Mizzell: Economic legacy of the pandemic: Challenges, opportunities

It’s no secret that the COVID-19 pandemic and its economic fallout have posed serious challenges to Indiana businesses, lenders and consumers. The abrupt shutdown of virtually all commerce in early 2020 shocked the system and led to unique economic challenges that may never be seen again in our lifetimes. And even though the world economy successfully weathered the storm, today, almost four years since the economic shutdown, we are still coping with the economic legacy of the pandemic. Nonetheless, as things improve, attorneys for businesses and lenders have the chance to embrace their role as a counselor to their clients and help achieve positive outcomes for all.

Challenges and their origin

As the pandemic waned, the Consumer Price Index, a common measure of inflation, began increasing quickly in early 2021 — a consequence of several factors all derived from the pandemic and government efforts to blunt the economic impact of the pandemic. The specter of limitlessly increasing inflation dominated headlines and ate into revenues and budgets everywhere.

To complicate the challenge of inflation, the Federal Reserve’s primary tool for combatting inflation is to raise the prime interest rate, or the rate that lenders use as a baseline in determining the interest rates for loans. A simple explanation for how this is intended to work is that an increase in the interest rate increases the cost of borrowing money and, therefore, slows demand. Weaker demand leads to a slowing in price increases and, thus, combats inflation.

Since late 2008, the Federal Reserve’s prime interest rate has been historically low, staying at 3.25% until the Fed moved to increase the rate in 2015. Rates gradually increased until late 2019 — peaking at 5.50% — until rapidly dropping back to 3.25% at the beginning of the pandemic. In response to the rapid increase in CPI, the Fed began to quickly and aggressively raise interest rates to curb the threat of inflation. CPI peaked in June of 2022 at 9.1% but has slowly declined since then.

In December 2023, CPI was at 3.4%, higher than average when compared to 2020, 2019 and 2018, but far lower than the 2022 average of 8.0%. Relatedly, the prime interest rate is currently 8.5% — the highest the rate has been since 2001, but a far cry from the historically high interest rates of the early ‘80s.

What does this mean for businesses?

In a relatively short period of time, businesses (and individuals) were faced with rapid inflation, increasing the costs of everyday goods and services across the board. Those who were unprepared or unable to cope with higher costs have had to make painful adjustments or cease business operations. According to studies done by the U.S. Census Bureau and the Chamber of Commerce, smaller businesses have been most concerned about inflation because increased costs eat directly into revenue. The same studies also show that small business owners are similarly, and just a little paradoxically, concerned about high interest rates as expansion plans are put on hold due to tightening credit. Those borrowers with adjustable-rate notes are in an even worse position, being forced to contend with an immediate increase in both the cost of goods and debt service.

The consequences for businesses are noticeable, although not yet catastrophic. Commercial loan defaults have remained relatively low, possibly because of preexisting favorable long-term loans and cooling inflation. However, credit card defaults have recently started to increase. Further, Chapter 11 bankruptcy filings, the most common form of bankruptcy for businesses, have increased by 19% across the country when compared to last year. This matches the overall 18% increase in all bankruptcy filings for the same period, although the absolute number of filings remains below pre-pandemic levels.

Opportunities

Despite recent inflation and an increase in distressed debt, there is reason for optimism. In December, Federal Reserve Chairman Jerome Powell announced that because of the decline in inflation, the Federal Reserve intends to stop raising interest rates for the time being. Chairman Powell also stated that the board had discussed reducing interest rates slightly over the next year. Further, despite the inflation-related turmoil, unemployment has remained low at 3.7% in December 2023.

A decline in inflation coupled with a halt to rate increases is great news for everyone. Pressure on businesses should decrease as cost increases slow. However, lenders and borrowers still need to navigate the new normal of the 2024 economy, and counsel for both should be prepared with an understanding of their financial challenges.

For lenders’ counsel, where possible and viable, consider advising clients about forbearance or formal workout agreements with struggling customers. With some exceptions, an immediate liquidation of a small business’s assets rarely benefits a lender. A lawyer representing a lender must remember that the goal is to maximize the return on investment to the lender; accordingly, caution is warranted so as not to throw out the good long-term loans with the bad. Consider the upside of working with a business suffering short-term, inflation-related stress; a workout agreement may ultimately result in a successful business — and a greater return on investment for the lender. This is especially true if the economy continues to stabilize post-pandemic.

For lawyers with small business clients facing difficulties, use this as an opportunity to work with your lender, promote transparency and do your best to create a positive return on investment for everyone, including the lender. Counsel your clients to avoid short-term traps like merchant cash advances. Focus on helping them adapt to higher costs. If all else fails, consider consulting with another attorney to assist you with a workout or, as a last resort, a formal restructuring, including a relatively new form of bankruptcy relief specifically designed for small businesses, a Subchapter V reorganization.

As attorneys advising lenders and businesses, we are in a unique position to counsel our clients toward resolutions that maximize value for everyone. Where possible, lenders and businesses should look at recent economic challenges as an opportunity to reevaluate and work together. Inflation has cooled, interest rates have stabilized, and although challenges remain, opportunities abound. Adaptable businesses and patient lenders may ultimately be rewarded by working together practically and flexibly now and into the future.•

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Jason Mizzell is an associate at Kroger Gardis & Regas LLP. Opinions expressed are those of the author.