Bankruptcy Filings Turbo-Charge Again and Rise by 13.88 Percent

Bankruptcy filings were up by 13.88 percent in September compared to the same month last year. After a single-digit increase in August, the bankruptcy engine turbo-charged again, with 42,540 petitions filed. The increase occurred in all major chapters, but the rate of increase in chapter 13 continued to slow and subchapter V also barely rose.

Chapter 7: September filings under chapter 7 spiked by 19.11 percent compared to last year. Comprising about 60 percent of all filings, chapter 7 liquidations continued their steep climb as many consumers continue to suffer financial distress. This data is consistent with other economic reports showing credit card debt at historically high levels with troublesome default rates.

Chapter 13: The increase in the number of wage-earner repayment plans continued to moderate with a September rise of only 5.77 percent. Part of the reason for the slower growth may simply be that the huge increases experienced last year could not continue forever. Moreover, as discussed below, the recent Federal Reserve policy to cut interest rates may provide non-bankruptcy options in the future for debtors who wish to refinance or sell their homes.

Chapter 11: Business reorganizations (or sales) under chapter 11 went up by a hefty 40.85 percent. This suggests that the anemic rate of increase in August was a mere blip exacerbated by the fall-off in small business filings explained below. Chapter 11s tend to be sensitive to interest rate changes, so the recent reduction in interest rates may eventually attenuate future filing increases.

Subchapter V of Chapter 11: With a filing increase of only 6.54 percent, the rise in petitions filed by small businesses taking advantage of the expedited subchapter V process was the second smallest in eighteen months. The smallest was last month. The recent decrease in debt eligibility limits appears to have profoundly suppressed subchapter V filings.

5-1

Fed Cuts Interest Rates by One-Half Point: The biggest news of the month was that the Fed (the Federal Open Market Committee or FOMC) reduced interest rates (the federal funds rate) by 50 basis points or one-half percent. The Fed also signaled that more cuts may follow this year. Individual members of the FOMC projected that interest rates may decline by 2 percentage points before bottoming out at about 3.25-3.5 percent.
Fed Chairman Jerome Powell described the move as a “recalibration of policy” with future decisions to be made “meeting by meeting.” Although the Fed’s official news release said that the “economic outlook is uncertain,” Chairman Powell was more upbeat at a news conference when he said that the overall economy is “in good shape” with inflation and unemployment in a proper balance. He did caution, however, that we are “probably not going back” to the historically low rates we experienced during the pandemic.
Impact on Bankruptcies: The Fed cautioned that there will be a lag between time of the rate cuts and the time when their impact will be felt throughout the economy. Here are some commentaries on the impact:

“Most distressed companies will watch for rate cuts, a more positive economic outlook or geopolitical changes as they battle compressed margins.” [“2024 Restructuring Update: Rise in Bankruptcies IS Likely to Continue, Steven J. Fleming and David Tyburski of PwC, AIRA Journal, Vol. 37, No. 3 (2024).] Take-away: some companies may put off chapter 11 bankruptcy and hope to finance their debt at more manageable levels.
“Consumers have increasingly been turning to one of the most expensive forms of borrowing – credit cards – in part because other kinds of credit and sources of cash have been harder to come by. Cutting rates could unlock other avenues for borrowing and give consumers a crucial relief valve.” [WSJ, “Heard on the Street,” Telis Demos, (9/16/24).] Take-way: With a lower cost of servicing their debt, some consumers may be able to delay filing bankruptcy and seek alternatives. Chapter 13 debtors who own homes may have refinance options they did not have in the high interest environment. Still, the amount of debt and delinquencies remain sky high so bankruptcy may remain the main option for the foreseeable future.
“Even with somewhat lower rates, many firms and households might be reluctant to borrow because they will still face higher rates than what they currently pay on loans with fixed costs that were locked in several years ago.” [WSJ, “”Lower Rates Don’t Guarantee a Soft Landing,” Nick Timiraos (9/27/24).] Take-away: For those holding fixed rate debt that is more than two years old, new credit will cost more than the debt they incurred before the rate hikes commenced in 2022.

Watch the AIS webinar on October 8th for additional discussion on this and other bankruptcy news. Learn more about our upcoming webinar.

On September 30th, Rep. Jerrold Nadler (D-NY), who is the Ranking Member on the House Judiciary Committee, introduced the “Student Loan Borrower Relief Act of 2024” to remove the requirement that debtors prove “undue hardship” before receiving a discharge of student loans. Most student loan borrowers undoubtedly carry credit card, auto loan, and other debt that would also be part of their bankruptcy cases. With recent legal set-backs to Biden Administration efforts to wipe out student loans and with many borrowers now required to make monthly payments after expiration of pandemic-era student loan deferments, there may be additional pressure on Congress to act. If Congress does make it easier to discharge student loans, there likely would be a noticeable uptick in chapter 7 and 13 bankruptcy filings.

Bankruptcy filings resumed their digit-digit climb in September, even though the rate of increase was tempered for two of the major chapters. Interest rate cuts may have an ameliorative impact on consumer distress over time, but chapter 7 liquidations may be less influenced by the reduced cost of new debt because those debtors may have a harder time borrowing themselves out of bankruptcy. The next couple of months may provide some clues on future trends, but the trajectory to reach pre-pandemic bankruptcy numbers remains on track.