Bankruptcies Show a Surprising Decline

(Bloomberg Businessweek) -- When the Covid-19 recession hit it seemed certain that a wave of bankruptcy filings would follow, swamping the court system and possibly even leading to a systemic collapse. Oddly, though, there hasn’t been any wave. By one key measure, bankruptcy filings have actually declined from last year.

While Chapter 11 filings overall are up 21% from last year, that number has been swelled by a sharp increase in filings by companies that have multiple affiliates, each of which files separately, says Ed Flynn, a consultant to the American Bankruptcy Institute. Counting just parent companies and those with no affiliates, Chapter 11 filings are 28% lower for March 1 through Sept. 30 compared with the same period a year earlier, according to Flynn’s calculations. “It’s kind of amazing,” he says.

For the week ended Oct. 4, total filings under all bankruptcy chapters (7, 9, 11, 12, 13, and 15) were down 32% from the same week a year earlier, says Flynn.

This is mostly good news—a sign that companies and households aren’t as stressed at this stage as many economists and bankers expected them to be. “This really seemed like it had the potential to be a huge collapse,” says David Mericle, chief U.S. economist of Goldman, Sachs & Co. “For most people, and I would include myself, this has come as a pleasant surprise.”

On other hand, bankruptcy filings aren’t a perfect measure of hardship. Many companies are barely hanging on and could be forced to file soon if a new round of coronavirus relief isn’t forthcoming. Also, many small businesses and low- to middle-income households go bust without ever showing up in federal bankruptcy court.

Goldman Sachs economists have been tracking the recession and recovery since April. Mericle summarized their latest findings in an Oct. 7 note to clients titled “The Surprisingly Limited Scarring Effects from the Pandemic Recession.” In addition to citing favorable bankruptcy data, the note says that many businesses that closed have since reopened, and that there has been a surge in business formation, to a rate about 50% higher than the average of the past decade.

On the household side, Mericle’s note says, employment has rebounded, and about half of those who remain jobless say they’re on temporary layoff—which means they could be called back to work soon if conditions continue to improve. What’s more, about 60% of the remaining unemployment is in industries that are virus-sensitive and “will likely benefit from a surge in demand once a vaccine becomes widely available, which we expect in the first half of 2021,” the note says.

Goldman Sachs economists challenge some bankruptcy statistics that appear threatening. Bloomberg’s Corporate Bankruptcy Index, which covers companies with at least $50 million in liabilities, has more than doubled to around 223 from under 100 in February, but Mericle writes that Goldman Sachs credit analysts have concluded that many of the companies that filed, including some retailers and energy producers, were already weak, “not otherwise healthy businesses needlessly sunk by an unprecedented shock.”

The economists also dispute a recent study by the Federal Reserve Bank of San Francisco that says the insolvency risk for nonfinancial U.S. companies is “comparable to the peak of the 2008 global financial crisis,” and “Chapter 11 bankruptcy filings are running at their fastest pace since 2013.” That increase is mainly because of a change in the bankruptcy code that went into effect earlier this year making Chapter 11 more attractive, the Goldman note says, and has been offset by a decline in other types of bankruptcy filings. (This explanation is different from, but compatible with, the explanation of Ed Flynn of the American Bankruptcy Institute.)

Mericle attributes the lower-than-expected number of bankruptcy filings to three things: federal relief, including the $500 billion-plus Paycheck Protection Program; a sharp rebound in business activity; and forbearance by landlords, lenders, and suppliers.

You might expect small companies to fare worse because they have fewer options for raising money if they get in trouble. Aside from the cash they generate, they rely mostly on bank loans, in contrast to large companies that can issue shares, bonds, commercial paper, and so on. Yet the National Federation for Independent Business reported on Oct. 1 that business for its members is so strong that finding qualified workers is one of their main problems. The federation’s Small Business Optimism Index rose above its 46-year average in August.

That’s not to say all is well. The NFIB announced on Oct. 7 that 86% of its members that received Paycheck Protection Program loans have spent all the money and 49% “anticipate needing additional financial support over the next 12 months.”

“Financial distress is going to have a long tail before it shows up in bankruptcy court,” says Robert Lawless, a professor at the University of Illinois College of Law and administrator of the blog Credit Slips.

“We should be happy that there aren’t more filings, but I don’t think we should extrapolate that out to not worrying about future bankruptcies,” agrees Ed Tillinghast, a bankruptcy lawyer who is a partner at Sheppard Mullin, an international law firm. “The longer this goes on, the more difficult it’s going to be for businesses to manage.”

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