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Why have there been so few corporate failures?

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Corporate failures tend to peak during the early recovery phase. UK insolvency specialist Begbies Traynor recently predicted that the annual record of 30,000 UK business failures set in the early nineties will be exceeded in 2010. (26,000 UK failed in 2009 before the important early recovery phase began.)

Begbies also estimated that 140,000 UK companies experienced significant or critical financial problems during the final quarter of 2009 (an increase of six per cent over the preceding quarter) – and that many of these will be unable to cope with the increasing interest rates expected during the second half of 2010.

Companies have not become more resilient, nor did they enter the recession with lower leverage (although low interest rates have tended to make debt more supportable than is usually the case in a recession).

The reason there have been fewer large company failures lies in the financial position of the lenders. Exposure to internationally traded financial institutions and instruments deplete a lender’s capacity to absorb the significant additional write-offs and liquidations that would arise if major companies collapsed.

Lenders and regulators realise that when a large company collapses, the financial consequences are multiplied by the cascade effect as smaller, dependent companies cannot endure the financial impact of bad debts and lower sales.

The cascade cannot easily be arrested until it has run its course. When several large failures arise in close succession, unemployment increases, asset prices decline, sentiment deteriorates and the recession deepens.

So perhaps we can argue that the financial difficulty of lenders has benefited the corporate arena by restraining lender’s normal tendency towards intolerance of corporate distress, leading them to support companies operating at the margin of survival.

What, in other conditions, may have been unsupportable leverage in many large companies has been re-engineered by lenders who have converted “excessive” debt into new equity, giving banks effective control of many companies. Low interest rates have also contributed to the extent to which banks are able to tolerate non-performing credits for an extended period.

But lenders are now rebuilding their capital and will not remain holders of diversified investment portfolios. As a result, they will sell their equity positions, with private equity being the principal buyer and, as the capacity of lenders to take a financial hit is restored, they will start to take less a less supportive attitude towards impaired credits.

They will get tougher with SMEs and the rate of collapse will increase but, significantly, they will also allow large companies to fail, believing that the cascade of failure will be moderated by a more buoyant economy.

This depressing possibility will be compounded by the almost certain significant reduction in public-sector spending, which will act as a drag on economic recovery and will lead to more company failures than would otherwise have been the case.

The paucity of company failures in this recession to date does not make this a less pernicious event than we’ve seen in the past. Nor should we assume that survival to date implies a resilience that will strengthen as the economy improves. What we can say is that the forces that lead to company failure may have been redirected but have not diminished. The peak may simply have been deferred…

Anthony Holmes is an international corporate turnaround specialist and transitional leadership expert. He has led the revival of seven companies over 15 years, and his 30-year international business career spans strategic consultancy, investment banking and senior corporate management in a diverse range of industries. Holmes is also penning two business books: Managing Through Turbulent Times and A Time to Lead, A Time to Manage.

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Recession over, but worries continue
January / February 2010
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