Solvency crisis is still to come

Crunch time looms as the reckoning arrives for households and businesses unable to repay their loans.

The battle against Covid-19 is only half won. Picture: NCA NewsWire/Ian Currie

All around the world, central bankers and regulators have been congratulating themselves over the financial system’s resilience in the face of the most severe economic contraction since the Great Depression.

However, they know in their hearts that the battle against COVID-19 has only been half-won.

As Reserve Bank head of financial stability Jonathan Kearns said earlier this month, the liquidity aspect of the crisis is about to give way to a solvency phase as the reckoning arrives for households and businesses unable to repay their loans.

The scale can’t be estimated with any precision, although at the peak, 10 per cent of housing loans and 17 per cent of small business loans – worth a grand total of $260bn – had deferred repayments.

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With the contraction less severe than anticipated, deferrals now stand at $80bn, a little more than 3 per cent of both housing and SME loans.

Kearns said hibernating repayments had avoided unnecessary household and business defaults for borrowers facing temporary liquidity strains, as well as asset firesales which would depress property and other prices.

That’s the good part of the story, supported by a mid-December report from UBS bank analyst Jon Mott.

Mott said that since the outbreak of COVID-19, there had been concerns about the performance and outlook for SMEs, which accounted for only 14 per cent of outstanding bank credit but employed about 55 per cent of the workforce.

“As a result, we believe the health of the Australian economy is directly tied to a recovery in the SME sector,” Mott said.

“Although many businesses are still struggling, and some will inevitably fail, many SMEs are displaying resilience given substantial policy stimulus and an easing of lockdown restrictions.

“While SMEs are not out of the woods given the removal of stimulus due in March, we believe it is likely that the worst may be behind them and a recovery is on its way.”

The more unfortunate part is that there’s still an abundance of financial stress, and a lot of it hasn’t been brought to account because of government assistance packages, temporary protections against insolvent trading, and a new debt restructuring process for small businesses due to start on January 1 that is clouded with uncertainty.

As a result, there are fears that an army of zombie companies, which are alive only in name, has been unleashed.

John Winter, chief executive of the Australian Restructuring Insolvency and Turnaround Association, said the best example is the restaurant trade, where many eateries have handed back their leases but are still drawing on the JobKeeper program and had not yet been wound up.

“The tsunami of insolvencies has been pushed out to the latter part of next year but it’s definitely still coming,” Winter said.

“Our GDP is well down so there’s less money in the system which means businesses will have to close, and we’re down 60 per cent in insolvencies so we’re also going to have to play catch-up.”

While some forecasts of company failures as a result of COVID-19 are as high as 240,000, Winter believes such figures are a “very significant overstatement”.

He expects a five-fold increase on the normal annual figure of about 10,000.

In the current environment, doubts have also been expressed about the insolvency industry’s ability to cope with such a surge.

About half the industry is itself drawing on JobKeeper, because the various support measures put in place to minimise company failures have dried up revenue.

“No revenue is expected until the second half of next year but everyone is confident that the industry is capable of managing the big wave (of insolvencies) when it comes,” Winter said.