Small Business Lending, ESG Risk And COVID19 Responses

The rise of the COVID-19 pandemic around the world is changing rapidly. Boards and senior executives will already have implemented business continuity plans across the globe. The growth of working from home for entire firms in some industries will be stress testing remote working capability. Any failures will quickly highlight the firms which haven’t taken these issues seriously as they fail to perform their contractual obligations.

Doing the right thing by customers, employees, suppliers and the community is the bare minimum required to maintain your social license to operate in a crisis. Doing the right thing doesn’t mean engaging in irrational levels of self-sacrifice. It does mean open and honest communication about the reality of what zero revenue coming in the door means for your operating model.

Many businesses will have already laid-off workers and attempted to sell off as much inventory on hand as possible. Many employees will be trying to work from home if they can. If they can’t, expect aggressive interrogation as to why that is the case.

Aside from visible frontline staff and a small number of critical physical-location-only roles, this crisis is highlighting how working from home could have been embraced years ago by many firms without issue. Imagine the economic loss from commuting time alone that is now starkly in focus for those who haven’t been able to work from home before.

Because of the enormous impact of revenue loss alone, many firms will take drastic measures. The risk of insolvent trading means that some directors may choose to shutter a firm instead of taking advantage of low-interest bridging finance from their bank. Their suppliers may already have cut off trade credit, and their employees have been let go or stood down.

The rapid deterioration of consumer spending will present a grave challenge for some firms: do they place orders with suppliers? Do they risk increasing any debt they already have? Do they need to consider administration immediately? Is appointing a liquidator necessary to preserve value left in the business on the other side of the pandemic?

 These are not easy questions. It is easy to criticise from the sidelines the discussions going on around the kitchen table boardrooms of small businesses, the boardrooms of major corporations and the management committees of the big banks.

We don’t know what the other side of the bridge looks like at the moment. We don’t know how long the slowdown of economic activity will last. This situation means it is precarious to take on additional debt or keep paying high monthly expenses and run down cash and short-term investment balances for an unknown duration of time.

A firm can raise either debt or equity finance. If raising debt finance is too risky, then raising equity finance through a rights issue can increase the cash available to ride out the pandemic. For some firms, their industry sector is now too risky, and fund managers may have no interest in participating in a rights issue. But at the right price, equity finance can be found somewhere.

 If a firm is raising debt finance, they may already be able to draw down lines of credit or commitments their bankers have made to them to assist in meeting operating expenses. Firms still have to reduce their monthly bills, including payroll and payments to suppliers.

There is a wave of restructuring and business model simplification coming to Australia and New Zealand as a result of COVID19. Firms will still need to spend money on critical regulatory and technology projects. They may need to accelerate transformation plans that reduce labour costs and adjust their operating model, so there is less reliance on any suppliers unable to perform during this crisis.

Because of the decentralised nature of the capitalist society we live in, coordinated action at the industry level to protect a particular industry is a risk for government and central banks. This crisis can’t be an excuse to bail out shareholders. Shareholders are paid to bear equity risk through capital gains, dividends, debt reduction, and share buybacks.

Already, much central bank intervention is protecting the banks and non-bank lenders, with modest flow-through guarantees to the employees laid off already due to a collapse in revenue. The scale of the economic slowdown still doesn’t seem to be appreciated by policymakers.

It doesn’t matter to a small business owner if they have lower interest rates or access to cheap financing if their revenue has gone to zero dollars a day. Why would they borrow under such uncertainty? Under company law, are they a prudent director if they take on more debt and risk trading while insolvent?

The need for independent legal and accounting advice before entering into any of these bank-championed arrangements is clear. The need for independent financial advice for business owners thinking about what to do under the circumstances is clear. The last thing the economy needs is hundreds of thousands of small businesses entering into zombie loans that will eventually break the banking system unless the central banks fully underwrite the loans, hence begging the question of why have a banking sector at all?

The flow-on effect of so many small businesses facing revenue collapse will be in the property sector. What is the present value of future cash flows from an apartment building full of casual workers renting? If there is a mortgage against that property, what is the likelihood of impairment within months? What is the plan for mortgage enforcement and tenancy law enforcement?

This thought process may sound extreme, but the jobless claims in the United States look like they will increase 10-fold in less than a week. How is this going to be any different in Australia and New Zealand? Unemployment could be over 10% in weeks.

There are high numbers of casual workers, part-time workers and full-time workers on modest incomes who already may have suffered from not getting as many hours as they want and now find themselves out of work?

The government and central bank are facing a crisis they have never seen before. Here are some of the critical factors:

  • A novel virus with unknown factors and rapid global spread
  • A supply shock in China
  • A demand shock in China
  • A demand shock ex-China
  • A supply shock ex-China
  • A financial market decline
  • A credit market crunch
  • Fast government and private sector decisions made under considerable uncertainty

These factors are a recipe for a very tough recession. The pass-through of interest rate savings to small business owners is cool. Until you start realising that many of the small businesses affected may not even have debt! They do have fixed costs though – their leases, their committed bills, their payrolls. It doesn’t matter if you save $2000 a month on your loan repayments when you still have a $10,000 a month lease payment to make! This situation would not be uncommon for, say, a café operating in the CBD.

There is so much uncertainty that firms stopping hiring and laying people off now makes rational sense as many only have cash reserves to last a short period. However, the societal impact of how fast this is happening while at the same time an exponentially growing pandemic caseload is stressing the public health system and people are hoarding toilet paper will change our society for quite some time.