EU emergency loan programs raise fears of debt trap

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MILAN / PARIS / MADRID (Reuters) – Michele Berteramo, owner of Movida restaurant and cocktail bar on Milan’s Naviglio Pavese canal, was set to spend 40,000 euros (£ 36,160) on renovations when the novel coronavirus pandemic hit northern Italy.

A man is seen behind a bar in the Movida restaurant located at the Naviglio Pavese canal in Milan, Italy, June 5, 2020. REUTERS / Valentina Za

Instead, he burned the money keeping his business afloat during the foreclosure. La Movida reopened on May 18, but struggles to recover as crowds shy away from the popular nightlife district.

“We were able to skip the rent payments, but this can’t go on forever… we’re going to need bank financing to operate,” said the 46-year-old restaurateur.

Berteramo has used the emergency loan program guaranteed by the Italian government to help pay his bills, but if he is to continue his renovation plans he will have to take on even more debt, in a declining economy, to do it.

Its conundrum is a long-term concern for governments and banks across Europe, which are rushing to support struggling companies but fear that rising debt levels will hamper their ability to invest in the sector. growth.

Credit to non-financial corporations in the euro area hit an 11-year high in April, according to data from the European Central Bank (ECB). According to Reuters calculations, more than € 290 billion in loans under government-backed lending programs were made in the four largest economies of the European Union and in Britain during the continuing crisis in coronavirus.

“If the growth of the European Union only returns to its pre-COVID growth rate, after today’s significant shock, Europe will face a future similar to Japan,” Stephen said. Caprio, UBS credit strategist, calling the years of stagnation in Japan an increase in debt. combined with deflation to hamper the economy in the 1990s and 2000s.

“European companies already had too much leverage. This will naturally stifle business investment ”.

Highlighting fears that such a scenario could come true, central bankers are already pointing to the dual threat of debt and deflation. “The high levels of public and private debt across the euro area (…) could trigger a dangerous spiral between falling prices and falling aggregate demand,” said Ignazio Visco, member of the Council of Europe. ECB governors in a speech at the end of May.

Core debt to non-financial private companies in the euro area represented 165% of the region’s gross domestic product (GDP) at the end of 2019 according to the latest figures from the Bank for International Settlements, compared to 150% in the United States. The European ratio is expected to rise further following this year’s lending craze.

The problem is particularly acute in small and medium-sized enterprises (SMEs), which account for around two-thirds of private sector jobs in the European Union to 27 countries but do not have the possibility of direct access to capital markets unlike to their larger counterparts.

FROM DEBT TO EQUITY

Policymakers are discussing options for raising more equity, rather than debt, in companies, but few countries have ready-made vehicles to channel mass investment to SMEs.

While several governments have set aside funds for capital injections into large companies, they must imagine innovative options for small businesses.

“Aid to businesses will have to be redirected from Act 1 loans towards partial equity participation (…) the choices are complex, costly and form part of the political debate”, declared the Governor of the Banque de France , François Villeroy de Galhau, in an opinion article in Journal Le Figaro on April 24.

The European Union has estimated that businesses will need € 720 billion in solvency support in 2020 alone and aims to activate around € 300 billion of investment by securing and complementing investments in the sector. private.

This could provide longer-term support to mid-sized businesses, although there are caveats – priority will be given to businesses that match the EU’s broader goals of improving digital technology and moving to a greener economy.

“It will be difficult to get these funds for traditional industries,” said Jose Manuel Gonzalez-Paramo, a former politician at the European Central Bank of Spain, adding that small businesses are unlikely to attract big. part of that money.

It’s only ‘once they get older that they are on the radar. You can’t imagine a fund investing in bars for example, ”he told Reuters.

INCOMING CALLS

French investment firm Tikehau Capital, which focuses on mid-sized companies, is eyeing opportunities.

“We are receiving more and more calls, many 100% family businesses in Spain, Germany, England,” said Mathieu Chabran, co-founder of Tikehau.

“They are worried that their debt levels will double, so they think it might not be such a bad idea to let in a financial investor with long term capital.”

Tikehau manages around € 25.4 billion in assets – but there are a limited number of investors of this caliber operating in the small and medium-sized business sector.

In Britain – which has one of the most developed capital markets in the region – financial lobby group CityUK estimates the level of equity raised by small and medium-sized businesses over the past two years is 7. , 2 billion pounds ($ 9.00 billion). The group also predicts that £ 32-36 billion in loans taken out by companies using the government’s emergency loan programs will be “unsustainable” by the end of the first quarter of 2021.

Backed by the Bank of England, CityUK has launched a ‘recapitalization’ project to examine how private equity, insurers and pension funds could invest more in SMEs.

“It’s a huge and complicated challenge,” said CityUK Managing Director Miles Celic. “There will be no one-size-fits-all solution. We need a range of viable options … and many different types of investors.

It examines new types of instruments to encourage investment by SMEs, ranging from simple equity purchases to ‘debt with profit sharing’ – a type of loan that is treated more as equity on a balance sheet and is refunds would be linked to profits.

In France, central bank director Villeroy said a similar instrument, known as “equity loans”, could be adapted to help SMEs.

Italy is considering offering tax breaks both to small businesses that are strengthening their capital and to investors who are offering their liquidity to help these businesses.

The Fondo Italiano d’Investimento – a fund backed by the state lender CDP – is preparing to launch a jackpot of 800 million euros to take minority stakes in Italian companies with revenues of 20 to 250 million euros .

Most of these programs and instruments will require some government support – although this in itself may be a problem.

Germany has set aside € 100 billion for equity investments in struggling companies, but this has hardly been touched to date. Banks have criticized Berlin for imposing conditions that are too onerous – such as wage controls – saying they are encouraging companies to take on more debt.

With lockdowns only recently starting to ease across much of Europe, bankers also say many companies, especially SMEs, are unlikely to focus on raising capital just yet.

But as the debt repayment holidays begin to expire and the availability of emergency loans runs out, late 2020 and early 2021 are likely to be when businesses need the option of new capital. .

“We need the programs to be launched as soon as possible so that the funds arrive on time,” Carlos Torres, president of Spain’s second-largest bank BBVA, said at a conference hosted by the main business lobby of the country last week.

“Arriving late can, in many cases, mean not coming.”

Milanese restaurateur Berteramo has used up his first state-guaranteed loan of 25,000 euros and is awaiting a second installment to be subscribed by the local region. “We only have debt right now … I’m starting to worry a little bit,” he said.

As it is, the only easy way to raise more equity would be to take a business partner, which is not attractive. “The fewer people who run a restaurant, the better,” he said.

Additional reports from Tom Sims; Written by Rachel Armstrong; Editing by Crispian Balmer

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