Transcript: Why so many bankruptcies?

This is an audio transcript of the Unhedged podcast episode: ‘Why so many bankruptcies?’

Robert Armstrong?
Bankruptcies are up in America, and I am not talking about moral bankruptcy, nor am I even talking about personal bankruptcy. I’m talking about corporate bankruptcy — 2024, the highest number of corporate bankruptcy filings since 2010, according to S&P.

Today on the show, is America teetering on the edge of economic disaster?

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This is Unhedged, the markets and finance podcast from the Financial Times and Pushkin. I’m Rob Armstrong, coming to you from the frostbitten and frigid headquarters of Unhedged here in New York. There’s icicles hanging from the ceilings. We can see our breath. A polar bear is tapping at the window. I’m joined by Aiden Reiter, who is wearing five scarves, on the other side of the table. (Laughter)

Aiden Reiter
Hello. It’s almost hard to talk over all these scarves.

Robert Armstrong
OK. What’s weird about this to me, Aiden, is that you wrote about this increase in bankruptcies the other day. But what we’ve mostly been working on recently is increasing evidence that the US economy, rather than being too weak or starting to wobble, is concerningly strong.

Aiden Reiter
Yeah, we’ve had a couple of stronger-than-hoped inflation readings. We had a Fed meeting that showed the Fed is very cautious about what inflation might be in the next year. And they’re cautious about other things too but we don’t need to talk about that. And we’ve had a couple other data readings that are supportive of a stronger economy, right?

Robert Armstrong
PMIs are warming up, surveys of business purchasing managers. They’re saying new orders are rising. There’s been an uptick, especially on the manufacturing side, which we haven’t seen in a long time.

Aiden Reiter
Yeah. Job openings are up, suggesting we’re entering into a slightly tighter labour market.

Robert Armstrong
The bond market’s kind of worried about all of this, or that’s one interpretation of what the bond market is doing.

Aiden Reiter
Yeah. Yields on 10-year Treasuries are way up. They’re at their highest level since last April. They’re at 4.7 per cent.

Robert Armstrong
Right. So that means bond prices are falling and that’s consistent with a Fed that stays a little tighter and etc, etc and people preferring to be in equities maybe. Or it could mean all kinds of things. And yet amidst all this slight concern about an overheating economy, we have this bankruptcy number, which is strange.

Aiden Reiter
It’s a little up from last year. I think it’s about 8 per cent up?

Robert Armstrong
8 per cent, yes.

Aiden Reiter
So, you know, things have not been amazing for a while, but they’re getting worse, arguably, or they have been getting worse for some of these companies.

Robert Armstrong
I mean, looking at this, at the time series that S&P provides here, the natural interpretation is something like this. You had, you know, high bankruptcies still in 2010 because we’re still operating in the shadow of the great financial crisis. But then, the fact that the Fed has basically pushed rates way down kicks in, and you have low bankruptcies every year up until now simply because rates are so low, you know.

Aiden Reiter
That is an interpretation.

Robert Armstrong
Yeah, an interpretation. And bankruptcies were basically nothing in ’21 and 2022 because it was basically illegal to go bankrupt that time.

Aiden Reiter
Yeah. You were pumped with money, pumped with PPP to stop you from getting bankrupt.

Robert Armstrong
Yeah. And so now it’s like this is just a return to normalcy. And so I would guess that the companies that are going bankrupt, the first guess would be they’re the ones who mismanaged their debt. Rates are higher now. It is now possible to go bankrupt again because interest rates have risen.

Aiden Reiter
That is a great guess about what might be happening. (Robert laughs) But we took a closer look and might not really be the answer.

Robert Armstrong
Yeah. I love how great guess is just a euphemism for you are wrong.

Aiden Reiter
(Laughter) Well, you’re as wrong as far as we can tell. So we looked at the 10 biggest bankruptcies and called out a couple of names. So of those 10 biggest bankruptcies, five were private so we didn’t look at those. One was just this, you know, essentially an asbestos legal claim holding company that was meant to go bankrupt on behalf of Johnson & Johnson. Think what you want about that. That’s enough for another podcast. And then four were these relatively big names. Then we added in two other big names that we thought (overlapping speech).

Robert Armstrong
Yeah. So what are the companies? What are the companies we’re talking about?

Aiden Reiter
So we’re talking about Big Lots, which is a home goods store and, you know, discount seller; container maker Tupperware of, you know, of 1950s fame; fabric seller Jo-Ann Stores. We’ve got Party City, where everybody loves to go buy Halloween costumes and other fun party supplies; discount air carrier Spirit Airlines, the butt of every SNL joke; Franchise Group, which is the owner of retail chains The Vitamin Shoppe, Pet Supplies Plus and a couple other franchise chains.

Robert Armstrong
So the big ones, it’s interesting. There’s definitely a pattern there. But I have a very important question for you before we even get to that. Have you ever been into a Party City?

Aiden Reiter
Many times.

Robert Armstrong
What kind of glorious things do I get in Party City? And why have you been into Party City many times?

Aiden Reiter
I grew up in the suburbs of Connecticut. What else is there to do besides go to Party City? (Robert laughs) No. Growing up, you know, that’s where you get your balloons. It’s where you get your tinsel. It’s where you would get a mask. Or at least before Amazon.

Robert Armstrong
Yes. Now, that’s kind of the point here, isn’t it? But is it true that these companies — we did a small sample of the biggest ones — but of the ones you looked at, was debt mismanagement, did they have a lot of floating rate debt? Did they pile on too much debt and take private or something like it? Is debt the problem here?

Aiden Reiter
It’s part of the problem, but it’s not the problem, right? So we’ve talked about before, a lot of people thought that, you know, small-cap stocks, right, small companies that theoretically have more floating rate debt were set to have this renaissance when rates came down. And they’d had a renaissance for other reasons, but it wasn’t because of that because if you look at their interest expense, their interest expenses haven’t risen because floating rate debt has not been that punishing to them.

This is kind of a similar picture. If you look at the debt profiles of all these companies, some of them really took on debt for other reasons, right? Spirit Airlines took on a whole heap of cash.

Robert Armstrong
Just, you know, debt, just to stay alive.

Aiden Reiter
Just to stay alive, right? And as, you know, Franchise Group had some private merger complicated talks going on that put them with debt. But for the most part, if you look at the interest expense of these companies, Spirit was actually able to shrink its payments over time. Jo-Ann and Party City kept them mostly in check and Tupperware even . . . 

Robert Armstrong
Their interest payments.

Aiden Reiter
Their interest payments. So Tupperware even shrunk them. So it’s not high rates and floating rate debt that sunk these companies.

Robert Armstrong
It’s the other side.

Aiden Reiter
It’s the other side. Well, they did take on a lot of debt, right? We should note that Big Lots, Spirit and Franchise piled on debt for other reasons. But it’s the other side of the equation. It’s their earnings completely plummeted, right? So if you look at their net debt to earnings ratio, right, which is a pretty good indicator of whether or not these are . . . 

Robert Armstrong
Yeah. It’s the standard way to think about how indebted a company is.

Aiden Reiter
Yeah. So most of them climbed from, you know, 1-2 up to past 6, which is the threshold at which lenders go running for the hills.

Robert Armstrong
Earnings.

Aiden Reiter
Debt, 6 times earnings.

Robert Armstrong
Yeah. Debt, 6 times earnings. Right. Yeah.

Aiden Reiter
Yeah. So they’ve all kind of crept above that threshold (inaudible).

Robert Armstrong
Because their earnings were falling, not so much because the debt was rising.

Aiden Reiter
Yes. So interest expenses for the most part weren’t ballooning. So it was more an earnings picture. That being said, some did see a crazy jump. Like, Spirit saw an insane jump to 56 debt-to-earnings ratio, but even they brought it back down.

Robert Armstrong
Yeah. So it’s interesting that, you know, on first glance we have this group of companies that leads the bankruptcy list. And they are very retail, kind of, and they had an earnings crisis as well as just . . . perhaps even more so than a debt crisis.

Aiden Reiter
Yeah. So the point is, it’s not that, you know, high rates in the economy and the Fed keeping high rates is finally enacting pain. It’s enacting pain for a lot of companies, but that’s not the cause, at least for these companies we’ve looked at. Yes, they have a lot of debt, but it’s not the floating rates. It’s the earnings came down.

And it’s because these companies — and again, we only looked at six — are kind of dinosaurs already, right? Franchise Group — in the age of Amazon, everybody’s buying stuff online. Who’s going into Jo-Ann to buy their yarn? Who’s going into Party City to buy their balloons? And these companies just had a lot of trouble transitioning into the online marketplace or, you know, creating a real reason people come to their stores. Tupperware is a specially bizarre example. Not only have they not been able to transition to online, they’ve kept their peer-to-peer selling model, which just has not been able to keep up with the way that we all buy things today.

Spirit’s a whole other case, right? There were some issues with their planes. Airlines are a very tough industry to be in to begin with so there’s always that. They kind of got butted out by other cheap competitors. And then there was this failed merger with JetBlue that really sunk them.

Robert Armstrong
The picture you’ve just sketched suggests that rather than thinking, gosh, bankruptcies are up, the US economy is weaker than you would otherwise think, this looks to me like it supports a theory called the K-shaped recovery.

Aiden Reiter
Definitely.

Robert Armstrong
That we have a strong economy overall. But that’s one leg of the K, the one that points up. But then there is a bottom leg of the K where there are certain companies, industries, individuals who are more vulnerable and are having more trouble.

Aiden Reiter
Yeah. All these companies had trouble, or most of these companies had trouble, transitioning to the online economy. But if you look at them, you know, the thing that really unites them for the most part is they are discount stores. Big Lots, Jo-Ann, Franchise and your Pet Supplies Plus, right? These are discount stores theoretically in, quote unquote, middle America or in places where people are looking for those deals.

Robert Armstrong
Well, I can give you another painful example. I thought this year was gonna be worse economically than it’s turned out to be. And one of my stock picks in the FT stockpicking contest was Dollar Tree. I think it was . . . 

Aiden Reiter
Dollar General?

Robert Armstrong
Dollar General. It was one of the two. Anyway, I was thinking, here’s a company that’s doing a turnaround. If there is economic stress, you know, maybe they’ll turn around anyway. That whole industry has just been crushed. Their core customer is just spending less. They’re seeing, you know, their big complaint in the dollar stores is that the average basket is getting cheaper. The average ticket is lower. So people are still coming into the dollar stores, but their core customer is spending less every time they come into the store. And even in the range of a dollar store, they are buying the cheaper items, the less profitable items. So that’s consistent with the tale you just told about your Party Cities and your Big Lots and your . . . What’s the pet one?

Aiden Reiter
Franchise Group, which owns Pet Supplies Plus and The Vitamin Shoppe.

Robert Armstrong
Pet Supplies Plus. Go into Costco and it’s just like, why would you ever go to anywhere else? You get the gazillion pound bag of dog food and the price is unbelievable. And yeah, you know, it’s just like the world of retail has changed. It’s not just Amazon, it’s Walmart and Costco. You know, the bigger stores, the big discounters.

Aiden Reiter
Yeah. So, I mean, to the extent this suggests there is a K-shaped recovery, it’s real. We should caveat a couple of things, though. First of all, these companies are not necessarily going anywhere, right?

Robert Armstrong
Yes. Bankruptcy doesn’t mean you disappear.

Aiden Reiter
It can precede disappearing.

Robert Armstrong
Liquidation.

Aiden Reiter
Yes. But for the most part, that’s just them renegotiating debts, maybe being sold to new buyers. Some of them kind of like entered in and out of bankruptcy multiple times the past couple of years. Party City is the good example there. So, you know, we might still see these franchises. They’re just going to be different businesses.

We should also note that, you know, there’s something called creative destruction, right? People think post-2010, post some crisis, you wanna see some of these companies go belly up because they were not competitive enough. So to some people, this is actually a sign of a healthy economy that’s working well.

Robert Armstrong
Indeed. You might look back at the last 10 or 15 years and say the problem was bankruptcies were too low. They were certainly too low in ’21 and ’22. And you might look through the whole like 2011-22 period and say the US economy is not churning enough. There’s not enough creative destruction.

Aiden Reiter
Yeah. And, you know, people said that about Europe as well, right? Europe has much more support, especially during Covid, for employees. They do that through via, you know, employment vehicles. So essentially, you had these, quote unquote, zombie companies. And is that why Europe and US are having this big gap? I mean, it’s an argument that’s out there. But we would say that, you know, the US also hasn’t been shuttering companies up until now.

Robert Armstrong
Yes. I guess we are also seeing evidence of the K-shaped economy hypothesis on the household side. You and I have talked a lot about consumer credit default rates. I’m looking here at the household debt report, which is an excellent report, everybody should read it, released by the New York Federal Reserve. And looking at transition to 90 days delinquent — 90 days delinquent is when you’re really delinquent on a loan, right? That’s one month that, you know, you’re letting it slide.

Aiden Reiter
Getting into default.

Robert Armstrong
You’re getting towards default. And you look at the percentage of credit card balances that are entering 90-day delinquency and, you know, they’re up above 10 per cent now. They were closer to six or five. There’s been a pretty steep increase in the line. That’s credit cards. And on the auto loan side, among young people especially, this is our kind of favourite stat, is like young people are really sliding into default at sharply higher rates on their auto loans.

Aiden Reiter
Yes. But you know, we should note that it has been a bad economy, right? That was . . . things were sliding up a lot in the run-up to the first Fed cut. Since then, those numbers have gotten better for almost every age group, right? 18-29, 30-39, younger, poor households.

Robert Armstrong
There’s like, the line looks like it’s peaked and just begun to turn over in terms of transitions to delinquency.

Aiden Reiter
Yeah. So, you know, households, right, there has been this K-shaped economy, if you believe in that theory. There has been a lot more strain on lower-income households and that’s shown in these numbers. But it’s starting to turn the corner. There actually was a very good piece from the Kansas Fed a couple of weeks ago that made the point that, you know, banks put out these forecasts of the likelihood of people to default. And that number has kind of stayed the same level.

Robert Armstrong
These numbers are kind of the banks’ own assessment of the amount of defaults they’re gonna see in their own credit portfolio.

Aiden Reiter
Yes. Among already highly indebted borrowers. And, you know, even though that number had gone up a lot in the last few years, people defaulting or getting close to default, that number of how many people would default has actually stayed flat.

Robert Armstrong
Are expected to default.

Aiden Reiter
And that has tended to be a leading indicator in the past. And it takes about 18 months. So it looks like now, we’re going see things turning the curve, right? So just like the default rates among young people are coming down, it’s expected that things will start stabilising for people who are heavily indebted in the coming months.

Robert Armstrong
So we have pretty good evidence both on the corporate side and on the household side that there’s a K-shaped recovery here. But there is also some evidence that for the bottom leg of that K, the weaker . . . that smaller but weaker part of the economy, things might be getting a little better?

Aiden Reiter
I think that’s definitely fair. I mean, inflation is a part of the economy that specifically hurts lower-income households because they spend more of their weekly bill on essentials, right? They can’t get around spending more at the grocery store as opposed to it might take up less of a more wealthy person’s budget and monthly spending. So if inflation ticks up again, they’re going to continue to see problems. And to be honest, they’re at a low point because over the last few years they had been squeezed by inflation and had been squeezed by low rates. But the point is, we might be starting to turn the corner, especially if the US economy is heating up and we don’t re-enter into inflation.

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Robert Armstrong
Well, that sounds almost optimistic.

Aiden Reiter
Good for a curmudgeonly pair like us.

Robert Armstrong
(Laughter) We’ll be right back with Long and Short.

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Welcome back. This is Long and Short, that portion of the show where we go long things we like and short things that we do not like. Aiden, are you long or short something today?

Aiden Reiter
I am long ceramics. The dishwasher at Unhedged HQ is broken, so us and all of our colleagues are drinking out of paper cups. And just not having a ceramic mug makes me so sad that I am now really appreciative of my ceramics and I’m long the mug.

Robert Armstrong
And it’s also a general point. Any time in modern life where you lose one of the mechanical basics, you really realise how awesome they are. Like, what’s better than a dishwasher? That thing rules!

Aiden Reiter
Yeah. And also like, I think there’s something so demoralising about sitting in your office and drinking out of a paper cup. Like a paper cup is for being on the go and nothing else.

Robert Armstrong
Yeah, it’s true. Well, I am long something too. I am long the Greenland debate. I mean, my initial reaction to the president saying he wanted to buy Greenland from Denmark was to laugh it off. But reading about it, including excellent articles in our newspaper, has really informed me about the geopolitics of the Arctic. I look forward to a robust debate about the future of the far north.

Aiden Reiter
Well, I hope, like the Arctic, it stays a cold debate because I might be drafted into that war.

Robert Armstrong
(Laughter) You’re gonna love Greenland, man, when you’re fighting the Danes. (Aiden laughs)

Listeners, I’ll be back in your feed on Tuesday. If Aiden hasn’t been drafted, he might be too. Until then, stay sharp out there.

Unhedged is produced by Jake Harper and edited by Bryant Urstadt. Our executive producer is Jacob Goldstein. We had additional help from Topher Forhecz. Cheryl Brumley is the FT’s global head of audio. Special thanks to Laura Clarke, Alastair Mackie, Gretta Cohn and Natalie Sadler.

FT premium subscribers can get the Unhedged newsletter for free. A 30-day free trial is available to everyone else. Just go to ft.com/unhedgedoffer.

I’m Rob Armstrong. Thanks for listening.

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