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Bankruptcy Trends Pose a Challenge to Economic Recovery

by on Creditors' Rights. Published February 24th, 2021
Bankruptcy Trends Pose a Challenge to Economic Recovery

The pandemic continues to complicate economic recovery in several industries as the “second wave” of bankruptcies hits

Key takeaways:

  • The U.S. economy appears to be recovering. Yet many economists predict higher inflation and an increase in Chapter 7 and Chapter 11 bankruptcies.
  • Pandemic-related bankruptcies occurred the most in the hospitality, energy, retail, entertainment, and commercial real estate industries.
  • The increase of distressed debt in 2020 provides opportunities for investors and distressed debt fund managers.

On the heels of what has been described as a “rollercoaster” year for public markets, the U.S. economy has shown signs of a return to normal in 2021. Many companies have reopened or resumed in-person operations and bankruptcy filings slowed in the first two months of this year. The slowdown, however, now appears to have been temporary. 

Bankruptcy filings resumed in March 2021. As of this writing, the number of bankruptcy filings in 2021 by firms with at least $50 million of liabilities is “neck-and-neck with the 2020 pace,” according to data compiled by Bloomberg. This is worrisome because 2020 was filled with news of many high-profile bankruptcies: Hertz, J.C. Penney, Neiman-Marcus, Lord & Taylor, Frontier Communications, Gold’s Gym, Chesapeake Energy Corp., Friendly’s, and Virgin Atlantic, among others. 

As the government considers economic support and stimulus measures, many corporate leaders will face tough decisions about how to manage their resources. And although Goldman Sachs forecasts record economic growth this year—8%, which would be the largest economic expansion in seven decades—other economists warn of higher inflation and an uptick in personal and corporate bankruptcies that will hit in the next 12 to 24 months.

Comparing 2021 to 2009

Some believe that the current recession is more severe than the Great Recession of 2007–2009. The GDP decline is much steeper now and jobless rates, while declining, were higher in May 2020 than at any point during 2007–2009. 

The federal government is poised to provide a more robust economic support to fight the pandemic. The stimulus legislation enacted between 2008 and 2012 amounted to roughly $1.8 trillion. The government recently committed more than the total in the recently enacted American Rescue Plan alone, which follows the 2020 allocations of $2.6 trillion in pandemic-related support.

Economists are looking to 2009 to bolster predictions about how the U.S. economy will rebound from the current recession. The recovery in 2009 was reasonably fast, but so far, the current recovery has been faster. According to Howard Marks, the co-founder of Oaktree Capital and a “prolific chronicler of the distressed investment scene,” while it took authorities months to figure out how to respond to the previous crisis, “[in 2020] they dusted off the 2008 playbook and implemented it in a couple of weeks.”

Another major difference between 2009 and 2021 is the continuing uncertainty surrounding the pandemic. While the rollout of vaccines gives some approximation of when life can be expected to return to normal, no one really knows what normal looks like and when it will arrive. It is difficult for businesses to make confident moves toward recovery or restructuring when basic elements like cash flow remain unpredictable.

Some at-risk industries

Like 2009, the current crisis will have its share of losers, even as the economy recovers. Instead of the housing market, the leisure, energy, and retail industries were hit hardest this time. Ratings agency Fitch predicts high default rates in both the leisure and entertainment industries (40%) and retail and energy (20%)

Consumer discretionary companies, including department stores and restaurants, face a steep road back to full recovery. High-end apparel retailers and sit-down fine dining establishments are also expected to struggle, as will any companies that have failed to optimize their online presence. Brick-and-mortar retailers, already battling lower profitability and the need to compete with online giants, have turned to creative financing when shut out by many traditional lenders. 

The energy industry is suffering from “dual supply-and-demand shocks” globally. COVID-19 lockdowns lowered the demand. The increased supply resulted from heightened levels of U.S. production and the U.S.-Saudi price war — factors that contributed to the price of oil falling to below zero. Other industries experiencing financial distress are hospitality and travel, commercial real estate, and financial services. 

The flood of distressed debt into the market in 2020 provides opportunities for investors and distressed debt fund managers. Numerous defaults are expected once government support is exhausted. It could be that, like the Great Recession, some of the fallout from the pandemic-related downturn remains long past the initial recovery phase. 

A boomtime for restructuring specialists

The professionals waiting to aid distressed companies through corporate reorganizations and cash injections have a better outlook. Some analysts predict that even after the vaccine is widely distributed and the threat of COVID-19 has subsided, businesses of all sizes “may struggle to adjust to changing consumer habits.”

Some restructuring specialists see the potential for a “next wave” of troubled companies needing longer-term financing and possible restructuring once the stimulus money is spent. Few expect the scale of 2020, during which the distressed bonds and loan markets had already hit close to $1 trillion by March. 

But according to Bruce Richards, CEO of Marathon Asset Management, “2021 is going to be a big year for capital solutions,” adding that “[t]here’s a wall of money and tremendous technical support for the high-yield market.”

Mixed forecasts still dominate 

The high-yield and distressed debt markets have come roaring back since mid-2020, and many experts predict the pace of bankruptcies will slow. Others fear that what we are seeing is only the tip of a large iceberg. It is important to note that the number of bankruptcies caused by the 2007 economic crisis did not peak until 2010.

Many businesses will face mounting pressures as the recovery continues, particularly if inflation driven by record government spending affects consumer discretionary spending levels. Companies that took on high levels of debt to sustain operations through the pandemic could be crippled by rising interest rates coupled with a lack of demand, further perpetuating the bankruptcy cycle.

Contact Us

Johnston Clem Gifford’s Distressed Debt & Bankruptcy lawyers routinely advise commercial and retail banks, credit unions, hedge funds, REITs, consumer finance lenders, insurers, secured and unsecured creditors, creditors’ committees, bankruptcy trustees, and other parties affected by financial insolvency issues. Contact us online or by calling (214) 974-8000.