Despite market turbulence in recent years, the European economy has shown resilience and is expected to slowly pick up throughout the second half of 2023 and 2024. However, countries more reliant on manufacturing and vulnerable to natural gas price increases may face greater pressures. While inflation is declining, core inflation remains persistent due to tight labor markets. As central banks view addressing the inflation risk as a key objective, it is expected that their rates will stay higher for longer (please see Jul 23 EY European Economic Outlook). However, markets do not need to be in recession to see increased restructuring activity.
Based on the EY non-performing exposures tracker for Q4 2022, while non-performing loan (NPL) stock has been at historic lows, NPLs are projected to increase, mainly due to rising interest rates. This is further supported by the European banks’ Stage 2 loans (those performing but with higher risk), which increased year-on-year by 0.5 percentage points – reversing the decreasing trend seen throughout 2021 and exceeding the previous peak of 9.1% in Q4 2020.
The challenges that lie ahead may further be demonstrated by ca. 14% increase y-o-y in Austrian corporate insolvency rates in the first half of 2023.
EY survey results indicate upward trends in restructuring activity both in the second half of 2022 and the first half of 2023. However, compared to the first edition of the survey, fewer respondents commented on this phenomenon and the stated reasons were more balanced (positive and negative developments).
On the positive side, the reasons included a better-than-expected economic recovery, governments providing ongoing support, banks being supportive to provide forbearance measures, companies quite successful in adapting to new business circumstances and especially, large corporates still having solid cash reserves.
However, these have been offset by ongoing pressures on the cost side, including energy, re-shifting supply chains to purchase at higher costs, COVID-19 moratoria ending and starting to repay old and new COVID-19 loans. More frequently noted were also increasing wage pressures. Furthermore, respondents largely stressed rising interest rates from the ECB and other central banks (Poland, Czech Republic, Hungary and Romania), which have put significant pressures on liquidity.
Additionally, a new theme appeared – weakening demand. Respondents frequently commented on consumers’ deteriorating ability to spend money driven by salary increases well below inflation levels, increasing cost of living (mortgage, food and beverage, and energy costs increasing) and money invested in assets with questionable cash flows and valuations to protect against inflation. These reasons have resulted in savings being depleted and people changing habits from spending to saving. This makes it increasingly challenging for corporates to pass through the increased costs to end demand.