- Ecclesiastes 12:4 And the doors shall be shut in the streets, when the sound of the grinding is low, and he shall rise up at the voice of the bird, and all the daughters of musick shall be brought low;
Business bankruptcy filings year-to-date are trending slightly higher compared with the same period last year, but industry experts warn the seemingly moderate escalation obscures the reality of a spike in fillings to come in the wake of the novel coronavirus pandemic.
“I think we will see bankruptcy activity on a scale that has not been seen in anybody’s business lifetime,” James Hammond, CEO of New Generation Research, Inc., which tracks business bankruptcy filings, told Yahoo Finance.
Chapter 11 filings, which give business debtors relief from creditors in order to reorganize and emerge with their companies intact, totaled 2,063 from Jan. 1-April 21, versus 1,736 through the same period last year. Chapter 7 filings, which involve liquidating a business, for the same period were about level year over year, with 1,262 so far this year, versus 1,253 in 2019. But experts expect the numbers to rise dramatically.
“The flood is coming,” Nick Montgomery, also of New Generation, said. “It has just been slightly delayed as companies resist succumbing, and the markets try and figure out how to triage all of the corporate patients.”
On Thursday, fresh data showed 4.427 million Americans had filed for unemployment for the week ending April 18 — in another sign that businesses are struggling and bankruptcies could be coming soon.
“In this recession that we have had over basically five weeks of unemployment claims going up — what’s missing so far is major bankruptcies on the part of any corporation,” MUFG Chief Financial Economist Chris Rupkey told Yahoo Finance’s YFi PM on Thursday. “… I’m just wondering if that’s the other shoe to drop.”
Why haven’t bankruptcies already skyrocketed?
While the current filing numbers look benign on their face, there are several reasons filings have not already skyrocketed despite COVID-19’s shutdown of the U.S. economy since March.
Harvard Law professor, Mark Roe, told Yahoo Finance that part of the delay is due to the fact that most companies, when hit with a shock, will exhaust cash sources first, and file for bankruptcy only when they have no other choice. Cash resources contributing to a delay could include the grants and loans made available to small and large businesses through the CARES Act, the $2.2 trillion coronavirus stimulus bill passed by Congress last month.
“Even if a company isn’t selling anything now, if it has some cash in the bank, or can draw on a bank line, or can somehow just push things along to kick the can down the road most companies will try to do that,” he said, adding that small businesses that have already entered bankruptcy are not eligible for the Act’s Payroll Protection Program.
Roe estimated that if the economy continues on its current trend, a surge in bankruptcies should be expected around September or October. In addition, he said, historical correlations exist between increased claims for unemployment and business bankruptcy filings.
“When unemployment claims shoot up, you tend to get an increase in bankruptcy filings three to six months later,” he said. On the other hand, a treatment for COVID-19 that turns the economy around could prevent such a scenario. “If it doesn’t, we should expect a surge,” Roe said.
There are other factors at play that could be delaying bankruptcies, including social distancing. That makes it challenging, if not impossible, for prospective creditors and liquidation buyers to evaluate and market a debtor’s residual assets, steps required to move cases forward, according to Hammond.
“If you’re having a liquidation event and nobody can show up to buy the liquidated material, then you have a price collapse, and that’s just simple supply and demand,” Hammond said. Even at a bargain basement price, he said getting rid of certain assets is a problem for both Chapter 7 and Chapter 11 filers, because nobody can go out to purchase the goods.
The problem hit New York City-based retailer, Modell’s Sporting Goods, which filed for Chapter 11 on March 11, and asked the court permit it to “mothball” operations after state governments ordered nonessential business closures that slowed its ability to conduct liquidation sales. The court granted a 30-day pause, and Modell’s subsequently asked for an additional 60-day reprieve.
The shaky ground on which debtors and creditors stand poses an additional hurdle for prospective Chapter 11 filers, because the proceedings typically rely not only on a company’s ability to liquidate assets, but also on its ability to obtain financing for everyday activity with debtor-in-possession (DIP) financing. Such financing is increasingly hard to come by.
Very few creditors are currently lending to sick companies, aside from those already committed to funding before the novel coronavirus struck, according to Montgomery. “Even healthy [companies] are scrambling to get financing,” he said.
The seizing up of capital combined with the inability of companies to liquidate assets, Montgomery said, is causing a fundamental change to how Chapter 11 is utilized. In normal times, speed is of the essence, he explained. Now, as exemplified by Modell’s two requests for delay, “All of a sudden we will want to use Chapter 11 to keep a debtor alive for a better day, and to some extent mothball, even in advance of Chapter 11.”
Retail could have a tougher time than energy
In the last two weeks, bankruptcy filings have been initiated by companies across a wide range of industries, including Frontier Communications Corp., LSC Communications Inc. (LKSD), True Religion Apparel Inc., Pace Industries, LLC, Longview Power LLC, Yuma Energy Inc. (YUMA), The Northwest. Other recent filers include retailer Pier 1 Imports (PIRRQ), which was approved to file for Chapter 11 protection in February, and the XFL football league, which filed April 13.
Certain industries looking to reorganize will struggle more than others, Hammond said. Energy is one area he sees as ripe for creditors to take on even with the newly introduced COVID-19 risk, while retail is less strongly positioned.
“It’s hard to see how a lot of businesses can survive on the retail side,” he said. “They were on the sharp end of the stick before COVID … but oil is the world’s most valuable commodity and it will be used again.”
Roe is concerned that too many bankruptcies at once could cause a negative feedback loop for the economy, because companies saddled with a larger percentage of debt spur less investment and hiring.
“If it’s everybody in the S&P 500 that’s heavily indebted, it’s a bigger problem…it becomes an economy-wide problem, instead of just a local problem.”
Bankruptcy lawyers are already ‘super busy’
Veteran industry players are already positioning to seize on valuable assets held by distressed companies. Hammond said the coming influx of claims also promises to open up bankruptcy business to newcomers who during the last couple of years have lamented that any business to be had was already spoken for.
“I don’t think it’s an accident that folks like Fortress are suddenly buying or raising enormous amounts of money for distressed assets,” Hammond said. “This is a long view that people are taking. You couldn’t have raised assets for this sort of thing two years ago. There wasn’t much interest.”
New Generation Research says Chapter 7 liquidations will be the first business bankruptcies to see a surge in filings, with Chapter 11 filing decisions still making little sense for most companies in the coming weeks and possibly months. Anecdotes from law firms that utilize New Generation’s data services are also informing the company’s predictions.
“We’re hearing this repeatedly, that restructuring lawyers are billing 300 hours a month. They’re super busy,” Hammond said. “And this is the activity that precedes what happens in the court.”
Editor’s note: This article has been corrected to reflect that Frontier Communications, and not Frontier Airlines, filed for bankruptcy protection in the past two weeks. Frontier Airlines filed for reorganization in 2008 and emerged from bankruptcy protection in 2009.
Alexis Keenan is a reporter for Yahoo Finance and former litigation attorney.