Leveraged firms aren’t out of bankruptcy danger just yet, paper warns

The Covid-19 pandemic has inflicted unprecedented economic disruption, but relatively few business failures — so far.

A paper published Thursday by the Bank for International Settlements (BIS) observed that a “bankruptcy gap” has prevailed during the pandemic, as actual business failures have fallen significantly short of expectations globally.

“A large wave of insolvencies was expected. So far, however, insolvencies have remained very low, and even fell in many jurisdictions during 2020,” the report said.

While this has been a welcome surprise, “it may be too early to dismiss future solvency risk,” the paper warned.

“Significant increases in leverage and weak earnings forecasts in some sectors suggest that for some firms, greater credit extension may have only postponed, rather than cancelled, their insolvency,” the BIS said.

Indeed, the paper said that the most significant factor that explains the disparity between expected and actual bankruptcy numbers is the provision of exceptional monetary and fiscal support that has ensured ample credit to keep companies afloat.

“This has been pivotal in preventing insolvencies, because it is ultimately insufficient cash flows that give rise to bankruptcies,” the paper said.

However, the increase in credit that has prevented insolvencies in the short term has increased debt levels, which may pose problems down the road.

For instance, the paper said that a “worrying scenario” involves a combination of higher debt levels and depressed earnings for firms in hard-hit sectors — such as the airline, hotel, restaurant and leisure industries — that would leave these firms “highly dependent on additional support to avoid insolvency.”

“These risks could be compounded if vaccines are less successful in containing the spread of Covid-19,” the BIS noted. “Prolonged weakness in these sectors could in turn spill over into the more leveraged commercial real-estate sector.”

James Langton

James is a senior reporter for Advisor.ca and its sister publication, Investment Executive. He has been reporting on regulation, securities law, industry news and more since 1994.