We Can’t Hold Off the Bankruptcy Wave Forever – Bloomberg

When Covid-19 first plunged Europe into lockdown last spring, there were plausible predictions of a tidal wave of corporate insolvencies. Thathasnt happened, at least not yet.

The number of companies declaring bankruptcy declined by about a fifth in the euro area last year, even as economic output contracted more than 6%. Firms were saved by overwhelming government support,including hundreds of billions of euros of public loan guarantees, wage subsidies and loan forbearance by banks. Rules were relaxed on when businesses must file for insolvency.

European bankruptcies are being artificially suppressed

Source: Eurostat

The big question is whether Europe has merely delayed the inevitable by propping up financially distressed enterprises (unkindlydubbed zombies by economists), or whether resurgent demand and accelerating vaccination rates can keep the bankruptcy wave at bay. Theres been more groundfor optimism recently but many company failures stilllookunavoidable.

Leaving aside high-profile implosions, like the ones at budget airline Norwegian Air Shuttle ASA, Topshop owner Arcadia Group and fraudulent fintech Wirecard AG, the recent insolvency trend has been the opposite of what usually happens in a recession.

Bankruptcies soared during the last crisis. This time they fell

Source: Coface

Compared with the U.S., where large companies such as car-rental giant Hertz Global Holdings Inc. and telecoms provider Frontier Communications Corp.had to file for Chapter 11 bankruptcy, some European countries have beenespecially forgiving. Germany recorded the smallest number of corporate insolvencies since at least 1999;English and French bankruptciesare the lowest in more than 30 years.

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With big parts of the economy left relatively unscathed by the pandemic, interest rates still at rock bottom, consumers ready to spend their pandemic savings and Europes 750 billion-euro ($900 billion) Covid recovery fund poised to start disbursements, its tempting to think the worst is over.

Policy makers, though, shouldnt consider the low number of insolvency filings in Europe as a sign of corporate health,the European Systemic Risk Board which oversees the continents financial system has warned.It noted that in a worst-case scenario the current calm might be the sea retreating before a tsunami.

Because of government loan guarantees, business failureswould also further damage public finances. Thats one reason Frances President Emmanuel Macron and other leaders are in a hurry to relax lockdown restrictions. Every day of lost revenues deepens the hole from which companies must climb.

Genuine zombie businesses those that were financially distressed before the pandemic but were able to avoid filing for creditor protection last year will, however, remain in that hole. Many insolvencies have been postponed rather than prevented, notes French credit insurer Coface SA. Euler Hermes, another credit insurer, expects global insolvencies to be 13% higher in 2021 than in 2019. In 2022 it expects insolvencies will be 27% higher than in 2019.

Given the circumstances, that would be a decent outcome. Even once-healthy companies are burdened with huge borrowings and reopening for business brings new risks.After a long hibernation firms have to rebuild inventory and rehire staff, potentially sinking them further into debt.The travel and hospitality industries face the biggest difficulties, which bodes ill for southern Europe where they account for a bigger share of output and governments have less fiscal firepower. Spain and Italy may see more insolvencies than Germany.

A tricky dance is now underway in which governments and lenders try to wean companies off financial support while separating businesses with sound long-term prospectsfrom the no hopers. Telling one from other isnt easy.

After a long hiatus Germany says over-indebted businesses should file promptly for insolvency. A German government backstop for the credit insurance that underpins vital trade expires next month.

And yet, with national elections looming in Germany and France and governments everywhere under pressure over their handling of the pandemic, theres a strong temptation to keep the cash spigot open. Look at how Paris has showered money on Air France-KLM. Britains small businesses have been given up to 10 years to repay so-called Bounce Backloans. Much of the 47billion pounds ($65billion) theyve borrowed will probably never be recouped.

Its no wonder European banks are sounding more sanguine about commercial lending. Lloyds Banking Group Plc and HSBC Holdings Plc have unwound some bad-loan provisions, while Austrias Erste Group Bank AG says the vast majority of customers resumed loan payments without delay.Even if this confidence turns out to be misplaced, the financesector is better capitalized now than before the last recession. Shareholders are more upbeat, too: The Euro Stoxx banks index has gained 23% this year.

Free-market acolytes will say Europes decision to prop up zombies has already done lasting damage by preventing labor and capital from shifting to more dynamic businesses. Creative destruction is essential to capitalism, they say. Productivity will suffer.

Thats too crude. While massive government intervention is often targeted poorly, it has preventedthe collapse of healthy businesses. Employees kept their jobs and banks were able to keep extending credit. Europes recession was brutal but it could have been much worse.

A year ago no lender or government could judge reasonably which companies prospects had been permanently impaired. By the summer they should have a much better idea. Some hard decisions await.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:Chris Bryant at cbryant32@bloomberg.net

To contact the editor responsible for this story:James Boxell at jboxell@bloomberg.net

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We Can't Hold Off the Bankruptcy Wave Forever - Bloomberg