Total business and non-business bankruptcy filings for 1H20 are down, even in the midst of high unemployment and future economic uncertainty. Historically bankruptcies peak shortly after recessions, but this time we think bankruptcies may peak later given the amount of fiscal and monetary stimulus injected into the economy following the COVID-19 pandemic.
Bankruptcies filings in 1H20 dropped 24% y/y
Recent data released from the American Bankruptcy Institute data highlighted that in 1H20 total bankruptcy filings declined 24% y/y from 1H19. And on top of that, business bankruptcy filings in 2Q20 fell nearly 40% y/y from 2Q19 (per Epiq).
On the surface the trend is surprising, especially the sharp drop in 2Q20 amid the surge in unemployment. However, with the massive amount of fiscal and monetary stimulus injected into the economy to stem off a recession, it’s also not surprising; these figures highlight just how well the government was able to “freeze” the economy in its decline, and prevent business failures.
… but business bankruptcy details paint a different picture
Summary statistics (i.e. headline numbers) can sometimes mask underlying trends in the data, and digging into business bankruptcy filings shows a different story than the headline decline. Specifically, Chapter 11 bankruptcy filings in July increased 53% y/y (and +6% m/m), highlighting the pressure businesses are facing in this environment. Furthermore, even before the COVID-19 pandemic bankruptcies had started to tick higher as weaker businesses that had limped along in the “post financial crisis period” started to feel the pressure of changing consumer behavior toward e-commerce and a decrease in stimulus from the Fed (i.e. rising rates).
Historically bankruptcy filings and the stock market tend to move differently
Looking back at previous recessions / bear markets bankruptcy filings typically do experience a strong uptick as the economy weakens. However, because the data around them is lagging, and businesses have an incentive to hold-off filing for as long as possible, the peak of bankruptcies typically doesn’t occur until the recovery has already started.
Looking ahead bankruptcy trends could be volatile
Total business bankruptcy filings have been declining for over a decade since their post-financial crisis peak in 2009. The unprecedented low interest rate environment, and monetary policy support, has helped many businesses limp along that should have otherwise closed their doors years ago.
While this support had started to disappear prior to COVID-19, fiscal and monetary support is now being thrown into the economy once-again with low interest rates, government grants (i.e. PPP loans), disaster loans (e.g. EIDL), and moratoriums on evictions. And once again, businesses that might have otherwise failed have been able to limp along in 2020 and not file for bankruptcy.
It’s difficult say how long many of these businesses, especially ones that were already facing fundamental business problems, can survive in the post-COVID world. However, should many of these businesses close we would expect to see a snowball effect of rising unemployment and bankruptcies. When (and if) this will happen remains uncertain – if the government continues to provide the policy support it has, these businesses may never need to close, and instead use this time to re-tool their business models for the future.
ENDNOTES
Disclosures
This material is not intended to be a recommendation or investment advice, does not constitute a solicitation to buy, sell or hold a security or an investment strategy, and is not provided in a fiduciary capacity. The information provided does not take into account the specific objectives or circumstances of any particular investor, or suggest any specific course of action. Investment decisions should be made based on an investor’s objectives and circumstances and in consultation with his or her advisors.
The views and opinions expressed are for informational and educational purposes only as of the date of production/writing and may change without notice at any time based on numerous factors, such as market or other conditions, legal and regulatory developments, additional risks and uncertainties and may not come to pass. This material may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections, forecasts, estimates of market returns, and proposed or expected portfolio composition. Any changes to assumptions that may have been made in preparing this material could have a material impact on the information presented herein by way of example. Past performance is no guarantee of future results. Investing involves risk; principal loss is possible.
All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.
A word on risk
All investments carry a certain degree of risk, including possible loss of principal, and there is no assurance that an investment will provide positive performance over any period of time. Equity investments are subject to market risk or the risk that stocks will decline in response to such factors as adverse company news or industry developments or a general economic decline. Debt or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, tax risk, political and economic risk, and income risk. As interest rates rise, bond prices fall. Non-U.S. investments involve risks such as currency fluctuation, political and economic instability, lack of liquidity and differing legal and accounting standards. These risks are magnified in emerging markets. This report should not be regarded by the recipients as a substitute for the exercise of their own judgment. It is important to review your investment objectives, risk tolerance and liquidity needs before choosing an investment style or manager.