Cautious optimism in new era of financial conservatism

UK chief financial officers (CFOs) have become markedly more optimistic about the financial prospects for their own companies, but there is no expectation that the country is on the verge of a strong recovery, according to the findings of the latest quarterly Deloitte CFO Survey.

Despite optimism among CFOs rising to the highest level since the survey began in September 2007, the mood is hardly euphoric. Instead, debt reduction and financial caution are in favour and it is clear that CFOs think these trends are here to stay. CFOs believe that the credit crunch marks a move to a new era of lower debt, less reliance on bank borrowing and a greater focus on liquidity.

Nearly three quarters (73 per cent) of CFOs expect growth in their own markets to remain sluggish next year and 12 per cent expect an outright contraction. Just 14 per cent of those surveyed expect a return to normal or trend growth rates in their markets in 2010.

CFOs believe that the recession and credit crunch will bring lasting change to the way in which corporates structure their balance sheets. Seventy per cent believe that the downturn will permanently change balance sheets, with companies running higher levels of cash or liquid reserves and relying more on equity and corporate bond finance and less on bank borrowing.

Richard Edwards, Midlands practice senior partner at Deloitte, said: “While the economic outlook has improved, CFOs remain cautious. Many think now is not a good time to take risk onto their balance sheet and debt remains out of favour. Many more CFOs plan to reduce debt over the next year than raise it.

“It is a measure of the shift of preferences that 18 per cent of CFOs say they have used capital markets to raise finance to repay bank borrowing this year and a further 19 per cent say they are likely to do so.

“We are likely to see companies running lower levels of corporate gearing and higher levels of liquid reserves.”

While credit cost and availability have improved over the last year, most corporates continue to rate credit as costly and hard to obtain. Disruption in the financial system has fundamentally changed CFOs’ preferences for financing their businesses. Bank borrowing is still out of favour, while corporate bond and equity issuance are increasingly in favour. CFOs are expecting a lasting shift away from bank borrowing as a source of capital.

The caution about the outlook is captured in CFOs’ plans for their own companies for the rest of this year. Few companies are expanding or likely to increase hiring before the end of the year.

However, given the weakness in M&A activity over the last year one striking finding of this quarter’s survey is that 39 per cent of CFOs say that their companies are making, or likely to make, corporate acquisitions before the end of this year. Optimism about M&A and private equity activity has also reached the highest level since the survey began two years ago.

Mr Edwards said: “CFOs’ views on valuations have changed markedly in the last two years with UK equities having gone from being seen as the most undervalued to an overvalued asset class. Commercial real estate has gone from most overvalued to least overvalued status. Government bonds are seen as the most overvalued asset class.”

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