CLIENT ALERT: Bumpy Road Ahead For Credit Grantors - Now Is The Time To Prepare

By: Charles M Tatelbaum and Corey D. Cohen, Tripp Scott PA

While the focus of the Federal Reserve has been on lowering inflation to its "self-created" inflation rate of 2%, little has been publicized about the consequences facing both businesses and consumers as a result of the increased borrowing rates of interest.

Following the pandemic, until the Federal Reserve raised concern about inflation, the interest rate for business loans was close to zero, and the consumer borrowing rate for credit cards, vehicle loans, home mortgages, home-equity loans, etc. was under 4%. As the Federal Reserve has continued to increase the cost of borrowing, both business and consumer lenders are correspondingly raising their interest rates. As a result, vehicle loans are now in the range of 9% per annum, adjustable home-equity loans are close to 6%, fixed rate mortgage interest rates are slightly above that, and credit card interest rates have approached and are exceeding 20%.

For commercial borrowers, when the interest rates were low and close to zero, businesses took advantage of the low interest rates to borrow extensively for expansion, research and development, and stock buybacks. Now that interest rates have increased substantially, the cost of the debt service is eroding available cash needed for daily operations and any business expansion or dealing with business slowdowns. The commercial real estate market has been hit exponentially hard by the decrease in the utilization of commercial office space post-pandemic, the closing of retail operations in malls and office buildings, and the requirement for commercial real estate loans to be renegotiated as the post-pandemic loans are coming due.

In the consumer borrowing environment, more Americans are falling behind on their car loan and credit card payments than at any time in more than a decade, a troubling signal of consumer stress as higher prices and rising borrowing costs are squeezing household budgets, the Washington Post reported. The pain is most acute for lower-income earners, who have largely used whatever they managed to save during the pandemic with the help of government stimulus checks and breaks on obligations such as rent and student loans. “The increase in delinquencies and defaults is symptomatic of the tough decisions that these households are having to make right now — whether to pay their credit card bills, their rent or buy groceries,” said Mark Zandi, Chief Economist at Moody’s Analytics. Now, as the economy finds its post-pandemic footing, there are signs the hardship for millions of consumers will get worse before it improves. The average credit card interest rate — already at a record high 20.6 percent, according to Bankrate.com — appears likely to keep climbing, as the Federal Reserve indicated it could continue raising interest rates to get inflation under control. Student loan payments that were paused for more than three years are poised to resume in October. And banks and other lenders have been clamping down on credit for months, a process that accelerated after the spring banking crisis sent shock waves through the industry.

Now is the time for credit grantors and lenders to prepare for what is expected to be a possible onslaught of bankruptcy and insolvency court filings. In the business environment, those struggling businesses may take pre-bankruptcy steps in order to "set-up" their creditors and lenders to extend credit terms by making payments that could be clawed back at a later time in a bankruptcy proceeding. Additionally, these financially struggling businesses may take other steps that could prejudice an unsuspecting creditor's rights in an ensuing bankruptcy or reorganization proceeding. There are steps that can be taken by both business and consumer creditors to help make the obligations more "bankruptcy proof", but those steps need to be taken now and prior to the filing of any court proceeding.

The creditors' rights and bankruptcy practice group at Tripp Scott has the experience and knowledge to help friends and clients proactively prepare for what may soon be an unintended consequence of the Federal Reserve's efforts at inflation reduction.