The August bankruptcy filing numbers are in. They not only reinforce the upward trend glimpsed in recent months but show an appreciable acceleration in filing rates. Moreover, government policy and general economic trends provide a reason to expect more of the same in the future.
What Do the Numbers Show?
Total bankruptcy filings in August 2022 totaled 35,375. That is a significant increase of 14.6 percent over July and nearly 9.6 percent over August 2021. This marks only the second time we have seen a year-over-year increase in monthly filings since the pandemic began in early 2020. Notably, the August increase was the largest since May 2010 when the economy was feeling the ill effects of the Great Recession.
Chapter 13 filings experienced a sizable increase of more than 15.4 percent from the previous month – and a whopping increase of more than 55 percent over August 2021. Chapter 7 filings were more mixed, with a significant 12.9 percent increase over July and a 10.9 decrease from August 2021. The previous drops in chapter 7 filings moderated in recent months, so it is no surprise to see an increase now. Although chapter 11s went up by nearly 90 percent from August over last month, many factors come into play that make analysis and predictions of future chapter 11 filings a bit harder.
Why Are Bankruptcy Filing Rates Rising?
Most commentators attribute steady chapter 13 increases to the resumption of foreclosures and evictions. Automobile repossessions likewise have been on the rise. Add to that inflation and interest rate hikes (which, among other things, make refinancing less viable) and employed consumers with secured debt may continue to find chapter 13 relief an increasingly attractive way to save their homes and cars while adopting a no-frills lifestyle.
Chapter 7 filings may have avoided similar significant upticks because of the lag time between the expiration of a record-breaking amount of government cash handed out during COVID and consumer debtors running out of money to pay their bills. According to the most recent Federal Reserve survey, consumer debt jumped by more than 10 percent in the quarter ending in June, with an even more significant 13 percent rise in credit card balances. Apart from the inevitable limit on credit available to middle and lower-income consumers, interest rates make borrowing for essential purchases more out of reach. It is hard to see how chapter 7s can avoid the upward trend we have seen in chapter 13s.
Although private equity continues to keep many businesses funded through more challenging times, the Creditor Rights Coalition recently highlighted a Morgan Stanley report saying that corporate economic strength may be flagging and the impact of interest rate hikes may "become more apparent in the coming quarters.” It is worth noting that not only did overall chapter 11 filings dramatically increase in August, but small business filings under the popular subchapter V streamlined procedures rose by 40 percent in August compared to both the previous month and to August 2021.
What Will Happen Next?
Predicting bankruptcy filings month-to-month or even year-to-year has proved to be an especially tricky business over the last few years. After all, despite twists and turns, annual filings have been at historic lows since the pandemic hit. But there is a paucity of objective data to suggest that the low filing environment is anything other than an aberration caused by extraordinary government actions. If filing rates merely returned to the stability we saw from 2016-2019; then filings could nearly double from the current lows.
A cursory review of general economic news, even if tempered by optimism that the Federal Reserve will guide the economy to a soft landing without a recession, reveals factors that may portend higher bankruptcy filing rates. For example, high inflation is persistent (even if it goes down a notch), the Federal Reserve probably will continue to maintain higher interest rates, consumer credit use has expanded, and the job market has softened.
What Does It All Mean?
The lending community needs to prepare for higher bankruptcy filing rates. If they do not, they run the risk of being flat-footed when the demands on default servicing operations similarly increase. In the aftermath of the economic meltdown more than a decade ago, many bankruptcy lawyers prospered, but many consumers were harmed by lender servicing practices that could not keep up with dramatically elevated delinquencies. As a result, financial institutions paid unprecedented amounts in settlements to customers, as well as to state and federal regulatory authorities.
It is not time to panic that bankruptcy filings will double and reach the pre-pandemic "normal.” But it is also no time to assume that current historically low filing rates will persist. Recent bankruptcy filing data show an upswing that may grow steeper and last a while longer.
Commentary provided by Clifford J. White, Managing Director – Bankruptcy Compliance for AIS.