After confounding expectations for years, 2022 saw a rapid rise in corporate insolvencies, and the risk is intensifying. We asked Coface economist Jonathan Steenberg why the tide has turned so dramatically, what the pattern of insolvencies tells us, and how you can protect your business from being swept away.
What is the outlook for corporate insolvencies?
Last year, the number of UK corporate insolvencies reached its highest levels since the 2009 Global Financial Crisis, but unfortunately, that was just the beginning.
According to the Insolvency Service, the seasonally adjusted number of company insolvencies registered in England and Wales in Q1 2023 was 18% higher than in Q1 2022, although slightly lower than Q4 2022. The yearly insolvency rate to March 31, 2023, was 50.8 per 10,000 active companies, compared with 38.9 per 10,000 in the previous 12 months.
With businesses beset by increased costs (energy, commodity prices, and wages), lower consumer demand, and yet another rise in interest rates, the indications are that insolvencies will rise through 2023 and that larger companies will be increasingly affected. That means the fallout could be more damaging in terms of jobs and unpaid debts.
Why is this happening now?
Put simply, we’ve reverted to the normal dynamic where corporate insolvencies are determined by companies’ liquidity, profitability, and ability to meet financial obligations, as well as the economic environment.
Ordinarily, a rapid fall in business activity would result in a rapid and substantial rise in corporate insolvencies, but in 2020, the reverse was true. Thanks to measures like furlough schemes, COVID support loans, deferred VAT, the suspension of lawful trading rules, and a moratorium restricting winding up petitions, there was actually a dramatic fall in corporate insolvencies in 2020, and numbers remained low in the first half of 2021.
As these schemes were phased out and support loans had to be repaid, corporate insolvencies started to behave more typically. For example, after the final end of the moratorium restricting winding up petitions in February 2022, compulsory liquidations were around 50% more frequent in the immediate months after and were almost 3 times higher after six months.
No sooner had the UK business community been taken off life support, then it was hit by a series of blows, as I mentioned earlier. These are all contributing to the rise in insolvencies, but I think interest rates are especially significant because companies have become so used to operating in a low-interest environment over many years. Low interest rates were the backdrop to the fall in insolvencies in the years before the pandemic and helped some struggling companies survive the global financial crisis, but over the last year and a half, the BoE base rate has been hiked 12 times from a historic low of 0.1% to a new rate of 4.5% in an effort to address persistently high inflation. That has left many unable to meet debt obligations, which had built up over successive lockdowns.
On top of the high policy rate, banks have been tightening credit standards for corporate lending, even before the recent failures and wind down of four US banks and the takeover of Credit Suisse. This more restrictive approach, especially for SMEs and medium-sized companies, is problematic at a time when many are trying to renegotiate terms and obtain credit and could lead to more insolvencies.
What does the pattern of insolvencies tell us about who is affected?
As night followed day, the phasing out of support scheme measures led to a rise in insolvencies. Initially, this was driven by a specific type of insolvency proceeding, creditor’s voluntary liquidations (CVLs), which are more common among small and micro companies.
The proportion of CVLs rose to 89% in 2021 and 84% in 2022. However, when small and micro companies are excluded from the statistics, corporate insolvencies actually remained 9% lower in 2022 than in 2019. This meant the consequences were more limited.
This pattern is set to change in 2023 if you look at the increase in winding up petitions filed and notices of intentions made in Q1. When a winding up petition is filed, it usually takes around one to three months to liquidate a company, although it can take much longer, depending on the size and complexity of the company and its creditors. This points to a higher rate of corporate insolvencies in the first half of 2023 alone (between 15 and 22% higher than 2022) and suggests that more suppliers could be dragged into the mire.
What sectors are most vulnerable?
According to the Insolvency Service, the construction sector experienced the highest number of insolvencies in England and Wales for the year ending Q1 2023 (4,367, 18% of cases), which was higher than the previous 12 months.
Looking at the winding-up petitions and notice of intentions made in Q1, we expect to see further increases in insolvencies across most sectors, but we have particular concerns about construction and other heavier industries such as metals and chemicals, which are energy intensive and operating in a landscape of falling demand. It’s one of several reasons why Coface assesses these sectors as ‘high risk’ and ‘very high risk’ in the UK.
Other sectors where we expect insolvencies to rise include agri-food, hospitality, and retail. Agri-food has had a difficult time since the invasion of Ukraine due to rising costs and unstable supply chains, while companies in the hospitality and retail sectors are highly vulnerable to wage and energy price rises as well as changing consumer habits.
What advice do you have for companies?
While the Bank of England upgraded its growth forecast on May 11, it will take time before this is seen in the insolvency statistics, as these typically lag behind other economic indicators. In short, nobody can afford to be complacent about the risk of default.
For that reason, I’d recommend that companies review their risk credit strategy if they have not already done so and look more closely at all new customers and requests for increased credit. Coface’s Business Information Services are a great resource for due diligence, as you can find real-time business information about millions of companies worldwide. Our unique Debtor Risk Assessment (DRA) scores are particularly relevant just now as they show a company’s probability of payment default over a twelve-month horizon based on intelligence from Coface’s global network, including payment incidents. A high DRA score means you can have a high level of confidence that you’ll get paid.
With a Coface credit insurance policy, you can have the added comfort of knowing that your business is protected from losses arising from bad debt due to customer insolvency or protracted late payments. You can recoup up to 90% of the invoice amount, and Coface pays claims as quickly as 30 days.