Hot and cold indicators–should one feel at a loss?

Can water be hot and cold at the same time – yes, with the English system of two separate faucets. Similarly, the economy can appear to be on the way up and down at the same time. Let us briefly explore why this is the case.

Mixed news

We have all seen the articles predicting that recession in Finland is over and GNP is on renewed growth path. At the same time, we hear that credit insurance companies are reporting a steep increase in policy payouts, pension insurance companies are suffering from higher payment defaults, and bankruptcy numbers are up. Simultaneously, corporate lawyers are experiencing increasing M&A activity, recent weeks have seen multiple new RFPs for IPOs, and people in the transaction market are again talking about dual tracks.

Reasons and lemons

It appears that 2024 will be one of those years where work outs, court facing restructurings, and bankruptcies are at elevated levels at the same time as capital market activity (including IPOs) and M&A is picking up. To understand this phenomenon, one must grasp how insolvency works in real life. Lemons take longer to ripen – it often takes many years for misguided business decisions and poor market conditions to eat up existing financing lines (especially covenant light ones) and balance sheet equity. Empirical studies show that “the bigger the elephant the longer it takes to fall on its side”. So, we should not be surprised by what I would call late cyclical insolvency numbers and even some bigger corporate failures surfacing on shore this fall. Finally, to add to the insult, an increased order book eats up more working capital – something that the ripe lemons may not be able to finance.

Flashback 1993

In the early 1990s Finland experienced the deepest recession since the second world war. In October 1993 Eka Co-Operative, that was the fifth biggest business group in Finland, landed into restructuring. I was appointed as one of the trustees and spent the next twelve months negotiating a restructuring program. The negotiations were difficult as nobody expected the business to recover, and everything looked very gloomy. Early 1995 we realized that the economy had already reached a turning point early 1994 and consequently Eka went on to beat the expectations by a healthy margin.

What to look out for?

All in all, we can prepare ourselves with news headlines that may continue to look confusing to the unprepared reader. Boards are well served by focusing on liquidity and both solvent and distressed M&A opportunities. Banks may need to make decisions between seeing some of their clients falling off the cliff and throwing in new money to finance bets on the recovering markets.

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