The growing burden of corporate debt

The rise in interest rates aims, among other things, to encourage companies to borrow less. However, globally, corporate leverage is on the rise. This increases the vulnerability of a growing number of SMEs. We warn of the consequences of upcoming interest rate hikes in the Eurozone and the United States.

Many transitions (electrification, digitization, robotization) assume that companies continue to invest in order to remain competitive. But margins are shrinking due to increased costs (salaries, energy, interest). Entrepreneurs are desperate to stay in the game and not fall behind, and are prepared to take on more debt for this purpose. But as interest rates continue to rise, they take hit after hit, with the consequence that weaker SMEs find themselves unable to meet their obligations.

We expect for Europe that 18% of SMEs in the UK, 10% in France and 7% in Germany would be in trouble if interest rates were to rise another 200 basis points.

Rising interest rates, combined with other factors, could also hit large companies hard and put them out of business. Johan Geeroms, our Director Risk Underwriting Benelux mentions the retail sector as an example. “In the first quarter alone, 11 distributors in this sector with an annual turnover of more than 50 million euros went bankrupt in Europe. Together, they represented a turnover of 2.4 billion euros. When large companies go down, it often has a huge impact on an entire network of suppliers and buyers.”

Businesses are going through a confusing time, marked by a lot of change and a lot of uncertainty. How will energy prices develop in winter? The labor market shortage. Geopolitical risks that could have a considerable impact. Think of the US elections, the war in Ukraine, and the upcoming deficits and budget cuts. In this climate of uncertainty, companies must also deal with banks and financial institutions which are increasingly tightening conditions and raising interest rates.

Despite rising interest rates, corporate debt is growing. Last year, the net debt of the largest companies increased by 6.2%. Many companies borrow money to refinance their current debt. A few years ago, borrowing money was still practically free. Those days are over, so old debts suddenly become a drag. For businesses already struggling, it is becoming increasingly difficult to borrow money.

According to Johan Geeroms: “We are entering a tense period which can evolve in two directions. The balance is precarious and it takes very little for significant regression to occur.”

Based on the numbers we have, we continue to expect the current mild recession in the Eurozone and later in the year in the US to end in a soft landing. We expect limited global GDP growth in 2023 and 2024. In 2023, +2.5% and in 2024, +2.3%. But this requires an absence of disturbing events or irrational acts. And central banks should not pursue excessively restrictive policies.

Inflation plays a major role. This should show a clear downward trend. But we expect the ECB to raise interest rates twice more this year (in July and September). We don’t expect any improvement before mid-2024.

“Continued high interest rates will lead to a considerable number of bankruptcies in the near future,” says Johan Geeroms.