Despite the pandemic and the economic turmoil it caused, bankruptcy filings have been declining over the last 4 quarters and marked a 15-year low in February 2021 not seen since before the Great Recession. Meanwhile, unemployment shot up to over 14% by May 2020 and has since declined to 6.2%.
Under normal circumstances, the unemployment rate and bankruptcy filings follow similar patterns, but over the past year, they have markedly diverged. The ostensible reason for this is the unprecedented government stimulus. The question is: will all these funds injected into the US economy prevent bankruptcies or merely forestall their occurrence?
As indicated on the above chart, which was the centerpiece of a blog by Epiq AACER, on previous occasions when the unemployment level was 6.2%, there were roughly 85,000 bankruptcies being filed in the same month. In February 2021 the number of new filings was closer to 31,000 – 29,250 individual filers plus 1,950 commercial filings.
“However, one could also estimate there are 300,000+ bankruptcy filings currently in waiting (see orange arrows in the chart) starting from Q2 of 2020,” said Gregg Morin, Epiq AACER, Vice President of Business Development and Revenue. “If history is a good indicator of future new monthly bankruptcy filing rates, we can surmise that the gap between where new filings have landed and historical unemployment rates will narrow as the unemployment rate eventually settles.”
Unfortunately, the Congressional Budget Office (CBO) is projecting unemployment to only reach 5.3% by the end of 2021. “Based on the historical data, once short-term stimulus aid runs out and temporary delays in debt payment reach their expiration dates, it's likely that we will see a return to total overall filings at around ~85,000 with ~75,000 as individual filers when unemployment is in the 5-6% range,” said Morin.
That translates into potentially 10,000 commercial filings per month or 20% more than we've seen in January and February 2021. To put this into perspective, there were only 32,517 commercial bankruptcy filings in all of 2020.
Experience has taught us that business failures rise as an economic cycle moves into the recovery phase after a recession. However, the impact of this pandemic on the economy is unprecedented given the level of automation and the ability of many firms to remain viable, or even flourish, with a remote workforce, though that has not been the case for many other businesses. Throw in the government's debt moratoriums and stimulus packages, and it's anybody's guess if it will be enough to buck strong historical trends.
For business credit execs, the watchword is caution. Here are some thoughts to inform your vigilance:
- Bankruptcies and other business closures are dependent on an individual company's circumstances, so it is important that you continue to step up portfolio monitoring, both in terms of your efforts and the analytical tools you are using, especially with your higher-risk segments
- As has been discussed at length throughout the pandemic, certain industries and industry segments have been more severely impacted by the pandemic, so it remains important, as the economy improves, that you maintain an ongoing dialogue with those customers
- It is unlikely that commercial bankruptcies will simply jump from 2,000 to 10,000 per month, so continue to follow the bankruptcy filing trends (consumer, too) for any uptick - it's likely to be gradual at first before accelerating
We've all come a long way since March of 2020, and the road ahead is a lot clearer now than it was a year ago. In times like these, the most successful credit executives are those who are constantly reevaluating their circumstances in order to adapt and improve performance.
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