Empirical advisory experience suggests most financial crises are originated by a mismatching between assets and liabilities duration. It is reasonable to expect a further wave of advisory activity supporting debt duration normalization to prevent NPL increase and avoid unsuccessful restructurings, thus supporting corporate recoveries

The last 4 years of empirical experience in corporate finance advisory for SMEs, but also for Mid-Large Corporates, suggest that most financial crises are very often originated by a quali-quantitative mismatching between assets and liabilities on the firms' balance sheet.

The credit crunch exacerbated in the last 5-7 years has strongly pushed CEOs and CFOs' funding strategies to redirect more accessible trading finance lines to support unproductive capex or, worst, to cover operating losses, all in the context of adverse market conditions.

The banking score system is currently unprepared to efficiently evaluate that providing trading finance in a context of decreasing turnover, combined with a negative operating leverage, is equal to enlarging the increasingly heavier bulk of non-performing loans, activating the generation of losses and balance sheets that are over-exposed on debt. This frame can seriously compromise any possible recovery programs, due to the gradual deterioration of internal operations. Decreasing revenues, combined with a negative EBITDA, inhibit the closing of the trading finance rounds, pushing the management to increase the stock of debt versus suppliers, personnel and the fiscal administration, instead of rapidly undertaking effective turnaround measures able to reduce the break-even point and produce positive cash flows.

Empirically speaking, this decline period takes around two-three years in which the corporate situation, from an initial, defined situation of strategic positioning, with reference to the sector and the control of relevant critical success factors to adequately compete in it, negatively evolves from a deteriorating context to a critical one, implying heavy and expensive turnaround for both banking systems and white knights, which dramatically increases the number of defaults.

The ultimate result of such process goes past the simple operational restructuring or the re-definition of financial policies, which only operate on a single aspect of the firm's deteriorated condition. It implies a real 'business transformation', which should include serious interventions to deeply revolutionize both the core proposition of the company and its financial dimension.

The corporate finance discipline strongly suggests the adoption of an efficient score system, able to synchronize the financial coverage of fixed assets based on a long-term duration with sources of finance that display a similar maturity. The sound combination between equity and debt should take into account the prudential generation of cash flows.

Despite such theoretical advice, the empirical evidence highlights a dangerous combination of adverse selection on behalf of the banking system, which is led to provide trading finance in a context of plummeting revenues backed by high fixed costs (negative operating leverage), with an entrepreneurial moral hazard in the exploitation of short term debt to cover operational losses.

It is reasonable to expect in the medium term a strong wave of debt duration normalization from the corporate finance advisory industry, as a measure of potential NPL mitigation. This should allow to support Corporates, avoiding costly and unsuccessful restructuring processes.

Bridge Management S.p.A. published this content on 09 December 2016 and is solely responsible for the information contained herein.
Distributed by Public, unedited and unaltered, on 09 December 2016 15:20:11 UTC.

Original documenthttp://www.bridgemanagement.it/it/2016/12/09/assets-liabilities-mismatching-as-potential-seed-of-corporate-crisis/

Public permalinkhttp://www.publicnow.com/view/518F54655D16CAB6E05F5CB0AB49C8B08D68EFCF