By Ed Macnamara, Head of Restructuring in PwC’s Restructuring & Forensics Practice
The operating environment in which businesses across Europe now find themselves compared to the same period last year is almost unrecognisable—even taking the financial lows of the COVID-19 pandemic into account. The war in Ukraine and the sudden spiral in energy prices, soaring inflation and sharply rising interest rates have compounded the challenges already facing some firms. These challenges now include the wind-down of COVID-related support packages, supply-chain problems and skills shortages.
Market hawks at the European Central Bank (ECB) have recently announced a 75- basis-point interest-rate rise to the highest level since the 2009 financial crisis. It has also now changed the terms and conditions of its targeted longer-term refinancing operations (TLTROs). As the tool that provides European banks with attractive borrowing conditions designed to encourage lending to consumers and businesses, this is just one of the many indicators of frostier conditions to come for those needing to service debt, refinance and ultimately survive.
Retail and wholesale banking sectors will be called upon to carve out a sustainable way forward for struggling consumers and businesses while maintaining the delicate system needed for the capital markets to continue functioning. Debt, inflation, spiking energy prices and interest rates manifest themselves in a number of ways in the restructuring sector. The banking community will need to closely watch the early warning signs of stress turning into distress.
There is no doubt that lenders will increasingly be called upon to refresh and refinance revolving-credit facilities, restructure debt or provide emergency loans for businesses operating in a range of locations and regulatory jurisdictions. Investors will be called upon to provide new money through debt and equity funding as firms navigate the unsettled economic waters alongside their key customers—businesses and consumers reining in spending.
The acceleration of distress issues can be rapid in more benign environments. In today’s climate, the pace of decline can be even faster.
Outlook for Q4 (fourth quarter) 2022 and into 2023
Although the restructuring market has been fairly quiet over the last 12 to 18 months, we are seeing restructuring activity start to pick up now—but still well below the levels we all anticipate to come. Consequently, to avoid insolvency, the use of restructurings outside of a formal insolvency process is on many corporates’ radars and should be factored into any robust contingency-planning efforts. Cost-reduction programmes and working-capital re-optimisation alongside cash improvement and liquidity management will be front and centre.
In light of the volatility and uncertainty in the current macro environment, the need for visibility, planning and control over short- and medium-term cash will be paramount to prevent real cash crises from crystallising at lightning speed for many businesses. If the situation requires more stringent measures, the use of restructuring plans alongside other mechanisms may increase as directors seek to restructure their heavily indebted balance sheets.
For restructuring mechanisms to succeed in delivering the long-term transformation of the business, it’s vital that all stakeholders, such as landlords, lenders and tax-collection agencies, take a collaborative approach to collective responsibility, recognising their respective contributions wherever possible.
The following challenges are key indicators for companies and their lenders to be open and honest about:
- Unreliable cash-flow reporting and forecasting;
- Scenario-planning robustness;
- Realistic cash focus and cash-conscious culture across all areas of the business to optimise cash;
- Visibility of working-capital performance across the organisation, including the amount of liquidity tied up in excess inventory levels;
- Covenants at risk of breaches and high levels of debt;
- Realistic downside scenarios and associated mitigating action plans;
- Unexpected funding requirements with a limited understanding of tactical cash levers that can be pulled in the short-to-medium term; and/or
- Lack of clarity on what other organisations within the same sector are doing to optimise cash.
What are we hearing directly from businesses?
Businesses are effectively a microcosm of the current economic climate—the scales of supply and demand are being impacted by inflation, rising import and energy costs, foreign-exchange headwinds and interest-rate movements. The cost of borrowing is rising at rates not seen in decades, with many corporates and individuals already carrying high levels of debt driven by the COVID-19 pandemic. At the same time, the loan-refinancing season is continuing apace.
To illustrate the sentiment among businesses and the wider investor community, we recently surveyed 400 leaders across a broad range of sectors, including listed and private companies with revenues from £25 million to more than £1 billion. Soundings were taken from 160 investors in parallel to the businesses in which they invest to understand whether current strategies are aligning or diverging.
Businesses are, understandably, focusing on securing their financial positions today, leaving them less prepared for the issues of tomorrow. Fifty-one percent of investors reported increasing numbers of businesses approaching them for rescue finance. Notably, the survey reveals that strategies around Environmental, Social and Governance (ESG), Diversity and Inclusion (D&I) and Net Zero have become less of a focus for businesses. However, 74 percent of investors reported they assessed ESG when extending credit.
Inflation is the major deterrent for investors looking for interest-rate rises to make deals more favourable. And with some indicators pointing to spiking inflation next year, businesses may find their refinancing plans derailed by small percentage point changes. Such is the uncertainty surrounding the market that more than half (54 percent) of businesses believed predicting future risk was increasingly challenging.
Finding the right supports to navigate these challenges is critical. These economic challenges are set to become more acute, and those failing to act now will fall further behind as the picture worsens in the months and years to come.
Half of the businesses are divesting non-core assets as they seek to improve their liquidity positions, and a further 28 percent plan to do so in the future. Corporates must be careful to keep pace with investor requirements if they are to position themselves favourably.
Overall, this data shows that a mismatch exists between what lenders are looking for and what businesses are focusing on. Strong liquidity and the ability to pass on price increases are seen as the most important qualities for securing financing among businesses, whereas investors are seeking a resilient and adaptable business model and strong revenue. Businesses must be decisive to alleviate the pressures of today’s environment and carve a sure path forward.
If the pandemic proved anything, it was how interconnected the business world is and how the most adaptable, nimble businesses thrive. In this inflationary market, which shows no sign of abating in the near term, it is more important than ever for businesses to heed the lessons from COVID-19 and act now to secure their long-term futures.
The current macro headwinds will impact businesses across most sectors going forward. Trading and cash-flow generation are expected to worsen in the coming months as the cost-of-living crisis deepens, notwithstanding temporary government support in the United Kingdom and Europe with the energy-price-guarantee support package and energy-windfall taxes, respectively. Discretionary spending will be further reduced as fixed-rate interest periods on mortgages end next year.
Companies with extended runways before debt facilities mature will focus on operational-performance improvements and cost reductions, then M&A (mergers and acquisitions) and refinancing options before considering liability management and debt restructuring. When these options are exhausted, companies will need to restructure quickly, and companies and their stakeholders will have to address a combination of liquidity, balance-sheet and operational challenges. By developing a turnaround and restructuring mindset early on, companies can increase opportunities for recovery and build a stable base for future growth.