Nine Companies Where Refinancing Risk Could Lead to Distress
Corporate borrowing costs have been rising, with the London Interbank Offered Rate (LIBOR) recently reaching its highest level since the financial crisis. The U.S. Federal Reserve, meanwhile, has shifted toward increasing rates and is strongly hinting that there are more hikes to come. With the expectation of even higher borrowing costs in the future, corporations in the United States have been issuing debt while they can still capture reasonably low rates. However, not all companies have been able to take advantage of what may be the last opportunity to lock in cheap debt... and that could increase the risk of bankruptcy for debt-laden companies like Sears Holdings (NASDAQ: SHLD).
But Sears in not alone in this, Toys R US Inc., Genon Energy Inc., and iHeartMedia Inc. (OTCMKTS: IHRT) also have to deal with debt maturities in the next 24 months. The reasons these companies haven't refinanced vary by company, of course, and notably include weak balance sheets and stressed business models. But the end result is the same – these companies, and others, haven't tapped inexpensive debt to substitute their impending maturities.
Adding to the risks these companies face is the potential elimination of net interest expense deductions being suggested in the U.S. Republican House tax reform plan. The takeaway of this plan is that any business with interest costs in excess of interest income will not be able to write off that expense against their taxes. If the net interest expense deduction is done away with, it could easily push a marginally profitable company into the red.
A Few Concerns
With a rapidly evolving credit market in mind, we screened the CreditRiskMonitor database to find companies like Sears and Westmoreland Coal Company (NASDAQ: WLB) that we believe counterparties should be carefully monitoring. We specifically looked for companies that have a FRISK® score of 1 in addition to material debt maturities over the next eight quarters.
A FRISK® score of 1 is the worst possible score on CreditRiskMonitor's proprietary 1 to 10 bankruptcy risk scale and indicates that a business has a 10% to 50% probability of financial distress, including default and even bankruptcy, within the next twelve months. Key FRISK® score inputs include the company’s market sentiment, credit ratings, financial information, and the crowd sourced activity of CreditRiskMonitor's own customers – a group that includes over 35% of the Fortune 1000 companies in addition to more than 1000 other large corporations worldwide. The FRISK® score is calculated every day, which provides a timely update of the credit risks that corporate counterparties may face.
Below is a list of nine major U.S. businesses, and their respective FRISK® scores, as of March 3rd, 2017. We think that one or more of these companies could face a material refinancing hurdle in the near future:
If you do business with any of these corporations, whether the relationship is a supplier, customer, or business partner, it's important to know your dollar risk exposure and how much financial risk is involved. However, the bottom rung FRISK® score isn't the only sign of potential distress at these firms.
For example, these businesses possess a combination of high leverage, low liquidity, and/or a poor Z-score, in addition to the lowest possible FRISK® score. All of these metrics collectively hint that trouble could be close around the corner.
Putting some numbers to this, the average debt to assets for this group exceeds 100%, with Affinion Group's debt to assets reaching a painful 242%. The average quick ratio is roughly 0.52, well below the 1.0 to 2.0 that most would consider a healthy figure. The Gymboree Corporation has the worst quick ratio of the group at just 0.08. If the company violates a debt covenant, it may have a hard time coming up with the cash to pay subordinate lenders. And the Z’’-score for this group is negative 3.2. A neutral Z’’-score is between 1.10 and 2.60, so these companies are clearly facing heightened default risk relative to your average company. Additionally, Petroquest Energy (NYSE: PQ) had the worst Z’’-score at negative 16.4.
Clearly, every company on this list has its own story. The information here simply gives risk managers an initial read of the risk involved. But if you do business with any of these companies you should be paying extra attention to the financial risks you face, and consider how you will mitigate them in a worst case scenario, right now.
With peak liquidity arguably coming to a close and net debt levels trending near record highs, risk managers are increasingly concerned about the collateral effects of higher interest rates. That's probably not a material issue for well-financed companies with easy access to debt markets. However, for those with heavy debt loads, limited access to additional capital, and notable impending debt maturities, many of the weakest names, a few of which we have highlighted, could fall into financial distress. Add in potential changes to the tax code, and it becomes evident that all stakeholders need to be well informed and prepared.
The FRISK® score is calculated by a proprietary model that measures the degree of financial distress for a public company. The model has been back-tested over the last decade to predict 96% of US public company bankruptcies. The score is enhanced by our subscriber base through crowd sourced behavioral data patterns. Provided below is the scoring chart that displays the statistical probability of bankruptcy within the next twelve months for each score category:
FRISK® Stress Index is a model that provides the average probability of failure for a group of companies (e.g. by industry, portfolio, or country) over the next 12 months. The level of risk is measured through a scale of 0 to 50, with 50 being the most risky.
CreditRiskMonitor is a financial news and analysis service designed to help professionals stay ahead of public company risk quickly, accurately and cost-effectively. More than 35% of the Fortune 1000, plus thousands more worldwide, rely on our commercial credit reporting and predictive risk analytics for assessing the financial stability of more than 56,000 global public companies.
At the core of CreditRiskMonitor’s service is its 96%-accurate FRISK® score, which is formulated to predict public company bankruptcy risk. One of four key components calculated in the FRISK® score is crowdsourced subscriber activity. This unique system tracks subscribers' patterns of research activity, capturing and aggregating the real-time concerns of what are essentially the key gatekeepers of corporate credit. Other features of CreditRiskMonitor’s service include timely news alerts, the Altman Z”-Score, agency ratings, financial ratios and trends. CreditRiskMonitor’s network of trade contributors provides more than $140 billion in trade data on their counterparties every month, giving them visibility into their biggest dollar risks.