Finance

Bloomberg Special Report: The Bankruptcy Breakdown

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the covet 19 pandemic has throttled economic activity and dragged down corporate profits and as the disease has spread a cascade of bankruptcies has followed with no end in sight it’s a natural consequence small and big businesses struggling when you know they haven’t got clients coming in the prognosis is grim for many companies and entire industries not to mention for investors caught an outbreak of distress i do think people are going to have to be patient and people are going to have to be creative meanwhile governments and central banks are pulling out all the stops to slow the torrent of red ink that has distorted normal recessionary dynamics and again postponed many of the uh credit consequences which were likely to see over the longer term what’s driving all of these defaults and how deep will the damage go the bankruptcy breakdown is straight ahead welcome to a bloomberg special report the bankruptcy breakdown i’m lisa abramowitz the size of the current bankruptcy crisis is painfully evident each week we get more firms joining a parade of businesses filing for protection in this program we’ll examine the shape of the problem how it’s spreading through the larger economy and why policymakers are finding it so challenging to contain let’s begin with a look at how quickly bankruptcy has gone from last resort to the new normal this has been an unprecedented year for corporate unraveling never before have so many retailers and healthcare companies gone bankrupt in such a short time every sector has gotten hit from the beaten down shale patch to airlines to sports leagues companies have put the blame for bankruptcy on the pandemic which is partly true but many were already fragile after taking on record amounts of debt during a decade of low interest rates hertz is a perfect example the iconic rental car company filed for bankruptcy in may with revenues all but drying up as travel ground to a halt but it also had failed to build a big enough cash cushion relative to its 24 billion dollars of debt hertz’s story is not unique this may end up being the worst year for corporate defaults in history the six biggest u.s banks set aside 35 billion dollars in second quarter alone to cover potential loan losses the numbers would be far worse if policymakers hadn’t fired a bazooka injecting trillions of dollars of fiscal and monetary support into the global economy these measures have propped up markets and emboldened investors to plow into riskier securities but all that hasn’t been enough to offset the consequences of a recession companies are still struggling to survive with little income and ballooning debt after borrowing record amounts of cash to stay alive during the pandemic investment-grade companies in the u.s sold a staggering 1.3 trillion dollars of bonds in just the first half of the year exceeding all of last year’s issuance by more than 65 billion dollars defaults downgrades distress by one model this year’s spate of mega bankruptcies is just getting started take a listen to recent comments from ed altman nyu professor and creator of the z score which is used to determine corporate distress there are now probably about 33 billion dollar bankruptcy so far this year and if that continues at a similar rate the rest of the year you’re talking about around 65 or so by year end the previous highest of these mega bankruptcies was 2009 when it was 49. so we we will easily break that record and that’s the re uh that’s partially due to this huge increase in high-yield bonds and leveraged loans of companies that are very large and uh we’ve seen some very uh you know clear numbers about this and very uh well-known companies credit analysts are trying to game out just how bad things could get in its base case scenario s p global expects the us default rate among high-yield companies to hit 12 and a half percent by march that would rival peaks last seen in 2009 and 1991. in a worst-case scenario the credit rating company sees the rate spiking above 15 percent which would by far be the highest in modern history still despite the precarious debt burdens many companies are borrowing even more to survive ralph schlosting co-ceo of evercore and former president of blackrock laid it out on bloomberg surveillance in 0.809 we learned that financial institutions fail not because of capital but because of liquidity and in this recession deep recession uh we have learned also that uh that uh phenomena is more widespread so we spent a lot of time in the last four months encouraging companies to put more cash on their balance sheets but here’s here’s the conundrum ralph because we’re heading into a period of slowing growth we have a more fragile economy and we have more indebted companies why not just file for bankruptcy why not renegotiate the debt loads now with creditors to reduce the obligations rather than putting their entire capital models in a more precarious situation well there is some of that going on uh as well uh i think the real issue in terms of how to solve one’s balance sheet issues depends upon the outlook for the business if if it truly is a v type downturn uh and then recovery uh then it’s just a matter of having the cash to survive to the other side of the chasm uh other businesses obviously are going to be more seriously uh and permanently impaired and for them you know bankruptcy and recapitalization is the right model banks are girding for things to get worse setting aside billions of dollars to absorb losses tied to future insolvencies morgan stanley’s james gorman told bloomberg he sees little chance that banks can get ahead of the reckoning that’s coming well i don’t know that you can get ahead of it i mean it’s a natural consequence small and big businesses struggling when you know they haven’t got clients coming in i mean look at look at the restaurants look at all the small businesses the their hairdressers and the doctors and the dentists and uh before you even get to big companies so you know that’s part of why we saw such a massive wave of financing in the last quarter as a lot of companies got ahead of that and built up stronger balance sheets anticipation of these tougher times the cost of this crisis will be massive both socially and economically many investors are already cutting their losses and selling holdings in distressed companies at steep discounts but others are eyeing opportunity nyu’s ed altman weighs in with these huge amounts of new bankruptcies and defaults the supply and demand for these securities has tipped much more toward a buyer’s market and that’s why the distressed investors are somewhat pleased about what’s going on because they’ve been waiting for this deluge of new bankruptcies and and defaults and what that means in terms of not only the recovery rates to the existing investors uh creditors but also what they have to pay to purchase these companies many of which will be restructured well in chapter 11. and that’s uh uh now signaling a boom market for the distressed debt market and money is flowing into these funds at a fairly high rate at this point coming up a global leader in corporate restructuring says she sees more bankruptcies coming as the year continues and she tells us which industries may feel the most pain i think we should be looking to see what’s happening with real estate this is bloomberg investors watched with alarm as default surged in the first half of 2020. in june marathon asset management ceo bruce richards told bloomberg he sees even more trouble ahead there’s a lot of problems brewing and so what do we expect with default rates well we’ve recorded at marathon since the beginning of covid since mid-march we’ve recorded 60 bankruptcies here in the united states totaling about 100 billion and we think that 100 billion number will grow to 400 billion that is the four and a half percent default rate will grow to 18 cumulative which takes you to an annual default rate of about 10. so default rates as you know is measured in trailing 12 months and so we’ll go from four and a half percent to 10 but before this is all over it’ll be a cumulative rate which is four times the four and a half percent that we’ve already seen 18 taking you to 400 billion welcome back to bloomberg special report the bankruptcy breakdown i’m lisa abramowitz bruce richards like many others expects to see a surge in defaults as the year progresses but bankruptcy is hardly a one-size-fits-all solution some companies will cease to exist others will restructure and emerge still with no prospect of a quick economic recovery it’s difficult to devise a plan to stay afloat i asked lisa donahue global co-leader of turnaround and restructuring at alex partners how she thinks companies will be approaching these challenges as the pressure of debt intensifies it’s going to be an individual type situation us chapter 11 can actually be a quite effective tool and and remember us chapter 11 is more about um actual rehabilitation and fixing a company and having it come out on the other side whereas sometimes in other countries it’s more about a managed wind down so what a bankruptcy can do for some of these companies if they find that they’re essentially running out of cash which is one of your inflection points on figuring out if that’s the right thing to do is you can deliver you can more effectively um you know shed non-core businesses you can effectively look toward closing unprofitable operations things like that so it’s a tool um that can be used to help some of these companies deal with some of these perhaps lingering problems that that they’ve had so it’s not necessarily an end of the road but it can possibly be a tool to help some of these companies out given the scope of bankruptcies given the scope of the pain given how much debt was built up over the decade ahead of this how low do you expect is some of the recoveries to be for debt investors you know predicting debt recoveries is not something that i don’t think anybody really wants to do but what i will say is i was reading an analysis about the typical recovery time post a recession and it is averaging somewhere around three to three and a half years to get back to equilibrium and when i say equilibrium i mean kind of normal operating back to pre-pandemic pre-recession levels so if you think about a three-year period to get back to where you were before whatever you were doing from a manufacturing operational perspective i don’t necessarily think that the recoveries are going to be less than prior recessions but i do think people are going to have to be patient and people are going to have to be creative and people are going to have to recognize that this is something that we’ve never seen before and that the strong companies will come out on the other side and smart management teams will proactively look for ways to extend their runway and to manage through a you know lower productive environment to get to profitability on the other side how concerned are you that a number of corporations are borrowing more and more money billions of dollars to get to the other side when they don’t know when the other side will be or what it will look like you know i’m less concerned with companies that are doing that because in order to preserve their value and in order to get to the other side they need liquidity so and the capital markets are very frothy right now there’s a lot of liquidity out there so i would say looking at not just the amount of debt but how their debt behaves what kind of debt they have how long term it is how prompt it is when their maturities are what sort of flexibility they have built into their debt now obviously too much debt is never a good thing but i’ve talked with a good deal of cfos and ceos of healthy companies that didn’t proactively go out and raise capital with the intent of managing their cash so that when they do get to the other side and it is clearer on what’s going to happen they can quickly pay it back down and deliver so it’s not a question of issuing debt for debt sake it’s a question of getting the flexibility that you need from a liquidity perspective to weather through whatever time period we’re looking at with this with this pandemic lisa you talked about how we’ve seen a lot of bankruptcies in retail certainly in energy what’s the next industry that you think is likely to get hit wow i don’t think we’re done with energy yet i think oil and gas is going to continue to struggle for a whole host of macro factors that are not necessarily pandemic related um i think we should be looking to see what’s happening with real estate we should then the longer this pandemic goes on we may see larger enterprises that might normally not have any sort of distress end up having to go in distress um automotive is ripe for um right for disruption given everything that’s happening in their supply chain and moving toward electric vehicles that’s something that could be accelerated some of the changes that will happen in that supply chain i think aerospace and defense is an area that we’re continuing to look at and see what what’s happening there from a distressed perspective from a supplier perspective to some of the big majors um and obviously i mentioned hospitality i think that the whole hospitality segment is geared on people moving and vacationing and having the ability to rent cars stay in hotels take cruises fly on on planes and as long as people aren’t moving that’s a that’s a sector that all of that whole hospitality um could could be in a lot of trouble coming up policymakers have acted swiftly and aggressively to throw lending lifelines to struggling companies but citigroup’s matt king thinks they may just be postponing a crisis not preventing one in many respects what we think is happening is effectively zombification businesses are remaining alive that would normally have have folded by now this is bloomberg so welcome back to a bloomberg special report the bankruptcy breakdown i’m lisa abramowitz while the economic impact of the coveted 19 pandemic has been devastating the response from policymakers has been extraordinary how effective it will be remains to be seen i asked citigroup’s matt king if he thinks unprecedented stimulus will head off a bankruptcy crisis or just postpone a destructive second wave the standard joke is you don’t become solvent by borrowing more money and what is it that we’ve done is we’ve massively facilitated borrowing by uh corporates across the board and smes and in the u.s even consumer incomes have gone up uh once you include all the government benefits which is really weird during a recession and so it’s very natural that that has distorted normal recessionary dynamics and again postponed many of the credit consequences which we’re likely to see over the longer term at the same time as businesses reopen but need to spend money engaging in distancing or as they find that they’ve tapped the extra liquidity but they still haven’t got the revenues uh we do actually expect to see a steady stream of further problems and some of those have been showing up already in downgrades from the rating agency and defaults the weird thing therefore is is not so much the way that the problems haven’t occurred at all it’s the way in which the problems which have occurred haven’t created the contagion or haven’t had the broader market impact or broader effect on repricing that we would typically have expected do you think that there will be some sort of contagion or effect later on as the pandemic continues that is feeling less and less likely so so and i think a lot an awful lot depends on how the central banks respond and whether they just act as a backstop in the way in which they sort of claim to be doing or whether they do what i fear they’re actually doing which is inflating larger and larger bubbles so in many respects what we think is happening is effectively zombification businesses are remaining alive that would normally have have have folded by now and and then we can debate whether or not that’s that’s good but at a minimum it makes everything less abrupt uh than it might normally have been at the same and and if the central banks are are prepared to give this backstop liquidity preventing markets from overreacting preventing fire sales and outflows as they were doing in march i think everyone would agree that that is a good a good thing there was this concept in the 1930s that bankruptcies should be allowed to build burn themselves out and they didn’t burn themselves out they actually built on one another and and the whole thing was a disaster and so in that respect it’s very very good what’s happening at the same time there is this that the more inflated are the market valuations and there is this weirdness we’re getting the worst economic data we’ve had uh since the 1930s even if we’ve probably seen the the bottom now there’s this massive gap between that and market valuations equity markets uh you know in some cases recently having made new highs almost as though nothing happened and the more inflated to those valuations i think the greater is the risk that at some point you do laps to fundamentals when you talk about pushing out the pain the idea that a lot of these companies that have been in dire straits have borrowed more money to stay alive will that have possibly worse consequences down the road the idea that debt loads have gotten bigger at a time of slowing growth uh and an increasing uh potential amount of risk aversion down the line should central banks pull back depends a little what you mean by worse so can it be worse than what we have seen to date is it not the nice bounce back and fully v-shaped recovery and return to the way things used to be yes absolutely you can’t carry on leveraging up indefinitely and in principle yes could you imagine something worse still whereby the central banks lose control of the markets and inve and you’re really getting a nasty sell-off yes i can imagine the more elevated the valuations and the more debt there is in the system the greater is the vulnerability there most of what i would expect though is a bit more benign it’s this sort of zombification or japanification it’s a bit of a continuation of actually what we’ve seen the last few decades which is there’s more and more debt in the system whenever real interest rates edge upwards markets suddenly sell off as people take money out and go back into risk-free assets precisely because they were sort of forcibly uh being crowded into buying riskier assets and so you become kind of more and more trapped in this environment with a large debt overhang but where equally it doesn’t quite erupt into uncontrolled bankruptcies and and and depression in the way in which you would have thought it’s more a steady stream of um as i say sort of zombification or growth being more disappointing than you would would have imagined unemployment being more elevated than you might have imagined and then we get into a debate as to whether that was a good or a bad thing given where policies are right now which regions do you expect to actually see insolvencies to actually see policy makers allow companies to go bankrupt at a faster pace there’s been a bit less about one region being more affected and it’s a bit more about how the effects have been moved away from the large corporates which could be more systemic for example with the fed um buying fallen angels and instead the effects of being a bit more concentrated on the uh small and medium-sized companies uh maybe hitting bank loan portfolios rather than the names which are big in the bond market and by and large i expect that to be the case sectorally there are also interesting differences that we haven’t fully seen play out but i think there’s a big difference between somewhere like the us where up until now you’ve been incentivized to pay your rent pay your utilities pay your employees and then the loans can become grants and then say somewhere like the uk where instead it’s almost been the opposite and and you’ve not been able to evict a tenant that wasn’t paying their rent it’s almost as though people have have been encouraged not to make those payments and i think we’ll begin to see some sectoral and regional differences coming through as a result when you talk about how the bond market maybe uh is going to be kept afloat perhaps more than the loan markets in certain segments which investors or or which actors do you think will absorb the bulk of the losses as there are insolvencies and as recoveries are lower that’s a good question because the whole effect is to disguise it and postpone it to the point where people almost forget who’s taken the loss rather than rather than having the loss and then repricing and in fact one historical episode that comes to mind is in japan when the bubble burst in 1990 you didn’t really get the pickup in bankruptcies until 1997 98 when the banks were recapitalized and almost allowed to take the losses i’m still though generally inclined to think that it will be more in um the banks which are provisioning a lot as things stand maybe likewise some of the clo portfolios um again the smaller companies um rather that and and also some segments of the high yield bond market what’s really happening is this strong segmentation at the moment and a big difference in risk premium between the areas receiving direct support and those that aren’t that wraps up our special report the bankruptcy breakdown stay tuned to bloomberg television and radio for ongoing coverage and visit bloomberg.com for all the latest news and analysis 24 hours a day stay safe everyone i’m lisa abramowitz and this is bloomberg

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