McGrathNicol report warns high numbers of insolvencies to continue

The surprisingly low rate of unemployment of 4 per cent, and the view that interest rates have peaked and will ease further this year, and a strong stock market are potentially providing a false sense of security about the outlook for 2025.

Insolvency and corporate restructuring experts McGrathNicol, one of the key advisory firms at the coalface of corporate distress, has issued a report that it expects the high numbers of insolvencies which emerged last year to continue this year.

“Insolvency numbers will remain high – at levels not seen since the global financial crisis – due to structural changes in the economy, input cost inflation and cost-of-living pressures,” executive chair Jason Preston says.

While the construction sector was responsible for the highest number of insolvencies last year, the report notes that the hospitality industry is now increasingly becoming represented in insolvency numbers.

Companies in Australia, Preston says, are under pressure from a number of structural problems including the need to cope with the energy transition as well as having to deal with persistently higher inflation levels and increasingly strict levels of regulation which is hitting some sectors particularly hard.

The report notes that restructuring activity, as companies attempt to do what they can to stave off insolvency, including deals with lenders, “has skyrocketed to levels not seen since the GFC”.

“The current macro economic settings are more difficult now, than what businesses are facing a few years ago,” he says.

“We expect the lingering effect of inflation will keep consumer and business sentiment weak for some time.”

The firm says it is seeing a shift in the type of companies in distress from those which have some specific problems with their capital structure, “to more substantive restructuring of fundamentally broken business models”.

The report notes that the Covid years helped to mask problems in companies which had problematic business models, thanks to a combination of government spending and a long period of ultra-low interest rates.

But with the Covid years behind them, it reports that “companies have woken to inflation, higher borrowing costs, and in many sectors, such as gambling and health care, a heightened regulatory environment creating a perfect storm for financial distress”. It warns that as 2025 continues and the challenges get worse for some specific companies and sectors, “more parties will need to agree to a compromise situation to avoid insolvency”.

In a briefing for journalists on Wednesday, Preston and his team were even clearer – reporting that the size of companies facing financial problems and potentially going into insolvency is increasing and can be expected to increase further with more employees affected. They note that the big banks are now boosting the numbers in their workout teams – another sign of the times in the underside of the economy.

Another factor which will make it harder for companies to work their way out of problems is an increasingly hard line from the Australian Taxation Office, which is now strengthening its resolve to collect $50bn in taxes unpaid.

Instead of taking the more benign approach it did in the immediate post-Covid years, they say the ATO is now less willing to work with companies under financial stress and wants its money back.

This includes putting increasing pressure on directors by issuing director penalty notices, now so widespread they are generically known as DPLs.

McGrathNicol executives reported that directors of distressed companies were now more worried about dealing with the ATO than their lenders given the potential personal liability issues with these notices.

Another problem which is emerging is the fallout from the increasing use of private credit in Australia.

A combination of banks withdrawing from certain sectors such as the riskier end of the property market and the availability of credit from private equity funds and investors looking for higher rates of returns has helped drive the rise of private credit around the world.

Private credit is being seen as another investment opportunity for cash-rich super funds.

“Australia’s private capital markets are also going through a transition with private debt almost surpassing private equity funds raised,” the report notes.

The firm’s executives at the briefing on Wednesday reported increasing concerns now being registered with them from players in the private credit space, which have stepped in to lend in areas such as property, where the banks have pulled back, with riskier lending deals.

Some of these firms, they reported, are now having to deal with borrowers with financial problems – a side of the business these new players to the lending side have not had to work on in the past.

While they point out that there is still a lot of liquidity in corporate Australia at the moment, it comes with its risks.

Corporate regulator ASIC has also this week signalled its concern about the rise of private credit in Australia, wanting to get a more detailed picture of the size of the sector and its risks.

Issues of the valuation of assets, opaqueness of investments and liquidity in the private credit space are several areas of concern.

Another factor which could cause problems in future, the firm’s executives say, when current debt levels mature, companies will be facing higher levels of interest rates and stricter terms from lenders.

The Australian economy got through the Covid years much better than expected, with concerns that it would fall into recession disproved. But the strength has been in the public sector with persistently high levels of government spending while the private sector is much weaker as it battles higher costs, a permanently higher interest rate regime along with increased regulation and structural changes.

As Anthony Albanese mulls calling an election, the McGrathNicol’s bearish report would suggest the sooner he does it the better.