Authors: KEVIN DAY & STEVE TAPLIN HPD LENDSCAPE
The COVID-19 is a humanitarian disaster, with many predicting economic catastrophe as businesses fail as a consequence of the pandemic and the desperate measures to contain it. This article explores what could happen, particularly in the context of SME finance, be that lines of credit, overdrafts, loans, leasing, supply chain finance or asset-based finance (factoring, invoice discounting, asset-based lending).
The COVID-19 pandemic is undoubtedly an international disaster. In just 100 days since the World Health Organisation first registered the outbreak in China on the 31st December 2019, there were over 200 countries and territories impacted, 90,000 deaths and 1.5 million confirmed cases. Many countries have imposed “lockdowns” to reduce the rate of infections, putting many businesses into a state of imposed hibernation.
How do we get out of this state of chaos and get back to some form of normality? Every business is different and so the impact will be felt in different ways. Unless you are in one of those sectors that is unaffected, revenue and cash flows are going to fall. If nobody is buying your goods or services, your business is going to run out of steam and eventually fail.
Lockdowns imposed by governments are temporary and relatively short-term. Politicians have had to make a difficult trade-off between reducing deaths versus damaging their economies. When will the protection of life versus the damage to the economy reach a tipping point, leading to a switch of priorities? The longer an economy is paused, the more lasting the damage that will be done.
Individuals, society, the state, and institutions, we all have a vested interest to get through the economic lockdown with as little permanent damage as possible. People seem more inclined to support the “common good”; there is a benevolent mood that will influence the behaviour of every part of the economy.
Banks and other business lenders are the life-support systems for business and have a critical role to play during this lockdown phase and beyond. After all, “business” is the backbone of the economy. It creates employment, generates tax revenue, and puts money into the pockets of consumers.
Too Many to Fail
If we remember back to the Credit Crunch of 2008, the banks were deemed to be “Too Big to Fail” and governments pumped huge amounts of money into many of the banks to keep them afloat. Governments could have left the banks at the mercy of commercial forces, but the consequences of a failing banking system would have had a huge fallout for the wider economy. Governments had no choice but to intervene and save the banks.
We now have a similar situation. Small and medium sized enterprises (SMEs) are the bedrock of most economies. According to the World Bank, SMEs account for 90% of business and more than 50% of employment worldwide. SMEs make a significant contribution to a country’s GDP, to its employment and to its economic wellbeing. Politicians have recognised this and created rescue and support packages to enable businesses to ride out the current economic turmoil. At least this is true in richer, developed nations.
Banks and financial institutions are conservative and risk averse but, in this period of business hibernation, they must step-in and take more risks. If a customer was a good credit risk before the crisis, it should emerge the other side of the crisis at the same level of credit risk. Some businesses will not, of course, but which ones? Time is too limited to analyse every case, so lenders need to take bold, blanket decisions. Governments can underwrite a degree of the risk, but lenders will have to accept that there will be increased losses. It will be their contribution to the economic recovery. Lenders are not charities, but they must be more charitable, given the situation we are in.
Wood for the Trees
Certain industries are more able to deal with a lockdown. The biggest cost for most businesses is staff. How easy is it for the business to temporarily reduce its staff costs, but then be able to have all its staff fully mobilised once normality returns? We can see plenty of “mothballed” retailers, coffee shops and restaurants on the high-street. With suspended staff costs, these businesses can probably survive if the economic lockdown is not too long.
Businesses trading internationally, either importing or exporting, may have an extended period of interruption as different countries are at different stages of managing the pandemic. Emerging markets do not have the resources of the developed countries and, unless international aid packages come to the rescue, the economic plight could be much more devastating, having a consequence on international trade with these countries.
For lenders, this is where Know Your Customer (KYC) is more important than ever so that lenders can respond positively to the short-term needs of businesses. Relevant data includes information about a business’s customer base such as industry sectors, relative size, credit quality, domestic or foreign, the list goes on. The keyword here is “data”.
Will borrowers commit fraud as a desperate measure to save the business? Fraud is a crime and the penalties when caught are serious for the perpetrators. If business owners are given support, will that reduce the temptation to commit fraud? This is another reason why lenders must be proactive.
Business Survival Guide
Every business needs to implement cash-preservation efforts using whatever schemes are available and working with business partners, suppliers, customers, taxation authorities, banks, lenders, landlords and staff to maximise the inflow and minimise the outflow of cash.
There is a “but” here. Every business exists in an eco-system of other businesses, domestically or internationally, and, ultimately, consumers. Paying suppliers promptly to avoid the supplier failing protects the supply-chain. Similarly, giving customers longer to pay keeps things ticking over. The “buy now, pay later” mantra can enable businesses to buy materials or products for immediate sales purposes or to enable it to build inventory for when the lockdown has ended.
Business requires confidence and trust, confidence that there will be a “tomorrow” and trust that when you say you will pay me, you will pay me. Business finance can help build this confidence by providing the necessary funding, even if the security and credit-risk profile is less than would normally be acceptable.
Can lenders, not exactly “throw away the rule book”, but just put the rule book to one side whilst we work through this short-term business crisis? If business casualties are minimised, the road to recovery of the economy will be faster and stronger.
Journey to Recovery
When it comes to the pandemic, it will unfortunately have to run its course. The main impact on business has been on the lockdowns imposed by governments, but these must be short term, even if that means more casualties from the virus. The negative impact on the economies of the world would result in far more deaths, through poverty, social unrest, and mental health issues.
When the lockdowns are lifted, businesses will get themselves back on their feet with every urgency one could imagine. Employees will be re-engaged, offices will be repopulated as the enforced homeworkers are liberated. Shop doors will reopen. Restaurants will have queues of eager customers. Projects put on hold will restart. Things will get back to normal.
Lenders to businesses will need to pull back any overfunding gradually to allow the business time to recover, tapering repayment plans in line with the business’s financial performance. Normal lending criteria will need to be eased into place.
How long will a recovery take? There are many forecasting that this will take several years, but this all depends on the level of damage caused. If businesses have been supported and the economy has achieved a state of hibernation, reigniting the journey to at least stability may not take as long as some imagine. We may see stifled economic growth, but we will have functioning economies.
The Future State
There will undoubtedly be lessons learned. How many businesses, financial institutions and governments were ill prepared for the impact of a pandemic? Certainly, companies that embraced cloud technology and remote working business practices were able to activate business continuity plans with minimal disruption.
There may be some real positive benefits. Will a customer meeting involving an environmentally unfriendly trek across the globe be replaced by a video call? Will we see the importance of investing in our health care systems? Will there be a greater focus on science to provide greater security in the future? Will we all just be that little bit kinder to each other?
One thing is certain, as history has demonstrated time and time again, we will get through this episode and it will be yet another tragic event in world history. When we do look back, let us hope that we can honestly say we took the right actions to preserve life and protect the global economy.
Photo by: Tim Wilgus