In this article, Clement Fuzeau, Katch Investment Group CMO, and Pascal Rohner, Katch Investment Group CIO and Switzerland expert discuss the new measures implemented by the Swiss government to help SMEs in countering Covid-19 negative impacts on their businesses.
In Switzerland, small and medium enterprises (SMEs) count for over 99% of commercial companies and provide about two-thirds of the jobs, with fluctuations from canton to canton. SMEs are a pillar of the Swiss economy, and entrepreneurs are encouraged to set up their businesses and “be their own boss”. In such an active market, these companies often need capital in a rapid and unbureaucratic manner, usually provided in the shape of a bridge loan. Bridge lending are loans demanded from companies that need a short-term capital input before a long-term financing or a settlement of an existing obligation.
Researches have shown that the bridge lending activity had been a relatively stable asset class in the Swiss alternative investment scene until, as it usually is, the Great Recession. This period of turmoil for the financial sector has led to some regulation’s tightening with regards to providing loans to companies. Indeed, the reinforcement of the pre-existing Basel II into Basel III requires banks to increase their capital and liquidity reserves, especially when it comes to debt investments. This cash is therefore dormant and cannot be reinjected into the economy in the form of business loans. This has a disproportionate effect on the small and mid-sized companies as the banks’ returns on such investments are smaller than the likes of a big corporation. The reason behind such a mechanism is straightforward: to obtain the same returns, banks can either provide one bulky loan to a large company or many smaller loans to SMEs. Therefore, SMEs have had to increasingly turn to alternative lenders for their short-term capital requirements, opting for bridge lending solutions. Such lenders are usually looking for higher returns and, therefore can be more inclined to engage with special situations. In this very specific situation, the Covid pandemic hit the world, and Switzerland ordered lockdowns in late Q1 2020. Many SMEs were therefore left without cash flows.
CF: What was the Swiss Government’s response to mitigate such an event?
PR: To help these businesses, the Confederation issued a CHF 40 billion bridge lending program on the 25th of March 2020. As proof of the imperative necessity of these loans, 75,000 of them were made in the first week of the program. Two loans are available: the Covid Light; with a principal of up to CHF 500,000, and the Covid Plus; with a principal of up to CHF 20 million. Both these loans are capped to 10% of one company’s annual turnover. The only difference between the Light and Plus loan program is the principal’s amount -explained above-, the debt structure and the interest rate. For the Light, the whole debt is provided by the Confederation at a 0% interest rate. For the Plus, the Confederation provides a surety designed to secure 85% of the debt. This tranche has a current interest rate of 0.5%, still extremely advantageous for the borrowers. The rest of the debt is secured by a bank, charging a -usually low- discretionary interest. However, this very generous deal has some relatively important drawbacks for the borrowers, with the most restricting one impeding businesses’ ability to reimburse capital contributions or distribute dividends. This will naturally favor SMEs as these firms usually operate with a structure that doesn’t have any shareholders, hence not restricting their business plan. Furthermore, to prevent large corporations from capitalizing on these programs, the borrowers’ annual revenue cannot exceed CHF 500 million. All these measures from the Swiss Confederation have proved to be successful. Indeed, it has helped to retain an impressive number of individuals in the workplace. In 2020, the unemployment rate was only at 4.8%, a miracle given the circumstances. Furthermore, according to the Phillips curve, such low unemployment’s figures should have triggered an increase in inflation. However, the CPI figure for 2020 was at -0.7% and even the CII was at -0.3%, thus exerting a deflationary pressure on the economy. As the SNB is perfectly aware, inflation and interest rates are positively correlated. They therefore made the sensitive decision to continue their negative interest rates policy. Such macroeconomic factors create a fertile soil for companies to flourish and prosper. SMEs are especially vulnerable to economic downturns as they tend to have lower cash reserves. As observed above, the Covid bridge lending program was successful in giving these companies the short-term liquidity solution they required with specific debt instruments. However, this policy’s effect is multiplied as the overall interest rates are negative, whereby companies also see their long-term investment solutions secured.
CF: Which industry is most likely to benefit from such policies in the long term?
PR: The way we like to measure beneficial positions is with the weight of returns incurred to investors. In the future, many industries have been expected to provide interesting returns. One of these is the healthcare industry, with a focus on chemical products manufacture. They are in the middle of the battle against the pandemic and their victory is inherently tied to the rest of the population’s. Such a position forces them, for the better, to conciliate a short-term efficient strategy and a long-term ambitious vision. Indeed, if these companies want to stay competitive, they need to find pandemic short-term solutions while keeping a broad understanding of the health challenges that are observed by any means. Healthcare has also continuously been monitored to be a recession resistant sector, especially during the Great Recession. Therefore, if such firms are more impervious to cyclical crisis than other businesses, this will result to lower default rates for lenders, thereby more returns for private investors. The drawback of such an industry are its high barriers to entry, possibly rendering market shakers harder to emerge. Another industry which has proven to provide great returns and low default rates is the tech industry. First, Switzerland is a very competitive country when it comes to this sector, being ranked the most innovative country in the world by the Global Innovation Index. This can be explained by a strong tertiary education system, high remunerations, and government sector adaptation. Second, many tech firms require bridge lending solutions as the industry is always changing, while operating in a constant growing environment. To remain competitive, they are required to constantly innovate, meaning that they sometimes take un-forecasted directions which require short term liquidity solutions.
In our view, the Swiss government has been very keen to support the backbone of the nation, and it has done so by generously securing loans that will help virtually all the SMEs. Such a manoeuvre is quite habile as it sends a strong message to both the borrowers and lending funds that the entire industry has a phenomenal growth potential. Specific sectors have benefited from both the global economic trends and the Confederation’s policies, demonstrating an important shift in the manner SMEs approach their cash needs and the sources from which they get funding.