State guarantees can be used to support loans for working capital. The amount of State aid in guarantees can be calculated to remain below the de minimis threshold of EUR 200,000.
With financial instruments being very much in vogue, there is much interest in the use of guarantees and loans as a means of granting State aid. Therefore, it is important to know how to calculate the amount of State aid that may be incorporated in a guarantee or loan. Previous articles presented methods of calculating the amount of aid in low-interest or interest-free loans. This article focuses on guarantees and reviews the methodology approved by the Commission in decision SA.42389 concerning a Danish guarantee scheme.
State guarantees are normally used to support loans. Companies obtain loans not just for investments in buildings and equipment but also for working capital to cover their day-to-day expenses. Normally public funding of working capital is prohibited because it covers operating costs. However, public funding for working capital may be granted in compliance with the rules on risk finance in the GBER or in the risk finance guidelines.
If a public authority does not want to use the GBER or the guidelines for small amounts of aid, it must ensure that the guarantees it grants are either free of State aid [i.e. priced at market rates] or any State aid remains below the de minimis threshold of EUR 200,000. In all cases, however, and regardless of whether a guarantee contains State aid or not or whether the amount is below or above the de minimis threshold, it is necessary to establish the market price of the guarantee. Without determining the market price, it is impossible to know whether the guarantee contains State aid and how much aid.
Therefore, a public authority that wishes to grant guarantees needs to develop a methodology for pricing such guarantees.
How much State aid is there in a guarantee?
A guarantee is normally granted to a company that wants to borrow money from a bank but cannot do so because the interest rate charged by the bank is excessively high. This is often the case for small companies or newly established companies which have no credit rating, no track record and no collateral to pledge. A guarantee enables such a company to borrow at a lower rate of interest or at more favourable terms [e.g. loan of longer duration which normally means more risk for the lender].
The gross grant equivalent of State aid, S, in the form of a guarantee is the difference between the premium that should be charged, P*, and the premium that is actually charged, P^.
The premium that should be charged must be equal or more than the expected loss, E, given the risk, r, of default on the underlying loan. Normally, the premium should be increased by an extra amount to cover administrative costs, A.
The expected loss is the amount that is guaranteed, G, multiplied by the probability of default, r.
Therefore, the amount of State aid is:
S = P* – P^ = [E + A] – P^ = [(G x r) + A] – P^.
This formula applies to one-off guarantees that are granted to companies which are not in difficulty. If a guarantee is provided in the context of a measure that offers guarantees to many different companies, then it becomes almost certain that one or more of the beneficiary companies will fail to repay the loans and the guarantees will be called. It then becomes necessary to back up the assumed liabilities with capital that it needs to be remunerated. The remuneration of capital is an additional cost that has to be added to the premium.
If the beneficiary company represents such a high risk that no market premium exists, then the real amount of aid it receives is not the difference between the hypothetical premium and what it is actually charged but the difference between the high interest rate that the company would have to pay for the loan and the interest that it actually pays as a result of the guarantee minus any premium it has already paid for the guarantee. If the company is in financial difficulty so that no bank would offer it a loan at all, then the amount of aid is the total sum of the loan.
The Danish guarantee measure
The method in the notified Danish scheme was to be used to calculate the amount of aid that was intended to be granted under the Danish Growth Fund.
The scheme applied to SMEs active in the agricultural sector. The scheme excluded undertakings in difficulty and undertakings subject to an outstanding recovery order following a previous Commission decision declaring aid illegal and incompatible with the internal market. These are the standard exclusions for most State aid measures.
Denmark notified the calculation method in order to establish a transparent way of determining the State aid element in guarantees that were to be granted on the basis of Regulation 702/2014 which is the Agricultural Block Exemption Regulation.
The notification concerned a modification to a methodology that the Commission had already approved under scheme N 682/2009. In the new, modified scheme the guarantees would be given for loans from banks for the purpose of enabling the borrowers to finance expansion of their business activities, innovation and other investments. Loans could also be granted for specific investments such as the purchase of machinery, vehicles, buildings, etc, or for general working capital requirements. Guarantees were not to be granted for the purpose of refinancing loans, or loans that would be used to repay existing debts.
The expected administrative cost was increased from DKK 9 million to DKK 12 million due to the increase in the total guarantee volume from DKK 1000 million to DKK 1400 million for 2016-2017. This corresponded to 0.9% of the total value of the guarantee scheme.
The guarantees would be granted on the following conditions:
- the maximum size of the underlying loan would remain at DKK 2 million (app. EUR 270,000).
- the guarantee would continue to cover a maximum of 75% of the outstanding loan, e. maximum DKK 1.5 million (app. EUR 200,000).
- the initial fee would be fixed at 1.5% of the guaranteed amount and the yearly premium on the depreciated guarantee amount would also be at 1.5%.
- the exposure of the responsible public authority would be limited to a maximum loss rate of 20% on the entire portfolio.
According to the notification, in the period 2013-2015 the responsible public authority paid almost DKK 22 million in guarantees under the scheme which corresponded to a default rate of 1.8%. The default rate was expected to increase as the scheme matured but would not exceed 20%. Therefore, the Danish authorities considered the expected default rate of 20% to remain a reasonable and conservative estimate.
The Danish authorities made a commitment to monitor the adequacy of the level of the theoretical market premium on the basis of the effective loss rate and adjust the theoretical market premium accordingly.
The calculation of the market premium for 2016-2017 was based on the following parameters [monetary values in DKK]:
Discount rate = 2.99%
Total loan volume = 1867 million
Total guaranteed volume = 1400 million [= 75% of the loan volume]
Expected default rate = 20%
Initial premium charged = 1.5%
Subsequent yearly premium = 1.5%
Maximum loan amount = 2 million
Maximum guarantee ratio = 75%
Income from premiums = 126 million
Administrative costs = 12 million
Payments on loan defaults = 280 million
Capital costs = 26.9 million
Total costs = 318.9 million
Total required market premium = 22.8%
The capital costs were based on the requirement of the 2008 Commission Notice on guarantees that requires a yield of 4% per annum for a capital amount that is equal to 8% of the granted guarantees.
The premium was determined in such a way so that the whole scheme would break even. The theoretical market price for the guarantees was derived as follows: Total costs [318.9]/Total guaranteed  = 22.8%.
Guarantees were to be depreciated linearly over the lifetime of the underlying loans which meant that the loans would be paid back in equal instalments and the guaranteed amount would decrease accordingly.
The annual gross grant equivalents of the aid were discounted to their present value using the reference rate and then added up to obtain the total gross grant equivalent. The discount rate was determined according to the 2008 Commission Communication for setting the reference and discount rates, which is the base rate plus 100 basis points.
On the basis of the parameters above, the calculations for a typical loan of DKK 2 million with guaranteed amount of DKK 1.5 million, are summarised in the following table:
The Commission explained that “(23) a recalculation of the aid equivalent based on the amended parameters and conditions shows that the average state aid element in the guarantees from now on will be 20.28% for a linearly depreciated loan over 6 years.”
The Commission also examined whether the scheme complied with the other provisions of the 2008 Notice on guarantees.
With respect to point 4.1 of the Notice, the Commission concluded that:
- “(30) the State aid element is still calculated as the difference between the appropriate market price of the guarantee provided and the actual price paid for the guarantee,
- the resulting yearly cash grant equivalents are discounted to their present value using the reference rate and then added up to obtain the total grant equivalent,
- undertakings in difficulty within the meaning of the Union Guidelines on State Aid for rescuing and restructuring non-financial undertakings in difficulty are excluded from the scheme,
- the extent of the guarantee can still be properly measured at the time of granting, and
- the guarantee does not cover more than 80% of each outstanding loan.”
With respect to point 4.5 of the Notice, the Commission was satisfied that “(31) the use of a single premium can continue to be used for the calculation of the State aid elements in the guarantees of the Growth Guarantee Scheme as:
- the scheme is still only open for guarantees for loans to SMEs,
- the guaranteed amount still does not exceed EUR 2.5 million per company,
- the Danish authorities commit to control the adequacy of the level of the theoretical market premium on the basis of the effective loss rate and adjust the theoretical market premium accordingly, and
- the theoretical market premium is still based on normal risks associated with granting the guarantee, the administrative costs of the scheme and a yearly remuneration of an adequate capital.”
On the basis of the above findings, the Commission approved the notified methodology.
While it is clear that the premia charged must be such as to cover losses of 22.8%, neither this measure, nor the previous measure [N 682/2009] explains how the market rate for individual loans was determined. For example, in the table above, the market premium of DKK 130,155 for year 1 corresponds to about 9% of the guaranteed amount of DKK 1,500,000. It is not obvious why the premium corresponds to 9% instead of 22.8%.
However, the guarantee for the indicative loan in the table results in a State aid amount of DKK 303,000 which is equivalent to about EUR 41,000. This is far less than the maximum de minimis threshold of EUR 200,000. This means that the scheme can be used to support loans for working capital, which normally would not be allowed under State aid rules because that is operating aid. The only exception is the use of the risk finance rules in the GBER and the risk finance guidelines.
 The full text of the decision can be accessed at: