Insolvency: Forewarned is forearmed
14 January 2008
In the wake of the credit crunch, there is a feeling in the business community that we are all now 'waiting for the other shoe to drop'. The bad news is that this does look set to happen - and many businesses may get a nasty shock when it does.
First, in the late summer, we saw the onset of the credit crunch, with turmoil in the markets. Then there was the immediate fallout, with banner headlines about the crisis at Northern Rock, the high-profile departures at Merrill Lynch and Citi, and Barclays being forced into an unscheduled trading statement. And finally, an eerie silence.
Business as usual?
But what the credit crunch has not done is go away. When Ernst & Young head of UK corporate restructuring Alan Bloom likened it to "an underwater volcano that's gone off in the US", he put his finger on why this particular financial crisis is so unnerving. The consensus is that there are choppy times ahead for business. The problem is knowing how stormy they will be.
On the surface, business seems to be ticking along pretty much as normal. Figures released in early November 2007 by Grant Thornton showed that corporate liquidations in England and Wales in the third quarter (Q3) of 2007 edged up by 1.8 per cent from the previous quarter, but were still down by 4.4 per cent on the same period in 2006. Administrations typically involving larger businesses were down by 10.4 per cent on the previous quarter and by 25 per cent on the same quarter last year.
So where is the problem? In fact, the real problem is that the Q3 2007 figures are too early to draw any conclusions about the impact of the credit crunch. And the most worrying fact is that any companies running into financial difficulties from now on are likely to find their lenders taking a much harder line than a few months ago, reflecting their greater reluctance to risk taking a financial hit.
This was why Malcolm Shierson, a partner in Grant Thornton's recovery and reorganisation department, made the following comment when announcing the apparently positive figures on corporate insolvency: "It would be fair to estimate that the rate of corporate insolvencies will increase by 5 per cent to 10 per cent in the final quarter of 2007, with incremental increases over the next four or five quarters."
This hardly represents 'business as usual' under the benign conditions we have all gotten used to in the past few years. And what has really changed is lenders' mentality. In the recent past lenders' automatic response to financial difficulties would be to try to turn around the borrower's financial position and to regard insolvency as a last resort.
Today, lenders would still like to see the problematic debt restructured if possible. But they are not prepared to offer troubled borrowers the same wide leeway they used to: gone are the heady days of covenant-lite and the like.
This effectively restricts the options open to businesses in financial difficulties and could see corporate insolvency rates grow markedly over the coming year.
Add to this the stalling of the UK housing market and weakening consumer confidence, coupled with rising inflationary pressures as the dollar continues to slide against the pound, and we are looking at a very worrying confluence of events.
The impact on the ground
In other words, the credit crunch volcano is building up for an eruption in the UK as well. And it would be a mistake to think that the impact will be limited to a few major banking institutions and hedge funds. Far from it.
In fact, next year looks set to be tough for all businesses that rely on discretionary consumer spending, ranging from multinationals to small and local operations.
Several factors will have an impact, including the general credit squeeze, tighter money supply, higher mortgage payments as people come off fixed rates and higher credit card charges. As these effects ripple through, the leisure and retail sectors are especially in the firing-line, with businesses such as pubs, hotels and restaurants all likely to struggle.
The recently published Debt Confidence Survey 2007 (DCF) by Deloitte supports this view, with 98 per cent of the respondents saying they believe that the good times have come to an end; this rises to 94 per cent among private equity respondents.
All this gloom may seem a little unseasonal. But Christmas still happened, only on borrowed time as well as money. But now is the time to batten down the hatches.
Patricia Godfrey is president of R3, the Association of Business Recovery Professionals, and head of restructuring and insolvency at Nabarro