Six months ago, corporate distress began to rise once again as the extraordinary fiscal support unleashed during the Covid-19 pandemic began to unwind. Today, the latest edition of The Weil European Distress Index shows that this uptick has morphed into a sharp spike, as the War in Ukraine, persistent supply chain disruption, inflation and the cost of living have all borne down on business.
At Weil, we define corporate distress as uncertainty about the fundamental value of financial assets, volatility and increases in perceived risk. This manifests itself in the disruption of the normal functioning of a company’s financial performance. There are several common characteristics of corporate distress: liquidity pressures, reduced profitability, rising insolvency risk, falling valuations and reduced return on investment.
Our index of over 3,750 listed European corporates shows that several factors have driven the current spike. There has been pressure around risk metrics – such as the debt-to-equity ratio and interest cover – as well as a squeeze on liquidity, weaker investment and a sharp deterioration of market fundamentals.
As a study of the underlying financial performance of companies over the last three months, our findings make for sombre reading. In the two most recent major crises, the Global Financial Crisis and Covid-19 pandemic, The Weil European Distress Index peaked in advance of the S&P European Speculative Grade Default Rate. And this time, central banks are hiking rates to combat inflation.
We can see that secondary bond markets have been pricing in higher risk for junk-rated borrowers. The value of the ICE BoA Euro High Yield Total Return index value FTSE Pan-European High-Yield Bond Index is down 4.6% since the start of June and 13% since the start of 2022. Meanwhile, the average offer price on a European leverage loan as measured by S&Ps European Leveraged Loan Index is 91.97, down 2.02% so far in June and 5.17% down since the start of the year. The index closed June 2021 at 98.76.
In short, corporates are entering a period where they need to pay more for their debt, just as their underlying businesses are coming under pressure.
How is this going to play out? Inflation will take a long time to unwind if current economic and geopolitical pressures continue to weigh on the market. To combat rising distress levels, governments need to concentrate on implementing policies for economic growth. And corporates coming under pressure need to act early. Better a debt restructuring than a full-blown insolvency.
All the indicators, however, point to a rise in corporate defaults.
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