Corporate debt crisis

04 April 2020
A month ago the FT reported on the build-up of corporate debt that in summary is basically the same mistakes the financial sector made prior to 2008. It is also estimated that that a sixth of US companies do not have the cash-flow to service interest payments. 2020 is going to see a corporate debt crisis that is likely to be every bit as bad as the financial melt-down that happened a decade ago, and already the companies are lining up for the corporate welfare.

It was the news that Debenhams was going into administration that bought all this back to the front of my mind. Only a week or two ago I mentioned to relatives that I thought there would be a Carrilion-style collapse where an over-leveraged basket-case that was already marginal in the best of circumstances would get pushed over the edge, and while Debenhams seems to all be above-board in a way Carillion was not, the fragility is still there.

The corrupted eco-system

The whole idea behind cheap credit is that it is supposed to encourage people to invest rather than save, but that is predicated on investments that have a return — for a company if capability & capacity is already in line with any reasonably expected bounds of the customer base then the extra investment does not add any value. However the legacy of the credit crunch was ultra-loose fiscal policy that made credit so cheap that it was more or less “free money” which companies were clearly not going to leave alone. Human nature took over and it became a mechanism for extracting value from companies rather than adding to it. This is most visible in debt being used for share buy-backs but the underlying problem is that high debt levels have become normalised. Of course where there is “money” there will grow an eco-system to absorb it, and entanglement of vested interests mean that corrective action is repeatedly kicked down the road until it is far too late.Margins for safety become viewed as optional and as many accountancy scandals have shown some of these margins are actually negative. Companies like Thomas Cook which are notionally rescued actually end up in an even deeper hole, but there is always someone somewhere who got a nice little earner out of the process.

The education sector

There is one sector which is particularly brazen in its approach to rewarding failure and that is universities — they are pleading for a bailout to paper over their failures. UK universities basically survived the last 15 or so years by charging overseas students high fees, often as not for an educational experience that does not remotely justify the price tag, and many institutions have embarked on debt-fuelled expansion for which ever-increasing numbers of students is essential for survival. Since this coincided both with a demographic dip and tightening visa requirements this from the outset means that expansion has only one viable approach: Cannibalisation.

The notable thing about the education sector is that it seems to blend the worst aspects of both the public and private sectors. Yes the row about vice-chancellor remuneration mirrors that of corporate pay awards, but the real gravy-train is all the consultants that get into the wood-work of state organisations. An implied but deliberately not explicit underwriting by the government was no doubt involved in business cases from institutions, while at the same time using autonomous status to borrow money in their own right. Supposedly exist to provide a public good but rampant salami-slicing to reduce unit costs. Many are a modern British Leyland.

The likely end-game

The spivs and wide-boys who bought about the credit crunch never went away, and with a problem caused by cheap credit being ‘solved’ with even cheaper credit, the same outcomes were going to repeat themselves. However with interest rates pared to the bone further fiscal loosening is not an option, and the fragile state of the corporate world means a lot of companies will not survive.