Mind the Gap! Turning our attention to larger SMEs (+£45m turnover) and the UK emergency funding market
Alexei Garan, Head of Shaw & Co’s Debt Advisory function considers the options available for larger SMEs – with turnovers of more than £45m – in need of emergency funding including the recently introduced CLBILS (Coronavirus LARGE Business Interruption Loan Scheme).
Many of our followers have seen Shaw & Co’s coverage on the Coronavirus Business Interruption Loan Scheme, or CBILS for short. As a reminder, this scheme is exclusively for SMEs with turnover under £45m.
However, last Thursday, the Chancellor announced a CBILS-type scheme for UK SMEs with turnover between £45m and £500m. I hope those at the back can keep up with all the acronyms because Coronavirus LARGE Business Interruption Loan Scheme (CLBILS) was the Chancellor’s attempt to address the gap that emerged between the smaller SMEs, eligible for CBILS, and the larger ones, destined to receive emergency funding from the Bank of England’s Covid Corporate Financing Facility (CCFF).
To access the CCFF a business needs an investment grade (IG) credit rating, Baa3/BBB- or higher. Only 108 UK SMEs with turnover of £45-500m have such a rating, with some 5,000 businesses rated below IG, if they are rated at all. So, when I say mind the gap, I mean mind the whopping great chasm. This gap was so huge that it is inevitable that the ‘forgotten’ 5,000 would make themselves heard, resulting in Thursday night’s announcement. Better late than never of course, we acknowledge the Chancellor to his credit is part of a team battling the biggest crisis since World War II.
The details of CLBILS are yet to be released. Initial guidance suggests these will be public by the end of April. We know it will be a separate scheme, no doubt due to the highly complex state aid rules. We expect a government guarantee to the benefit of the lender, in the same way as CBILS, but we have already been told that there will be no Business Interruption Payment, the grant the government issues under CBILS to cover the first 12 months of interest and lender arrangement fees. We are also pretty confident that the same CBILS approved lenders will be used as the distribution routes to aid efficiency.
Ahead of CLBILS details being released, larger SMEs are well advised to consider their options and if they are likely to qualify for CLBILS at all. Larger SMEs broadly fall into 3 groups. Firstly, unrated businesses that have little or no debt and hence never needed a rating. Secondly, unrated borrowers with plenty of debt but of bi-lateral type, such as bank loans and asset finance, that doesn’t require public ratings. And thirdly, those with debt and a sub-IG rating, Ba1/BB+ and lower.
Our team at Shaw & Co works across both the traditional and alternative financing markets and we set out below the options you’re likely to face in the coming weeks:
1 – Unrated companies with little or no debt
These companies have typically avoided debt as a matter of principle and are wary of debt products and their providers, however benign, and especially in crisis circumstances. These businesses will traditionally turn to their banks first, being the only financial relationship they hold.
We believe this is the segment that will attract most of banks’ focus. Unlevered businesses can offer decent security. That security will also be unencumbered by pre-existing facilities, or any facilities will also be with the same bank, making the process of putting a loan in place relatively straight forward.
It is our prediction that most CLBILS funds will end up being deployed to this segment of the market. The banks Relationship Managers are likely to know the business well and will be better experienced in general than the Relationship Managers dealing with the smaller CBILS applications. Most likely these Relationship Managers have been trying to sell these businesses unwanted facilities for many years! Credit will also likely prioritise CLBILS applications as the individual loans will be larger, which means banks can be more efficient in getting money out of the door and responding to political pressure to show meaningful progress.
As it is likely the first time that such a business has considered taking on debt, and given the speed of deployment required, it’s not the time to learn on the job. Despite these looking like the most straight forward of cases our team’s resources and expertise will still be of significant value to ensure the best suited debt arrangements are put in place. Without a Business Interruption Payment (BIP) larger SMEs are paying for these funds from day one so capital efficiency remains paramount.
For example, a client unadvised may seek an expensive multi-million-pound term loan, whilst a much smaller term loan may suffice supplemented by a cost-effective invoice discounting facility could provide additional cash in circumstances where the client’s customers remain a good credit risk but are just taking much longer to pay. Or, if stock isn’t moving due to a temporary reduction in activity, a facility secured against that stock may be more cost effective.
2 – Unrated companies with substantial debt
It’s hard to blame businesses for having taken advantage of the long period of low interest rates enforced by the Bank of England and cheered on by the Government. That said, banks appetite to support businesses with higher levels of pre-existing debt will be slim.
These businesses may be better advised to consider a full restructuring of existing facilities, extending and reshaping the new facilities to create the liquidity needed. Longer life loans may be required to re-sculpt amortisation profiles to match the new expected cash flows. Banks are limited to shorter life loans due to capital adequacy requirements. There is a healthy alternative non-bank lending market supported by insurance and pension company money looking for long life, yielding investments. These may now be much more suitable. Whilst higher in interest rates, the annual servicing costs may be reduced significantly.
We do expect a number of non-bank lenders to join the British Business Bank accredited lender list. However, this could take several months. This may provide valuable alternatives under the CLBILS arrangements, but we would advise that businesses start making arrangements the alternative markets well in advance. Our team has spent the last decade navigating the non-bank debt market often developing solutions that supplement whatever the traditional banks can do for clients. With the right advice, suitable and affordable packages can achieve the desired aims of alleviating the worst of this crisis. Those that have not ventured into the alternative markets before would be well advised not to do it alone, but nor should they be unduly nervous of the apparent complexity.
3 – Sub-investment grade rated companies
The most likely reason for a sub-investment grade rating is that these businesses have substantial borrowings from the types of lenders such as Collateralised Loan Obligations (CLO) or High Yield Funds (HYF). It is also quite likely that they are partly or wholly owned by a Private Equity (PE) firm or a narrow group of private shareholders.
Given the substantial debt levels, a traditional bank is an unlikely provider of additional liquidity. However, PE backers or shareholders might be in a position to support the business and defend their own investment with a liquidity injection. Aside from owners’ support, the investment managers of the CLOs or the HYFs not only already know your business well but may also be best positioned to offer a solution. Any solution is unlikely to fall within the CLBILS scheme.
A liquidity solution is most likely achieved through a full recapitalisation or another form of debt restructuring, where additional funds are provided as part of a larger debt package replacing existing facilities. The critical question here is how quickly could these options be negotiated, given the complex debt and documentation structures and multiple debt classes? Many of the CLO and HYF managers we know have raised substantial Credit Opportunity funds, targeting these very situations.
If your business falls into this category we would suggest focusing on a full recapitalisation immediately, rather than waiting for CLBILS, as it is unlikely to be a silver bullet. It is to your benefit to have an experienced debt and restructuring adviser’s expertise when dealing with this complexity against the background of an urgent cash need. We offer our own debt restructuring expertise and market knowledge in this sector.
I have attempted above to give an unvarnished but balanced perspective of the options the majority of middle market SMEs are likely to face in the coming weeks. A blogpost of course does not allow for these options to be exhaustively considered. That said, the average experience within the Debt Advisory team at Shaw & Co is over 20 years, spent in banks, restructuring firms and businesses. We have seen a few crises from a few vantage points. And whilst no two crises are the same, we stand ready to offer our experience of numerous ‘special situations’ to any businesses seeking fully independent expert advice.
Important Notice – This article should be read in the context of the date of publication stated at the top of the page. For further COVID-19 financial support updates for business, subscribe to our mailing list.
Alexei Garan – Head of Debt Advisory, Shaw & Co
Alexei leads Shaw & Co’s Debt Advisory team and supports clients in a range of sectors including Energy & Renewables, Engineering, FMCG, Healthcare, Human Capital, Leisure, Manufacturing and TMT. Over the last 10 years, he has advised on over £2bn in restructured post crisis client portfolios and arranged over £400m in client funding. Alexei has also been called in as an expert witness in several post-financial crisis legal cases.
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