Small, medium, and large enterprises all ran for cover and enjoyed state-backed loans (in line with the European Commission position regarding the State Aid Temporary Framework).
The last two years have been marked by a race to guarantees. In 2020, secured bank loans, deriving from the latest state aid legislation, amounted to around 240 billion euros.
To set the scene, it is necessary to take a step back and define secured loans. In Italy, there are two types of governmental support for loans: support provided by the SME fund for small and medium enterprises (“Fondo PMI”) and support provided by another governmental agency, the SACE, for larger enterprises. It is estimated that at the end of February 2022, applications for guarantees for new bank loans for micro, small, and medium enterprises submitted to Fondo PMI amounted to over 227 billion euros, while the volume of loans guaranteed by SACE reached 32.9 billion euros, for a total of 260 billion euros.
The problem is that while the claim of the lender, secured by the state, is unsecured vis-à-vis the borrower, once the lender is replaced by Fondo PMI or the SACE, that same claim becomes secured vis-à-vis the borrower, ranking above all other claims (except super-senior claims and claims of employees and the equivalent). So, as long as the borrower is current with its payment obligations under the loan, the claim remains unsecured; but if the borrower defaults on payments and the lender, enforcing the guarantee, is repaid by Fondo PMI or SACE, that claim becomes secured.
It is easy to imagine how disruptive this could become in the future. If as few as 20% of outstanding COVID loans cannot be repaid by the debtor (this is the provision booked in public accounting), there will be some 50 billion euros in claims against borrowers in financial distress that will rank senior to the majority of all other claims. This will impact not only the borrower but also (and foremost) the other creditors, whose claims become junior overnight once the state guarantee of the COVID loan is enforced. The sacrifice of all restructurings will be entirely shifted onto unsecured creditors (essentially, the supply chain of the debtor).
As a result of this, debt restructuring of companies may become extremely difficult. Essentially, there are two ways to restructure over-indebted companies: a proceeding similar to a creditors’ voluntary arrangement (“concordato preventivo” or CVA), which is a court composition system to be approved by creditors representing the majority of the claims and sanctioned by the court, binding on all creditors; or a debt restructuring agreement, which is an agreement entered into, and binding upon, one or more creditors (or classes of creditors, typically banks) that may or may not be sanctioned by the court.
Whichever way the debtor decides to go, debt restructuring requires an agreement with the creditors, including secured creditors, such as Fondo PMI and SACE. The problem is that secured creditors do not have any real incentive to enter into an agreement that will certainly provide a write-off of their claims. They know they will be paid out first and for the full face value of their claims. Furthermore, as a form of protection for the guarantor, secured creditors are required to enforce their claims against the debtor to activate their right to be indemnified. Once they are paid, there will be little or nothing left for unsecured creditors, who may run into trouble because of this. This may then prompt a domino effect whose repercussions are likely to create unimaginable damage to the economic and social fabric.
So, what can be done to neutralize the adverse effect of the secured nature of the ultimate creditors of COVID loans?
To be sure, in a CVA secured creditors may be paid less than full face value. This happens when the proceeds that can be expected from the liquidation of the assets forming the collateral of the claim are likely to be less than its face value. In that case, secured creditors (who do not have the right to vote if they are paid in full) are entitled to vote for the part of their claim subject to write-off. However, in the event of secured COVID loans, this route is hardly viable. The secured bank likely has not yet activated the guarantee upon filing the CVA application. The liabilities underlying COVID loans are still recorded as unsecured in the books of the debtor. However, given that those liabilities may become secured at any time, the CVA plan will have to post a provision equivalent to the write off, thus making the option of setting up a CVA with partial payment of secured creditors moot.
The option of debt restructuring agreements is even less viable, because they are binding only upon creditors who are party to the agreements (and secured creditors do not have any interest in agreeing to a write-off of their claims).
The way secured COVID loans work is counterintuitive: on the one hand, the purpose of the state guarantee of COVID loans is to shift onto the State the risk of insolvency of a debtor; on the other hand, however, the ultimate lenders (SACE and Fondo PMI) will never give up their right to enforce the collateral, thus shifting the risk of insolvency onto the class of unsecured creditors.
Essentially, what is needed is the right to cram down secured COVID lenders the way other secured creditors may be crammed down. For example, in a CVA or debt restructuring agreement, tax receivables and social charges may be crammed down under certain circumstances (including that such classes of secured creditors are treated no less than favorably than they would be treated in a bankruptcy liquidation). The rationale is the same as the one of for secured loans, that is, to ensure that rescue plans do not fail because of the State’s higher ranking claims. Technically it is doable. What remains to be seen is whether the government has the political will to do it.