SME sector needs more liquidity during COVID-19

Since publishing this article additional business supports were announced on 2 May - read detail.

In a recent report by the Central Bank of Ireland, it is estimated that non-agricultural SMEs in Ireland will need between €2.4bn and €5.7bn in additional liquidity if their revenues are curtailed for three months.

COVID-19 containment policies have required many businesses across entire sectors of the economy to close completely. As a result, many SMEs are sustaining losses which could threaten their survival. 

SMEs account for over 1m employees, or 68.4% of total employment in the Irish business economy (CSO, 2019). While wage supports announced by the Irish State will ease the wage burden of affected companies, SMEs still have large volumes of non-payroll expenses which they will need to cover or reduce. 

The importance of short-term liquidity support is paramount to assist them in meeting cost obligations during the crisis period, as well as helping to ensure a post-crisis recovery. 

Estimating the liquidity needs of SMEs during COVID-19
The report identified certain sectors of the economy that are more vulnerable than others to the effects of social distancing and containment policy. These include a substantial portion of the wholesale and retail sectors and the entire accommodation and food sectors.

The Irish state supports announced will have eased the wage burden of affected SMEs. As a result, the report focuses on non-personnel expenses when calculating SMEs’ demand for liquidity. A key factor that will determine the overall demand for liquidity is the ability of firms to reduce non-personnel expenses such as rent, rates, tax, insurance, trade credit, utilities and debt repayments (once payment moratoriums cease).

By identifying the vulnerable subsectors of the economy and considering the level to which the expenses in these subsectors can be reduced, the report estimates liquidity needs over a three-month period could be between €2.4bn and €5.7bn.

Accessing finance
Many firms may struggle to access credit, particularly if they have no existing lending relationship or lack collateral to support their application, especially if bank risk appetites contract as in the previous crisis.

Existing bank credit lines are unlikely to be sufficient to cover the financing needs of all affected firms over a three-month period.

Fiscal supports
In general, fiscal policymakers have three options for supporting SMEs’ access to liquidity, in the event that private sector liquidity is insufficient to meet demand. These include credit guarantee schemes, lending schemes, and direct fiscal supports.

Credit guarantee schemes
Credit guarantees can enhance the capacity of banks to lend. If a guarantee meets certain requirements, it acts to reduce the regulatory capital risk weight of the loans issued with the guarantee, allowing the banks to issue more loans than would be the case otherwise.

Guarantee programs can help SMEs, such as those without adequate collateral, to obtain sufficient short-term liquidity and avoid insolvency, thereby retaining the capacity to recommence operations when demand resumes. However, this comes with a cost – the SME must expect sufficient profitability after the shock to repay the loan plus interest.

Lending schemes
Targeted lending schemes can boost access to finance for borrowers with acute liquidity needs. These can take form two types – on-lending schemes and direct lending schemes. 

On-lending schemes operate through the provision of funds to banks, who in turn lend those funds to customers. Direct lending schemes, on the other hand, require government bodies to engage with borrowers directly, as well as manage approval processes and loan risk.

The Irish State has two major on-lending schemes, both administered by the Strategic Banking Corporation of Ireland (SBCI) – The COVID-19 Working Capital Loan Scheme and the Future Growth Loan Scheme.

Two direct lending schemes are currently in place in Ireland. Microfinance Ireland (MFI) lends to Irish micro enterprises and The Sustaining Enterprise Fund administered by Enterprise Ireland is also involved in lending to firms operating in the manufacturing or international service sectors. 

Direct fiscal supports
The final method of providing liquidity is through direct fiscal supports, such as grants or tax offsets for example. These have benefits in their support to the economy, but such traditional demand-side stimulus is likely to have limited short-term impact. Since many businesses are not operational, and thus direct fiscal supports would need to be made on the supply side, rather than the demand side in order to provide a useful form of liquidity support to firms in the current environment.

New supports needed
The current options available for policymakers to intervene all involve delicate trade-offs in their selection and design to ensure that the overall costs do not outweigh the benefits.

However, the longer the period over which the containment measures last, the greater the likelihood that liquidity pressures may evolve into solvency pressures. It is clear that current measures alone will not be sufficient to protect a large cohort of businesses who have been acutely affected by the pandemic. 

Firms with weaker balance sheets due to COVID-19, those who currently have no lender relationship with a bank and those who have limited collateral to support their application may struggle to access finance, especially if there were to be a reduction in banks’ risk appetite.

If the current government-backed lending schemes are to be effective, banks need to apply different parameters when assessing the credit-worthiness of an application. The banks’ normal credit checks will prohibit lending in a lot of cases as businesses may not be in a position to meet onerous debt service coverage ratios in the short to medium term. Borrowers need to access funding immediately and on-lenders need to have the resources and flexibility to facilitate a swift drawdown so it is important to distinguish this government-secured lending from normal every day commercial lending.

Several sectors have been decimated by the impact of the crisis. The tourism and hospitality sectors will be feeling the effects of COVID-19 for many months to come as social distancing rules make operating their business in an efficient manner a major challenge.

While the initial supports provided were uniform in nature as they were employee-focused, it is imperative that government assess the particular impact to each sector and assist accordingly going forward. The “one size fits all” approach will not provide adequate support to those industries that are most adversely affected.

If you are looking to engage with your existing funder or a new lender about raising additional funding for your business, contact a member of our corporate finance team to find out how we can help. We have a well-established track record of helping SMEs secure funding lines and have developed strong and long-lasting relationships with all major lending institutions. We can guide you through the process to help ensure a positive outcome.