The Dam May Not Have Burst, but There Could Be More to Do to Avoid a Flood of UK Corporate Distress

Bulging balance sheets and an allegedly “broken economy” would eventually put an end to a whole host of long-suffering businesses, still tussling with the impacts of Brexit, supply shortages, logistical challenges and a growing storm of geopolitical uncertainty. Or so the narrative went …

This long-foreshadowed tsunami of corporate failures (akin to the 2008-2009 recession) has been but a shallow wave due to the unexpected strength and resilience of the UK economy. There has been just a small, albeit sustained, increase in corporate insolvencies¹ since 2021, predominantly among smaller businesses. A large proportion of these insolvencies have been liquidations, as opposed to administrations or other more “rescue-focused” restructuring procedures.

The fact that corporate insolvencies have not been more pervasive appears to be a product of several factors, especially the somewhat extraordinary support and forbearance provided by the UK government and lenders, compared to historical standards. Companies have also been able to access capital from multiple alternative sources, as peer-to-peer marketplaces, asset-based lenders and private capital funds have played an ever-increasing role in UK capital markets—filling the void created by traditional banks, which have been constrained by more stringent post-Great Recession regulatory conditions over the past decade. Consequently, the distress impacting small and medium enterprises (SMEs) has not been as bad as perhaps was first feared.

Following the general election and a decisive victory for the Labour Party, there are tentative signs that confidence in the UK economy is beginning to build, aligned to falling consumer price inflation and an expectation that the Bank of England will continue its current path of reducing the Bank Rate. This gives hope to many businesses on two fronts: Easing price conditions will improve consumer demand, while lower interest rates should help boost investment and financial stability. There are, undoubtedly, many companies that continue to work hard to generate the free cash flows needed to sustain debt servicing obligations and investor returns.

There may now be a light at the end of the tunnel after an unprecedented period of economic and political turmoil, but any expectation that these risks have receded could be premature. Geopolitical uncertainties emanating from the war in Ukraine, the Middle East, China and the US presidential election could still have a material impact on trade and confidence in the short term. Consequently, borrowers relying on the path of monetary policy running smoothly to improve their financial position may find themselves very disappointed.

The Bank of England’s Financial Stability Report in June 2024² touches on many of these global vulnerabilities but, more specifically, the risks to leveraged borrowers that continue to remain under pressure, despite the improving outlook. Markets are clearly still adjusting to the higher interest rate environment, and although corporates are proving to be more broadly resilient than many expected, there are certain market segments where the pressures are more acute. There is, for example, growing concern about the divergence between debt and valuations across real estate markets and the number of highly leveraged positions in private equity portfolios.

While expectations for the neutral rate of interest are between 3.5% and 4% over the next three years—giving hope to more indebted companies that recent financial pressures may ease significantly—things can change quickly. There is a wall of debt maturities from the second half of 2024 that could, nevertheless, present refinancing challenges, particularly for leveraged borrowers that have higher credit risks associated with them. Yes, we have seen extraordinary forbearance in recent years, but the days of “extend and pretend” could well be over, especially in circumstances where the cost of capital is ultimately too prohibitive. We have also seen other key stakeholders, such as HM Revenue & Customs (HMRC), taking more forceful debt recovery action given the scale of current tax arrears, as highlighted in HMRC’s Annual Report.³ Leveraged borrowers may find themselves with fewer places to turn in creating the breathing space needed to either turn performance around or simply sustain existing borrowings through the next refinancing cycle.

This brings the need for some companies to consider their options proactively into sharper focus, to avoid a situation where their financial position becomes so distressed that many of the options available now are no longer feasible. Kroll’s Advisory team can point to many examples where problems have been identified or addressed too late, often resulting in suboptimal outcomes through a subsequent restructuring process.

For corporates with concerns about their longer-term capital structure, early engagement with key stakeholders should maximize the number of options, especially the “solvent” options, such as business reorganization, debt restructuring and refinancing, which can quickly disappear when stress builds and events become more accelerated. Even in circumstances when an insolvency mechanism may be needed to restructure a business, the benefit of time provides for better preparation and execution, often yielding better outcomes.

Recently, we have also seen how time can be advantageous in the use of restructuring plans (introduced as part of the Corporate Insolvency and Governance Act 2020) to facilitate an effective re-composition of a company’s financial position in order to secure its long-term viability without the need for formal insolvency proceedings. Examples of successful restructuring plans may be few, especially among SMEs that face a difficult cost/benefit decision, but this is nonetheless a powerful and flexible tool for achieving a compromise or new arrangement while addressing a company’s present financial difficulties. A review of the success of restructuring plans in 2023 concluded there was more to be done to reduce the associated costs, which would make them more accessible to a broader range of distressed companies.

If you are a director and/or shareholder with concerns that future market volatility may challenge the financial health and value of your business, or a lender with borrowers that you believe may encounter difficulties in fulfilling their future repayment obligations, Kroll’s Advisory team can work alongside you to examine your options and consult with important stakeholders on a potential change of strategy. We have a breadth of experience working with institutional and other lenders, debt funds and private equity in challenging situations and collaborating with clients to preserve value through various business restructuring processes.

We have also completed several successful refinancings for both performing and distressed companies, whether those refinancings were to support growth or to preserve the borrower as a going concern.

Please contact the team at one of our offices if you feel you could benefit from our advice and support.