Some say we are on the brink of a major slow down. Clearly the economy is not as strong as it has been, but surely the real questions are:

• just how sharp is the ‘adjustment’ likely to be;
• how long will it last; and
• where will it be felt most?

Let’s look back over some recent figures and at the same time consider what the future may hold:

• Currently GDP is growing at 2.9% pa and is expected to fall to under 2% over the next few months. Research has shown a 1% drop in GDP growth could lead to a 10% increase in corporate insolvencies (see our previous post). The economy has been incredibly resilient throughout the last decade, but the credit crunch has ended that period of stability.
• Whilst inflation is presently running just above the government’s target at just 2.2%, the Bank of England is forecasting a rise to over 3% in the near future giving rise to further pressures on disposable income. 
• House prices are weakening generally across the country, although less so in London. The recent reduction in loan to value ratios and income multiples on offer will restrict mortgage funding and reduce both demand and consumer confidence.
• Total personal debt levels, at £1.4 trillion, are huge and growing at £1 million every 5 minutes, more than three times the rate of inflation. The growth in personal debt may be slowing, but record numbers of personal insolvencies and a significant number of borrowers defaulting support the trend towards less excessive consumer spending.

In summary, the main aspects of the economy are less volatile than, say, the 1980s to early '90s when huge swings could be expected. The economy has certainly become more unstable during the last 6 months, but overall, I expect the ‘adjustment’ to be relatively shallow and short-lived, with the pain being suffered more in particular regions or sectors :

• Retailers who enjoy a strong market position and are well organised and managed are likely to fare better than their weaker competitors. Suppliers of ‘growth support services’ into retailers, such as shopfitters, can expect a further deterioration in both sales volumes and margins, causing viability and solvency issues (see previous post).
• Pubs and restaurants have already seen their takings fall as a result of consumers’ reduced free cash, the smoking ban, and cheap supermarket alcohol. Fixed costs remain high, and leisure outlets with poor procedures and low staff morale are at risk.
• Confidence is low in the construction industry, despite the Olympics Effect and government housing requirements. Many construction related companies will not be able to cope with any further reduction in prices or any deferral of work or payment by the major employers(see previous post).

The slow down in these parts of the economy will no doubt create added opportunities for Insolvency Practitioners to bring their turnaround skills to bear to rescue ailing but viable businesses, as well as to assist in close down scenarios. As always, early attention to potential problems increases the likelihood that a turnaround will be achievable.

• Print
• Comments
• Trackbacks

The credit crunch of August-September 2007 has disturbed the economic equilibrium - and may continue for a while yet. Debates about illiquidity or insolvency abound, but are we really facing a swing from boom to bust?

The underlying UK economy is strong, but we now have corporate transactions stalling through lack of funding, hedge fund failures, a sub-prime lender in administration and the Northern Rock bailout. What many considered a strange US phenomenon (had many people heard of sub-prime before this summer?) has become a real domestic issue. No wonder business and consumer sentiment is waning:

• the ICAEW UK Business Confidence Monitor (BCM) has moderated in Q3 2007 from a Q2 peak of +11.5 to a relatively weak +4.8;
• the BDO Optimism Index shows a sharp fall in August, from 101.9 to 101.2, confirming the impact of the US sub-prime crisis on UK businesses. This drop takes the Index to its lowest score since November 2005 and whilst business optimism has been decreasing slowly since July 2006, it appears that the impact of the turbulent financial markets has accelerated this trend; and
• the Nationwide Consumer Confidence Index fell back in August reflecting the impact of five interest rate rises over the past year. The main Index fell by two points, but it was not alone. All indices fell in August, the first time since December 2006 that all four measures of confidence showed a downturn in the same month.

For a reminder of how the credit crunch derived from the US sub-prime contagion via risk reappraisal amongst lenders and hedge funds, how CDOs, CLOs and SIV-lites were ideal vectors to spread the disease around the world, and the impact on bank lending, read "While you were away - fear and loathing in the markets" from The Times.

Other recent indications of the state and direction of the economy are:

• US business bankruptcies are on the rise, reports Bob Eisenbach, quoting Euler Hermes, who continued to forecast a small rise in the UK. After we reported Euler's November '06 forecast in a previous post, Geoff Swire commented when the UK's June insolvency figures became available that the forecast had been pessimistic. I suspect it was a timing issue and that corporate insolvency statistics in Q3 will rise in the UK, albeit by less than in the US.
• The world has changed dramatically: Germany’s Chamber of Industry has been flooded with distress calls from family Mittlestand firms unable to roll over credit lines and in Canada and Australia, junior mining finance has dried up almost entirely, according to Ambrose Evans-Pritchard on his Telegraph blog post "Brace yourself for the insolvency crunch".
• If the liquidity crisis continues it will will become an insolvency crisis and the banking industry will be hardest hit, according to Panmure Gordon.
• Insolvency firms are likely to be busy dismantling failed investment vehicles, with the most likely suspects being the quantitative hedge funds and funds focused on CDOs that have fallen foul of market conditions, writes Antonia Rawlinson "Uncertain times call for certain measures" in The Lawyer.
• "The M&A boom is over and law firms must adapt" agrees James Rossiter in The Times - restructuring is now the hottest game in town.

So what does all this mean? Yes the capital markets are in turmoil, banks are lending much more cautiously and some high risk investment vehicles are failing, but essentially this is only a liquidity problem. Its effect though is that stressed businesses will no longer be able to borrow their way out of trouble as they have become hard-wired to do over the last 3 years.

Crisis cash management and operational and corporate restructuring will come back into vogue as refinancing becomes passé. Only if stressed businesses fail to seek appropriate and timely assistance will the business insolvency statistics really start to rise.

• Print
• Comments
• Trackbacks