The bankruptcy tsunami ahead

Prepare now

A lot can be done to manage portfolio risk, and many FIs are now leveraging new data tools to lower risk and adjust for dramatic changes in loan loss reserve levels. The insights we get from data and the ability to take quick action on those insights, can really help us avoid worse case scenarios. Today, with the pandemic’s counter-intuitive effects on the economy, FIs must deploy a range of strategies all along the lifecycle from loan decisions, to accurately forecasting the reserves, to the fast action needed to recoup monies when bankruptcies are filed. In this article, I want to point out a trend that’s quite possibly creating a tsunami in bankruptcies and validates why we need to look forward and start planning now.

When up is down and down is up

At the start of 2020, publicly traded banks were focused on new reserve calculations due to CECL regulations taking effect. Then came the pandemic and we were thrown into a recession – a deep recession at historic speed. Everything seemed to go upside down. What we’d typically expect in a recession has not exactly been what we’ve seen. Instead of less lending, financial institutions quickly engaged with new lending through the Payroll Protection Program and their focus was on making loans to provide liquidity to their customers. Historic and aggressive government aid from the CARES Act and a broad array of Fed actions have helped prop up the economy and the reason behind some of these counter-intuitive impacts.

To follow some of the numbers would seem to defy the reality of others. Record numbers of people have lost their jobs at an unprecedented pace, yet savings are up, home sales brisk, bankruptcies and foreclosures down. We’ve been living in an artificial moment that has calmed markets and belies the tenuous nature of the reality in front of us. So, while the calm prevails, it’s best to look ahead with a clear eye for what may be coming.

Bankruptcies are down, but why?

Many experts are predicting a big wave of bankruptcies coming, using words like flood, epic wave, and quake to describe the force. Stuart Gilson of Harvard Business School warns of a potential bankruptcy pandemic. However, I think the most accurate and chilling metaphor out there is the prediction for a tsunami – at first the water recedes but then, after the calm, comes a massive and destructive wave rocketing inland.

According to statistics released by the American Bankruptcy Institute, the number of bankruptcy filings since April have remained well below the filing rates in each of the previous five years (2015-2019). Yet unemployment still hovers around the high-water mark of the Great Recession a decade ago. It’s easy to see why: bankruptcy courts were closed and people normally distressed were aided by stimulus, unemployment supplements, loan and credit holidays, and eviction protections.

The party may be over soon

No one expects bankruptcy levels to remain low for very long. In fact, recent data from the LegalShield Law Index, shows their Bankruptcy Index rose for the first time in 9 months, reversing its steady downward trend in 2020 and marking the sharpest percent increase in series history. They predict that without additional infusions of government aid, “we are on the precipice of an epic wave of small business and personal bankruptcies.”

Is your institution ready for that scenario? Can your institution sustain the hit? Do you know which accounts are going to default and leave you holding nothing? Do you know which accounts are the most likely to yield back some of the loss? Are your processes scalable to handle a surge in bankruptcies?