Since 2012, many property-related SME businesses, including care homes, have found themselves in a state of limbo awaiting the outcome of the FCA review into the selling of interest rate hedging products (IRHPs).
IRHPs were designed to help customers manage fluctuations in interest rates and to fix the cost of borrowing and repayments. As such, IRHPs were taken out in the period of climbing interest rates, preceding the 2008 financial crisis, and were often taken in support of geared loans with high loan-to-value ratios.
At the time, business confidence was strong, with good transactional activity and an appetite for lending, supporting higher valuations. If we roll forward to 2014, we see business confidence beginning to return but lending appetite remaining risk-averse, contributing to lower valuations. The position is not helped by downward pressure on care fees, leading to low profits.
The review process is now nearing a close with a projected end date of June 2014.
Where the review process has found in favour of the customer, the effected business is receiving financial redress. At a time of downward pressure on fee income, especially for those care homes that are majority funded by local authorities, the receipt of financial redress will come as a welcome tonic to address funding needs in the business.
This raises the question of what to do with the windfall; whether to reinvest the windfall into the business, pay down debt or take it as dividends? This quandary is particularly relevant to underperforming and over-geared businesses.
Back in focus
During the period of the review, the banks involved have agreed not to take enforcement action to recover bad or doubtful debts. As such, distressed businesses that might otherwise have faced the threat of insolvency have benefitted from an amnesty on enforcement. With the review process coming to a close, so will the amnesty, and distressed businesses will return to the focus of lenders.
With over-gearing being a key feature of many cash constrained or underperforming care homes, the underlying cause of distress is unlikely to have gone away during the period of the review process: values have yet to return to pre-2008 levels, sustaining high loan-to-value ratios.
Further, changes in banking regulation since the 2008 financial crisis now require banks to reserve capital against non-performing loans. This is likely to mean more pressure on borrowers to address loans that fall outside of acceptable loan-to-value ratios.
What to do
For all businesses, it is important to engage with lenders and other key stakeholders and to make stakeholders comfortable with the business. This is more so for owner managers of distressed businesses who will need to demonstrate that they are in control, with a strategy to address trading underperformance or over-gearing. It is essential to develop a turnaround plan and share this with lenders and other stakeholders. It is also important to provide detailed and timely management information to demonstrate the turnaround.
Key performance indicators (KPIs) can be a useful tool to both management and stakeholders to monitor trading performance and to track the turnaround plan. KPIs should be specific to each business but sector KPIs typically cover occupancy rates, fee income, payroll costs and profitability (EBITDAR to turnover).
A way forward
For an over-geared business, the best outcome for all stakeholders, including the lender, may be to right-size the debt, however, the lender will want to see that all options have been covered off first, including the owners recapitalising the company. The lender will also want to see that all possible steps to improve trading performance are in train, with detailed projections to demonstrate this.
For an underperforming business, the solution is less likely to be as clear-cut. The cause of underperformance will need to be identified and rectified through a turnaround plan. This is rarely a short-term fix and often requires capital investment. Generally, a balance must be struck between maintaining occupancy levels through quality of service and rationalising costs, which predominantly comprise staff costs. Again, there is likely to be a need to work with the lender to support capital investment and working capital through the turnaround phase. For this, the lender will want to be comfortable with the turnaround plan and projections.
Looking forward, lender appetite is likely to remain risk-averse in the short-term although the care industry offers signs of growth with an underlying demographic of an ageing population, which is likely to continue to attract lending and investment. Lenders and investors will want to see a good track record of trading performance and so it is essential to maintain good accounting records.
How Moore Stephens can help
Moore Stephens has a wealth of experience in the care sector. We provide a full range of services from business start-ups through to merger & acquisitions. Importantly, we are able to assist owner managers to prepare detailed management information and budgets; and develop strategies to turnaround underperforming businesses.
We maintain trusted relationships with many of the UK lenders and we are able to assist owner managers in discussions with lenders or provide an independent and objective review of a business’s current and projected trading performance in support of negotiations with lenders.
to read our detailed factsheet.
Restructuring and Insolvency