NEW YORK – Business bankruptcies are surging around the world, in some countries reaching volumes not seen since the aftermath of the 2008 financial crisis. It is likely just the start of a wave of corporate defaults.
A decade of cheap money instilled a false sense of invincibility in business executives and private equity managers who forgot that bust normally follows boom. Now, a combination of weakening demand, surging inflation, over-indebted balance sheets and much higher borrowing costs will prove too much for weaker borrowers.
United States bankruptcies in the first six months of 2023 were the highest since 2010 among the companies covered by S&P Global Market Intelligence. In England and Wales, corporate insolvencies are near a 14-year high. Swedish bankruptcies are the highest in a decade, while in Germany, bankruptcies jumped almost 50 per cent year on year in June to the highest level since 2016. In Japan, bankruptcies are at their highest in five years.
Insolvencies normally spike once a recession is already under way, but businesses are collapsing even as labour markets and corporate profits show surprising resilience. One explanation: Generous government financial aid programmes during the pandemic and a relaxation of the rules for when companies must file for bankruptcy led to an unusual hiatus in corporate failures in 2020 to 2021.
In many cases, this forbearance postponed rather than prevented a financial reckoning. Flawed business models, over-leveraged capital compositions and structurally challenged industries are ill-placed to cope with a surge in interest rates.
“Cheap money enabled a lot of cans to be kicked down the road,” said Mr Robin Knight, a partner at advisory firm AlixPartners. “All of a sudden, the defining characteristic of bankruptcy – running out of money – is relevant again, and the fundamentals of the underlying business are more important than ever.”
Cash-burning start-ups such as digital media company Vice Group Holding have already been ensnared. Vice once boasted an almost US$6 billion (S$8 billion) valuation, but it was reliant on external funding that finally dried up in May. Around a dozen former special purpose acquisition companies have failed this year for similar reasons, the latest being electric-vehicle maker Lordstown Motors and plant-based food company Tattooed Chef.
There has also been a notable uptick in of companies filing for Chapter 11 bankruptcy for a second time, a sign these groups should have been more comprehensively restructured before. One example is home-security monitoring company Monitronics, whose previous bankruptcy filing was just four years ago. “Interest rate hikes since the end of 2021 have further constrained the debtors’ cash flows,” its latest petition for bankruptcy states.
Worse is to come. But rather than a short, sharp shock as happened in 2008, restructuring experts anticipate a drawn-out period of corporate distress because interest rates are likely to remain elevated for a long time as central banks attempt to quash inflation. Smaller companies are vulnerable to a pullback in bank lending and are more likely to have floating-rate loans that feel higher borrowing costs more quickly. In many cases, their interest expenses will have doubled – unless hedged – in a just a couple of years.
Bigger blow-ups such as the April insolvency filing of US-listed homewares giant Bed Bath & Beyond are happening too. The collapse of Austrian furniture retailer Kika/Leiner in June was the Alpine country’s biggest bankruptcy in a decade. Large defaults add to the risk of a vicious circle of suppliers not being paid, workers losing their jobs, banks further tightening lending criteria and then more companies going bust.
Not surprisingly, freight and consumer goods firms have been hit as spending shifted to travel and socialising from buying stuff. British delivery company Tuffnells Parcels Express went bust in June, as did US pyrex and pressure-cooker maker Instant Brands; the latter was hurt by elevated transport and interest expenses, as well as retailers not replenishing orders.
The construction and industrial sectors are also feeling the pinch as commercial real estate seizes up and global manufacturing sags. British chemical maker Venator Materials filed for Chapter 11 bankruptcy in the US in May under the weight of US$1.1 billion in borrowings and a 38 per cent slump in quarterly sales linked to customer destocking.
Although you might expect non-cyclical technology and healthcare companies to be more resilient, they are quite exposed to floating-rate loans, a legacy of a leveraged buyout and takeover binge. They are also vulnerable to a contraction in the market for collateralised loan obligations that buy this kind of debt. As an example, Envision Healthcare filed for bankruptcy in May after the business suffered a Covid-19-related decline in patient visits and regulatory setbacks. Billions of dollars of Envision floating-rate borrowings were not protected by hedges, Bloomberg News reported last month. Whoops.
US junk bond yields dipped below 4 per cent in 2021 but have since risen to around 8.75 per cent; it is questionable whether even these higher yields properly compensate investors for the risks they are taking.
Executives must have hoped interest rates would swiftly return to manageable levels, but that looks increasingly improbable. In the meantime, the average maturity of US and European junk bonds has shrunk to the lowest on record. While there is not much risky debt maturing in 2023, the refinancing challenges become more daunting thereafter, and businesses may decide to get ahead of the problem by restructuring debts sooner rather than later.
For financial advisers and corporate lawyers, restructuring assignments are helping offset a big decline in mergers and acquisitions and initial public offerings. For everyone else, there is little to cheer. A prolonged period of corporate distress is only just beginning. BLOOMBERG