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Economic storm could trigger insolvency wave

There is an increased probability of default for a number of industries, as the threat of rising interest rates finally eventuates.

17 June 2022 

Australia is currently experiencing an economic storm of increasing cost of debt, labour and supply shortages, the cessation of COVID-related government support along with financiers removing any remaining periods of grace for clients in arrears, according to the latest CreditorWatch Industry Synopsis.

This means those businesses who have been trading unprofitably since 2020 will now have to face the reality of their situation. 

CreditorWatch Chief Economist, Anneke Thompson, said consumer confidence had sunk to levels not seen since the early stages of the COVID-19 pandemic.

“Our nation is in quite the predicament. The Westpac Consumer Sentiment recorded the 4th lowest sentiment in recent memory in May 2022 and the latest ANZ-Roy Morgan consumer confidence index – a guide to future household spending – tumbled 7.6% to 80.4 points, its lowest level since early April 2020,” she said.

“Given the 50-bps increase in the cash rate at the June RBA Board Meeting, it is almost certain that the decline in consumer sentiment will continue. 

"Coupled with an extremely cold and wet start to winter, and the rising cost of fuel and gas, it is likely that trading conditions in sectors dependent on discretionary spending will continue, and we expect the Probability of Default in these sectors to rise as the year progresses.”

Another factor to consider is the decision by The Fair Work Commission to increase the minimum wage by 5.2% in response to the high March inflation figures, according to CreditorWatch. 

All of these sectors are big employers and will see their wage costs increase, both as a result of the Fair Work Commission's decision, and the strong competition for workers in the sector also forcing up wages.

“The lowest risk sectors will also see an impact to their costs as a result of higher wages, although as already discussed, they are more able to pass on these costs to the end user,” Ms Thompson said.

"These low risk industries also tend to be dominated by larger operators, and will be less exposed to any fluctuations in the Australian housing market."

“Meanwhile, payment arrears data remains relatively unchanged month to month, with the construction industry, at 11.7% of the sector in 60 days or more arrears, still easily the worst performer. We would expect that payment arrears may start to increase as credit becomes more expensive.”

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While there was some hope that inflation had peaked in the US and UK, the latest data suggested this was not the case. 

Creditor Watch said US inflation rose to an annual rate of 8.6% as at May 2022, and in the UK it has soared to 9.0% as at April 2022. 

There were now significant calls around the globe, including in Australia, for pay increases for public sector workers and those on industry awards. 

“However, even with more generous than normal pay increases, real incomes for most workers continue to go backwards. Coupled with interest rate rises (the US Fed Funds and UK’s rate are both already 1.0%) and large increases in energy costs in particular, it is hard to see how households are not going to have to cut back on consumer spending significantly,” Ms Thompson said.

While measurable changes to consumer spending take some time to come through, impacts were already being felt across the economy.

The report found house prices have started to decline in Sydney and Melbourne (always the bellwether cities) and many agents are reporting that buyers are steering clear of properties that require an upgrade or renovation. 

This means that longer term was likely to see some pressure come off the labour shortages in the construction sector, although this probably won’t eventuate until 2023 as so many current jobs have been slowed down due to supply shortages and delays. 

CreditorWatch CEO, Patrick Coghlan said insolvency activity was well down from normal levels during the ‘lockdown phase’ of the COVID-19 pandemic. 

“While the reasoning behind giving companies some repayment breathing space during the period of great uncertainty was sound, what this means is Australia now has a much larger than usual number of companies that are probably close to insolvency,” Mr Coghlan said.

“The changes to monetary policy, prices and consumer behaviour will all combine to build a sense of urgency for many companies who are in this position. 

"The ATO has been hot on sending out letters to businesses that are behind in repayments, underscoring the need to pay back debts that may have been deferred over 2020-21. The second half could well be a wash-out for many of these struggling businesses.

“A sector that knows that feeling all too well is the construction industry which still remains extremely problematic. Fixed-price contracts that are unique to the sector remain a serious drag on profitability, and insolvency activity will increase over 2022.”

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