January insolvency rise a sign of year to come: CreditorWatch

Insolvencies leaped 12.5 per cent in January and will keep heading up this year as the lagging effect of cash rate increases flow through the economy, CreditorWatch says.

The credit bureau’s chief economist Anneke Thompson said businesses were entering insolvency at a higher rate than before the pandemic and it would take several interest rate cuts before consumers began spending again.

“We’re already above pre-Covid levels, round about 0.7 per cent now,” she said. “In pre-Covid it was roughly 0.6 per cent of businesses. I think it's going to keep tracking upwards at least till the middle of the year. Interest rate rises have a strong lag effect and I think that lag effect is taking hold now.

“Business sentiment has been low for some time, but now business conditions are starting to fall. For businesses that are marginally profitable at the moment - a few of those will fall into insolvency.”

ASIC figures released last week showed January’s increase was led by the accommodation and food sector with 75 failed companies in the month (up 21 per cent on the same period last year) and construction, with 107 failed companies (up 29 per cent).

Between them, they accounted for almost half the 404 businesses entering administration.

Ms Thompson said CreditorWatch analysis – which segmented the sectors slightly differently ­– put food and beverage services at the top of the danger list.

“For the food and beverage services sector demand is now falling,” she said. “That sector was doing OK until about the third quarter of 2023 but we actually spent less at cafes and restaurants in the busy Christmas period in December than we did in August, according to ABS retail trade data.

“So clearly, the lack of discretionary spending is having an impact on cafes and restaurants now.

“They're also grappling with high input costs – high rent, electricity, gas prices, labour costs, all sorts of things. Their costs are going up, but in some cases their revenue will be going down. So it’s tough out there for cafes and restaurants.”

On the bureau’s data, construction had the third highest rate of external administration and smaller companies in the sector were vulnerable despite government programs.

“The construction sector is still being impacted by high costs but also falling demand. The big renovation boom over the lockdown period is trailing off now and certainly a lot of households are putting renovation plans on hold so there's just less work out there.”

“Government work tends to benefit the companies big enough to build road projects and the Olympics in Brisbane.

“Where we see a lot of insolvencies is the smaller end. The sole operator or the small partnership that might have 15-20 houses on their books at any one time. They're the ones that are really struggling.

“They don't really benefit from government work. In fact, it has the opposite effect because costs keep going up if there's too much government work.

“A lot are just in that market where they're building houses in the suburbs, and they're just don't have the capacity or the capability to work on those government projects. They need a certain level of insurance and all sorts of boxes to tick to be able to work on those government projects and a lot of them can’t tick those boxes. They still get impacted by higher supply costs.”

Ms Thompson said government was also a factor in the bureau’s second most at-risk sector, administration and safety.

“There’s a lot of companies in the security sector – a lot of fly-by-nighters – and they had a lot of work during lockdown. There’s not so much security work now.”

Ms Thompson said the RBA would likely cut interest rates this year but discretionary spending would take a while to recover.

“It's going to take a couple of interest rate cuts for people to really be able to breathe a sigh of relief.

“I think one or two cash rate cuts, which is likely to happen this year, will obviously be welcomed by households but I think the money saved will just be ploughed into electricity bills and essentials. I don't think it will free up enough cash – two cash rate cuts – to really drive discretionary spending again.

“Once we get into 2025, though, and maybe two or three cuts then that will be the trigger for people to go out a bit more.”

She said the RBA would also be watching the jobs market closely.

“The labour side has really slowed down and my view is we might be in 4.5 per cent unemployment territory by the middle of the year.

“That will really get the RBA's attention because one of their mandates is to maintain full employment.”