Bankruptcy Filings Are Onward and Upward

There was no "October Surprise” in last month’s bankruptcy filing statistics. The total number of filings of 32,699 reflects a four percent increase over October 2021. This is third consecutive month of an overall increase in comparison to the same month in the previous year.

Chapter 13s spiked by 28.6 percent, chapter 7s tilted downward by 9.7 percent, and chapter 11s rose by 4.5 percent. Importantly, subchapter V small business reorganizations were up by a hefty 23.1 percent compared to last year.

Although the number of year-to-date total filings are down by 7.8 percent, the magnitude of decline has markedly diminished in recent months as the pace of consumer and business filings has gained steam. Barring unexpected consumer or business good fortune in the months ahead, 12-month filing numbers may soon show an increase and there may be a realistic possibility of reaching pre-pandemic filings levels over time.

The extraordinary increase in chapter 13 filings is showing no real abatement. There have been higher monthly increases (compared to the same month in the previous year), but the slope line remains decidedly upward. The most plausible explanation remains that household economic circumstances have deteriorated, consumers fear mortgage foreclosure and car repossession, and family breadwinners still have jobs so they can save their homes and cars through a chapter 13 repayment plan.

The chapter 7 situation may be a bit more perplexing as debtors continue to stave off liquidation and loss of non-exempt property. The time gap between the loss of government COVID assistance and depleted family funds may be longer than many of us expected but may still be on the horizon. Even debtors in hopeless financial circumstances sometimes delay filing bankruptcy beyond the time they should file and wait until creditors take possession of collateral or garnish wages. The smaller rates of chapter 7 filing decline support that possibility.

Chapter 11 trends always require a deeper dive into the numbers and sometimes the reasons for trends in reorganization are less apparent. The smaller volume of chapter 11s compared to other chapter filings also make percentage changes more pronounced. But it does seem that pandemic plummet in chapter 11s may be at the end for now. The significant monthly increases in subchapter V small business filings that we have seen recently suggests longer-term financial problems for sole proprietorships and smaller commercial enterprises. According to a report disseminated by the Creditor Rights Coalition, the amount of distressed debt has now reached pre-pandemic levels. Even though non-traditional debt often serves as a life preserver for large and even some medium sized businesses, the debt eventually must be paid.

As pronounced as recent trends appear to be, monthly gyrations are also to be expected. The holiday season tends to have lower filing numbers, so a decrease from October would not be surprising or suggest a change in basic trends. Moreover, there are many unanswered questions worth pondering, such as the following:

How far and how fast will filings increase? There has been a lot of depressing economic news lately, from high inflation, skyrocketing interest rates, and unclear national economic growth. Are consumers and businesses better able to handle financial setbacks today than they were before the pandemic? If they are not, then what will prevent filings from reaching pre-pandemic levels which were almost double today’s bankruptcy filing levels?
Will the number of chapter 13 filings surpass chapter 7 filings? Chapter 13s now constitute more than 44 percent of total filings. Is this a permanent adjustment in favor of chapter 13s or will chapter 7’s rocket upward if unemployment rates increase during the expected recession and make chapter 13 wage-earner plans an impossibility? There is also a lingering question of whether some consumer bankruptcy lawyers inappropriately place their clients in chapter 13 plans that have little likelihood of success. It is posited that some lawyers do that for the larger fees they can charge in chapter 13 and that some judges are willing to confirm plans that delay repossession or foreclosure without meaningful creditor distributions. The answer to these questions may have to await plan confirmation and completion data many months down the road.
Did creditors learn their lessons from the last recession and ensure they still have compliant bankruptcy processing systems? If the economy sours and regulatory scrutiny grows, which creditors will be tagged first? It is no secret that the deterrent effect of enforcement actions is greatest in the initial earlier days of a government initiative. So the amount of "noise” attached to complaints and settlements involving financial institutions or lenders who are investigated first will be the loudest. If major mortgage servicers improved their operations in the wake of previous settlements and changes to industry standards, are those enhanced practices still in place? Did auto lenders make similar improvements even though they were not targeted nearly as much as mortgage servicers in past years?

Bankruptcy filings are headed upward and no one can be sure how far they will continue to rise. If unemployment jumps above current low levels, as high inflation and interest rates persist or even get worse, the number of chapter 7s may go up along with the number of chapter 13s. It is always perilous to project the future, but acting as if bankruptcy filing rates will continue upward for the foreseeable future would seem to be a pretty safe course.

Commentary provided by Clifford J. White, Senior Advisor - Bankruptcy Compliance for AIS.