Strong recovery is masking structural challenges faced by UK businesses
Latest government monthly insolvency data shows a doubling of insolvencies compared to February 2021. FXE Lending Monitor publication picks up on the material increase in SME insolvencies since the end of 2021, following the historically low rates seen during the pandemic. This edition of the Lending Monitor looks at factors that could drive an acceleration of failure rates in 2022 – and the implications for lenders and businesses alike. The Lending Monitor is published by FXE Technologies, the technology arm of Funding Xchange, the government approved lending referral platform
The last quarter of 2021 has shown that the withdrawal of government support is starting to expose businesses that were never viable or that continue to be overly reliant on ‘pre-pandemic’ economic structures (commuters, bricks-n-mortar retail…) and are unlikely to return to their former shape. This failure rate could continue to accelerate significantly in 2022: In 2021, company insolvency rates were still 21% below pre-pandemic levels. That’s 10% higher than the historically low failure rates in 2020. However, there has been an 18% increase in insolvencies in Q4 vs. Q3 of 2021, potentially suggesting that this adjustment has started.
Structural challenges are yet to play through: businesses are saddled with balance sheets weakened by government-backed lending that staved off the immediate crisis. Funds borrowed through the Bounce Back Loan Scheme have predominantly been used in substitution for trading revenue, and now must be paid back. At the same time VAT deferrals have started to fall due, adding to the cashflow pressure. These rescue measures mean that median levels of debt have increased 10-fold from pre-pandemic level relative to turnover for the top quartile of micro businesses (that are using debt). This is an unprecedented increase in debt. With repayments of government lending and unwinding of HMRC deferrals having started in late 2021, we are only now starting to see which businesses can shoulder the repayments. Given other macro challenges – Brexit, spikes in inflation, war in Europe – uncertainty for businesses and lenders will remain a key concern in 2022.
The Funding Xchange Lending Monitor also issues a warning that traditional lending assessment methods will not operate efficiently in the post pandemic era.
Traditional assessment methodologies take a historic look at business performance in making credit decisions. Over the past two years performance indicators for many businesses have shifted significantly, and businesses have faced unprecedented shocks that they have had to respond to in real time. Accordingly, traditional risk models that look for long-term trends are proving unfit for purpose even advanced Artificial Intelligence risk models are struggling to identify the path ahead. The Lending Monitor encourages lenders to embrace dynamic models that can identify potential challenges based on an understanding of ‘live’ trading performance, repayment patterns and strength of the management team. This is enabling lenders to respond, both in supporting businesses and minimising failure losses.
Katrin Herrling explained, “Having emerged from Covid, we still need to expect significant volatility. We have already seen a rise in defaults from booming sectors – for example, in the construction sector some contractors have been caught between fixed-price contracts and spikes in inflation rates. Equally, we can see how recession-resistant sectors like farming are shuddering at the prospects of not being able to secure fertiliser as energy prices continue to go up. For lenders, understanding how businesses are responding and trading through these new uncertainties is critical. Forward thinking lenders are increasingly using digital tools to proactively support businesses – standing by businesses with additional funding or adjusted repayment terms that leverage an understanding of businesses’ actual trading performance.”
The Portfolio Management tool recently launched by FXE Technologies, in conjunction with Shawbrook Bank, has been developed to assist both traditional and challenger banks to use current dynamic data to pick up early stage trends enabling them to recognise and act upon financial deteriorations. Major high street banks are also looking now to embed such thinking into their own portfolio management.
Emphasising the importance of such a change in approach Katrin Herrling added, “Lenders who fail to adapt to dynamic data driven triggers across their portfolios, risk being too slow in reacting to sector and business disruption within their overall lending portfolios. This may leave them overly exposed if the trend in insolvency rates reported in the latest Funding Xchange Lending Monitor continues in 2022.”
