COVID-19 UK: Finance – Securitisation: A financial vaccine for COVID-19? – Insight

April.21.2020

It has been reported that the UK Treasury is considering a new bailout mechanism for privately held companies in sectors seen as making "a material contribution" to the UK economy, which would take the form of one or more securitisation transactions partly backed by the UK government or sold to the Bank of England (BoE). While we understand that these proposals are still very much conceptual, we have set out below some high-level thoughts about this scheme, as well as considering how securitisation could be used as a tool to extend assistance to European small and medium sized businesses (SMEs) that are currently facing huge losses in revenues and/or bankruptcy in light of the COVID-19 crisis.

For reference, we recently covered some of the measures already introduced by the UK government to assist SMEs and start-ups during these uncertain times, including the Future Fund Scheme and other measures.

What has been proposed?

In short, the proposal involves individual loans (not exceeding £200m) advanced by UK lenders participating in the scheme being sold to one or more securitisation special purpose vehicles (SPVs) or to the BoE. The relevant SPV could fund the purchase price for the loans by issuing debt in the form of securities, the senior tranche of which would potentially be guaranteed by the government, with the lenders retaining the junior risk in the structure either by retaining a junior portion of the securitised loans or subscribing for the junior tranche of securities issued by the relevant SPV. We understand that the government expects, at a minimum, that loans to firms with a turnover above £500m that are not eligible for the COVID Corporate Financing Facility (CCFF) to be included, but that it is canvassing opinion as to whether that threshold should be reduced to achieve sufficient diversification and to mitigate concentration risk.

For more information on some of the government's financing-related schemes introduced for businesses as a result of the COVID-19 pandemic, read our COVID-19 UK: UPDATE: Finance - Mind the Gap - Insight, COVID-19 UK: Finance - Mind the Gap - Insight and COVID-19 UK Insight: Financing-related considerations articles.

Analysis

One criticism of this proposal is that the removal of the £500m turnover threshold under the Coronavirus Large Business Interruption Loan Scheme (CLBILS), which was launched on 20 April 2020, has meant that all viable businesses with an annual turnover of over £45m will be able to apply for government-backed finance. As a result, lenders' risk weighting of loans which benefit from the CLBILS scheme will be very low and therefore can be held on such lenders' balance sheets without the need (from the lenders' regulatory capital perspective) to securitise. A related point is that, with the ECB having recently announced that lenders can also use loans that they have made to governments, SMEs and self-employed individuals as collateral for such lenders to borrow money from the ECB, the need for lenders to structure and hold senior securitisation debt as collateral for such borrowings becomes less pressing. Overall it is clear that, while such a strategy is clearly inventive, it may be too complex (and costly) to work on a universal scale, in an environment where speed is clearly of the essence. We expect that market participants will wait to see what the BoE's response is before providing their views on any COVID-19 related securitisation scheme.

What is the issue facing European SMEs and how else can securitisation help European SMEs survive the crisis?

European SMEs alone employ more than 125 million people and contribute to more than half of Europe's GDP. In many cases, the crisis has hit so hard and fast that business owners must care for themselves and their families first before researching financial alternatives. With many SMEs operating on a "hand-to-mouth" basis, even short business interruptions can lead to bankruptcies.

Against that backdrop, we are aware of market participants exploring the use of securitisation structures as a means of providing liquidity to SMEs. Where, for example, fintech companies that have established and vetted relationships with SMEs through the provision of financial technology to those SMEs, with access to real-time business data, as well as a proven financial platform and large-scale operational abilities, we are seeing such entities exploring how they can set up efficient and sustainable lending platforms to such SMEs using securitisation technology. In this regard, we have looked at structures whereby such entities could extend cash advances to pre-qualified SMEs (i.e. SMEs that, pre-crisis, showed a certain level of sales that would therefore be likely to become active again post-crisis) to compensate for lost sales for a certain period of time. The receivables related to those cash advances can be securitised and the securitisation debt subscribed for (or guaranteed, as applicable) by governments, banks and funds as an accountable and efficient form of extending much needed help. In principle, those cash advances (and therefore the related securitisation debt) would be repaid from a percentage of the businesses' receivables once activity recovers.

Securitisation technology can definitely help, but as mentioned above, speed is of the essence to ensure that the well-intentioned efforts by the UK Treasury actually reach SMEs. To date, too few pay-outs, too few applications and a too high average loan size has meant that the currently available government support packages (including CLBILS and CCFF) are only reaching larger SMEs and larger businesses. Whether securitisation will become an additional tool in the UK government's stimulus package to help SMEs remains to be seen.