Global insolvencies in 2024: trouble on the horizon?

February 2024  |  COVER STORY | BANKRUPTCY & RESTRUCTURING

Financier Worldwide Magazine

February 2024 Issue

Uncertainty is the new normal for businesses across the globe. Many companies – from large multinationals to small and medium-sized enterprises (SMEs) – have faced huge challenges and undergone immense change in just the past few years.

Among the challenges have been market pressures in the form of evolving customer behaviour following the coronavirus (COVID-19) pandemic and the impact of competitors’ actions, as well as economic and political pressures, inflationary and cost of living rises, supply chain issues, tighter budgets and higher taxes.

Also taking a toll is geopolitical instability in Europe and the Middle East – principally the effects of the war in Ukraine and the Israel-Gaza conflict – which has further heightened cautious sentiment and added volatility, impacting the outlook for businesses and hindering their recovery and performance.

Thus, for the most part, the outlook for growth is subdued. According to the International Monetary Fund’s (IMF’s) October 2023 report ‘World Economic Outlook: Navigating Global Divergences’, the baseline forecast for global growth is flat at 2.9 percent in 2024 (down from 3.5 percent in 2022 and 3 percent in 2023), well below the historical 2000-19 average of 3.8 percent.

In terms of advanced economies, growth is expected to slow to 1.4 percent in 2024 (down from 2.6 percent in 2022 and 1.5 percent in 2023) as policy tightening starts to bite. In contrast, emerging market and developing economies are projected to have a modest decline in growth to 4 percent in 2024 (the same percentage as 2023 and down from 4.1 percent in 2022).

Compounding sluggish growth are inflationary pressures. The IMF forecasts that while global inflation is forecast to decline steadily to 5.8 percent in 2024 due to tighter monetary policy aided by lower international commodity prices, core inflation is generally projected to decline more gradually, and inflation is not expected to return to target until 2025 in most cases.

“The current economic outlook continues to suggest caution,” contends Manish Chandna, a senior director at Acuity Knowledge Partners. “Companies continue to face persistently high credit costs, decreased demand and strained margins.

“Weakened demand, in particular, has caused companies to invest additional efforts, resources and funds to meet growth expectations,” he continues. “This ongoing squeeze in profitability, along with the continued lack of funding, brings challenges to maintaining liquidity and solvency stability for companies vulnerable to default.”

Insolvencies outlook

A major consequence of the challenging business environment of recent years is the increasing number of insolvencies occurring across the globe. In the US, for example, corporate bankruptcies are on course to hit their highest level since 2010, while declarations of insolvency by European Union (EU) businesses saw a rise for the sixth consecutive quarter in Q2 2023, a trend that is expected to continue in 2024.

“In the corporate sector, businesses that borrowed heavily in times of low interest rates are most at risk and are now facing unsustainable payments and decreasing revenue,” says Yerbol Orynbayev, a financial services consultant. “Besides restructuring and M&A efforts, there is not much businesses can do. The mistakes were made before the pandemic and geopolitical conflicts. So, today’s economic climate is going to lead many more firms into insolvency – especially for serial borrowers.”

Taking a deep dive into the outlook for global insolvencies in 2024 is Allianz’s 2023 research report ‘Global Insolvency Outlook 2023-25: From maul to ruck?’, which suggests that a back to back acceleration is looming, with global insolvencies forecast to further accelerate in 2024 (up 10 percent year on year from 6 percent in 2023), before stabilising with a limited improvement in 2025. In both years, the global outcome would result from a broad-based dynamic. Moreover, in 2024, a majority of countries (four out of five) would contribute to the upside trend, with a plus 9 percent year on year increase in simple average for the countries concerned.

In terms of jurisdictions, the US (up 22 percent), Italy (up 24 percent) and the Netherlands (up 28 percent) are set to record the largest increases, forecasts Allianz. This global increase would push three out of five countries above their pre-pandemic number of insolvencies in 2024, from slightly less than half of them in 2023.

Additionally, in 2025, a majority of countries (four out of five again) will see quasi-stabilisation or a lower number of insolvencies, with a minus 7 percent year on year decrease in simple average for the countries concerned and the largest decreases in the small economies of Western Europe (Ireland, Nordics), alongside a few specific cases (Spain, Hungary, South Korea and Turkey).

“GDP growth would need to double in 2024 to stabilise business insolvencies,” states the report. “Weaker for longer demand and prolonged high financing costs is forecasted, which will increase

corporate risks and push up expectations for the rise of business insolvencies. The total level of activity is unlikely to reach the minimum required to at least stabilise the number of insolvencies.”

Liquidity issues

As we enter 2024, the ongoing profitability squeeze is challenging companies’ liquidity and solvency, while financing is likely to remain costlier and less available. As a result, liquidity positions are worsening with prospects unlikely to improve before 2025 at the earliest.

“Current financing options are expensive and have stricter lending requirements,” affirms Mr Chandna. “Corporate strategists have been working with restructuring consultants to explore options of private credit, particularly distressed debt funding, for tailored borrowing requirements.”

At the same time, financial markets are becoming increasingly aware that central banks’ monetary policies will not ease for the foreseeable future, which will have consequences for companies’ financing conditions. In emerging markets, there is the added challenge that a depreciation of the currency will push up corporate borrowing costs even further.

“Borrowing costs for corporations have increased as central banks have steadily raised rates in response to inflation,” continues Mr Chandna. “Consequently, companies are finding it difficult to service their debt or to refinance. Global funding declined in 2023. FinTech funding, for example, decreased globally in the first half of 2023, dropping more than 50 percent from H2 2022 to H1 2023 in the Europe, the Middle East and Africa region.”

And while many companies have been able to rebuild their cash buffers, such protection is under pressure due to squeezed profit margins and tightening funding conditions. Thus, many have emerged from the pandemic with much higher debt and a pressing need to service this debt, which is an increasing challenge in a high interest rate environment.

“Overall, interest rate increases and tighter lending standards have made it more challenging for companies with expiring debt maturities to ‘kick the can down the road’,” adds Amy Quackenboss, executive director at the American Bankruptcy Institute (ABI).” Just as the initial shock of the pandemic tipped many companies with shaky balance sheets to reorganise in early to mid-2020, those that relied on emergency funding and cheap financing to stay afloat are now walking a difficult financial tightrope.”

Sector breakdown

While virtually every sector has been impacted to some extent by the economic challenges of recent years, some have borne the brunt more than most. Many of the companies in these sectors often borrow large amounts to facilitate their development and growth but find themselves hamstrung by debt, pushing them to the precipice of insolvency.

“The commercial real estate, healthcare and retail sectors are key concerns,” notes Ms Quackenboss. “While they each have industry-specific challenges, companies on tight margins in these sectors are in uncertain territory. Commercial real estate is facing declining office space utilisation and shrinking affordable financing due to rising interest rates, creating a potential increase in defaults on expiring debt and a decline in new construction.

“The healthcare industry in particular, especially the long-term care sector, is facing challenging economic headwinds amid rising costs, higher borrowing rates and new regulations,” she continues. “Increasing pressure on consumers due to inflation and the resumption of student loan payments may lead to lower consumer spending, thus putting pressure on many retail businesses.”

Other sectors to have succumbed to the current economic malaise and contributed to the rise of global defaults include the media and entertainment sectors. Additionally, those with either high working capital needs, or those that are capital intensive, such as real estate, construction and hospitality, have also been significantly affected.

“To navigate through this challenging landscape, companies are slowing future expansion plans or taking professional advice from expert consulting firms on organisational restructuring and debt refinancing,” observes Mr Chandna. “When the repayment of a cheaper loan is due without any alternatives, companies have been forced to refinance their debt at higher interest rates, putting pressure on margins and leading to future bankruptcies.”

Regulatory efforts

In a bid to tackle burgeoning levels of insolvencies, many countries have introduced new rules and regulations to assist struggling companies, particularly SMEs, with their restructuring efforts. Such legislation provides much needed breathing room to survive continuing economic headwinds.

“The economic struggle during the pandemic stimulated many countries to fine tune insolvency frameworks and facilitate restructuring options, such as early detection of debt distress and early restructuring via out-of-court proceedings,” says Mr Chandna. “These countries include the UK, France, Italy, South Korea, Japan, Singapore, Hong Kong and China.

“Both the US and the EU have proposed new rules and guidance to facilitate restructuring efforts,” he continues. “These are expected to result in easier asset recovery, streamlined processes, applicable laws for cross-border insolvency, more financial resources and increased resolution planning by companies.”

Among the US efforts to facilitate restructuring for struggling companies is the Small Business Reorganization Act of 2019 (SBRA), which went into effect on 19 February 2020 to provide SME debtors with a more streamlined path for restructuring their debts.

“In response to the pandemic, the Coronavirus Aid, Relief, and Economic Security Act 2020 increased the eligibility limit for small businesses looking to file under the SBRA’s subchapter V from just over $2.7m of debt to $7.5m,” explains Ms Quackenboss. “This limit has been extended a few times by Congress and is currently due to come to an end in June 2024. To date, more than 6000 Chapter 11 debtors have chosen to proceed under subchapter V.”

And in Europe, the EU proposed a directive in December 2022 entitled ‘Harmonising certain aspects of insolvency law in the EU’ to enhance and standardise insolvency law in its member states. This proposal sought to impose an obligation on company directors to value creditor interests as part of their fiduciary duty, and actively seek advice from financial consultants, when suspecting potential insolvency.

Predictions

With the global economic outlook for 2024-25 suggesting only modest improvements, companies will continue to face challenges in borrowing costs and tighter lending, in turn increasing the risk of defaults and insolvencies. Smaller businesses are the ones most likely to be adversely affected, but larger entities should not consider themselves immune to ongoing pressures.

“In the US, corporate insolvencies are expected to rise in most markets, but the pace of growth is projected to be slower compared to that of 2023, as, for the time being, central banks are not expected to ease interest rates,” observes Mr Chandna. “The US Federal Reserve System continues to reiterate that managing inflation remains a key priority.

“Moreover, restructuring consultants are expected to be active in negotiating payment terms for improved solvency situations, debt restructuring mandates, successful implementation of company voluntary arrangements of underperforming businesses and administration of liquidation scenarios,” he continues. “Additionally, global conflicts and depreciating currency for emerging markets may worsen the current economic landscape in the days to come.”

In the view of Mr Orynbayev, in 2024 there will be a spike in corporate bankruptcies, the majority of which will be SMEs in construction and real estate which never truly recovered after the pandemic. “Unlike these SMEs, larger companies can streamline their workforce and access reserve capital to safeguard their future.

“In addition, these multinationals have the luxury of being deemed ‘too big to fail’ and will likely have government help if they crash,” he continues. “For SMEs, the only solution is for them to merge. This will help stabilise their balance sheets, increase their clientele and offer up the opportunity to restructure their workforce.”

Summing-up, amid volatility, uncertainty, complexity and ambiguity, it is evident that a range of sectors and industries face major liquidity and solvency challenges. And with broad-based revenue declines, dwindling profitability and the spectre of rising insolvencies ever present, companies must navigate a complex environment if they are to adapt and thrive.

© Financier Worldwide

BY

Fraser Tennant