You are here
A tidal wave of bankruptcies is coming
ALREADY, companies large and small are succumbing to the effects of the coronavirus. They include household names like Hertz and J Crew and comparatively anonymous energy companies like Diamond Offshore Drilling and Whiting Petroleum.
And the wave of bankruptcies is going to get bigger.
Edward Altman, creator of the Z score, a widely used method of predicting business failures, estimated that this year will easily set a record for so-called mega-bankruptcies - filings by companies with US$1 billion or more in debt.
And he expects the number of merely large bankruptcies - at least US$100 million - to challenge the record set the year after the 2008 economic crisis.
Even a meaningful rebound in economic activity over the coming months won't stop it, said Mr Altman, the Max L Heine professor of finance, emeritus, at New York University's Stern School of Business. "The really hurting companies are too far gone to be saved," he added.
Many are teetering on the edge. Chesapeake Energy, once the second-largest natural gas company in the country, is wrestling with about US$9 billion in debt. Tailored Brands - the parent of Men's Wearhouse, Jos A Bank and K&G - recently disclosed that it, too, might have to file for bankruptcy protection. So did Weatherford International, an oil field services company that emerged from bankruptcy only in December.
More than 6,800 companies filed for Chapter 11 bankruptcy protection last year, and this year will almost certainly have more. The flood of petitions from the worst economic downturn since the Great Depression could swamp the system, making it harder to save the companies that can be rescued, bankruptcy experts said.
Most good-size companies that go into bankruptcy try to restructure themselves, working out payment agreements for their debts so they can stay open. But if a plan can't be worked out - or isn't successful - they can be liquidated instead. Equipment and property are sold off to pay debts, and the company disappears.
Without reform in the system, "we anticipate that a significant fraction of viable small businesses will be forced to liquidate, causing high and irreversible economic losses," a group of academics said in a letter to Congress in May. "Workers will lose jobs even in otherwise viable businesses."
Among their suggestions: increasing budgets to recall retired judges and hire more clerks and giving companies more time to come up with workable plans to prevent them from being sold off for parts. "Tight deadlines may lead to overly optimistic restructuring plans and subsequent refilings that will congest courts and delay future recoveries," they wrote.
The pandemic - with its lockdowns, which have just started to ease - was enough on its own to put some businesses under. The gym chain 24 Hour Fitness, for example, declared bankruptcy this week, saying it would close 100 locations because of financial problems that its chief executive attributed entirely to the coronavirus.
But in many cases, the coronavirus crisis exposed deeper problems, like staggering debts run up by companies whose business models were already struggling to deal with changes in consumer behaviour.
Hertz has been weighed down by debt created in a leveraged buyout more than a decade ago and added to it with the acquisition of Dollar Thrifty in 2012. As it was battling direct competitors, the ascent of Uber and Lyft further upended the rental car industry.
J Crew and Neiman Marcus were carrying heavy debt loads from leveraged buyouts by private equity firms while struggling to deal with the changing preferences of shoppers who increasingly buy online.
Oil and gas companies like Diamond and Whiting borrowed heavily to expand when commodities prices were much higher. Those prices started to fall as production increased and plunged further still when Russia and Saudi Arabia got into a price war shortly before the economic shutdowns began.
A run of defaults looks almost inevitable. At the end of the first quarter of this year, US companies had amassed nearly US$10.5 trillion in debt - by far the most since the Federal Reserve Bank of St Louis began tracking the figure at the end of World War II. "An explosion in corporate debt," Prof Altman said.
Having a lot more debt to deal with is likely to make the coming bankruptcies a bruising experience for unsecured creditors, who may include retirees with pensions or health benefits, vendors waiting to be paid, tort plaintiffs whose lawsuits are cut short and sometimes even current workers. If a company goes into bankruptcy with more secured debts than the value of its assets, the secured creditors - including vulture investors who bought up the debt for a song - can walk away with virtually everything.
The sums at play in some of these cases will be enormous. Prof Altman expects at least 66 cases with more than US$1 billion in debt this year, eclipsing 2009's mark of 49. He also predicted 192 bankruptcies involving at least US$100 million in debt, which would trail only 2009's record of 242.
Robert Keach, a director of the American College of Bankruptcy, said that many companies had so far managed to put off bankruptcy by amassing cash and conserving it as best they can: drawing down existing credit lines, furloughing workers, delaying projects and taking advantage of federal and state pandemic-relief programmes.
But when those programmes expire, the companies will start burning through their cash. That's when bankruptcy filings are likely to soar and stay elevated, Mr Keach said.
Expect "a Covid-19 cliff" in the next 30 to 60 days, he added.
Companies that received loans under the federal Paycheck Protection Program may be waiting to file, said Mr Keach, who practises bankruptcy law with the firm of Bernstein Shur in Portland, Maine. The loans can be converted to grants if the companies meet certain requirements, and if the borrowers can put off bankruptcy until they're sure they won't have to pay the money back, they will have more cash when they file. That's an important consideration, because Chapter 11 is expensive. A bankrupt company must pay the fees of the lawyers and other professionals that help it reorganise as well as the fees of those who advise the official creditors' committees.
The experts' recommendations to Congress walk a fine line. They suggest allowing companies more time to come up with reorganisation plans, even though Chapter 11 cases are supposed to move quickly so bankrupt companies don't burn through their cash before they reorganise.
Generally, the longer a company stays in bankruptcy, the greater the chances of a liquidation. And that increases the likelihood that the company's troubles will spread: Suppliers of raw materials could fold if a manufacturer languishes in bankruptcy, and smaller stores in entirely differently lines of business can suffer if a shopping mall anchor can't stay open. NYTIMES