Credit Blues

The news has been dominated over the last several months with tales of woe and disaster stemming from the collapse of the US sub-prime market, most recently culminating in the run on Northern Rock, the fifth largest mortgage provider in the UK.

Both the US Federal Reserve and the European Central Bank (ECB) are trying to resist the growing threat of a severe year-end cash shortage in the credit markets. The Federal Reserve is to offer £3.9bn to US banks for a short-term loan facility, repayable in January.

Similarly, the ECB has offered €60bn to European banks and HSBC has announced that it will be injecting $35bn into two of its Structured Investment Vehicles, where, rather than rolling over their paper investments, investors have demanded their money back.

Finally, Citicorp has borrowed £3.6bn from the Abu Dhabi Investment Authority at the eye-watering interest rate of 11% pa. However, is all this high-level angst really going to affect businesses, or is it just a bank problem?

CHANGING RELATIONSHIPS

Each quarter, the Insolvency Service produces the quarterly statistics on insolvencies in England and Wales. In the third quarter of 2007 there was a very modest increase of 1.8% in liquidations on the previous quarter and administrations were slightly down.

None of that points to a recession around the corner, although those figures do not include the statistics from September onwards when the banks really started to feel the pinch.

Across Europe, liquidity is all important and lending criteria has undoubtedly been tightened. For companies which have looked to re-finance themselves out of sticky financial situations, the prospects of doing so in 2008 are far bleaker than they were at the beginning of 2007.

Indeed, even companies operating within their facilities are finding that their relationship bank is reluctant to lend more money for acquisitions. Larger corporates are far more likely to have complex funding structures with a number of lenders all entitled to a different piece of the pie.

Those lenders will have no impunity in selling their stake on to other more opportunistic players in the market if they are not 100% satisfied that their exposure is fully covered.

REVIEWS

The accounting year end also means facility reviews for many corporates. Managing directors and financial directors will inevitably find that they are discussing future funding plans with parties which have a very different vision for the company than their old relationship banker.

This could lead to an increase both in restructurings, where those parties who have bought into a situation seek to maximise their returns, and possible formal insolvencies. This is where companies which have not addressed operational issues have left it too late to affect any kind of turnaround process without the insolvency process intervening.

This could undoubtedly lead to an increase in the controversial ‘pre-pack’ sale, where a business is packaged for sale, the contract terms agreed and the business effectively sold on the same day that an insolvency practitioner has been appointed.

Directors during that time will still be responsible for ensuring that they do not increase the loss to existing creditors of the company.

Insolvency practitioners will have to be satisfied that the price being offered is a fair one in the circumstances and that more would not be achieved if the business was offered on the open market.

Their considerations will also be affected by the probability of the company suffering a trading loss if run for a short time, and if the brand or business could be irretrievably damaged by a formal insolvency.

FUTURE FITNESS

In a client-focused service business, the loss of customers and key staff is easy to predict in an insolvency but difficult to manage. It is perhaps harder to envisage the same imperatives with a manufacturing company. However, a lack of working capital and likely losses during the course of administration may militate against looking for a purchaser after the administrator has been appointed since there will be no realistic time frame for a deal to be put together after that event.

Undoubtedly, companies will face higher hurdles next year to obtain or even retain existing funding and directors will need to ensure that they understand the agendas of the new players in the tight credit market.

Businesses will have to be operationally fit enough to take on the challenges without resorting to a formal insolvency process except as a last resort. While the severity of the impact of the credit crisis cannot yet be predicted with any certainty, what is clear is that for many companies and banks, the operational clean up will have to begin in earnest and should be top of the list of all management New Year resolutions.