The perfect storm: What is the impact of Covid-19 on the Scottish hospitality industry?

Abstract

One of the most significant victims of Covid-19 is the tourism and hospitality sector badly affected by travel restrictions and lockdown. There are concerns that many companies in this sector will not be able to recover. This report provides insights into expected default rates in the next twelve months for the Scottish tourism and hospitality. The analysis utilises Wiserfunding expertise in risk modelling and applies its models to a sample of the Scottish tourism and hospitality companies to estimate probability of default (PD) at the company level under three scenarios: baseline, mild downturn and severe downturn.

Model Data Inputs and Scenarios

The analysis in this report has not addressed explicitly the effect of the government support, this will be the subject of further research. However, given the high expected default rates, it confirms that the current government efforts to support the sector (e.g. VAT discount) are going in the right direction. However, we would recommend the support programs to be tailored on the company size to maximise their impact. Business fundamentals should be taken into account too. Firms that show the highest level of adaptability should be rewarded and offered additional support to overcome the crisis, in order to increase the chances of success in the deployment of public funds. Finally, the withdrawal of the current borrowing schemes should be carefully planned in order not to create additional shocks to the companies with high leverage.

A sample of 5000 Scottish companies was selected from tourism and hospitality industry sectors (SIC2007 codes = 55, 56, 79). This sample is used to generate outcomes under three scenarios:

1. Baseline scenario
2. Mild downturn
3. Severe downturn

The models estimate the Probability of Default (PD) using financial ratios (see Table 1), non-financial variables and macroeconomic indicators. More information about risk modelling is given in the next section. Baseline scenario uses the values from the latest available year of financial statements submitted to the Companies House (2018-2019) and corresponding macroeconomic inputs. To model the two downturn scenarios, the values for the financial ratios should be ‘stressed’, i.e. adjusted to reflect the negative effect of the pandemic.

As for the mild downturn scenario, we have examined the last 20 years of financial accounts for Scottish tourism and hospitality sectors. The worst changes were observed during the Global Financial Crisis (GFC) Period (2007-2008), and post-GFC recessions followed by the European debt crisis (2009-2011). The tourism industry also suffered the effects of swine flu in 2009-2010. We took the observed percentage change of each financial variable between the peak and through points in the 2008 crisis as the initial estimates of mild downturn for our current event. We then made further conservative adjustments following the feedback from the tourist industry experts, and these are the values in Table 1.