Ominous signs from debt canaries

Adele Ferguson
July 10, 2013
The Age

When creditors are happy to accept an average of less than three cents in the dollar on debts owed, it is a portent of dark days.

When half the statutory demands served on small to medium-sized businesses result in no payment, it isn’t too far a stretch to think those dark days are closing in.

If the rising levels of company insolvencies and bankruptcies are thrown in the mix, along with the latest NAB business survey showing business conditions sliding to a four-year low, it should be a clarion call that the economic picture is even uglier than the official statistics would have us believe.

It explains a briefing paper to Victorian Treasurer Michael O’Brien last week that is understood to show that the downturn is widespread, with the billable hours of the state’s top law firms and accountancy firms down 25 per cent year on year.

Debt collection agency Prushka has been monitoring the trends for the past 12 months and likens the rapid deterioration in debt collection to the ”canary in the coalmine”.

According to Prushka’s Roger Mendelson, the figures from the group’s debt collection agency and legal arm show that of all the statutory demands served on behalf of Prushka over the past 12 months, 47 per cent across the country resulted in no payment. It says the amount recovered equated to 2.9 per cent of the total amount claimed. The reason? ”Creditors were prepared to accept very substantial reductions rather than face the cost and risk of proceeding to a petition to wind-up the respective company,” according to the agency.

To put it into perspective, a year ago only 20 per cent of statutory demands resulted in no payment and an average of 20 per cent of the total debt was recovered. This indicates a significant deterioration in debt collection and confidence.

Put simply an insolvency time bomb is ticking away in the small to medium-sized sector, which is a huge concern for the broader economy as SMEs employ 70 per cent of private sector employees.
The implication is that tens of thousands of companies – or even more – are technically insolvent, but are still trading because creditors are becoming increasingly cautious and prefer to recover a small amount of debt rather than spend the money chasing the full amount.

There is no doubt the system makes it hard for small businesses to chase debts. If a company fails to pay its debts, the creditor has to obtain a judgment. If undefended, this can take up to three months and cost at least $1000.

If still unpaid, the creditor serves a statutory demand. This is serious because if a statutory demand isn’t satisfied within 21 days, the company is deemed insolvent, which makes it in breach of loan covenants. The next step is to wind up a company, which costs about $5000.

A fraction of creditors proceed to this stage because of the costs and low chance of success. It helps explain why the latest ASIC statistics reveal just 941 companies entered external administration during April, compared with 869 insolvencies recorded in the previous corresponding period. While the figures were the highest on record since ASIC started collating the figures almost 15 years ago, they are still relatively low given the growing anecdotal evidence of SMEs reducing staff and going into survival mode.

It is a similar story on the personal front, with Insolvency and Trustee Service Australia (ITSA) releasing figures on Tuesday showing bankruptcies rising almost 8 per cent in the June quarter 2013 compared with the March quarter 2013. Over the past year the figures show that the proportion of debtors with business-related bankruptcies or debt agreements reached record proportions.

But these official figures are the tip of the iceberg. The fact that clients are reluctant to spend money winding up companies shows that things are far worse than any figures from ASIC and ITSA.
The brutal reality is official statistics don’t really show what is going on in large slabs of the economy. In addition, there is a time lag involved with the figures that do.

For Mendelson, it means more business failures in 2013, a rise in unemployment and a fall in tax receipts, which will combine to have a negative impact on the budget deficit. ”There is a risk, based on micro factors only, that a spiral will develop within the SME sector which could potentially lead to a recession. The spiral is caused by SMEs cutting costs, reducing business activity and therefore margins of their suppliers. This forces others to respond the same way, leading to a significant increase in unemployment which spooks the household sector and could lead to consumers cutting spending further.”

On the bright side, it means it won’t be long before the Reserve Bank starts thinking about another rate cut, particularly as the mining sector continues to wind back.

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