapid response by government and industry has helped companies survive the initial economic impact of the crisis, but as we look forward, it is clear that many businesses will need help to tackle a debt burden that could hold them back or drag them under.

TheCityUK’s report, supported by EY, the UK-based financial and related professional services industry has published a far-reaching set of options for converting, restructuring and repaying this debt to help hundreds of thousands of SMEs get back on their feet, save millions of jobs, protect billions of pounds of taxpayer money, and help power Britain’s economic recovery and future growth. The options, if taken forward, present a real opportunity for the government to leave a lasting positive legacy of regional growth and investment across all parts of the country.Central to the options outlined is the founding of a new government-backed entity, a ‘UK Recovery Corporation’. This would both, issue and hold, and oversee and manage, the unsustainable debt that is already government-guaranteed, in order to support funding on more manageable terms for businesses, and provide a vehicle in which the private sector could invest in over time.

Through the UK Recovery Corporation, viable SMEs would be offered the opportunity to convert their loans into new products allowing them to manage their debt in a more sustainable way and achieved without being put into default. Depending on the size of their debt, they could either access a ‘Business Repayment Plan (BRP)’ to convert unmanageable loans into means-tested tax liabilities, or for larger debts, use ‘Business Recovery Capital (BRC)’ to convert crisis loans into preference shares or long-term subordinated debt. Both products will ensure SMEs do not give up any equity in their business.

Also among the options presented is the creation of a new growth capital fund, or the scaling up of an existing fund, to provide businesses with growth capital to help power business recovery across the country. This will be particularly important in areas outside London, with London having historically dominated SME equity investment. Growth Shares for Business (GSB) will allow SMEs to rebuild cash reserves, invest in working capital and relaunch after the crisis. This growth capital would support the regeneration of local and regional economies and help drive forward the long-term recovery of communities across the UK.

There is a need to act quickly. Businesses currently need to start repaying Government Covid-19 loans in March 2021. But before March, many strong, well-managed UK businesses may come under immense pressure, as the government furlough scheme starts to taper off, rent deferrals come to an end, deferred VAT payments are due in full by 31 March 2021, and operating losses continue to accumulate. The ongoing sustainability of these businesses not only requires liquidity but also adequate recapitalisation.

The options put forward by TheCityUK Recapitalisation Group are the result of intensive work by over 200 financial experts from across 50 financial and related professional services firms, overseen by EY. It has been compiled in consultation with HM Treasury, the Bank of England and the Financial Conduct Authority, as well as business trade associations representing a wide spectrum of business sectors and sizes.

Sir Adrian Montague, Chairman, TheCityUK Leadership Council, said “Covid-19 is a 100-year storm which has caused untold economic damage. The government’s support schemes have been the essential sandbags holding back the flood, protecting businesses and saving jobs. However, with tough trading conditions forecast to remain, paying back these loans will be challenging for many SMEs. To secure a strong recovery, action must be taken now to help them sustainably retrench, rebuild and return to growth.”

“The UK is home to the world’s greatest breadth of financial expertise. We’ve tasked this national asset to find solutions to the recapitalisation challenge facing UK SMEs, and the commitment and rigour of the many people and firms involved have been inspiring. The options presented will help support a strong and sustainable recovery for businesses across all parts of the UK. However, failure to act decisively now will condemn many SMEs and communities across the nation to default and decline.”

Omar Ali, UK Financial Services Managing Partner at EY and Chair of TheCityUK Recapitalisation Technical Working Group, said “Over the next few months, as the government furlough scheme starts to taper off, deferred rent and VAT payments become due, and operating losses continue to accumulate, hundreds of thousands of businesses across the UK will face difficulties repaying the debt they have built up during the pandemic.”

“The options we present are the collective work of our industry, which has come together and worked at speed to find solutions to this imminent debt challenge that will ultimately impact us all. Our analysis suggests that some sectors may enter into difficulty as early as autumn this year. That is why taking action now is vital if we are to help businesses get back onto a stable footing as we emerge from the pandemic, and will ultimately support the UK’s economic recovery and fuel its future return to growth.”

At its launch, the UK government will be the principal investor in the UK Recovery Corporation. This follows historical precedents from both UK and overseas for governments seeding new institutions to support economic recovery, such as 3i (originally ICFC), UK Asset Resolution and KfW. Over time, and depending on policy decisions implemented, private investors could provide finance to the UK Recovery Corporation through securitisation or by acquiring portfolios of instruments, potentially providing a long-lasting legacy of SME investment across parts of the UK which have not benefited from equity investment in the past.

For viable SMEs, TheCityUK Recapitalisation Group proposes two key options which would be managed and held by the UK Recovery Corporation: the BRP and BRC.

• The Business Repayment Plan (BRP): for small businesses with a Bounce Back Loan Scheme (BBLS) or small Coronavirus Business Interruption Loan Scheme (CBILS) loan under £250,000. These businesses would convert the outstanding loan balance into a tax obligation administered by the UK Recovery Corporation but repaid through the tax system. This would be means-tested, ensuring businesses only pay what they can afford, which could be calculated based on taxable profits or another measure of business recovery. There may be certain restrictions on the borrower (such as the ability to pay dividends or dispose of assets) to ensure that tax obligations are repaid as a priority.
• Business Recovery Capital (BRC): for larger businesses with a CBILS loan up to £1m. Businesses would be able to convert their government-guaranteed loan into subordinated debt (an unsecured loan that ranks below others) or preferred share capital (that provide fixed dividends ahead of ordinary shareholders). These are non-voting instruments and, while there may be certain restrictions on borrowers that utilise the instrument, they will not lead to a business owner or founder losing control of their business.

Business growth option:

• Business Capital Growth Shares (BCGS) could be created and held by a new or adapted growth capital fund. This would be for viable SMEs that have either not taken out debt or are able to repay their debt but nonetheless need growth capital. This would allow them to rebuild cash reserves, invest in working capital and relaunch after the crisis. The growth capital could help support the regeneration of local and regional economies to drive the long-term recovery of communities across the UK.