United Kingdom
How liquidity risk will impact on the going concern assessment - Michael Goldstein
While the UK economy may be making a slow recovery from recession, many businesses are going to be feeling some pain for quite some time to come. In particular, the benign corporate credit environment of just a couple of years ago has been replaced by a much tougher funding landscape. That means some businesses may struggle to refinance existing loans that will hit maturity soon. The scale of this potential problem for UK business can be seen in the level of debt maturing in the next three years which exceeds all deals done in both 2008 and 2009*.
The economic consensus is that interest rates will rise in the medium term. For new lending, interest margins on corporate debt increased sharply in 2008 and in the first half of 2009, but softened in the second half. We believe this trend will continue in 2010. However, existing borrowers seeking to renew or increase facilities and whose circumstances have deteriorated since their last renewal, can expect their cost of debt to rise commensurate with the increased level of risk they represent to their lender. Those businesses in sectors that are being hit by the continuing impact of the recession and a slow recovery – for example property and retail – are likely to be particularly vulnerable.
In the past it was usually possible to obtain a letter of support from a lender that a facility would be renewed, along with an indication of likely terms, giving directors the confidence to state that their business will be appropriately funded. Today lenders may be reluctant to provide this - for obvious reasons such as a serious downturn in the business’ performance or value of the assets secured, but also for companies in a sector that is unattractive to the lender or for other reasons outside of the directors’ control.
This inability to refinance will restrict liquidity and change the business’ prospects, potentially making it more difficult for directors to meet their obligation to state that their business will be able to operate as a going concern and prepare the financial statements accordingly. It’s a dilemma that more businesses are going to have to confront.
Early consideration of their options and an open dialogue with advisers and lenders are key steps to helping directors achieve a successful resolution. Questions they need to ask themselves before any conversation with bankers might include:
- Will the facilities they have today meet their needs in the future?
- Are there likely to be circumstances that may cause a breach of existing covenants?
- What leverage are current facilities at and what are the possibilities for reducing leverage?
- How are other businesses in the same sector addressing their situation?
The banks themselves are of course also facing a difficult set of circumstances in having to repair their balance sheets and take more considered lending decisions. It is going to be a long time (if ever) before the levels of lending return to those seen pre-credit crisis. So in the absence of any significant certainty moving forward, businesses will need to engage with their bankers in order to try and identify how their change in circumstances is affecting their willingness and ability to lend. It may be possible from early conversations to reach a view about the bank’s attitude, and take appropriate action.
Ultimately directors who open communication channels between themselves, their lenders and their advisors as early as possible are more likely to achieve a better outcome for the business - helping ensure that any necessary actions can be taken before a crisis point is reached. The worst possible response would be to leave issues unresolved and question marks hanging over the business. While steps can be taken to address even the most difficult circumstances, as time passes the options available will become increasingly narrow.
* Source: Dealogic
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