EDD – Loans Guarantee Scheme
Purpose of the report
In accordance with the Financial Direction 3.3 the approval of the Treasury and Resources Minister is required when a States department initiates lending.
The Minister is asked to approve lending (by way of loan guarantees) of upto £2million by the Economic Development Department in order to commence the Small Firms Loan Guarantee Scheme (SFLGS). The Department is seeking approval to enter into four guarantee arrangements with four banks for upto £500,000 of loan guarantees with each bank.
Background
The States approved the principle of the SFLGS in P38/2005 – The Economic Growth Plan in April 2005. This Plan outlined a loan scheme, underwriting £5m of loans to small firms, in order to stimulate entrepreneurial activity.
The Scheme has now been finalised and has the following summary criteria:
o Loans will be taken between the Business and the Bank, interest rates are set by the bank
o All applications will require EDD approval
o EDD will underwrite upto 75% of loan
o Total underwriting of £2m
o Expected default rate 10% (based on UK benchmarks)
o Expected annual cost £200,000 if and when the loan scheme is fully subscribed
o Loans must not exceed £250,000
o Loans must be repaid within 10 years
o Borrower will pay EDD 2% arrangement fee
o Sector specific restrictions apply (see Appendix A, attached)
o The scheme will be reviewed on an annual basis and closed if not meeting its objective
Per Financial Direction 3.3, the Minister is allowed to approve upto £500,000 for any one loan agreement provided that the overall scheme does not exceed £3m.
Full details of the scheme are attached as Appendix A.
reCOMMENDATIONS
That the Minister approve the lending upto £2m by way of four separate £500,000 guarantee agreements with four banks in accordance with Financial Direction 3.3
reASONS FOR THE DECISION
To encourage entrepreneurial activity in the Island, in accordance with the Economic Growth Plan, at reduced risk and administration cost to the States.
Appendix A
Details of the Small Firms Loan Guarantee Scheme
Background
The States approved Economic Growth Plan proposed a multi facetted approach to growing the output of Jersey’s economy. One of these is to develop a new approach to enterprise that will remove some of the identified barriers to entrepreneurial activity.
The main barrier to entrepreneurial activity, identified in the 2002 Survey of Entrepreneurial activity, is access to business finance. The Economic Growth Plan recommended that it could be improved by, amongst other things; introducing a Pilot Small Firms Loan Guarantee (SFLG) scheme.
Lenders, in accordance with their policies to secure a business loan, are looking for security which many would-be-entrepreneurs do not have. This results in fewer numbers of business start-ups and restrained growth for young businesses. These policies do, however, create a market failure.
In the UK this failure was addressed with the introduction of a SFLG in 1981. The initiative was subject to a detailed review by KPMG in 1999 who clearly confirmed the SFLGS adds value to the economy.
A further evaluation, the 2004 Graham Review of the Small Firms Loan Guarantee Scheme, concluded that access to finance does not appear to be a significant barrier facing the generality of established businesses. However, as collateral appears to be a major consideration, borrowers without business or personal assets will struggle to access finance. In addition, scoring techniques, though beneficial for the majority of borrowers, favours those with a proven track record and good credit history. As a result of these two factors, start-up businesses continue to find it more difficult than the majority of businesses to access debt finance.
The main principle of the SFLGS is to provide security to lenders in the cases where would-be-entrepreneurs or growing young businesses do not have the necessary security to obtain a business loan.
Policies
The concept of Government guaranteeing the working capital of a private enterprise is new to Jersey but well established in many in other countries. One of these, the England, has already shared valuable information on how their scheme operates and its costs.
The policies recommended have broadly been taken from the UK scheme, and adjusted, where appropriate, to meet local needs. They are:
1) The borrower must be licensed under the Regulation of Undertaking Law
2) The licence must have been issued, and the undertaking commenced, within the previous 5 years.
3) The Principle owners of the undertaking must be resident and domiciled in Jersey.
4) The guarantee is for a maximum of 75% of a business loan
5) The guarantee can be used as security for business loans between £5,000 and £250,000.
6) The loan must be repaid within a minimum of 2 and maximum of 10 years.
7) Borrowers can have more than one guarantee, but within the maximum £250,000.
8) Every year the borrower pays, to the Government, a 2% premium on the value of the outstanding loan.
9) Interest rates and loan repayment periods are negotiated between the lender and the borrower and are not influenced by Government.
10) A number of sectors specific restrictions will apply. These are:
· Agriculture and horticulture
Loans for the production, processing and marketing of agricultural products are not permissible.
· Authors, music composers and certain other own-account artists
Artists, authors, composers, playwrights, musicians, actors, theatrical companies, etc are not eligible. Commercial and graphic artists are eligible.
· Banking, finance and associated services
Any activity that involves granting of finance or a financial service to clients is not eligible, such as banks, deposit takers and building societies; companies involved in granting loans, mortgages, hire purchase or credit services; mortgage brokers; venture capitalists; companies and stockbrokers. Accountants, auditors, management service companies such as bookkeeping firms, tax advisers, management consultants, business advisers and companies that lend support to small firms on financial matters without actually supplying funds are also not eligible.
· Betting and gambling
Betting shops, totalisers, casinos, lotteries, bingo halls and amusement halls are not eligible.
· Commission Agents
Those primarily engaged in acting as intermediaries between sellers and buyers or in conducting business on another company’s behalf are not eligible. The type of activity excluded is one where the agent merely puts a seller in contact with a buyer without buying and reselling the product themselves and without adding value to the product or service. Fees are usually taken as a portion of the business passing through (e.g. self-employed sales agents).
Budget
There will be claims on the guarantees as borrowers default on loans. In England 30% of all borrowers default, which equates in monetary terms to 8% of the total loans guaranteed. There is some income generation from the payment of the 2% premium, which reduces the net cost. The recommendation from the DTI is to be prudent and set aside 10% of the total amount of loans guaranteed. Based on the predictions, the annual cost should not exceed £200,000, funded from the £1 million Economic Growth Plan budget.
The Issue
Following the States approval of the Economic Growth Plan, and a Ministerial Decision[SP1] by Senator Philip Ozouf[SP2] the Directors of Enterprise and Business Development commenced negotiations with the main high street banks to become delivery partners for the Scheme. The banks have been very agreeable and supportive of the Scheme and an agreement contract, in the form of a guarantee, has been agreed and awaiting signature.[SP3]
Summary
The introduction the SFLG scheme is a key component in removing the barriers to entrepreneurial activity. It will improve access to finance for new and young businesses. Its availability has been long awaited and its introduction should be a priority for the Department. The States of Jersey agreed its introduction in principle in April 2005, the Minister for Economic Development agreed the policies of the Scheme in October 2006 but before the contacts can be signed the approval is required by the Minister for Treasury and Resources.
Recommendation
The Minister for Treasury and Resources is asked to approve the availability of a Pilot Small Firms Loan Guarantee scheme.
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