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Bankruptcies are creeping up, but is it time to be concerned?

While they still remain below last year’s levels, bankruptcy filings have been inching up in 2022. It’s an indicator to watch as the Fed engages its first interest hike since the pandemic—the first of many—and debt financing costs increase, likely toppling weaker performers as growth simultaneously slows.

In March, 16 new cases were filed, up from 13 the previous month and 11 in January. This is still 45% lower than March 2021, when there were 29 cases, but any fluctuation in these numbers may be cause for concern.

What does this mean for corporates worried about the volatile markets they’re facing?

1/ Companies living on borrowed time may have run out the clock

Generous government support has been enough to stave off a wave of company failures—bankruptcy filings have not taken off since the pandemic as some expected. But that aid is tailing off and could prompt more companies to seek debt relief in the coming months.

One area of concern is the fate of smaller firms. Small business bankruptcy filings, known as subchapter V cases, totaled 81 in the last week of March, an all-time high. The lower threshold filing—which applies to companies with a debt limit of US$7.5 million (and recently dropped to US$2.7 million, although this is expected to be reversed)—only came into play from February 2020 under the Small Business Reorganization Act.

2/ A potential recessionary curve ball might be thrown into the mix

The yield curve inversion on two-year and 10-year treasuries on April 1 points to a potential recession. Last month, Deutsche Bank said it expects an economic contraction in H2 2023. That is bad news for everyone, but especially heavily indebted companies at a time when interest rates are being lifted to tame runaway inflation.

The Fed estimated last year that, between 2015 and 2019, roughly 10% of public businesses and 5% of private firms in the US qualified as zombie, defined as those whose profits don’t exceed their debt repayments.

Going by recent bankruptcy activity, alarm bells are not ringing loudly just yet. However, the worst may be yet to come, and those zombies could soon no longer be the walking dead but firmly buried in the ground.