The impact that the COVID-19 crisis is having on corporates has been underlined by two new publications this week. Firstly, business confidence in the UK has seen its largest quarterly fall on record, according to Deloitte’s latest CFO survey. This reversal comes after the Q4 2019 survey showed the largest increase in sentiment in the wake of the general election.
The Deloitte CFO survey for Q1 2020, which gauges sentiment amongst the UK’s largest businesses, took place after the UK was placed into lockdown between 8 and 22 April. A total of 104 CFOs participated in the latest survey, including CFOs of 23 FTSE 100 and 43 FTSE 250 companies. The combined market value of the UK-listed companies that participated is £418bn, approximately 21% of the UK quoted equity market.
Optimism, revenue and risk appetite
In Q1 2020, 84% of CFOs report that they are less optimistic about the prospects for their company than they were three months ago. This is the lowest business confidence reading on record and, in stark contrast to Q4 2019 where a majority (53%) of CFOs said they were more optimistic about the financial prospects of their company.
Business sentiment around revenues has fallen markedly. In Q1, 97% of CFOs say they expect UK corporates’ revenues to decrease in the coming 12 months. CFOs expect their own businesses’ revenues to be 22% lower on average this year, than estimated in their pre-COVID-19 plans.
CFO perceptions of external uncertainty have risen to the highest level in the history of the survey. The majority of CFOs surveyed (89%) now feel there is a high or very high level of uncertainty facing their business, a sharp increase compared to 34% in the previous quarter.
The COVID-19 crisis has taken a heavy toll on economic activity. In Q1, 94% say they are unwilling to take risk onto their balance sheets. This is the second-lowest reading for risk appetite on record, the lowest level having been observed during the 2008 financial crisis.
Despite policy action to support corporate financing, CFOs from the survey’s panel of large businesses reported the sharpest squeeze in credit conditions on record, with a marked deterioration in the availability and cost of debt in the last three months.
Almost all CFOs (98%) expect UK corporates to reduce capital expenditure in the next 12 months, in contrast to 38% anticipating an increase in Q4 2019. Hiring expectations are also significantly more pessimistic, with 98% of CFOs expecting a slowdown in hiring in the next year. In the previous quarter, 27% of CFOs predicted hiring would increase over the year.
COVID-19 and the economy
Amid the COVID-19 pandemic, 53% of CFOs are expecting the UK economy to see a deep and prolonged economic downturn that lasts until the end of 2020.
Most CFOs expect demand in their own sectors to start to revive later this year. However, over half (53%) do not expect demand to recover to pre-pandemic levels until after Q2 2021.
Looking ahead to the long-term impact of COVID-19, 97% of CFOs believe the crisis will lead to an increase in pandemic planning, while 89% believe it will lead to a diversification and strengthening of supply chains. CFOs believe the post-COVID world will see a greater role for the state and higher levels of corporate and household taxation.
“The COVID-19 pandemic has seen business confidence drop from an all-time high to an all-time low in just three months,” commented Ian Stewart, chief economist at Deloitte. “CFOs expect the lockdown to ease in May and June and demand in their own sectors to start recovering later this year. But there is no expectation of a quick snap back in activity, with most CFOs assuming revenues will not return to pre-crisis levels for at least a year.”
Strategy and spending
The Deloitte CFO survey shows that CFOs are focusing on more defensive strategies than at any time since the survey began, with 76% rating reducing costs and 68% rating increasing cash flow as strong priorities.
CFOs are also taking specific actions to address challenges posed by the COVID-19 pandemic. Almost all CFOs (99%) have introduced or are planning to introduce alternative working arrangements such as flexible and remote working, 59% are furloughing employees, 52% are reducing output or shutting down factories and 30% have or intend to access the Bank of England’s COVID Corporate Financing Facility.
“Finance leaders are facing the toughest challenges in decades but most expect demand to start to come back this year,” said Richard Houston, senior partner and chief executive of Deloitte North and South Europe. “Leaders are already thinking beyond the downturn and how to adapt and prosper in a changed world. Almost all finance leaders believe that flexible working will gain ground in the wake of this crisis. We have an opportunity to re-think the future of work in a way that boosts opportunity and innovation.”
Are interest rate hedges effective?
Elsewhere, an article on the Bloomberg website written by Demetri Papacostas, the company’s head of Corporate and Commodity Specialists, suggests that corporates may need to validate the effectiveness of their interest rate hedges.
The awakening of market volatility has come quickly and across all asset classes. Of particular note is the increased volatility for interest rate instruments. Papacostas says that this is impacting the rigour, transparency and the flexibility to run analytics on demand.
The article notes that corporates may be asked by their auditors to run regressions to re-check effectiveness. This is for a company’s interest rate swaps, and even on a company’s own bonds outstanding. Whereas in the past companies used rudimentary tools to see how their bond reacted to rate/credit changes, Papacostas says that auditors are now often demanding solid tools with rigorous scenario and regression capabilities to estimate the risk inherent in the current very unpredictable environment.
In addition to the lack of rigorous analysis, Papacostas makes the point that corporate treasury effectiveness may also be constrained by the lack of transparency and flexibility. Often, auditors do not need just a valuation, but also solid proof of how the number was derived - including the underlying models and assumptions.
Finally, the article comments that given the speed of change in the financial markets, month-end or quarter-end valuations may not suffice. Papacostas notes that the preferred access is to be able to see on demand how market values have changed to generate scenario analysis based on the new environment and potentially amend hedges to reflect the new reality.
Papacostas concludes by says that, ideally, companies want to be able to generate a scenario analysis that reflects real-time moves, create a sophisticated regression that gives a sense of the magnitude of exposure, and when their auditors demand to see how they arrived at those numbers, they can generate the supporting documentation at the press of a button.
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