Liquidity: Does The Global Financial Crisis Give Us Any Clues As To The Future?

fdu’s guest blogger, David Tilston is a Chartered Accountant, a Fellow of The Association of Corporate Treasurers and a member of The Institute for Turnaround. He has held CFO roles in both listed PLC and PE-backed companies and has significant experience of managing turnaround situations.

As we are facing quite abnormal times I thought I would look back to what happened following the Global Financial Crisis in 2008, the last time we faced an economic shock of significant magnitude.

What happened to UK GDP and Company Liquidations during the Global Financial Crisis?

I have examined the change in quarterly UK Real GDP compared to the equivalent quarter in the same year, and computed the same analysis in respect of quarterly company liquidations in England and Wales (as a proxy for the UK).

Although a financial crisis was already building, the flash points occurred with the bankruptcy of Lehman Brothers on 15 September 2008 which followed US Government intervention at the Federal National Mortgage Association (“Fannie May”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”) the previous week. AIG suffered a liquidity crisis and was bailed out by the US Government several days later.

The change in quarterly liquidations is shown in the bar chart in the graph below (scale on the left hand axis) and the change in quarterly GDP is shown by the line in the graph below (scale on the right hand axis).

Link between GDP and co liquidations

In the UK, Q3 2008 GDP contracted compared to the same quarter in the  prior year. Q1 2009 GDP was 5.8% below Q1 2008, and after 18 months of contraction quarterly GDP only returned to growth in early 2010.

“Company liquidations were approximately 50% higher.”

The picture around quarterly company liquidations (in England & Wales) showed similar dramatic change, but with a lagged effect. During the 9 month period from October 2008 – June 2009 company liquidations were approximately 50% higher than the comparative period 12 months earlier. Quarterly company liquidations did not start to fall, compared to the same period in the prior year, until Q4 2009 (five quarters after the initial decline in of GDP).

Company liquidations nevertheless remained above those seen in early 2009 as you can see from the graph below.

Quarterly liquidations - England and Wales

What are economists saying about the outlook for GDP currently?

There are a wide range of forecasts in the market currently which is quite understandable. Factors for this uncertainty include (but not exclusively) government decisions around easing of lockdowns, the risk of secondary lockdowns if more individuals get infected with COVID-19 and the timing of a widely available vaccine.

EY ITEM Club (who use the HM Treasury model of the UK economy to produce their forecasts) recently produced their Spring 2020 forecast which was (reasonably) widely caveated. Their forecast for UK GDP is for a 6.8% contraction in 2020 with 4.5% growth in 2021, 2.0% growth in 2022 and GDP not returning to Q4 2019 levels until 2023.

More interestingly in separate presentations EY have developed three stylised scenarios for the shape of the recovery :

  • a V shaped scenario (suggesting a rapid bounce back in activity),
  • a U-shaped scenario (where low consumer and business confidence delays a return to normal) and
  • an L-shaped scenario (where a secondary wave of infections leads to subsequent lockdowns and no full recovery arises until a vaccine is available).

KPMG’s economist has published some useful contextual analysis versus previous recessions and separately highlighted 4 illustrative scenarios including a downside case involving the delay in availability of a vaccine.

We wait to see which scenario is closest to reality!

Is the current COVID-19 crisis really comparable to the Global Financial Crisis?

It is fair to say that the Global Financial Crisis is not directly comparable to the current situation. In late 2009 the financial sector was under severe pressure and the ability for banks to advance loans was constrained by their own losses.

The economic impact being felt currently is driven by other factors, notably the protection of employees which is having a knock on impact on demand and supply chains. Liquidity is being made available to companies and is being boosted by Government support measures and grants.

The magnitude of the economic impact is however expected to be more severe that that of the Global Financial Crisis, at least in terms of fall in GDP and the challenges of kick-starting many economies internationally from a state of near hibernation.

What does this mean for companies and what are the implications for corporate liquidity?

The path to recovery is extremely uncertain at present and likely to remain so for some considerable period of time. Some sectors such as airlines, hospitality and retail have already suffered major damage as widely reported. Many business models may need to change. This means that judgements around assumptions/scenarios to make in any short term cashflow forecast are likely to vary from one week to the next.

The UK Government appears likely to announce changes to insolvency regulations in the near future. This may provide further flexibility on the options available to financially distressed and should be monitored.

Management teams will need to delicately balance various factors such as bringing staff back to full productive capacity on a controlled basis, complying with changing government guidance, balancing customer demand with restrictions in the supply chain and managing the financial implications increased working capital requirements.

“Many companies may remain at risk of insolvency for an extended period.”

Survival is crucial and many companies may remain at risk of insolvency for an extended period (as the statistics from the Global Financial Crisis illustrate). Some companies will also be burdened by additional debt taken on to survive the crisis which, in certain cases, will take many years to pay down. Long term solutions to such debt will be required at some stage, but careful navigation of the risks around short term liquidity is also essential. With this in mind: