How to Work Industry Analysis Into Credit Decisions
When thumbing through a credit textbook recently, we were struck by the chapter on industry risk. The textbook authors were advocating a process that would have taken days to complete. A valuable exercise to be sure, but a challenge timewise, with everything else that has to get done.
Now, there's an easier way to add an industry perspective to your credit assessments. The FRISK® Stress Index is the risk manager's equivalent of having precut vegetables in the kitchen. This new tool measures bankruptcy risk for 98 industries and every country, without the work. Plus, it's free.
Here's a look at how to add industry risk to your analyses.
Industry Risk: A Top Down Approach
Our data shows that in many cases, industry risk is "contagious". Industry-wide systemic risks often impact one company after another, within an entire sector.
This insight has value for anyone who needs to assess an individual company's financial stress. When it comes to the creditworthiness of customers, economic forces, new regulations, and other macro factors can all impact a customer's prospects.
Let's look at a snapshot of financial risk for a very troubled industry - the energy sector - to see how the FRISK® Stress Index works, and what conclusions can be drawn about the industry participants' ability to pay.
Example: Oil and Gas Industry Financial Stress
Anyone who buys gas knows that the oil and gas industry is in turmoil. Industry financial risk is up sharply, resulting in an alarming rate of bankruptcy, as shown in the chart below.
According to this chart:
- The risk of bankruptcy is 655 percent higher now than at the start of the Great Recession in late 2007.
- More than nine in 100 sector companies are likely to fail in the next 12 months (left axis) - more than 9 times as likely as the average U.S. public company.
- Bankruptcy risk is accelerating.
Note a few other important points about this industry risk snapshot:
- Industry risk in the oil and gas industry may feel like old news now, but the FRISK® Stress Index started signaling this troubled industry well ahead of the current news cycle. The red arrow on the chart above shows that industry risk started climbing sharply two years ago, in late 2014.
- The chart above shows risk for the overall industry sector, using the two-digit SIC code, but the index can also be explored at the three- and four-digit SIC code level, as well as by country, for a very granular look at industry stress as it relates to a specific customer or supplier.
How to Get the Most Out of Industry Risk Analysis
Understanding industry risk can lead to better credit decisions. Consider the following examples:
- As part of a global business portfolio expansion, a finance team we work with was asked to approve credit for new customers in Brazil. The FRISK® Stress Index for Brazilian companies in that sector put the risk into perspective.
- A manufacturing company who purchases a lot of steel was aware that the steel industry in general was in trouble, but used the FRISK® Stress Index to identify suppliers that were not in financial trouble.
- A CFO we know initiated an industry risk analysis to find opportunities in stressed industries, to help her sales counterpart identify stronger customers and prospects.
An industry risk assessment can add an important new data point about the financial pressures on your customers, useful alone and combined with other metrics and scoring methods. Take this new tool for a test drive … what troubled spots or opportunities might you be missing?
Learn how to bring new industry insights to your credit decisions.
Download our free FRISK® Stress Index guide
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.