“There are a lot of companies hurting. We are working 24/7,” said Joseph Acosta, a partner at Dorsey & Whitney who specializes in bankruptcy.
Large company bankruptcies are up 120%
Not surprisingly, some sectors hit the hardest by the pandemic are seeing the biggest spikes in bankruptcy filings. For instance, aviation bankruptcy filings are up 110% on an annualized basis, while oil and gas filings have climbed 45%, Jefferies said. Entertainment bankruptcy filings are also up 22%.
Unfortunately, bankruptcy watchers believe this may just be the tip of the iceberg.
“It hasn’t even reached its height yet. That will come once the government stops aid packages,” said Acosta.
As of the end of August, bankruptcy filings by large companies, defined as those with at least half a billion dollars in liabilities, had surged 120% year-over-year, according to Jefferies. That includes a record 34 filings in the May and June period.
Some small businesses can’t afford to go bankrupt
However, it’s important to note that the number of bankruptcies among all companies — small, medium and large — has not surged. At least not yet. The total bankruptcy count for 2020 is down 14% from the same period of last year, according to Jefferies.
But that’s likely because there have been fewer bankruptcy filings by small companies, the ones with the fewest resources on hand during a crisis.
“We expect this disparity may be due to inadequate cash/liquidity on hand for bankruptcy lawyer retainers,” Jefferies banking analyst Ken Usdin wrote in a note to clients.
In other words, these companies literally can’t afford to go bankrupt.
Other factors behind the dearth of small business bankruptcies cited by Usdin include forbearance programs offered by major banks and government assistance such as the Payroll Protection Program (PPP) that delayed filings. But those relief programs will expire, eventually.
“Reorganization costs money. Some small businesses figure, ‘Until someone starts taking my stuff away, I’ll just keep going,'” said Acosta, the Dorsey & Whitney partner.
Struggling businesses that need to go through bankruptcy must pay for an attorney to go to court and compile a reorganization plan.
“You can’t use PPP funds to file for bankruptcy,” said Acosta.
Banks prepare for loans to go bust
Jefferies also expects bankruptcy filings will accelerate. The investment bank pointed to the fact that senior loan officers at banks indicated in a July Federal Reserve survey they will tighten lending standards. That tends to be strongly correlated with credit losses, Jefferies said.
Banks are bracing for a wave of defaults.
It’s easy to see how bankruptcy filings would be much higher without the unprecedented support from Uncle Sam.
The federal stimulus package provided direct aid to consumers, forgivable loans to small businesses and tens of billions of dollars to besieged airlines.
US companies sold more than $40 billion of junk bonds in August alone — more than quadruple the amount from the same period of 2019, according to Fitch Ratings. Junk bond volume is already nearing the record-shattering $281 billion raised in 2012, Fitch said.
Default rate set to climb further
The good news is all of that cash has allowed some companies teetering on the brink of bankruptcy to repay debt.
Fitch’s list of top bonds of concern fell 49% in August from the May peak to $26.7 billion.
The bad news is that Fitch still expects the US junk bond default rate to climb to as high as 8% in 2021, compared with just 2.4% in 2018.
And the uncertain environment, on everything from the economy and the health crisis to the election, will only make it harder for struggling companies to raise cash.
“It’s going to get even worse,” said Acosta.