Bankruptcy courts will put financial engineering to the test.


US corporate bankruptcy attorneys could be forced to postpone their summer vacation abruptly. Given that they have been mostly vacant for at least two years, they might not object.

Even though stock markets have been down all year, recent months have significantly tightened financial conditions. As a result, several businesses experiencing cash flow or supply chain issues have not been as quickly able to seek new rescue capital—money that would have flowed freely at just about any moment in the previous decade.

Revlon, Scandinavian Airlines, and Voyager Digital recently had to file for Chapter 11 bankruptcy due to low cash hurriedly. Their court documents detailed how swiftly their grief overcame them, showing how rapidly a recession may be looming.

Regarding the bankruptcy cases themselves, anticipate that a large number of them will be inherently intriguing. After the financial crisis, years of low-interest rates gave rise to various forms of financial engineering and, in the case of cryptocurrencies, a completely new economic paradigm. A significant portion of that invention was not adequately recognized then, but attorneys and judges will need to sort it out today.

S&P’s distressed debt ratio, estimated at the end of May, revealed that just 3% of the corporate credit instruments it was tracking were trading with yields more than ten percentage points above US Treasury bonds, suggesting a high default risk. The ratio reached about 9% by the first week of July. More than twice as high as a year ago, the effective yield for the lowest-rated category of junk bonds monitored by Intercontinental Exchange and Bank of America is now 15%.

The higher cost of debt reflects how money has grown increasingly scarce. Investors cited Avaya, a provider of telecom hardware that recently borrowed $350 million from a senior secured loan at a staggering 15 percent cost per year. According to a hedge fund executive, there was no need to gamble on the dregs after the recent widespread sell-off of risky assets because there was enough upheaval in the debt of high-quality corporations.

SAS, a Swedish airline, learned this the hard way. The business declared bankruptcy in New York during a strike without consenting to further finance or a new agreement with aircraft lessors. Companies that say bankruptcy frequently try to reach a rapid settlement with creditors.

Similarly, the cosmetics company Revlon declared bankruptcy when attempts to reach an out-of-court settlement with its creditors failed. At the same time, its suppliers grew wary of doing business with the struggling organization.

The overall increased complexity of the capital markets will also come under scrutiny due to recent bankruptcies.

A lawyer at the company Sidley Austin, Elizabeth Tabas Carson, claims that “there is a lot of hidden leverage in the system.” She referred to obscure structures that have yet to be tried in a “low market,” such as back-leverage, NAV financing, and subscription financings.

The crypto industry will almost probably come up with the most creative solutions. Voyager Digital, a Canadian cryptocurrency broker and lender, filed for bankruptcy last week in New York after prohibiting account users from withdrawing funds from their accounts. Voyager has financed a collapsed hedge firm called Three Arrows with $650 million in cryptocurrency.