The Small Business Cashflow Scheme was established in May 2020 to assist small-to-medium-sized businesses impacted by COVID-19. The scheme provided loans to businesses employing 50 or fewer full-time equivalent employees for a maximum loan term of 5 years. The loans are administered by IR.
Eligible businesses were able to 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 needed to declare that they were a viable business and that they would use the money for core business operating costs. Applications for new lending for the scheme ended on 31 December 2023.
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. After this period, regular principal and interest payments are required to be paid on outstanding balances.
IR 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 IPSAS 41 Financial Instruments because it is uncertain when borrowers will make repayments.
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.
After loans are issued, an adjustment is made each month to unwind the interest. This adjusts the present value of the write-down over time. IR also receives repayments from borrowers.
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 is recognised in the surplus and deficit of the Financial Statements of the Government of New Zealand. The difference is also shown in the Schedule of Non-departmental Gains and Losses.
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.
Since the scheme began in May 2020, $2.363 billion has been disbursed and $1.289 billion has been repaid. The nominal and fair values of the loan balance as at 30 June 2024 are $1.120 billion and $465 million respectively.
The nominal and fair values of loans are shown below.
| Fair and nominal values | Actual 2023 ($000) | Actual 2024 ($000) |
|---|---|---|
| Opening fair value | $820,599 | $786,453 |
| Lending | $100,105 | $65 |
| Initial fair value write-down on lending | $(53,926) | $25 |
| Repayments | $(431,517) | $(378,181) |
| Interest unwind2 | $110,192 | $94,613 |
| Fair value remeasurement | $241,000 | $(38,393) |
| Closing fair value | $786,453 | $464,582 |
| Current and non-current apportionment | ||
| Small Business Cashflow Scheme loans–current | $352,000 | $325,000 |
| Small Business Cashflow Scheme loans–non-current | $434,453 | $139,582 |
| Fair value Small Business Cashflow Scheme loans | $786,453 | $464,582 |
| Opening nominal value | $1,785,260 | $1,478,351 |
| Lending | $100,105 | $65 |
| Repayments | $(431,517) | $(378,181) |
| Interest | $32,808 | $33,168 |
| Write-offs | $(8,305) | $(13,585) |
| Closing nominal value | $1,478,351 | $1,119,818 |
Financial instruments–fair value hierarchy disclosures
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.
The Small Business Cashflow Scheme is valued at 30 June 2024 using significant non-observable inputs (level 3). There are no quoted market prices (level 1) and no observable inputs (level 2).
The next section provides details on the model, and the table below outlines the significant assumptions and sensitivities for the level 3 valuation technique.
Small Business Cashflow Scheme valuation model, significant assumptions and uncertainties
At the end of the year, the Small Business Cashflow Scheme is valued by an independent external valuer using an actuarial and predictive model. We provide data to the valuer on borrowing and repayments, and data on borrowers such as industry and region. The data is up to 30 June 2024. The key assumptions in determining the $465 million fair value of the Small Business Cashflow Scheme as at 30 June 2024 are the timing of principal and interest repayments and the default rates. The most critical assumption is the default rates which have been explicitly modelled for each industry sector.
The valuer has refined the valuation approach this year and now determines the fair value by forecasting the expected loan repayments and interest payments and applying estimated default rate and repayment rate assumptions. The expected repayments are then discounted and an allowance for expenses is deducted.
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 cash flows
- the businesses that have acquired loans may have also been impacted by the recent high levels of inflation and general macroeconomic uncertainty
- the uncertain and volatile nature of the future debt repayments.
The fair value movement at 30 June 2024 is a decrease of $39 million (2023: $241 million increase). This is mainly due to lower repayments than forecast this year and assumption updates to reflect lower repayment experience in the future.
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 below:
| Remeasurement | Actual 2023 ($000) | Actual 2024 ($000) |
|---|---|---|
| Discount rate adjustment | $3,000 | $(700) |
| Expected repayment adjustment | $238,000 | $(37,693) |
| Total fair value remeasurement - Small Business Cashflow Scheme loans | $241,000 | $(38,393) |
The significant assumptions and sensitivities behind the fair value are:
| 2023 | Assumptions and sensitivities | 2024 |
|---|---|---|
| Assumptions | ||
| 3.00% | Loan interest rate | 3.00% |
| 29.00% to 33.20% | Default rate | 23.00% to 32.00% |
| 19.00% | Discount rate | 12.00% |
| Sensitivities | ||
| N/A1 | Impact of a 5% increase in the default rate ($000) | $(126,800) |
| N/A1 | Impact of a 5% decrease in the default rate ($000) | $121,100 |
1A sensitivity is not available for 2022–23 due to the change in valuation methodology for this year.
The loan portfolio is exposed to a variety of financial instrument risks, including credit risk and interest rate risk.
Credit 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.
IR 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
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. There is a risk 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.