Underwriting post COVID: Increased focus on obligor's supply chain and debtor base.by EC Credit
Our Senior Credit Analyst has over 35 years experience in Asset Finance - he has spent the bulk of his career as a senior underwriter working at institutions such as BNP Paribas and GE Capital.
UnderwritingSMEs has always been challenging but never have the smoke and mirrors been as strong a factor as we see in today's post pandemic world - our ‘new normal’. As was the case after the 2008 GFC, spotting the next batch of zombie companies requires a combination of diligence with details and early recognition of subtle pointers.
Much of the economy has been on life support for the past 15 months – the government have provided a comprehensive package of support with a staggering £74 billion of govt backed loans, £66 billion of Furlough payments and £16 billion of rates relief extended. Coming down from such a pumped-up, bloated reality, many companies will have to face the sharp light of a new reality, and assessing which companies will survive is the challenge.
Detail matters more than ever before. At Equipment Connect, thanks in part to our tech and data integrations, we are drilling down on recent forensic information including bank statements, debtor lists, management information, tax payments. Based on this data, we sometimes pull back appetite in certain segments and seek more securepositions in sectors exposed to uncertainty in year’s ahead.
On every deal we look at, we consistently consider the macro picture. It is, after all, dangerous to simply assess the proposed obligor in isolation. Instead, drawing on experience and fresh data, we seek to understand the dynamics at play within specific industry segments and to evaluate the full supply chain.
As with any recession, many companieswill fail in the wake of this pandemic and it will probably be Q1 22 until we see bankruptcies spike. In addition, there will also be those micro SMEs who suffer from scaling up problems in working capital as they aggressively chase green pastures with perceived opportunity.
A key hazard is the domino effect of bad debts which can easily bring companies down if they have been overdependent on key customers. Underwriters therefore need to have recent information to form a decision about who will be around over the medium term to repay them.
In making these calls, we need to think about the industry structure we are funding and it's likely vulnerabilities to CV19: not all industries have been adverselyaffected but it is true to say that the CV19 impact has been more far reaching than previous recessions both in terms of direct disruption to business but also, the second order effect of changing working practices and new regulations.
As hospitality gets back to work, we know that their workforce is transitory and in the recession many workers have changed industries to survive, leaving the labour dependent hospitality sector desperately short of manpower to scale back up. We all know about restaurants and hospitality but manufacturing, active ground for Equipment Connect, has faced interruption too with higher costs and higher sensitivity to fragmented supply chains holding back business. Whilst many businesses have got back to opening their doors, labour constraints and constraintsaround how many customers can be handled mean that many will still lose money as they cannot get back to break even. Pre-recession we saw some big failures due to increased labour costs, but both labour and material inflation are likely to materially worsen and put pressure on firms in tight operating segments.
With our credit analysis, we are focusing more on adequacy and headroom of working capital funding from banks and invoice discounters. We are also looking at debtor dependencies and the robustness of balance sheets in providing collateral to leverage new larger facilities needed to potentially 'trade-out' in the future. Where we deem it necessary, we are asking for CV19 update statements to find out what measures have been taken to mitigate effects and to pin down the extent of furloughing, tax breaks, the taking on of government backed loans within the company.
Getting the most up-to-date detailed information and projections has never been so important. Assessing the rationale for the investment, and understanding whether the related working capital demands are sustainable is key. It is important to think about the structure of industries across the supply chain and to apply one's nose/experience to gauge which ones will survive.