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Data reveals April U.S. bankruptcies drop, but Chapter 11 filings rise

Edward Altman, NYU Stern School of Business Professor Emeritus & Bankruptcy Expert, joins Yahoo Finance’s Zack Guzman to discuss the outlook on U.S. bankruptcies amid the coronavirus pandemic.

Video Transcript

ZACK GUZMAN: We've been tracking the way that the coronavirus crisis has been weighing on US companies here. Of course, we reported yesterday J Crew one of the major retailers filing for bankruptcy protection. And overall in the month of April, interesting numbers to highlight. Filings in April fell compared to the year before, perhaps a sign that efforts by the Federal Reserve have been working as the government tries to respond to business stress when you look at that, but a potential warning sign when we look at companies like J Crew. The filings of chapter 11 bankruptcies, most popularly used by companies-- larger corporations to restructure their debt, did jump 26% to 560 last month from 444 in April 2019, according to data compiled by Epiq Systems when you look at that.

But when we look at the threat of bankruptcies moving forward, I want to dig into what we should be thinking about and what the markets are telling us. And for more on that, we welcome back to the show Professor Ed Altman from the NYU Stern School of Business as well as the noted creator of the Altman Z-score of standardized test for bankruptcy risk. And, Professor, it's good to see you again.

I know you like watching the metrics. Last time we chatted back in March, you had noted that you had seen an unprecedented move in terms of the default-rate risk for a lot of companies out there. How have you seen that adjust once we got this rally off the March lows in the equity market? What's your take on the risks out there now?

EDWARD ALTMAN: Well, it's very true that the markets have rebounded in April, and May has kind of been flat so far, maybe down a little. And I think the main reason is the Fed and the government's unprecedented attempts to shore up the liquidity in the market and the outlook going forward is clearly better than it was at the end of March when we were last talking.

As a result, my forecast for default rates have dropped a bit from around 8% for the next 12 months-- that's defaults on high-yield bonds-- to slightly less than that-- not a great deal less but less. As, one, companies have greater access to liquidity, and so they're pushing it down the road a bit, and also the models that I use look at yield spreads and distress ratio. That's a percentage of high-yield bonds trading above 1,000 basis points above the risk-free rate. Both of those are down from what they were in March, and therefore their forecast is lower.

I think the consensus forecast, however-- and I'll get to bankruptcies in a moment-- is that they will be somewhere around 6% to 8% by the end of the year. That's a big jump from what it was in 2019--

ZACK GUZMAN: Yeah.

EDWARD ALTMAN: --but not at the level that it was in 2009, not yet.

ZACK GUZMAN: Well, it's important to note too because that's always been our comparison point back to 2008-2009. And I know Brian wants to jump in here too because of the way that the Fed's been responding has been a similar way-- very fast, aggressive, and even perhaps, you could say, more aggressive than what we saw back then.

BRIAN CHEUNG: Yeah. I mean, I just wanted to kind of piggyback off that point, which is that the Federal Reserve has been providing liquidity, and it's probably because of the terms of this crisis are very different than they were to 2008-2009. You have maybe otherwise healthy companies with solid balance sheets now being stressed with effectively no revenue because of these forced closures.

So I guess from your perspective, Professor Altman, what is different about the COVID-19 crisis and the way that this is putting pressure on some of these companies that might make companies more at risk of bank-- of, you know, filing for bankruptcy during this time period but actually still being able to have the opportunity to maybe emerge out of that bankruptcy once we get to the other side of this?

EDWARD ALTMAN: Yeah. I think the key point, Brian, is the length of this slowdown in the economy, and that is up for grabs. Even Warren Buffett is saying, you know, things are so uncertain now, you really can't make any big moves, and he's keeping everything in cash. And as a result, the forecast is scratching their heads.

Most, I would say, are coming down with a protracted downturn in the economy through 2020-- the end of 2020 and into '21. If that would be the case, then the default rates and the bankruptcies will accelerate, and probably by the end of 2021 we will have something like 15% to 20% default rate cumulatively for '20 and '21. 15% to 20% is about what it was in 2008-2009. 2008, if you recall, was only about 5%. It really didn't kick in until the end of the year. 2009 was about 11%. So that's a total cumulatively of about 16% default rates and commensurate number of bankruptcies.

This time, it's going to take a while for those defaults to start kicking in, although we count defaults differently than number of bankruptcy filings. We also include firms that are missing their interest payments and therefore are in arrears but are not yet in bankruptcy and also what's called distressed exchanges where the creditors receive less than they would have based on the original indenture contracts that they thought that they had.

So all of those together are beginning to accelerate in 2020. Bankruptcy filings are not yet. That takes a while. It takes a while to hire the lawyers. It takes a while to go through the court proceedings, go through your various creditors, see if you can get some out-of-court settlements before you file.

As a result, I'm not surprised that the bankruptcy filings that Zack mentioned are actually down a little bit compared to last year for the month of March and April. It's kind of like, you know, illogical that they would be down.

ZACK GUZMAN: Yeah. Maybe--

EDWARD ALTMAN: By the way, they are going to kick up. There's no question about it.

ZACK GUZMAN: Yeah.

EDWARD ALTMAN: What's going to happen is, of course, that it's going to be somewhat delayed based on getting their act together. You know, you don't just file bankruptcy when you feel uncomfortable. You file bankruptcy when you run out of money and the outlook is you can't get any new money.

ZACK GUZMAN: Yeah.

EDWARD ALTMAN: And the Fed has been helping out in getting that new money for most but not all of those marginal firms.

ZACK GUZMAN: Well, that's very important too because, you know, we've been highlighting the way that they've been focusing on the fallen angels. When we spoke back in March, we were talking about the risk of those companies that were just above investment grade but teetering on the brink of dipping into junk territory.

EDWARD ALTMAN: Yeah.

ZACK GUZMAN: And the fact that we have the two rating agencies, when you look at S&P Global and Moody's, downgrading US companies at the fastest pace in more than a decade, there are a lot of concerns of what would happen once they do dip into junk and you have to have investors grapple with that. Has anything changed on that front now that the Fed stepped in and maybe-- it sounds like you're saying that they've done enough to overall kind of assuage the fears that we've seen out there when this was really hitting the market in March. But now moving forward, if those downgrades continue, are we still positioned well enough to kind of stave off another Depression-like era?

EDWARD ALTMAN: Well, Depression era I think, you know, that's kind of extreme to talk about at this point. Certainly the unemployment figures seem to point to that, but, you know, that might be just short term.

Let me try to address your main question, those downgrades, the fallen angels from BBB down to BB and B. First of all, since the pandemic was realized in March here, the amount of downgrades is probably about $150 billion US. The rating agencies used to say that they expected maybe $300 billion for the entire downturn, meaning 2020-21. We already have 150, and it's going to continue, maybe at a slower rate for a while.

That's a big, big impact. And there will be, in my opinion, this crowding-out effect where the marginal firms that normally would have gotten capital are now going to compete with fallen angels that are raising capital.

And by the way, they're going to raise capital, these fallen angels, because the Fed, unprecedented in any case, has now included them in those companies that are eligible to have their debt purchased by the Fed going forward. Before they never touched the junk bonds. They never touched fallen angels. They certainly wouldn't touch CCCs and Bs.

Now they're going to-- so that's going to provide liquidity for investors. It's going to keep their prices up. And therefore the fallen angel themselves are not likely to have default coming forward. But what they will do is impact the really low-quality companies that are now going to compete with those fallen angels--

ZACK GUZMAN: Yeah.

EDWARD ALTMAN: --to get financing. I expect that that will be increased, the amount of defaults, by probably in the vicinity of $20 to $30 billion over the next 12 months-- and that is a reasonably high impact--

ZACK GUZMAN: Yeah, sure.

EDWARD ALTMAN: --and also the number of bankruptcies, particularly prepackaged chapter 11s.

ZACK GUZMAN: All right, so some interesting moves there, perhaps, in the junk-bond market as the Fed steps in here. But very interesting thoughts, as always. Professor Ed Altman from NYU Stern School of Business, appreciate you taking the time, sir.

EDWARD ALTMAN: You're welcome. Thank you.

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