Restructuring - Macroeconomic headwinds to increase restructuring activity

13 February 2023

Notwithstanding renewed optimism from the World Economic Forum in Davos, global economies are still reeling in the wake of the coronavirus pandemic and the ongoing Russian conflict in Ukraine. The list of macroeconomic headwinds remains ominous—high inflation, increasing interest rates, soaring energy prices, tight labour markets, disrupted supply chains, and heightened geopolitical risks, to name a few. Combined, these factors have created an economic environment characterised by generationally-high cost of living pressure, corporate profit erosion, revised valuations and weak global growth forecasts.

Assessing these factors, Fitch Ratings has recently raised the low end of its U.S. institutional leverage loan (LL) and high yield (HY) default forecast ranges. The revised 2023 ranges are 2.5%-3.0% for LL and 3.0%-3.5% for HY. This compares to 2022 actual default rates for LL and HY of 1.6% and 1.3% respectively.

The European outlook is similar. Fitch Ratings has forecast 2023 default rates of 4.5% for LL and 2.5% for HY, compared to 2022 rates of 1.3% and 0.7% respectively.

What does this mean for Australian businesses?
We expect 2023 to be a challenging year for many Australian businesses. Higher costs of debt and input prices will intersect with an expected deceleration in consumer spending due to negative real wage growth and falling house prices. Australian businesses exposed to U.S. and European operations may face liquidity pressure more quickly as those economies slow at a greater speed.

In an environment of tightening credit availability, an increase in restructuring activity is likely to be driven by businesses facing liquidity shortages. This will be even more acute for those businesses that fell behind with their statutory payment obligations over the past few years.

Sectors likely to remain, or come under, increased financial pressure in 2023 include property and construction, energy intensive industries, consumer goods, and discretionary spending-exposed businesses including retail, leisure, and hospitality.

Are there any green shoots?
China’s recent relaxation of its COVID-19 lockdown policies presents a potential green shoot for the Australian economy, as Chinese demand recovers and supply chain issues improve. There is also a growing consensus that global inflation may now have peaked and evidence of improved workforce availability.

However, the success of the Reserve Bank of Australia’s finely balanced strategy to efficiently tame inflation without “the cure proving worse than the illness” remains key to the near-term health of corporate Australia.