Matt Henderson, business recovery and insolvency partner at Johnston Carmichael
The latest insolvency statistics from the Office of The Accountant in Bankruptcy reveal that more than 1,446 Scottish companies are failing every year – about 28 every week.
These statistics do not include administrations or CVA’s – so the actual position is even worse. In the midst of the worst recession in decades you might expect insolvencies to be at an all-time peak however, while the numbers certainly are significant, they are not as high as you might think given the depth and length of the downturn.
A striking feature of the current recession is how long it is taking to come out of it.
The continuous bad news that has been hitting our economy over the last three years has been relentless. Taking all this into consideration, why then are the numbers for company failures not a lot higher than they actually are?
I believe the answer lies mainly with lenders who are supporting problem accounts rather than seeking an exit through an insolvency appointment.
Interest rates are fairly low, so the cost of continued support from a bank to a struggling business is also relatively low and it’s also fair to say that the insolvency option for a bank would often be just too horrific.
In many cases, because there are so few well-funded investors, there actually isn’t a market for the underlying assets of a distressed business.
It is therefore much better to avoid crystallising a huge loss, where possible.
Often the lending is simply being carried by the bank in the hope that a better market for the distressed assets will, one day, become a reality.
The carrying of over-geared companies with underlying assets of unpalatable market value has created the zombie company, ones which stagger on with no prospect of anything happening to them until market confidence returns and they are killed off by their funder.
Indefinite carrying of problem accounts by the banks cannot happen in all cases.
While low interest rates reduce the so-called carry cost, their ongoing monitoring and management can be expensive meaning some kind of an exit must eventually be found.
In the past many problem accounts were simply re-banked but this is actually very rare these days as other banks don’t want to take on more problems than they have already.
Many banks are doing all they can to avoid the crystallisation of losses on property-backed lending.
They do not want to flood the market by placing companies into administration and some have been moving assets into special purpose vehicles or amend and extend facilities - sometimes cynically referred to as amend and pretend facilities.
While banks are being criticised for not lending to businesses, the reality is the situation is unlikely to change until their balance sheets are improved especially amongst those with greater exposure to the property market.
An insolvency appointment is the last-ditch option for a lender who will generally try all other options before considering the appointment of an administrator.
Sometimes this becomes necessary for defensive reasons such as ensuring that control is not lost to another creditor who is poised to place their customer into liquidation or administration.
Banks will always try to retain good business where they can by supporting struggling companies through tough times, but they will only do so if there is a credible turnaround plan and an underlying business worth retaining.
A business in financial trouble can steer a course through difficult times, but most often it will only be able to do so if it continues to get financial support from its lender.
Ongoing support will often only be provided if a new investor can be found or if restructuring plans are agreed and implemented to reduce or stabilise costs or to dispose of non-core assets.
While the recent insolvency picture does not appear to be as gloomy as we might have anticipated, the most worrying time for many businesses is likely be when the economy starts to show plausible signs of improvement and there will be a greater need for companies to fund growth.
This hunger for additional capital will mean that struggling companies will need to obtain further credit just at the time when their lenders will start to have other options that they don’t have at the moment.
Lenders will need to choose between funding the growth of a company with an unwieldy historic debt burden or going down the path of administration, hoping improved market conditions will deliver better prices for their distressed assets.
Matt Henderson is a business recovery and insolvency partner at Johnston Carmichael