03 Re-Organisation

Institutional grade restructuring activity likely to remain subdued

Favourable macro-economic conditions which fuelled the M&A boom throughout 2021 also doused early onset COVID-19 restructuring activity. Record low interest rates, wide-open access to debt and capital markets, appreciating asset values and strong consumer spending (supported by savings war chests) have delivered a soft landing to the weaning of government stimulus.

Following record low U.S. defaults in 2021, Fitch Ratings anticipates the benign default environment to continue through 2023 calender year, despite concerns regarding inflation, supply chain challenges, continued pandemic uncertainty and rising interest rates. It has forecast:

  • a U.S. high yield default rate of 1% for 2022 and a projected range of 1-1.5% for 2023 (historical non-recessionary average 2.2%); and
  • a U.S. leveraged finance default rate of 1.5% and a projected range of 1.25-1.75% for 2023 (historical non-recessionary average 1.7%).

So, it’s all rosy for Australian businesses?

Not entirely. Australian businesses are experiencing acute pandemic-related supply chain challenges and labour shortages. These factors are leading to inefficiencies, increased costs, business disruption and the testing of customer, client and counterparty patience.

With no immediate relief in sight, persistent inflationary pressure will lead to an increase in interest rates and higher funding costs in 2022. The ability of the government to respond fiscally to any adverse shock is further limited, following two years of policy spending.

Situational problems facing fixed-price contractors will strain working capital and may develop into heightened default and insolvency risks. The construction industry for instance, is already facing such headwinds while also navigating the withdrawal of Chinese investment associated with Evergrande’s demise.

We also anticipate that corporate social responsibility will play a critical role in the transition of debt and capital away from intensive carbon-emitting industries in Australia.

What could upset “the applecart” more broadly in 2022?

Geopolitical risks pose a significant threat to economic growth. The military conflict advanced by Russia in Ukraine will undoubtably have a negative impact on global debt and capital markets. The resultant tightening of credit and capital flows may land some heavy blows to corporate health.