A guest post by Niall McGeever (Central Bank of Ireland) on new company registrations and corporate insolvency in Ireland during the pandemic. [Disclaimer: This blog represents the author’s views and not those of the Central Bank of Ireland]
The severity of the COVID-19 shock
and the modest liquid asset holdings of many Irish firms (Financial Stability Review 2020 I; McGeever et al., 2020) raises the
question of how the pandemic is affecting business dynamism and failure rates. A
marked reduction in new firm formation or a spike in insolvencies could lower
the productive capacity of the economy and negatively affect output and
There’s lots of economic research
showing the importance of new firms for productivity and employment growth. Lawless (2013),
for example, shows that young firms contribute disproportionately to employment
growth in Ireland.
While a certain level of insolvency over time is inevitable
and even desirable to ensure resource re-allocation to productive firms, the
failure of otherwise viable firms due to the pandemic could reduce output and
productivity growth. See Lambert
et al. (2020) for more discussion on this point.
The chart below, Figure 2 from the Letter, shows the new company registration rate between January 2001 and September 2020. The rate averages around 9.5 per cent per annum and is broadly pro-cyclical.
The initial Covid-19 shock coincided with a sharp decline in new
company registrations, with the rate falling to 5.3 per cent in April and 6.1
per cent in May. The Companies Registration Office tell us that over 90
per cent of applications to register a new company are made online, so the
decline in April and May cannot be explained by procedural delay due to the
pandemic. Instead, it likely reflects a temporary decline in both new
enterprise formation and stalled investment decision-making by pre-existing
The largest declines during this period were, perhaps
unsurprisingly, in Accommodation and Food and in Arts, Entertainment and
Recreation. New registrations in these sectors were down 50 per cent on the
same period in 2019.
Whilst the number of registrations in the first nine months of
2020 were down around 12 per cent on the same period of 2019, new company
registrations rebounded quite strongly over the summer and had returned to
roughly pre-pandemic levels by September. An emerging trend in the
Wholesale and Retail trade category is the consistent increase in new
registrations in “retail sales via mail order houses or via internet” and in
“other retail sales not in stores, stalls or markets” between June and
September relative to the same period in 2019. This trend is also reflected
Census Bureau data, for example, shows higher new business applications by
non-store (e.g., internet sales) retailers during 2020.
We next look at insolvent liquidations. The next chart (Figure 4 in the Letter) shows the insolvent liquidation rate from January 2001 to September 2020. The rate generally tracks macroeconomic conditions very closely and it is worth noting that it rose notably rose with the unemployment rate in early 2008.
immediate impact of Covid-19 shock was to sharply reduce insolvent liquidations. The annualised rate was
exceptionally low at 0.07 per cent in April 2020 and only a touch higher at
0.10 per cent in May. This is due principally to the inability of company
directors to safely convene creditors’ meetings. Prior to the pandemic, it was
a requirement to hold a physical meeting with creditors to initiate a
creditors’ voluntary liquidation. This became impractical during the acute
phase of public health restrictions and so the main channel for insolvent
liquidations was blocked. This procedural issue was quickly resolved and the
Oireachtas passed a company law amendment to facilitate creditors’ meetings by
liquidation rate reverted to pre-pandemic levels in June and showed no signs of
a marked increase up to September. At a sectoral level, Accommodation and Food
and Wholesale and Retail Trade show signs of higher liquidations both during
the pandemic and relative to 2019. These patterns are aligned with the negative
labour market shocks in both sectors.. To a lesser extent, we also see the Arts
and health sectors recording higher numbers.
clear evidence of financial distress facing many firms, there is no evidence yet
of a marked increase in corporate insolvencies. The striking contrast between
the insolvent liquidation rate and current labour market conditions is unusual
and points to the significant role of government supports, loan payment breaks,
and forbearance from other creditors in helping firms to stay cash-flow
Today the Bank published its fourth and final Quarterly Bulletin for 2020. The report contains a detailed overview of developments in the economy since the publication of last Bulletin in July as well as our latest macroeconomic forecasts out to 2022.
The forecast for GDP growth has been revised upwards to -0.4 per cent in 2020 reflecting more positive developments in consumption, strong export performance and an enhanced level of fiscal support arising from the July stimulus package. Growth prospects for next year and 2022 are more subdued compared to the previous Bulletin due to the implications of a WTO Brexit. As outlined Box A, a disruptive transition to a WTO trading relationship would frontload associated output and employment losses. In this baseline scenario, the growth rate of the Irish economy is 2 percentage points lower in 2021 relative to a Free Trade Agreement due to the introduction of tariff and non-tariff barriers. The ILO unemployment rate is projected to average 5.3 per cent for this year, rising to 8 per cent in 2021 following the closure of income-support schemes at the end of the first quarter (Box D in the Bulletin discusses the challenges that arise for measuring unemployment in the time of COVID-19).
Since re-opening from a period of lockdown, the recovery of the
Irish economy has been uneven as levels of domestically focussed economic
activity remain well below pre-pandemic levels. In particular, consumer-facing services
sectors, such as tourism, hospitality and retail services, which are also more
labour-intensive, have been slower to recover contributing to a projected
decline in underlying domestic demand of 7.1 per cent this year. The strong
performance of exports, which are expected to decline by just 0.3 percent in
2020, is the main factor driving an upward revision in the baseline projection for
GDP. Box C details the
relative resilience of high-value exports such as computer services and
pharmaceuticals during a period of declining trade-weighted world demand.
The Central Bank’s Business Cycle Indicator (BCI), a monthly
summary indicator of overall economic conditions estimated from a larger dataset
of high-frequency releases, fell sharply during the months of March and April
reaching a historical low (Figure 1). The latest estimates show that economic
conditions continued to improve into July and August, but the rate of recovery has
slowed down. Despite the improvement over the four months to August, the
overall level of the BCI remains substantially below that observed prior to the
emergence of the COVID-19 crisis.
Figure 1: Business Cycle Indicator (BCI) for Ireland’s Economy
The outlook remains highly uncertain, depending not only on the economic
consequences of COVID-19 and its containment, but also on the nature of the
trading relationship between the EU and the UK. Recognising this uncertainty, Box E analyses the
impact of a ‘severe’ COVID-19 scenario as an alternative to the baseline
forecasts in which there is a strong resurgence of the pandemic, leading to the
restoration of widespread and stringent containment measures for a more
prolonged period. Underlying domestic demand is projected to fall by 8.5 per
cent in 2020 in this case with a continued contraction of -1.3 per cent into
2021. While the economy does not begin to recover until 2022, underlying
domestic demand remains 6 percentage points below 2019 levels. In the ‘severe’
scenario, the unemployment rate rises to 12.5 per cent in 2021 before
moderating to 10.1 per cent the following year.
A guest post by Fergal McCann (Central Bank of Ireland) on SME finances and firm supports during the pandemic.
The Central Bank has published a Financial Stability Note, written by Derek Lambert, Fergal McCann, John McQuinn, Samantha Myers and Fang Yao, entitled “SME finances, the pandemic, and the design of enterprise support policies”. The Note estimates the likely losses that are being experienced in the SME sector over from March 2020 to year end, introduces a model of SME financial distress which can be used to evaluate the effect of announced SME support policies, and discusses policy implementation issues in the current climate.
Aggregate revenue shortfalls We begin by updating an aggregate model of SME revenue shortfalls. McGeever, McQuinn and Myers (‘MMM’, 2020) used a first variant of this model to estimate three-month initial liquidity needs for SMEs of €2.4bn to €5.7bn. We update this model to account for reported reductions in wage and non-wage costs, using both PUP/TWSS take-up rates and CSO surveys on the business impact of COVID-19. Firstly, we show that, using observed data, our estimates for Q2 are at the very high end of the MMM estimates, suggesting the effect of the COVID-19 shock is about as severe as we were willing to project back in March/April when the initial MMM work was being carried out. Revenue shortfalls for 2020 are estimated between €10.3bn and €11.7bn across the SME sector, which are of course subject to significant uncertainty, both due to the uncertain outlook and the use of firms’ survey responses during the pandemic.
We highlight in the paper that such aggregate revenue shortfall estimates are not necessarily estimates of the size of required government support. These shortfalls already account for wage cost reductions through the TWSS. In aggregate, these shortfalls can be met by a combination of utilisation of pre-existing cash reserves, draw-down of existing credit commitments, new borrowing, additional cost reductions or loss-sharing, or if necessary governmental non-wage grants, reliefs and guaranteed loans. In this vein, we also model that across the board non-personnel cost reductions of 30 per cent could have large effects in reducing the overall shortfalls, suggestive of the importance of burden-sharing and cost efficiencies, along with fiscal support, in addressing the crisis.
Protection or liquidation We outline considerations for designing policy responses to
SME financial distress. Some enterprises entered the COVID-19 shock with
unsustainable business models and during a typical downturn the closure of such
companies can be seen as part of the overall process of economic restructuring
and dynamism. However, identification of such firms is difficult given the
nature of the COVID-19 shock.
There is a risk that, if traditional financial signals were being used, widespread liquidation could arise in the short run. We also point out that there are employee, supplier and customer relationships tied up in all firms, with relationship-specific capital on the line as firms are liquidated. Blanchard, Philippon and Pisani-Ferry (2020) summarises much of our thinking in this area:
“In normal times, policies should help the reallocation process, letting some firms fail and others expand, and helping the reallocation of workers across sectors. These are not normal times, however: many firms may fail because they are insolvent even if they are viable. Given the very high uncertainty, banks may be reluctant to advance credit. Unemployment is extremely high, making it difficult for laid off workers to find other jobs. For these reasons we think that protection (of workers) and preservation (of firms) should be given a higher priority than in normal times.”
Despite the above, we of course acknowledge that those designing SME supports must do whatever feasible to use taxpayer funds as efficiently as possible, given the nature of deficit dynamics during the pandemic. Targeting is difficult, especially in the current climate, but it is not fiscally or economically sustainable for supports to be provided without regard to viability, particularly as the likely duration of the pandemic period elongates.
Firm supports: loans, grants or equity? Outside of the over €5bn that will be used to support wages
through the TWSS and EWSS, there is a 60/40 split between debt and grants in
the announced SME support packages. If tax warehousing is accounted for as a
debt, this rises to 70/30. We point out that the amounts announced are committed funds – in the case of
debt-based supports in particular, final take-up rates are unknown.
We highlight the risk that debt-based supports may have weak
demand from firms wary of borrowing, may lead to debt overhang issues over the
medium term and face implementation issues when channelled through lenders. However,
debt-based supports benefit from lenders’ access to information and incentives
to screen credit risk, in cases where banks retain appropriate levels of risk
(such as the 80-20 split embedded in the Irish Credit Guarantee Scheme).
Direct fiscal supports, such as grants or tax or rate waivers, provide liquidity and support the economy but raise issues regarding costs, targeting and moral hazard. Relative to a guaranteed loan, where costs only arise as defaults occur, grant funding is far more expensive up-front for the taxpayer. One potential option to address this drawback is for the State is to provide equity-like or “conditional grant” injections to SMEs which involve an element of clawback or potential return, lowering the cost of intervention relative to a direct grant. In this light, the proposal of Boot et al. (2020) is worthy of further consideration, where higher future tax rates are agreed in exchange for up-front aid.
A model of financial distress Finally we present key results from a forthcoming model of SME financial distress (McCann and Yao, 2020). The financial distress (FD) indicator is based on SMEs’ capacity to meet losses through cash holdings, or to service interest expenses during the shock. We calibrate 2018-2019 data on SME balance sheets to the revenue and cost reductions reported by SMEs in 2020, and use the model to assess the role of various policy support options.
Relative to a no-policy scenario, we implement firms’ lowering of wage costs, both through TWSS wage supports and the transition of employees to the Pandemic Unemployment Payment (PUP), as well as non-wage policies worth €7.5bn, capturing the role of the credit guarantee, other lending, tax warehousing and enterprise grant policies. When the full package of policies announced in 2020 are included in the model, distress rates fall from 18.7 to 15.8 per cent (or 25.9 to 14.9 per cent when weighting firms by their debt balances outstanding).
Why does a cohort of SMEs remain in financial distress (FD) after policy supports are modelled? There are a number of factors at play. Firstly, the schemes’ total availability of €7.5bn means there is an aggregate maximum on the number of SMEs that can access funds. Secondly, specific schemes have specific maximum amounts, which in the cases of those experiencing the most severe financial effects of the pandemic, may not suffice to alleviate FD. Thirdly, the schemes have reasonably wide eligibility criteria, often related to firms experiencing a fall in revenues of a certain amount. This means that many firms that were never at risk of entering FD by our definition are just as entitled to draw down funds as firms experiencing the greatest losses. This issue of widespread access to funding was a necessary feature of scheme designs across the globe in response to the pandemic.
The latter finding on debt-weighted distress suggests that support schemes will have more beneficial financial stability effects than are visible when looking at a simple share of enterprises falling into financial distress. The greater efficacy of policy in lowering debt-weighted distress relates to the tendency of larger SMEs to have larger debts, implying that these firms draw down larger amounts of total scheme funds available, as well as to the concentration of SME debt among affected sectors such as the accommodation, food, wholesale and retail sectors. The table below reports the impact of the sequential addition of specific policy supports, highlighting that the effects of lowering wage bills through PUP and TWSS are larger than the effect of other supports.
Financial Distress (%), by firm count
Financial Distress (%), by debt balance
+ Income and Wage Supports
+ Tax Warehouse
Finally we show that, relative to currently calibrated support policy, a hypothetical “viability-based” grant system that targets firms based directly on the size of their operating losses, supporting firms closest to viability first, would reduce distress rates to about half the levels modelled under currently-designed policy (comparing the middle and right hand side sections of Figure 1). Such a hypothetical system would prioritise solely the minimization of the financial distress rate, for a given fiscal outlay, and is therefore not intended as a specific recommendation but rather to illustrate the effect of current supports relative to a benchmark model. In practice of course, policy must take on board sector-specific, regional and longer-run considerations that go beyond solely the minimization of financial distress rates.
Source: Model-based estimates from McCann and Yao (2020). Notes: “Targeted Grants” replicate payroll supports modelling from the “Current Supports” scenario, but replace the grant, credit and tax components with a €7.5bn grant that provides support to firms in order of their viability (with firms closest to exiting financial distress receiving support first). By construction, the debt-weighted exercise relates only to firms with debt balances above zero in the 2018-19 data
Conclusions and wider policy issues The model suggests that existing policy supports are likely to have mitigated SME financial distress in some cases, but challenges will remain for a relatively large group of SMEs. From a policy perspective many of the firms modelled as being in financial distress may be viable over the medium term – the identification of FD does not imply enterprise liquidation. This points to the importance of a dual approach to policy for SMEs, where targeted and effective financial support is required in the first instance, but a focus is also placed on the system-wide capacity to restructure the liabilities of potentially-viable firms. This latter step will ensure that the set of firms with the greatest prospects of survival over the medium term are given a chance to trade through the current challenges posed by the pandemic. The Central Bank is a key stakeholder in this process, with oversight of lenders’ approach to loan restructuring as SMEs’ payment breaks begin to expire. The Central Bank’s approach to this process was outlined by Deputy Governor Ed Sibley on Monday September 28th and can be accessed here.
References McCann, Fergal and F. Yao (2020, forthcoming), Modelling financial distress in SME sectors during the Covid-19 pandemic – from liquidity to solvency, Central Bank of Ireland, Mimeo. McGeever, Niall, John McQuinn, and Samantha Myers (2020). SME liquidity needs during the COVID-19 shock. Central Bank of Ireland Financial Stability Note, 2020 No. 2
Over the last fortnight, the Central Bank has published several articles and new data on trends and policy challenges relating to credit.
This includes articles on payment breaks for mortgages by Ed Gaffney and Darren Greaney and for firms by David Duignan and Niall McGeever, as well as enhanced statistics on mortgage arrears by David Duignan, Andrew Hopkins, Ciaran Meehan and Martina Sherman. The new data shows a “persistently high number of PDH [owner-occupier] mortgages that remain in long-term arrears some ten years on from the financial crisis”.
To coincide with a Central Bank Webinar on Distressed Debt on Monday 28 September, Fergal McCann and Terry O’Malley published an article on “Resolving mortgage distress after COVID-19: some lessons from the last crisis”. The article is presented as a “stock-taking exercise as COVID-related [payment breaks] begin to expire”. It draws on the lessons of the last decade, emphasising the need for early engagement and a focus on long-term sustainable solutions. The paper also provides rich new information on the financial position of borrowers as they engaged with the restructuring process over the last decade, highlighting the sharp falls in living standards that had been experienced by many. It also provides clear evidence of the role of deeper up-front payment relief in explaining lower re-default after modification Finally, it highlights the need for lenders and credit servicing-firms to put in place plans and capacity to help customers in financial distress.
The paper uses data from the latest wave of the Household Finance and Consumption Survey (HFCS 2018) to track changes in the financial position of Irish households between 2013 (the last survey) and 2018. The CSO carries out the survey in Ireland. It is part of a wider cross-country project examining household wealth, income and consumption, coordinated by the ECB.
While carried out prior to the outbreak of COVID-19, the HFCS survey provides insights into issues relevant to the assessment of the economic impact of the pandemic on Irish households. For example, the data highlight the improved financial position and resilience of households prior to the COVID-19 crisis, than was the case leading into 2008. Moreover, these data highlight distributional considerations and differences between households that align with the asymmetrical effects the COVID-19 induced economic shock has had on households, including along age, employment sector and housing tenure status dimensions.
Key developments between 2013 and 2018 When comparing changes between 2013 and 2018, it is important to consider the economic context under which both surveys were conducted. In many respects, 2013 reflects the low point of the recession following the financial crisis; by 2018 the economic recovery was well underway. With this in mind, it may come as little surprise that the financial position of many households in Ireland improved considerably between waves.
We observe that household net wealth grew by over €76,000 for the median household – or by 74 per cent – to €179,200 between 2013 and 2018. House price growth and declining mortgage debt were the primary drivers of this development.
Net wealth increased across the entire wealth distribution, while inequality, as measured by the gini coefficient, fell between waves. Key to this was the decline in negative equity, which fell from 33 per cent of mortgaged households in 2013 to 4 per cent in 2018. Median gross household income surpassed its previous peak in 2007, reaching €47,700 in 2018. Combining household wealth and income, we find the two are closely linked and that relatively higher income households also tend to be wealthier households — although the relationship is not one-for-one.
Economic implications Compared to 2013, households were more resilient in 2018, with debt to asset and debt to income ratios falling significantly between survey waves. These improvements are particularly pronounced for those between 30 and 49 years of age. The debt service burden – the cost of servicing debt repayments to (gross) income – has also fallen since 2013, primarily due to rising incomes. Net liquid assets – the sum of liquid assets less non-collateralised debt – are a commonly used financial buffer metric. The proportion of Irish households with net liquid assets increased to 72.6 per cent in 2018, while the median value of these financial resources increased from €2,000 to €3,000 2018.
To better understand the resilience of indebted households to negative shocks, Table 1 shows the proportion of households by debt-service bucket in 2018, where savings account for at least three mortgage payments. Over two thirds (67.8%) of lower debt service households – that is households with mortgage repayments less than 5% of their gross income – have savings at least three times that of their regular mortgage repayments. Looking at households with the highest debt service ratio (>40% of income), we find that 42% of these households have savings of at least three times that of their regular mortgage repayment.
Turning to household spending patterns, we find that the gross income share that households regularly spend on goods, services and housing varies substantially by income. The average household spends about 80 per cent of their income. Those in the bottom income quantile, on average, report spending more than their income on regular expenses. For the 13% of households that report having expenses greater than their income, typical strategies employed to bridge the gap include using savings, especially for middle income households; getting help from friends and family, especially for lower income households; and using credit cards and overdrafts.
In line with other data sources, homeownership rates have fallen while the share of those renting accommodation has risen. Over 60 per cent of recent owner-occupier home-buyers were under the age of 40 at time of purchase. Almost 30 per cent of recent buyers report receiving an inheritance or gift within three years of their house purchase with a median value of €25,000 (self-reported). The prevalence of inheritance was lower for older borrowers, however the amounts they received tended to be higher.
House price developments play a key role in changes in the net wealth position of Irish households. The ‘collateral channel’ argues that wealthier households have easier credit access. We do find that households are less credit constrained in 2018, which holds true for younger and older households, and for homeowners and renters. Although we cannot rule-out improvements on the supply-side as a driver of this development.
In the mid-2000s, housing equity was used by many households to fund both consumer spending (often on durables) and investment (often in more housing). This peaked in 2006/07, when the value of housing equity withdrawal for the household sector was equivalent to some 10 per cent of income. When house prices fell sharply, this had real effects on spending and investment. In the paper we show that, despite housing wealth in 2018 exceeding previous highs, the household sector as a whole continues to inject as opposed to withdraw equity. In 2018, injections were running at around 10 per cent of income (Figure 1). This reasons for relatively large ‘injections’ include the continued repayment of long-lived, large debts from the early-/mid-2000s, and a far lower level of top-up borrowing relative to the past.
The paper highlights several potential areas of future research using the HFCS data*. For example, we provide useful insights into how households can withstand unexpected income shocks and the financial resilience of households, which are particularly relevant in light of the COVID-19 crisis.
In many respects, we can see that households are better placed going into 2020 than they were leading into the last crisis in 2008. Given the healthier position of many household balance sheets in 2018. Our work indicates that, if house prices and/or incomes falls, we would not expect household debt to drag on spending in the same way it did going in to 2008. Incomes developments are therefore likely to be the primary determinant of consumer spending when the public health threat from COVID-19 recedes. Understanding the distribution of income shocks within the context of household wealth and income position will be important going forward.
(*) Datasets for research and analysis are available from both the CSO (the HFCS RMF) and the ECB. The ECB dataset also includes cross-country data for most countries.