Business bankruptcies are surging around the world, in some countries reaching volumes not seen since the aftermath of the 2008 financial crisis. It's 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.
US 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% year-on-year in June to the highest level since 2016. In Japan, bankruptcies are at their the highest in five years.
Insolvencies normally spike once a recession is already underway, but businesses are collapsing even as labor markets and corporate profits show surprising resilience. One explanation: Generous government financial aid programs in the pandemic and a relaxation of the rules for when companies must file for bankruptcy led to an unusual hiatus in corporate failures in 2020-2021.
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," says 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 startups such as digital media company Vice Group Holding Inc. have already been ensnared. Vice once boasted an almost $6 billion valuation, but it was reliant on external funding that finally dried up in May. Around a dozen former SPACs have failed this year for similar reasons, the latest being EV maker Lordstown Motors Corp. and plant-based food company Tattooed Chef Inc.
There's also been a notable uptick in 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 Inc. 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 blowups such as the April insolvency filing of US-listed homewares giant Bed Bath & Beyond Inc. are happening too. The collapse of Austrian furniture retailer Kika/Leiner last month was the Alpine country's biggest bankruptcy in a decade. Large defaults add to the risk of a vicious cycle 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 socializing from buying stuff. UK delivery company Tuffnells Parcels Express Ltd. went bust last month, as did US pyrex and pressure-cooker maker Instant Brands Inc.; 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. UK chemical maker Venator Materials Plc filed for Chapter 11 bankruptcy in the US in May under the weight of $1.1 billion in borrowings and a 38% slump in quarterly sales linked to customer destocking. Given the speed at which profit warnings are piling up in chemicals, Venator might not be the last of its ilk to fall on its face.
Though you might expect non-cyclical technology and healthcare companies to be more resilient, they're quite exposed to floating-rate loans, a legacy of a leveraged buyout and takeover binge. They're also vulnerable to a contraction in the market for collateralized loan obligations that buy this kind of debt. As an example, Envision Healthcare Corp. filed for bankruptcy in May after the KKR & Co.-owned business suffered a Covid-related decline in patient visits and regulatory setbacks. Billions of dollars of Envision floating-rate borrowings weren't protected by hedges, Bloomberg News reported last month. Whoops.
US junk bond yields dipped below 4% in 2021 but have since risen to around 8.75%; it's questionable whether even these higher yields properly compensate investors for the risks they're 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 isn't much risky debt maturing this year, the refinancing challenges become more daunting thereafter, and businesses may decide to get ahead of the problem by restructuring debts sooner rather than later.
"You have major maturity walls coming up in 2024, '25 and '26," Moelis & Co. co-founder Navid Mahmoodzadegan told investors last month. "A lot of those companies unfortunately aren't going to be able to refinance through those maturities. And so I think there's going to be a lot of not just bankruptcies, but a lot of balance sheet restructuring, recapitalization activity around many different names."
For financial advisers and corporate lawyers, restructuring assignments are helping offset a big decline in M&A and initial public offerings. For everyone else there's little to cheer. A prolonged period of corporate distress is only just beginning.
Disclaimer: This article first appeared on Bloomberg, and is published by special syndication arrangement.