‘Complacent’ businesses face a reckoning as state handouts end

After one and a half decades of ultra-low interest rates and billions of pounds in pandemic state aid, reality is now catching up with businesses.

The number of insolvencies is already at the highest level since the financial crisis, but experts say it is only the beginning. Advisors report a worrying degree of “complacency” among bosses that means many more companies are poised to collapse as borrowing costs rise and the Chancellor tightens the purse strings.

The UK economy is likely tipping into recession, nervous banks are tightening their lending criteria and the Government will significantly scale back energy support from April. Last Thursday, the Bank of England lifted interest rates to their highest levels since 2008, at 4pc.

Insolvency specialists who have witnessed several downturns say reality has not yet dawned on many business owners, even as figures show 22,000 companies failed last year.

Colin Haig, partner and head of restructuring at accountancy group Azets, says many managers believe “the state will provide” after generous support during the pandemic.

“I just sense that management teams are possibly slightly more relaxed at this stage in the cycle than they were in other recessions that I've lived through,” he says. “I've been doing this work since 1980 so that's at least four recessions I’ve seen. They probably ought to be a bit more bloody nervous.”

Complacency was bred by the free-spending attitude of the state during lockdowns. The Government underwrote state-backed loans with very few checks, the furlough scheme supported labour costs and there was a ban on landlords enforcing rent arrears. At the same time, HMRC was much more flexible than usual when it came to taxes owed.

“Whenever you have a forced injection of liquidity into the economy, it has unfortunate side effects of promoting a certain sort of apathy, complacency, and we've got no space for that right now,” Haig says.

Olga Galazoula, global head of restructuring at Ashurst, says making it through Covid has “lured people into a sense of security”, she says.

“We’re definitely seeing examples of CFOs saying ‘I’ve got a big problem coming up in a few weeks, where is the money coming from?’,” Galazoula says, suggesting many hope the state will provide a solution.

Even before the pandemic hit, interest rates had been slashed to 300-year lows in the wake of the financial crisis. This enabled “zombie” companies that would otherwise have collapsed to live off cheap borrowing without any real growth, though some economists believe this issue has been overstated.

Steven Cooklin, chief executive at insolvency litigation financing firm Manolete, said higher borrowing costs will be unknown territory for many bosses. Rising rates hit businesses faster than households, as over three quarters of corporate bank loans are on variable rates.  

“Many of these business owners would have only ever operated in a very low interest rate environment,” he says. “They just won't be used to having to service a more meaningful interest bill.”

Complacent attitudes matter because businesses who seek help sooner have a much greater chance of preserving their business and protecting jobs. Those who blithely wait in the hope that something will turn up are likely to suffer.

There’s no sign of respite. The Government will drastically scale back energy support for businesses from April. It will replace the existing scheme, which capped the unit cost of gas and electricity at a fixed price, with an initiative that instead offers a less generous discount.

“It’s not for the Government to habitually pay the bills of businesses,” Exchequer Secretary to the Treasury, James Cartlidge said last month.

Many companies will be left very vulnerable to potential price fluctuations, according to the Federation of Small Businesses (FSB).

“We know from our own data that if energy prices go up again this year, then we're going to see a significant number of businesses having to make difficult decisions about whether they should be closing, downsizing or radically restructuring,” says Paul Wilson, policy director at the FSB.

As well as financial support for the Government during Covid, companies that struggled were protected from being pursued by creditors until March last year.

“There probably were many companies during that period that should have closed because they were never going to be able to pay their debts,” says Jeremy Whiteson, a restructuring and insolvency partner at law firm Fladgate.

Some banks are now starting to pursue Covid loans with more vigour. Manolete is running a pilot for Barclays to recoup lost taxpayer money from bounceback loan defaults. It is trying to recover money that has been “misappropriated”. However, banks are likely to go after legitimate loans too in time.

Debts among small and medium sized companies are 20pc higher than before the pandemic, according to the FSB. Repayments are now coming due as the UK tips into recession.

Debts also make it much more difficult for businesses to borrow to invest.

“Businesses have more debt than they would have done before and it's harder for them to take on additional finance,” says Wilson. “What we're seeing in our figures is success rates of applications for finance are down to around 46pc. That’s compared to a historical average of around 65pc.”

Strained public finances mean that now there is “only a limited amount of flexibility that HMRC can give”, Cooklin says. HMRC is in a way a “lender of last resort” for businesses that might stop paying their taxes temporarily if running into trouble elsewhere, he says.

Unlike the financial crisis, where Lehman Brothers, a large investment bank, was the first to go bust, this will be a bottom-up recession where small and medium sized businesses are at the sharp end of insolvencies. However, high interest rates, inflation and energy prices hit companies across the board, and larger businesses are starting to run into trouble too.

Corporate collapses are overwhelmingly bad for the economy in the short-term but could create fertile ground for a long-term recovery.

“Creative destruction is the idea that resources get moved into more productive uses and in so doing, they destroy the old firms that were using them before,” says Gregory Thwaites, a professor in economics at the University of Nottingham.

Unlike churn, when workers change jobs, “creative destruction is more the idea of people moving from shrinking or closing firms, which are less productive than the growing or opening firms that they're moving to”.

Economists warned during Covid that while vast support schemes helped protect livelihoods, they impeded this process by propping up unviable businesses. Deutsche Bank said that, while rising inequality and market concentration had stymied creative destruction, so had central bank intervention, low interest rates and pandemic support.

“All these factors suggest we could be heading for a world of lower growth, as companies that should fail in a free market are kept afloat only thanks to a variety of interventions,” argued analysts Jim Reid and Peter Sidorov.

While letting unproductive businesses fail can be a good thing in the long run, it is not clear that the current wave of rising insolvencies is a sign of creative destruction, says Thwaites. Higher interest rates make borrowing and investment more unaffordable for good businesses too, so there is a risk that a downturn can trigger needless destruction.

Pandemic support and low interest rates are not unique to the UK, he points out, and the poor growth rate we’re currently experiencing is likely a result of more deep-seated problems.

“We don't know yet whether the firms that are going bust are the good firms or bad firms,” says Thwaites.