Brexit adds to SME cocktail of risks as State finally launches Covid loans

There will be no shortage of political and banking voices clamouring for the spotlight as Tánaiste Leo Varadkar formally launches the €2 billion Covid-19 credit guarantee scheme for small businesses on Monday.

It’s been a long gestation. Cash-strapped firms would have been forgiven for thinking in the four months since the loans were first promised that a vaccine would be approved for the virus before they saw any of the funds.

The scheme, as has been well flagged, will see the Government assume 80 per cent of the credit risk for loans that run into trouble, with rates for facilities between €10,000 and €1 million set “significantly below” market rates.

Bank of Ireland has flagged that its rates would be below 3.25 per cent – which compares to your typical Irish SME rate of between 5 and 6 per cent.

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Legislation

Ireland is well behind the UK and some other countries in terms of setting up such a scheme, not helped by the fact that it needed enabling legislation at a time when a new Government was being formed and finding its feet.

Still, AIB chief executive Colin Hunt, for one, has let it be known internally that he wants his get funds "shovelled out the door" as soon as possible, mindful that the guaranteed loans need to be granted, as per the European Commission approval last month, by the end of 2020.

The amount covered by the scheme is a fraction of the figure of as much as €5.7 billion that the Central Bank estimated in April SMEs needed to weather the coronavirus storm. Adding in the requirements of larger corporates, the total could be closer to €10 billion, according to senior bankers.

But now comes the hard part of banks wading through loan applications, mindful that they cannot lend recklessly and extend credit that they have little prospect of getting back. There is a clear danger of the scheme could turn into a political football.

Part of the reason why Irish banking stocks are trading on the stock market at discounts to an already well beaten-down European banking sector is the fear among investors that the country’s lenders – in which the State retains major stakes – may face political pressure to support unviable businesses, according to market observers.

Imminent risk

A reminder, if one were needed, of another imminent risk that banks must consider when assessing SME loan applications under the guarantee scheme came from the EU's Brexit negotiator Michel Barnier's address to the Institute of International and European Affairs (IIEA) in Dublin by video link from Brussels on Wednesday.

The Frenchman said that he was "worried and disappointed" following a meeting on Wednesday with his UK counterpart David Frost by London's continued lack of engagement on key sticking points standing in the way of a future trade deal as time is running out for negotiations. These centre around the contentious issues of state aid, fisheries policies, and ways of resolving potential future disputes.

With an eighth round of talks set to start in London next week and the end of October set by Barnier as a deadline for a final agreement if a new partnership is to be in place by January, the prospect of a no-deal rose further this week as both sides dug deeper trenches.

Barnier took aim at UK reports that Boris Johnson’s government had moved to compromise on fisheries, saying that “no new legal texts have been tabled by the UK negotiator”.

"Where the EU has shown openness to possible solutions, the UK has shunned our offers," he said. "The UK government's position would lock Ireland's fishermen and women from waters they fished in long before Ireland and the UK joined the European Economic Community in 1973."

However, the Daily Telegraph cited a source on the UK side as saying: “Barnier’s speech is a deliberate and misleading caricature of our proposals aimed at deflecting scrutiny from the EU’s own positions which are wholly unrealistic and unprecedented.”

Real standoff

Meanwhile, a column in the Times on Friday by James Forsyth, political editor of the Spectator, said that the real standoff isn't over fish, but state aid, and that Boris Johnson's officials only gave a trade deal a "30 to 40 per cent chance".

Of course, the fresh war of words could be put down to the routine posturing we have seen from both sides in the past few years. But lenders must in the meantime factor in the growing threat of a no-deal Brexit when looking at the cocktail of risks facing businesses seeking loans under the guarantee scheme.

Meanwhile, banks have their existing books to worry about as they face a surge in loan defaults among borrowers in Covid-hit sectors as payment breaks of up to six months start to come to an end in the coming weeks.

While there has been speculation in recent days that banks may offer an extension to particularly vulnerable sectors, particularly pubs that have remained closed since March, this would need the nod from regulators and there appears to be little traction.

Space

The blanket payment breaks have certainly provided breathing space for both banks and borrowers since the crisis erupted. But it’s now time for banks to offer tailored restructuring solutions – including debt write-offs, if needed – to borrowers who will not be able to return to regular payments after the respite period.

Goodbody Stockbrokers analyst Eamonn Hughes estimates that 20 per cent of the €7.8 billion of existing AIB and Bank of Ireland loans to SMEs and larger companies in the so-called distribution sector, including hospitality, pubs, retailers and wholesalers, will end up in default between this year and next as a result of the pandemic.

A no-deal Brexit would only add to the figure.