Credit crunch: assessing the damage

bank of england

The summer meltdown in the global credit markets looks sure to have an impact
on UK business. The problem for finance directors returning to their desk after
the summer break is to try and work out how it will impact on their business.

It is tempting to suggest the meltdown in the sub-prime market is only a
problem for companies in the financial sector and that companies in the
non-financial sector (or the real economy) will carry on unscathed. But
financial services sector is now such a big part of the UK economy, and not just
in London and the south east, that a slowdown among financial institutions is
bound to have ramifications elsewhere.

The consequences for some companies and for their proposed deals have been
obvious. Private equity deals based on the leveraged terms that were making the
headlines earlier in the year will no longer get away. And for companies which
interact directly with the credit markets this autumn looks like being a hard
slog. For instance Whitbread, which runs restaurant chains throughout the UK,
announced at the end of August that it had decided to delay a possible £1bn bond
issue. Christopher Roger, the finance director, summed up the temperature for
corporates: ‘The propensity to lend to anyone but a sovereign government is very
low at the moment.’

There have also been anxieties and a subsequent drop in the asset-backed
commercial paper market used by banks and large companies to help them manage
their short-term working capital needs. Though liquidity may return as the
summer ends and providing no more horror stories emerge, the message is clear Ð
borrowing money will be tougher.

While the markets may be shut for raising new money, it should not be a
disaster for well organised companies. The credit cycle has been benign for the
last few years and any finance director worth his or her salt will have been
taking advantage of cheap money and plenty of it to repair the balance sheet and
ensure the company has plenty of funds lined up to meet the company’s strategic
business plans.

Credit limit

But if a company is on the edge of a major corporate finance deal, or an
opportunity comes up, the FD would be well advised to check the attitudes of
their traditional financing source. Banks are still saying they are keen to lend
but they may not be prepared to extend quite the multiples of credit they were
before the summer break and they may be interested in finding a little more

One of the results of the credit crunch is that asset-backed lending is set
to return to the fore. FDs will still be welcome to talk to their banks but they
may well find themselves talking to those in charge of factoring or invoice
discounting when it comes to talking about renewing the overdraft which the
business relies on to fund the working capital shortfall. The consulting company
Oxford Economics has warned that significant losses at financial institutions
could lead to a general contraction in lending. It reckons losses from sub-prime
could be in the region of $100bn (£49bn) $150bn (admittedly that’s a big region)
and that could be the precursor to substantial losses in other markets.

One obvious meeting place between corporates and the financial sector is the
pension fund. The gloom over pension deficits, and the cost on the company purse
to repair holes in the pension fund liability, was lifting earlier in the summer
before the sub-prime turmoil. The strong performance on the stock market had
lifted asset valuations and there was a feeling that the worst of the pension
storm had passed. FDs and trustees of company pension funds may need to check
whether the upturn in confidence is still justified.

Many pension funds had taken the advice of pension consultants and had moved
out of equities boosting up their holding of bonds and other assets, including
alternative asset classes such as hedge funds. The decision-making and informa
tion gathering of pension funds can be pedestrian (why not we’re talking
investment horizons of decades here). But it may be worth while for the FD to
see if the investment sub-committee of the pension trustees is up to speed with
how their assets, especially the more exotic ones, are performing and to check
whether the trustees understand the full extent of the risk that might just be

Acting now may save the pension fund and its sponsoring company some pain and
heartache in the months ahead. However that is assuming pension funds can get an
accurate handle on the picture. It is clear the valuation of the more exotic
instruments is taking a long time. This is partly complexity, partly that
liquidity has dried up so there are no recent sales to allow marking to market,
and partly (maybe) expedience in that the number crunchers might be asked to
recheck their numbers if the answer seems unacceptably low.

I was once asked to value a subsidiary prior to its sales. My valuation was
based on its actual profitability over the last few years, not on the inflated
numbers (literally) that had been give to the board. As my valuation was half of
expectation, I was asked to try again. Could the same be happening with complex

If your company isn’t in the middle of any corporate finance deal and isn’t
out to the bank for large amounts due to be refinanced soon and your pension
fund hasn’t overdone the alternative investments then your balance sheet and
your funding may be sitting pretty. In that case the outstanding worry for your
company may be more general economic conditions.

Feeling the pinch

The financial service sector has already started to shed jobs, for instance
as sub-prime mortgages businesses are wound up. The credit crunch combined with
the recent round of interest rate rises will be tipping struggling corporates
over the edge.

At the same time consumers may be forced to cut back this autumn. FDs would
be well advised to recheck their poor, doubtful and bad debts and to be careful
about over extending credit to new or growing customers. Such caution may
exacerbate the situation both for your business and ultimately for the wider
economy but it is the only sensible course in uncertain times. It would also be
worth updating forecast and budgets to reflect the reality of less rosy looking

As history teaches us the elements that really panic investors is lack of
information and the appearance that the markets have shut down. In the market
crash of 1987 market makers dealt with the panic selling and crashing market by
refusing to answer the phone. No answered call, no sell equals more panic.

Even further back in the Wall Street crash of 1929 investors were spooked by
the way the ticker tape machine overwhelmed by the sheer volume was no longer
able to give timely stock prices. Investors could guess they were facing huge
losses on their stocks and shares, but no real idea how much. While finance
directors can’t reassure the rest of the board about what will happen next, they
can make sure that they keep in touch with the financing elements that matter
most to their business.

Of course this should be kept in perspective. Some people, savers for
example, like interest rates to rise and some people will have made money from
the recent market turmoil just as some have lost out. The total amount of money
in the world is the same. It’s not interest rates or losses that will cause the
damage, it’s uncertainty.

Peter Charles is an interim finance director and
turnaround consultant

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