(References to surplus and deficit in this note refer to the surplus and deficit of the 'Financial Statements of the Government of New Zealand').
The purpose of the Small Business Cashflow Scheme is to assist small-to-medium-sized businesses impacted by COVID-19. It provides loans to businesses employing 50 or fewer full-time equivalent employees for a maximum loan term of 5 years. The loans are administered by Inland Revenue.
Eligible businesses can borrow a $20,000 base amount plus an additional $1,800 per equivalent full-time employee, up to a maximum loan of $110,000. To be eligible for the loans, borrowers need to declare that they are a viable business, and that they will use the money for core business operating costs.
Loans are interest-free for the first 2 years and then an interest rate of 3% per annum applies. Repayments are not required for the first 2 years, but voluntary payments can still be made. During months 25 to 60, regular principal and interest payments are required to be paid on outstanding balances.
Inland Revenue holds the total nominal debt, administers the initial fair value write-down expense and any subsequent fair value adjustments, and is responsible for collecting the loan.
Small Business Cashflow Scheme loans are designated at fair value through surplus or deficit under PBE IFRS 9 Financial Instruments.
The difference between the amount of the loan and the fair value on initial recognition is recognised as an expense.
The initial fair value is lower than the amount of the initial loan for a number of reasons, including that:
- repayments are not required for the first 2 years
- the time value of money will erode the value of future repayments because there is no interest charged in the first 2 years
- the interest rate of 3% charged is lower than the market interest rates for loans to small-to-medium-sized businesses
- borrowers may default on their obligations.
At the end of the year, actuarial and predictive models are used to compare the carrying value to the fair value of the loan portfolio, and the difference will be recognised in the surplus and deficit of the 'Financial Statements of the Government of New Zealand'.
We use the following key terms to help us define loan values.
- Fair value
- The market value of loans if they could be exchanged between knowledgeable, willing parties in an arm's-length transaction.
- Nominal value
- The total amount owed by borrowers at a point in time, including loan principal and interest.
| Actual 2021 ($000) | Fair and nominal values | Actual 2022 ($000) |
|---|---|---|
| $737,988 | Opening fair value | $920,826 |
| $297,749 | Lending | $537,545 |
| $(142,920) | Fair value write-down on lending | $(230,069) |
| $(112,360) | Repayments | $(362,278) |
| $119,369 | Interest unwind | $122,575 |
| $21,000 | Fair value remeasurement | $(168,000) |
| $920,826 | Closing fair value | $820,599 |
| Current and non-current apportionment | ||
| $253,000 | Small Business Cashflow Scheme loans - current | $183,000 |
| $667,826 | Small Business Cashflow Scheme loans - non-current | $637,599 |
| $920,826 | Fair value Small Business Cashflow Scheme loans | $820,599 |
| $1,423,441 | Opening nominal value | $1,609,132 |
| $297,749 | Lending | $537,545 |
| $(112,360) | Repayments | $(362,278) |
| $451 | Interest | $5,178 |
| $(149) | Write-offs | $(4,317) |
| $1,609,132 | Closing nominal value | $1,785,260 |
For those instruments recognised at fair value in the 'Schedule of non-departmental assets', fair values are determined according to the following hierarchy:
- quoted market price (level 1)—financial instruments with quoted prices for identical instruments in active markets
- valuation technique using observable inputs (level 2)—financial instruments with quoted prices for similar instruments in active markets or quoted prices for identical or similar instruments in inactive markets and financial instruments valued using models where all significant inputs are observable
- valuation techniques with significant non-observable inputs (level 3)—financial instruments valued using models where 1 or more significant inputs is not observable.
Inland Revenue's financial assets as at 30 June 2022 were valued using significant non-observable inputs (level 3). There are no quoted market prices (level 1) and no observable inputs (level 2). The following table analyses the basis of the valuation of classes of financial instruments measured at fair value in the 'Schedule of non-departmental assets'.
Schedule of non-departmental assets (2022)
| Actual 2021 ($000) | Valuation technique Level 3-significant non-observable inputs | Actual 2022 ($000) |
|---|---|---|
| Financial assets | ||
| $920,826 | Small Business Cashflow Scheme | $820,599 |
The next section provides details on the model, and the table below outlines the significant assumptions and sensitivities for the level 3 valuation technique.
At the end of the year, the Small Business Cashflow Scheme is valued by an independent external valuer using actuarial and predictive models. We provided data to the valuer on borrowing and repayments, and data on borrowers such as industry and region. The data is up to 30 June 2022.
The key assumptions in determining the $821 million fair value of Small Business Cashflow Scheme loans as at 30 June 2022 are the timing of principal and interest repayments and the default rate. The most critical assumption is the default rates which have been explicitly modelled for each industry sector and cross-checked by modelling using market discount rates. An additional cross-check was provided by applying banking capital requirements and a risk-weighted assets assumption to estimate the regulatory capital required for a bank owning these loans. This has enabled a calculation of the hypothetical fair value of the loans to a New Zealand bank.
As noted by the valuer, there are significant uncertainties in estimating the fair value of the scheme. The key uncertainties include:
- the scheme is new and there is limited data to determine the likely repayment default experience
- there are limited reference points to determine discount rates for discounting the cashflows
- there are uncertainties from the impacts of COVID-19 on the wider economy or on the specifics of the businesses receiving loans from the scheme
- the uncertain and volatile nature of the future debt repayments.
The fair value movement at 30 June 2022 is a decrease of $168 million (2021: $21 million increase). This decrease incorporates the following changes to the fair value:
- The discount rates and risk-free rates have increased since 30 June 2021, which has decreased the value of the scheme by $79 million (2021: $13 million increase).
- Expected repayment adjustments have decreased the value of the scheme by $89 million (2021: $8 million increase). $50 million of this decrease relates to the change in the interest rule; all loans are now interest-free for the first 2 years regardless of whether they are repaid within 2 years.
A breakdown of the fair value remeasurement - Small Business Cashflow Scheme loans reported in the 'Schedule of non-departmental gains and losses' is set out in the table below.
Schedule of non-departmental gains and losses (2022)
| Actual 2021 ($000) | Remeasurement | Actual 2022 ($000) |
|---|---|---|
| $13,000 | Discount rate adjustment | $(79,000) |
| $8,000 | Expected repayment adjustment | $(89,000) |
| $21,000 | Total fair value remeasurement - Small Business Cashflow Scheme loans | $(168,000) |
The significant assumptions and sensitivities behind the fair value are as follows.
| 2021 | Assumptions and sensitivities | 2022 |
|---|---|---|
| Assumptions | ||
| 3.00% | Loan interest rate | 3.00% |
| 29.40% to 29.50% | Default rates applied to lending years | 30.70% to 33.70% |
| 13.00% | Discount rate | 16.00% |
| Sensitivities | ||
| $(60,000) | Impact on fair value of a 20% increase in the initial fair value write-down ($000) | $(108,000) |
| $60,000 | Impact on fair value of a 20% decrease in the initial fair value write-down ($000) | $108,000 |
| $(30,000) | Impact on fair value of a 10% increase in the initial fair value write-down ($000) | $(54,000) |
| $30,000 | Impact on fair value of a 10% decrease in the initial fair value write-down ($000) | $54,000 |
The modelling and sensitivity analysis undertaken by the valuer notes a wide range of possible fair values, estimated to be +/- 20% of the fair value. This can be expressed as a fair value between $500 million and $1.100 billion.
The loan portfolio is exposed to a variety of financial instrument risks, including credit risk and interest rate risk.
Credit risk is the risk that borrowers will default on their obligation to repay their loans, causing the scheme to incur a loss. The risk of default has been assumed to be equivalent to a C-grade investment.
The scheme does not require borrowers to provide any collateral or security to support advances made. As the total sum advanced is widely dispersed over a large number of borrowers, the scheme does not have any material individual concentrations of credit risk.
Inland Revenue will use a variety of activities that inform and assist customers to repay their loans and enforce compliance to reduce the risk of non-payment of obligations.
Interest rate risk is the risk that the value of financial instruments will fluctuate due to changes in interest rates.
Changes in interest rates impact discount rates. The risk is that, if interest rates rise, the value of the scheme will significantly decrease as the discount rates applied to the expected future repayments will be higher, decreasing their value.
Changes in interest rates could also impact on the Government's return on loans advanced. The interest rate attached to the loans is set by the Government.