An Alternative Approach to Understanding Bankruptcy Statistics

bankruptcy-statisticsMost companies extend credit to their customers in one way or another. Perhaps you invoice on completion of a project or ship a product before receiving payment. If you extend credit to your customers, understanding local and regional business trends can help minimize potential losses. Analyzing business bankruptcy statistics can yield insights into which areas have a riskier environment for creditors. However, the standard approach for ranking states with bankruptcy data obscures the real trends.

We have an alternative approach to analyzing current business bankruptcy filings. We believe this approach will help credit professionals identify potential risks when making credit decisions.

Why Regional Economic Trends Matter

Credit managers consider numerous factors when determining how much credit to extend to their customers. Most of the information is company specific, such as financial strength, liquidity and profitability as reflected on financial statements as well as credit references from other vendors. However, there are macro trends that can also impact the credit decision, especially for companies that do not have a strong financial position. For example, when the price of oil dropped from $110 a barrel to less than half, this macro trend had a huge impact on all vendors doing business with the energy industry.

An increase in business bankruptcy filings in a geographical area can also create higher risk for creditors due to a domino effect. When one business files bankruptcy, this can affect the financial condition of vendors who will not get paid by the bankrupt company. At The Kaplan Group, we are frequently hired for debt collection cases where the debtor’s primary cash flow problem was caused by a large customer filing bankruptcy. Unfortunately, these vendors often close before paying our client. As people lose their jobs due to employers filing bankruptcy, local consumer spending declines, impacting more businesses in the area and contributing to an overall decline in revenue and profitability.

Standard Approach to Determining Bankruptcy Trends

Typically, states are ranked by the number or percentage of total business bankruptcy filings during a specific period. For example, the United States Courts website ranks states by the number of filings during the second quarter of 2016:

5 States With Most Filings
New York 636
California 577
Texas 530
Illinois 486
Pennsylvania 483
5 States With Fewest Filings
South Dakota 10
Vermont 12
Wyoming 12
Alaska 13
Hawaii 14

This ranking suggests that doing business with companies in the top five states is most risky while it is much safer in states such as South Dakota, Vermont, and Wyoming.

BankruptcyData ranks states by the percentage of total filings. In the table below, they report that Delaware had 11.31% of all business bankruptcy filings in the USA during the first quarter of 2016:

Percentage of All US Business Bankruptcy Filings – Q1 2016
Delaware 11.31%
Texas 10.71%
California 10.41%
New York 7.55%
Florida 6.87%

 

The obvious problem with these rankings is that, with the exception of Delaware, which is a special case, the states with the largest populations and economies always rank at the top.

Population Rank Population (millions) GDP Rank
California 1 39 1
Texas 2 27 2
Florida 3 20 3
New York 4 20 4
Illinois 5 13 5
Pennsylvania 6 13 6

 

It is intuitive that states with larger populations and larger economies would have more businesses and therefore more business bankruptcies, and this is confirmed by the data above. This does not help credit professionals evaluate risk on a geographical basis because all these rankings do is reflect the population and economy size.

ALTERNATIVE APPROACH

In the table below, we have divided each state’s population and its gross domestic product by the number of business bankruptcy filings. This allows us to compare and rank states to adjust for these factors. Rankings based on population and economy size are similar, so we computed a simple average of these two rankings for our final ranking of states to evaluate business credit risk based on bankruptcy filings.

Average Adjusted Ranking Rank Adjusted For Population Rank Adjusted For GDP Number of Bankruptcy Filings Rank Based on # of Filings
Delaware 1 1 1 199 13
Missouri 2 2 2 461 7
New Hampshire 4 3 4 60 34
Kansas 4 4 3 128 19
Arkansas 7 8 5 101 23
Illinois 7 5 9 486 4
Pennsylvania 7 6 8 483 5
Tennessee 7 7 7 242 10
Mississippi 9 11 6 87 27
North Carolina 11 10 11 300 8
Wisconsin 12 12 12 164 15
West Virginia 14 17 10 46 37
Nevada 14 13 15 75 30
Georgia 15 14 16 260 9
New York 16 9 22 636 1
Kentucky 16 19 13 104 22
Florida 17 20 14 470 6
Iowa 18 16 19 78 29
Oklahoma 18 18 17 94 26
Virginia 18 15 21 212 11
Arizona 22 25 18 140 17
Utah 23 23 23 64 31
New Jersey 26 22 29 200 12
Rhode Island 26 24 28 22 43
Indiana 26 27 25 135 18
Idaho 27 33 20 29 39
North Dakota 28 21 35 17 44
Vermont 28 30 26 12 48
Texas 29 28 30 530 3
Michigan 29 31 27 184 14
Maine 29 34 24 23 42
Wyoming 30 26 34 12 49
Colorado 30 29 31 105 21
Maryland 36 36 36 100 24
Montana 36 40 32 15 45
Alaska 37 32 41 13 47
New Mexico 38 43 33 29 40
Connecticut 40 35 45 60 32
Nebraska 40 38 42 28 41
Ohio 40 42 38 163 16
Massachusetts 42 37 46 106 20
California 42 39 44 577 2
Oregon 42 44 39 56 36
Minnesota 42 41 43 79 28
Alabama 43 48 37 56 35
Louisiana 43 46 40 60 33
Washington 46 45 47 98 25
South Dakota 48 47 48 10 50
Hawaii 50 49 50 14 46
South Carolina 50 50 49 36 38

None of the six most populous states rank in the top 5. California, which has a population twice to 50 times larger than all other states (except Texas) is now tied for 42nd out of 50. Texas drops from #3 to #29 and New York declines to #29.

But not all states with large populations and economies saw a significant change. Illinois and Pennsylvania each have an average ranking of 7 in this revised analysis, just a small change from their top 5 ranking based on number of filings.

Of most interest to credit risk professionals are the states with smaller number of filings that suddenly rise to the riskiest places in the country when adjusted for population and economy size. Delaware is an anomaly because so many out of state companies incorporate there due to favorable corporate charter laws that it skews the results. Delaware should be ignored in any ranking system. But New Hampshire, which had fewer business bankruptcy filings than 33 other states, turns out to be the second worst state after Missouri (which ranked 7th in number of filings).

Trend Analysis

In any financial analysis, it is good to look at trends in addition to single points in time. Credit professionals want to understand if risk is increasing or decreasing in an area.

To show trends in filings, BankruptcyData looks at the change in a state’s percentage of total bankruptcy filings on a year over year basis. For example, comparing the percentage change for the first half of 2016 versus the first half of 2015, BankruptcyData reports the following:

Greatest Increase
Missouri +4.85%
Texas +2.67%
Delaware +2.28%
Greatest Decrease
Illinois -4.55%
California -2.46%
Virginia -1.44%

However, since the percentages are so influenced by state population and economy size, the trends that result can be just as misleading.

In the table below, we compared the average ranking in our analysis during the second quarter of 2016 to the first quarter. North Carolina shows the worst trend, going from #45 during the first quarter to #11 in the second quarter. Kansas, Pennsylvania, Kentucky and Virginia also showed an alarming increase in the number of relative filings during the second quarter.

Alternatively, Missouri, which ranked worst in BankruptcyData’s year over year analysis based on percentages, had its adjusted ranking increase only 2 spots. Texas actually improved its ranking compared to other states by 10 spots.

First Quarter Average Rank Second Quarter Average Rank Change in Average
North Carolina 45 11 -35
Kansas 32 4 -28
Pennsylvania 35 7 -28
Kentucky 38 16 -22
Virginia 38 18 -20
North Dakota 47 28 -19
Illinois 21 7 -14
Wyoming 44 30 -14
Iowa 31 18 -13
Alaska 49 37 -13
New York 26 16 -11
Tennessee 16 7 -9
Wisconsin 18 12 -6
Louisiana 48 43 -5
Maryland 41 36 -5
South Dakota 50 48 -3
Missouri 4 2 -2
Nebraska 42 40 -2
Oklahoma 19 18 -2
West Virginia 15 14 -2
Ohio 41 40 -1
Arkansas 7 7 -1
Delaware 1 1 0
Rhode Island 26 26 0
Michigan 28 29 1
New Hampshire 3 4 1
Idaho 25 27 2
Arizona 18 22 4
Indiana 22 26 4
Hawaii 45 50 5
Utah 18 23 5
Mississippi 3 9 6
South Carolina 44 50 6
Georgia 9 15 6
Minnesota 36 42 6
Florida 9 17 8
Massachusetts 34 42 8
Connecticut 31 40 9
Nevada 5 14 9
Texas 19 29 10
Washington 34 46 13
New Mexico 25 38 13
Montana 23 36 14
Alabama 29 43 14
Colorado 15 30 15
Oregon 27 42 15
New Jersey 9 26 17
Vermont 12 28 17
California 21 42 21
Maine 7 29 22

Second Quarter 2016 Business Bankruptcy Analysis

The map below provides a quick look at which states had the highest business bankruptcy risk in 2016. The best states with the least bankruptcy risk are South Carolina, Hawaii, South Dakota and Washington, whereas credit risk is higher in Missouri, New Hampshire, Arkansas and Kansas.

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As you can see, understanding what bankruptcy statistics really mean isn’t as simple as looking at a list of numbers.

Before extending credit to a customer, it’s important that you evaluate both the customer’s individual financial status and the general environment in which the customer is operating. In order to make sure your evaluation is accurate and helpful, you need to understand what the numbers actually say. As a collection agency, we know first hand that being careful about where and how businesses extend credit can help prevent future debt collection problems.

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