Having double dipped and bumped along the bottom, the UK economy's rollercoaster ride looks set to continue for some time to come. Yet despite these grim conditions, it has been surprising to see a year on year decline in the number of companies entering formal insolvency. Our restructuring group reports on the factors at play and their experience of the current market.
Past recessions have been characterised by a steep fall in economic conditions, a large rise in insolvencies and continued fall out during the economic recovery. However this time round, there has been a departure from the usual cycle. Whilst some sectors have fared worse than others, construction being a notable example, those such as leisure and retail have not yet seen as significant a decline as may have been expected (although Comet's recent demise may herald a change in fortune for some).
An obvious factor has been the low interest rate environment, which has helped to keep loans affordable, even in a reduced trading environment (as long as they were not hedged at an unattractive time). But this is not the end of the story. Struggling companies have also benefited from another striking feature of the recession so far - the more lenient approach adopted by major creditors.
Banks' response to the recession
This recession, unlike any other, has its roots in the near collapse of the financial markets in 2007/8. Following the financial crisis, stricter capital adequacy rules have been imposed on banks, leading them to focus on strengthening their capital base and managing their lending risk. This has indirectly benefited a number of borrowers in the early stages of financial difficulty, who might otherwise have felt the full force of a bank's recovery division. With an eye on their balance sheets, banks have tended to take a "wait and see" approach on debt recovery (in the hope that an economic turnaround will boost borrowers' finances) rather than creating loan provisions for large numbers of customers at an early stage.
The current conditions have also led some lenders to close their books, making loans coming up for maturity more difficult to refinance than they would have been in traditional markets. Again this has resulted in banks applying the "sticking plaster" approach to certain of their non-performing loans with a view to dealing with them when time and/or market conditions allow. Some banks have taken the view that selling entire loan portfolios (rather than seeking to work them out or pursue formal insolvency processes) is a more cost effective strategy and allows quicker reparations to their balance sheets than might otherwise be the case. Those picking up the loans are, in our experience, less averse to commencing formal insolvency processes and we may see a spike in the figures over the coming year.
Other factors working in borrowers' favour include a general shortfall in bank staff with specialist restructuring experience, following a decline in numbers during the good times. Most banks have been forced to deal with their largest corporate exposures first, with less manpower available for some of the less critical bad loans. The state-controlled banks may have also had to respond to calls from their political owners to avoid insolvency proceedings where possible, particularly where this could lead to job losses.
Landlords' response to the recession
In our experience, landlords have been more willing to negotiate with their tenants, some accepting the payment of rent on a monthly basis and others linking rent to turnover. Landlords have been wary, particularly in the retail sector, of forcing tenants into insolvency, given the knock-on effect, particularly in shopping centres, of closed units resulting in a decrease in footfall to other tenants' premises. If a unit cannot be re-let, landlords are also concerned to avoid becoming liable for empty property rates and therefore keeping the premises tenanted (even if by an insolvent company) may well be preferable to suffering any of those charges themselves.
In some cases, landlords' view of formal insolvency procedures has been coloured by their experience of Company Voluntary Arrangements, which have been a feature of the retail insolvency landscape over the last few years. These procedures allow companies to agree compromise arrangements for all their creditors, with 75% creditor approval. As part of these arrangements, landlords have often seen themselves burnt by companies picking and choosing which leases they are prepared to honour and which they are not. Negotiation with tenants has therefore often been seen as the lesser of two evils.
In the retail sphere, whilst there have been notable insolvencies amongst tenants, not least, Comet and JJB Sports recently and Clinton Cards and the Game Group earlier this year, the continued availability of consumer credit appears so far to have shielded tenants from a catastrophic drop in spending. However, not all areas of the country have fared as well as others - the South East appears to be more buoyant than most, whereas other parts of Britain have suffered a greater decline in business confidence.
We have also seen an increase in companies' ability to stretch their debt payment schedules with general creditors. As a result of the increased cost of taking insolvency proceedings (with court fees and the Official Receiver's deposit approaching £1,500, without even taking into account legal fees), it may be that creditors have been less minded to throw good money after bad in pursuing a debtor's insolvency. HMRC, whilst traditionally inclined to start insolvency proceedings early, has also been extending the availability of its "Time to Pay" arrangements for companies experiencing cashflow difficulties.
Whilst so far we have avoided the number of corporate failures seen in previous recessions, it is often the return of the economy that heralds an increase in insolvency. Although this cannot be seen as a good thing for those companies for whom the grim reaper calls, it may at least be a sign to others in the corporate world that better times are returning.