North America Bankruptcy Review: Most Prevalent 2020 Failures

Our proprietary FRISK® score continues to warn of financial risk at major public companies across North America. In recent years, bankruptcy trends were relatively moderate with low interest rate environments and flush capital markets.  With the coronavirus outbreak in 2020 and its cash crunch inducing a decline in revenue, bankruptcy filings have surged, particularly at large, public companies. As we reach the end of the summer and the imminent arrival of Q4, it is worth reviewing the largest bankruptcies and overarching trends so far.

High Profile U.S. Bankruptcies

The coronavirus pandemic caused the most significant financial damage to public companies during Q2 2020. During this period, five well-known companies filed for Chapter 11 bankruptcy protection spanning various industries, including rental & leasing, communications services, oil production, oil services, and department stores. One resource provided by the CreditRiskMonitor service is our Bankruptcy Case Studies that demonstrate the red flags to look for in financially distressed public companies.

Among these top five operators, total liabilities before filing for bankruptcy reached $71 billion. That figure surpassed the total annual comparable figures for 2017 ($43 billion), 2018 ($48 billion), and 2019 ($54 billion) with less than 75% of 2020 in books. Compared to the average of $48 billion in the last three years, this 56% increase indicates that creditors have been exposed to far more financial risk in 2020 than they have in recent years. Additionally, as defaults and bankruptcies have trended higher, recovery rates on secured and unsecured credit claims have also dropped, producing a double-whammy for creditors at the bottom of the capital structure. Trade creditors represent the lowest level of creditors, sitting right above equity, and trade claims have been receiving close to nothing by the end of the bankruptcy process. 

As the Bankruptcy Case Studies illustrate for these five failures, the FRISK® score was trending within the high-risk “red zone” for more than a year and stood at the worst-possible score of “1” prior to filing. This warning signal allows counterparties the option to mitigate risk. 

The FRISK® score falling into the red zone is a profoundly important warning sign. The most concerning factor in each of these bankruptcies is that every company promptly paid their bills (as denoted by a green DBT Index) for a prolonged period while under severe and often increasing financial duress, as highlighted by their red zone FRISK® score. 

According to our research, about 80% of public companies continue to pay on time in the months leading up to their bankruptcy filings. This phenomenon is known as the “Cloaking Effect,” and all subscribers should be mindful of its potential for obscuring risk when evaluating public company risk. The DBT Index is also nearly analogous with Dun & Bradstreet’s PAYDEX® score, as both are calculated based on dollar-weighted historical payment patterns. CreditRiskMonitor always recommends comparing the FRISK® score with the DBT Index and/or the PAYDEX® score to identify meaningful divergences that aid in the direct identification of cloaking and allowing subscribers the opportunity to circumvent financial losses.

With all of that in mind, let’s examine two industries in North America that experienced the most bankruptcies because of the coronavirus pandemic: retail and energy.

Lingering Retail Apocalypse

Store closures were normal in the U.S. retail landscape with a few thousand annually, but that trend went parabolic a few years ago as closings exceeded 8,000 in 2017, more than 7,000 in 2018, well over 10,000 in 2019. So far in 2020, at least 6,300 stores have already shuttered and some retail analysts forecast that COVID-19 could make this a record year for store closures.

Part of this has been due to e-Commerce spending, which now commands more than 15% of all online retail market share, but with the additional pressure from the government-mandated shutdowns of nonessential businesses due to the coronavirus, retail sales have plummeted in Q1 and Q2. Consequently, retailers lost access to the vast majority of their revenue and distressed operators were unable to service their operating costs including rent, salaries, and interest obligations. Through August, fourteen public retailers have failed, two of which were headquartered in Canada and Mexico, respectively. All of these now-bankrupt retailers received FRISK® scores of “1”, the worst-possible level, before their filings.

The retail industry has become more accustomed to bankruptcy liquidations. Several of the aforementioned names will not be emerging from bankruptcy, with creditors deeming that the business is worth more dead and harvested for spare parts than resurrected. We are all familiar with the liquidations of iconic Toys R Us and Sears Holdings and we are seeing a similar story in 2020 with the Chapter 7 bankruptcies at Pier 1 Imports and Stein Mart. Additionally, as the coronavirus shutdowns persist, other bankrupt industry operators such as J. C. Penney, Lord & Taylor, and Stage Stores are or have seriously considered liquidations due to ongoing conflicts with creditors. 

According to CreditRiskMonitor’s database, another 80+ companies in North America alone still score in the high-risk red zone, indicating financial stress and heightened risk of bankruptcy across the general merchandise, apparel and accessories, furniture, and miscellaneous retail industries. CreditRiskMonitor advises scrutinizing these retailers as they may also collapse into bankruptcy in the quarters ahead. 

Plugged & Abandoned 

The OPEC+ price war created a supply glut at roughly the same time that the coronavirus pandemic reduced demand for oil and gas globally. While certain portions of the industry are somewhat insulated (integrated majors, pipelines, and refineries), other areas such as exploration & production (“E&P”) and oilfield servicing segments continue to suffer from subdued energy commodity prices. Almost all E&P companies employ heavy levels of debt financing to support operations, leaving marginal producers dealing with severe financial challenges as crude oil and natural gas have remained lower for longer. 

CreditRiskMonitor’s database shows that about 270 of the 360 (75%) oil and gas (“O&G”) extraction companies we track are currently scoring within the red zone. For context, most crude oil blends today are approximately 30% or more below spot prices realized during 2019. Certainly, some E&Ps have greater scale, hedging programs, access to financing, readily saleable assets, and room to shift their capital allocations – all factors that will determine which companies survive and which file for bankruptcy. The oil and gas servicing operators are quite different as they are directly dependent on drilling and production volumes resulting in less profitable contracts and significant revenue declines.

The vast majority of the production and services companies that filed for bankruptcy sought out court protections during or slightly after the dramatic collapse of oil prices earlier this year. Among the three largest failures, total liabilities totaled to more than $30 billion.  The challenges are far from over with worldwide rig counts collapsing from over 2,000 in 2019 to only 1,000 today.  The impact of this decline from an earnings and cash flow perspective cannot be overstated.  When looking at the U.S. specifically, total rig counts have declined from approximately 800 to only 250, representing a year-over-year decline of nearly 70%. More oil and gas bankruptcies from both production and services should be anticipated unless the price of crude experiences a substantial and sustained recovery, both of which seem to be distant possibilities for the remainder of 2020. 

Bottom Line

Record levels of corporate debt in combination with the 2020 coronavirus economic tremors have led to a massive surge in bankruptcy filings. From the retail and O&G industries alone, mega-bankruptcies with total liabilities exceeding $1 billion tallied up to 20 companies. In nearly every one of these cases, the companies continued paying their bills on time, disguising the extent of their financial strain. The FRISK® score highlighted these distressed companies, placing them deep within the high-risk red zone, and providing ample warning to our subscribers to take action. Given that corporations have incurred even more debt through the coronavirus pandemic, we anticipate that heightened bankruptcy trends will continue throughout the remainder of 2020 and into 2021. While increased borrowing staved off the interim liquidity crisis, it does not solve the untenable capital structure issue that so many public companies struggle with today. Contact CreditRiskMonitor today to identify your riskiest customers and suppliers.