The brisk upward pace of bankruptcy filings accelerated in October by rising a very hefty 24.3 percent over the same month in 2022. This month’s bankruptcy filings rose faster than they have since 2009. The increase in chapter 11 filings was stunning by registering a 112.2 percent increase over last October. Bankruptcy professionals will prosper from these increased numbers, but they may portend acute challenges for both business and consumer lenders.
A Closer Look by Chapter
By far, the most significant percentage filing increase occurred in chapter 11. After rising by more than 40 percent last month compared to September 2022, the October filing increase rocketed up and more than doubled! That is the second time this year that chapter 11 filings doubled from the same month in the previous year. Part of the increase was due to big cases with several separately incorporated entities, such as Rite Aid drug stores. The run-up in chapter 11 filings this year reflects a significant upward shift in the overall pattern. More thoughts on what that means are found below.
Chapter 7 liquidation cases climbed by a very steep 27.97 percent. Chapter 7s historically account for upwards of two-thirds of all filings, so the recent acceleration in chapter 7 filings is certain to generate an end-of-year filing number that significantly exceeds most prognosticators’ previous expectations.
Chapter 13s rose by 17.42 percent. The continued pace of increase in chapter 13 repayment plan cases is all the more impressive because chapter 13s began rising in 2021, well before filings under the other chapters of the Bankruptcy Code. The need for chapter 13 relief by distressed consumers who carry secured debt on their homes and cars shows little sign of cooling.
Macroeconomic Factors Continue to Fuel Filings
As reported previously, the rise in interest rates is likely the strongest factor in bankruptcy filings. Even though other economic data have been mixed, rapidly rising interest rates for over a year have sharply increased the costs of auto loans and other big-ticket consumer items. As household and corporate budgets tighten, borrowers cannot put off the day of financial reckoning by borrowing more. As pandemic-era government cash assistance dried up, many individuals turned to credit cards. Companies that require frequent borrowing have faced speed bumps that make it harder to refinance old debt that is coming due or to take out new loans for business expansion.
On October 24th, Federal Reserve Chair Jerome Powell gave a telling speech at the Economic Club of New York. He said that "inflation is still too high”, and the Fed governors remain "united in our commitment to bringing inflation down sustainably to 2 percent.” He noted that a continued strong labor market "could warrant further tightening of monetary policy.” A few days later, the Fed held interest rates steady, and Chairman Powell softened his words to suggest that interest rates may hold at the current rate in the immediate future. (A subsequent jobs report showed a cooling economy. That would further signal that interest rates may remain steady for a while longer.)
Even though interest rates remain high, many consumers are going deeper into debt. A Federal Reserve Statistical Release shows that revolving credit (e.g., credit cards) increased in August at an annual rate of 13.9 percent. Increased borrowing – especially when consumers max out on their credit cards – ultimately leads to higher bankruptcy filing numbers.
As further proof that interest rates are a pivotal factor in pushing up the number of bankruptcy filings, let’s look at a few headlines from the financial press:
"America’s consumer-debt stress is mounting – mortgage rates top 7%, credit card liabilities hit $1 trillion, and now auto-loan defaults are on the rise” (Business Insider, 10/25/23) – the story cites automobile loan defaults rising above pre-pandemic levels.
"U.S. Economy Grew a Strong 4.9%, Driven by Consumer Spree that May Not Last” (WSJ, 10/26/23) – the reporter quotes economist Andrew Hunter saying, "higher rates and various other headwinds [will] start taking a bit more of a toll.”
"Zombie firms are filing bankruptcy as the Fed commits to higher rates” (CNBC (via the American Bankruptcy Institute), 10/31/23) – this means that "unprofitable businesses that stay afloat by taking on new debt” are out of options and need to seek bankruptcy relief.
Conclusion
October bankruptcy filings continued upward at the strongest pace we have seen in fourteen years. Total bankruptcies will remain below the half-million mark for this calendar year, but the current trajectory suggests the same upward path next year. Absent changes to interest rates, the die may be cast for the foreseeable future. With hot spots around the globe turning hotter, the chances for better economic conditions do not seem bright. That only solidifies an expectation of high growth in loan defaults and bankruptcies.
Commentary provided by Clifford J. White, Senior Advisor - Bankruptcy Compliance for AIS.