How to Profit on a “Bankruptcy Wave” Hitting Markets Hard

Shah Gilani Jun 02, 2023

Just last week, ATM maker Diebold Nixdorf, Inc. (DBD) filed for chapter 11 bankruptcy, citing more than $2.66 billion in debt and inadequate cash flow to make any further interest payments on its loans and bonds.

They aren’t the exception this year. Frighteningly, they are the norm.

Bankruptcies in the U.S. are rising at an alarming rate. So far in 2023, through the end of April, S&P data shows there have been 236 corporate bankruptcies recorded. That’s a 216% increase over the number of bankruptcies recorded last year over the same period. A just released UBS study shows bankruptcies in the U.S. worth $10 million or more, year-to-date, had a rolling average of about 8 per week.

Obviously, this is going to have a knock-on effect on markets. But with bankruptcies exploding across the U.S. and companies shutting down altogether or attempting radical restructurings, one sector will suffer the consequences across the board more than any other – commercial real estate.

Companies defaulting on property leases, along with creditors selling office buildings and real estate assets into an already depressed commercial property market, is weighing heavily on an already underwater asset space.

With another wave of property downgrades, grossly marked-down sales, and abandoned buildings and sites on the way, we could even be looking at another bank crisis as the banks that hold those mortgages are forced to cope with the depreciation of those assets. And of course, all other sectors tied to commercial real estate will implode along with them.

There is, as always, a way to avoid the pain here, protect yourself, and make money targeting the sectors and stocks that are going to get hit hardest. And I have the perfect place for you to start.

Bankruptcy Isn’t Just Hitting the Little Guys

Over the recent Mother’s Day weekend, a period of 48 hours, seven companies filed bankruptcy. There hasn’t been a cluster of bankruptcies like that since the darkest day of 2008.

And they weren’t small businesses. All seven had liabilities they couldn’t meet. Including four companies with over $1 billion in debt.

Vice, the once-hot broadcaster, was one of them. Even after a $450 million infusion from private equity giant TPG in 2017, which then valued the company at a whopping $5.7 billion, Vice’s liabilities appeared to exceed $1 billion and sold itself for a measly $225 million to a handful of its creditors including Fortress Investment Group, Soros Fund Management, and Monroe Capital.

Envision Healthcare, backed by another investment management giant, KKR & Co., that raised $1 billion of fresh cash in 2022 still couldn’t keep up with payments on its $10 billion in debt.

Venator Materials, a chemical producer, Kidde-Fenwal Inc, a fire protection firm, Cox Operating LLC, an oil producer, Athenex Inc. a biotech company, and Monitronics, a home security company all cited breaking point debt burdens and looming debt maturities as reasons for their bankruptcy filings.

And we haven’t come close to entering a recession, yet.

The Death Spiral for Banks and Commercial Lenders

Bankrupt companies are walking away from commercial property, including offices, entire office buildings, warehouses, storefronts, leases and purchase commitments, when they have to.

In the case of restructurings, commercial leases are being written off by lessors who have no choice but to cut and run on account of bankrupt companies’ legal right to walk. With bankrupt companies tightening up operations and leaning out in restructurings, offices and commercial property assets are often the first assets to be reduced or sold.

The problem with selling commercial real estate assets into an already depressed market is creditors have to take what they can get, and that means selling at rock-bottom prices.

As more bankrupt companies abandon offices and commercial real estate obligations and restructurings require selling depressed property assets into what’s beginning to look like a bottomless pit, holders of mortgages on those properties, banks and investors, including institutional investors like pension funds, are going to have to mark those assets down to comply with accounting rules.

Banks that have to increasingly mark down property mortgages and loans, or sell them at a loss, are going to see their earnings get clobbered and likely their stock prices. That’s why this is very likely going to lead to another bank crisis, only the coming crisis won’t be limited to four banks.

And as banks tighten lending standards and all to loan loss reserves, there’ll be less money available to struggling companies, many more of whom will have to turn to bankruptcy as their only alternative. Which leads to even more abandonment of commercial property.

It’s going to be an increasingly negative feedback loop with commercial real estate at the epicenter.

One Perfect Profit Play to Make Right Now

In the coming weeks, I’ll be going more in-depth into who’s going to suffer the most as this problem escalates. My next installment will cover banks in specific, because there a lot of ground to cover in terms of who’s holding onto commercial loans and mortgages and who’s really in for it.

But there’s one ETF you can target right now that’s especially vulnerable to the escalating velocity of corporate bankruptcies and the discharge of corporate debt at depreciated values: the iShares iBoxx $ High Yield Corporate Bond ETF (HYG). It tracks a market-weighted index of high-yield corporate debt that’s denominated in U.S. dollars, otherwise known as “junk bonds.”

Even in a normal environment, junk bonds are risky, subject to a higher possibility of default or other adverse effects, but with the “bankruptcy wave” and a credit crunch in progress, it’s even worse. Expect HYG to take a hit in the coming months and be ready by playing puts and put spreads to put cash in your pocket as it tumbles.

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