The Bankruptcy Blues
Corporate Graveyards are Filling Up
This week, we’re diving deep into corporate bankruptcies. What they are, what they mean, and most importantly, their historic correlation to economic recessions.
What It Is
Bankruptcy refers to the state of an individual or business that has become insolvent. In English: a person or business who is unable to repay their outstanding debts.
The purpose of declaring bankruptcy is typically to determine a defined, equitable settlement of these outstanding debt obligations. This is most commonly practiced through the filing of Chapter 11 bankruptcies, which handle reorganization of the debtor’s business affairs, debts, and assets.
Reorganization
The reorganization of a company’s assets and liabilities usually leads to a renegotiation of the terms of debt. Interest rates may decrease, and the term of payment may be lengthened in order to reduce immediate pressure on a struggling company.
Bankruptcy does not spell immediate, impending doom. In fact, many filers emerge from reorganization with a more profitable business model and greater future prospects.
That being said, Chapter 11 bankruptcy is the most complex filing practice. Reorganizing an entire company’s affairs, relationships, assets, and debts is a massive undertaking, and requires attorney participation.
For these reasons, Chapter 11 is a carefully considered move, best done after the exhaustion of alternate options. In other words, Chapter 11 is a company’s last ditch effort before being pitched into the corporate graveyard.
Bankruptcies on the Rise
Since the beginning of the Coronavirus pandemic, corporate bankruptcies have accelerated at an alarming rate. As of August 17th, a record 45 companies each with assets greater than $1 billion have filed for Chapter 11 bankruptcy.
This is greater than the 38 companies in a comparable period of 2009, and more than double last year’s count of 18.
The following graph from The Financial Times is revealing:
This data is only representative through August. With Q3 filings being reported this month, I expect this aggressive bankruptcy rate will have slowed due to stimulus and economic catalyzation, but will largely continue.
In the last two weeks, notable US companies have announced significant workforce layoffs.
Disney cut 28,000 jobs from its theme parks.
Kohl’s is cutting 15% of its corporate workforce.
American Airlines plans to cut 20% of its workforce, a total of 19,000 people.
Allstate laid off 8% of its employees on September 30th.
Even despite trillions of dollars in stimulus and the unshuttering of the economy, companies are clearly still struggling. Additional layoffs will likely be the harbingers of continued bankruptcy filings.
Who Filed For Chapter 11
2020’s list of mega bankruptcies contains an alarming amount of household names:
J.C. Penney - May 15th
Lord & Taylor - August 2nd
Brooks Brothers - July 8th
Sur la Table - July 8th
Neiman Marcus - May 7th
Aldo - May 7th
Chuck E. Cheese - June 25th
Yep, not even our mousy, venerable friend and his cheese were able to escape the Chapter 11 axe.
Household names aside, some of the largest multimillion dollar corporate defaults have come from the oil and gas industry. This year has seen 33 bankruptcy filings to date. There were only 18 in 2019.
Bankruptcies and Economic Recession
It would behoove our understanding of the current economy to know if rapid increases in bankruptcy filings correlate to the onset of economic recession.
Recession of 1981-1982
The Iranian Revolution of 1979 resulted in a sharp increase in oil prices that catalyzed an energy crisis, and sent the United States into a brief recession. Starting in 1980, Chapter 11 filings increased from ~7,000 to 15,000, slightly preceding the recession’s timeline.
Of note, Chapter 11 filings continued to be filed at high rates through 1987, well past the end of the energy crisis.
Dot-com Bubble and 9/11
Following a period of sustained, irrationally optimistic growth by tech stocks in the late 90’s, the market burst, plunging the economy into a recession that was exacerbated by the events of 9/11.
Chapter 11 filings increased from ~9,000 to 11,500 over this period, again slightly preceding the full timeline of the brief recession.
Great Financial Crisis of 2008
Beginning in 2007, the financial collapse was preceded by a sharp increase in Chapter 11 filings. Some 5,000 business filings increased to ~10,000 in 2008, and continued to over 15,000 by 2009.
This recession reveals the foretelling power of bankruptcy filings particularly well. On September 29th, 2008, the Dow Jones Industrial Average fell a staggering 21%, and would continue to hemorrhage for weeks.
The graph above shows the rate of corporate bankruptcies increase steeply in 2006 and 2007, well before the stock market reacted in late 2008. Major corporate defaults began as early as February of this year.
Looking Ahead
These examples reveal an ugly truth. The last three recessions were foreshadowed by a not insignificant increase of Chapter 11 filings.
If we follow a similar timeline to the events of 2008, market disruption could occur as late as the end of 2021 and beginning of 2022.
Of course, this is all necessarily speculation. A global pandemic, widespread social unrest, a potential bank collapse, and one of the most polarizing elections in United States history make the current economic environment notably disparate from the economy of the financial crisis.
Then again, history repeats itself.
Stay tuned -- next week, we’ll take a look at how the airline industry is actually doing.
Thanks for reading :)