The insolvency time bomb: prepare for a record-high increase in insolvencies, the collateral damage of the Covid-19 crisis

The Covid-19 crisis will trigger a major acceleration in business insolvencies due to both the suddenness and historic size of the economic shock and its expected lasting effects, according to a new study by Euler Hermes, the world’s largest trade credit insurer. These lasting effects are critical for companies that were already the most fragile before the crisis and are now among the sectors hit the hardest by measures to contain the pandemic (transportation, automotive, non-essential retail, hotels and restaurants).

At a global level, Euler Hermes’ insolvency index is expected to surge to a record high of +35 percent cumulated over a two-year period (after +17 percent in 2020 and +16 percent in 2021) as the global economy faces a U-shaped recovery from the Covid-19 crisis. This would represent a +16 percent  year-on-year CAGR over the two-year period, similar to the intensity recorded on average amid the 2008 financial crisis.

Unlike in 2007-2009, all regions and countries are expected to post double-digit increases in insolvencies, with the biggest surges seen in North America (+56 percent by the end of 2021), followed by Central and Eastern Europe (+35 percent) and Latin America (+33 percent). In Asia, Euler Hermes expects an increase of +31 percent by 2021, and in Western Europe +32 percent.

However, countries will see asymmetric trajectories over 2020 and 2021 due to uneven initial conditions, as well as differing strategies of emerging from lockdowns and different emergency policy measures, in particular regarding temporary changes in insolvency frameworks. Two out of three countries will post a stronger rise in insolvencies in 2020 than in 2021 – notably the U.S., Brazil, China, Spain and Italy – while one out of three would record an acceleration in 2021 – notably India, the UK, France and to a lesser extent, Germany.

“So far, government interventions to prevent a liquidity crunch for corporates, including tax deferrals, state loans and guarantees, wage subsidies and debt moratoriums, have helped limit the immediate translation of the Covid-19 shock into official insolvencies in many countries. But if this policy relief is withdrawn too fast, we expect the increase in insolvencies to be +5 to +10pp higher,” says Maxime Lemerle, Head of Sector and Insolvency Research at Euler Hermes. “At the same time, prolonging support for too long could prop up ‘zombie’ companies, increasing insolvency risk in the medium to long term.”