Paragon Bank Managing Director of SME Lending John Phillipou has considered some of the key trends around the Recovery Loan Scheme and what SMEs need to consider when applying for the scheme. Read his Q&A below.
What is the biggest piece of overall advice you’d give SMEs looking at funding options to support their post-pandemic recovery?
As SMEs make plans post-pandemic, they should consider having access to a selection of funding options that exist in the market. It’s key for business owners to be educated on exactly what type of solutions are available to them, both through government schemes such as RLS and beyond those, in order to help guide their decision making.
SME owners should also resist the urge to ‘bite off more than they can chew’ by taking out a bigger loan than needed. It’s crucial for businesses to consider what the longer term repayments will look like. Through government schemes such as CBILS, a lot of companies will have taken a sizeable amount of cash support, often with plans to store the excess cash as a ‘rainy day’ fund to aid liquidity. However, it’s very tempting to spend the money once you’ve got it and many businesses could find themselves regretting taking out such large loans further down the line when the interest repayments start.
In summary, my guidance is – have lots of options open but only draw what you think you need. If you need £250,000 then don’t borrow half a million, no matter how tempting that feels. Insolvencies across the UK are currently at a record low – this is potentially still an artificial market position due to the various government schemes propping up the economy. The true picture will only start to emerge in two to three months’ time when repayments begin, and those varying support schemes fall away.
What kind of funding is Paragon providing through the RLS scheme?
One of the great things about the Recovery Loan Scheme is that it has relatively simple eligibility criteria, which has helped both lenders and borrowers. The two foundation stones for the scheme are that an RLS loan should either create cheaper funding for the client or facilitate loans we would struggle to fund as part of our everyday ‘business as usual’ lending policy.
The latter is a big benefit for two reasons. Firstly, it allows us to lend against technologically advanced, innovative assets that will help power SMEs’ recovery forward, but that aren’t always ‘tried and tested’ to meet our usual criteria. Secondly, it means we can now lend to customers that may not meet our credit risk requirements because of the short-to-medium term impact of Covid-19 on their business, helping those businesses to recover post-pandemic.
Are you anticipating any trends to emerge due to RLS?
We anticipate that more sustainable and innovative ‘green’ assets are going to be funded – for example, the use of electric or hydrogen cell technology and other similar initiatives. Historically, those assets can be challenging to fund over the long-term as there is an unknown element to how they perform over time. Schemes like RLS can help lenders adjust their risk appetite to facilitate green lending better in the future.
Another emerging trend is around funding the technological part of the asset, not just the mechanical piece. When agreeing a loan against an asset, banks look carefully at the value of the equipment involved based upon resale data. As the market goes more digital, the value of the assets is transitioning from pure ‘metal’ costs towards the softer ‘system and interface’ costs. This upgrade in technology means that banks can’t easily pin a security price, which means lending against digitally powered assets has historically been a challenge.
With those assets, software is the most expensive thing but currently valued at zero by many lenders. RLS will give lenders the opportunity to ‘lend and learn’ and review processes and lending criteria for the long-term. In that sense, RLS has the potential to empower and support the path of digital transformation amongst UK SMEs.
Are you seeing any of those trends come through already?
It is too early to confirm emerging trends but what I can say is we are pushing ourselves more openly in the market. We are definitely adopting the ‘lend and learn’ policy and we are now seeing proposals for a wider range of assets.
Through RLS, we are able to be very innovation-focused and support businesses through their own transformation. A lot of traditional lenders have shied away from assets that aren’t ‘tried and tested’, which means highly innovative assets sometimes struggle to secure funding. The security provided through RLS will help address this for the long-term.
What are the main differences between CBILS and RLS?
The Recovery Loan Scheme is very different to the Coronavirus Business Interruption Loan Scheme. One of the features of some CBILs was the 12-month payment free period offered by certain lenders. This obviously has short term cashflow benefits, however the downside is that by the time business owners start repaying the loans there has been no capital payback against the assets purchase during the first year. This has a potential knock-on effect when it comes to upgrading or exchanging the equipment. There is an increased risk of negative equity due to equipment depreciating in value but no capital having been repaid against it.
RLS does not have that feature – you are paying back capital that is a lot more akin to a normal business transaction. Over time, RLS is a stable product that has real potential to power SMEs in their recovery from the pandemic.
Do you have any tips for SME owners looking to apply for RLS funding?
Be prepared – get all the evidence you can regarding your long-term plans – but know that funders aren’t expecting you to know all the answers in such an uncertain market. The pandemic has changed a lot of things for a lot of businesses and lenders will understand that businesses are entering a period of transition.
While you’ll be required to show why you need an asset in the short to medium-term, there is a lower expectation to have all the long-term details nailed down.