Stay Ahead of the Curve: Risk Evaluation for Public and Private Companies

U.S. non-financial corporate debt is currently more than $9.9 trillion: a staggering 47% of GDP. Junk debt ($1.2 trillion) and leveraged loans ($1.15 trillion) already make up nearly a quarter of this balance and the “BBB” category (just above junk rating) has soared to make up 38%, setting the stage for another gruesome financial reckoning and a huge risk for unsecured trade creditors.

In the next economic downturn, CreditRiskMonitor® forecasts that financial losses stemming from public companies will reach $1.1 trillion or more. This estimate is based on today’s balance of corporate debt against the average peak corporate default rate of 12%, as shown below:

Global debt is higher than it's ever been, driven by historically low interest rates.
Source: NYU Salomon Center and Federal Reserve Bank of St. Louis.

Trade credit has the lowest priority of payment in bankruptcy. Professionals need to use the best credit risk monitoring services available before the next recession.

Payment Behavior

Coined by Dun & Bradstreet in their 2012 white paper, “Bankruptcy: Why the Surprise?”, the cloaking effect describes the phenomenon that public companies have the capability of maintaining prompt payment all the way up until their bankruptcy filing. Dr. Camilo Gomez, CreditRiskMonitor’s Senior Vice President of Quantitative Research, offers insight on the payment trends prior to bankruptcy for both public and private companies: “Private companies often show deterioration in payment behavior in the quarters leading up to bankruptcy, whereas public companies demonstrate relatively consistent performance.”

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During a benign credit cycle, your receivable bad debt expenses will be very low because public company profits are stable and financing is easily accessible. As credit conditions deteriorate, financing for public companies becomes increasingly expensive and availability shrinks. Companies with highly leveraged balance sheets can quickly slip into bankruptcy and cause substantial financial losses for counterparties.

An example of this event can be found in the bankruptcy of Toys “R” Us: The company had more than $1 billion in accounts payable, and suppliers incurred enormous write-downs on their accounts receivable. 

Path of Bankruptcy

Dr. Gomez further explains that public companies tend to file for bankruptcy under Chapter 11 and subsequently emerge from bankruptcy. This tendency to reemerge is why your credit department needs to manage credit risk while also maintaining the best possible relationship throughout a crisis period. In contrast, private companies typically file under Chapter 7, which results in liquidation, because the Chapter 11 process is so lengthy and expensive.

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Chapter 11 bankruptcies carry long payment times which dramatically slow collections from one or two quarters to a year or more. Your credit and collections departments will avoid these risks by using cutting-edge risk scoring solutions like the FRISK® and PAYCE® scores.

Predictive Bankruptcy Models

CreditRiskMonitor®’s FRISK® score predicts bankruptcy for public with 96% accuracy. The FRISK® is based on a “1” (highest risk)-to-“10” (lowest risk) scale, and anything equal to “5” or less is indicative of high risk. We recommend that subscribers pay attention to businesses that are in this “red zone” category, as illustrated below.

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The FRISK® score is highly convenient for credit professionals because:

  • Coverage spans approximately 56,000 public companies worldwide.
  • 80% of all bankruptcy filings occur in the “1” to “3” range.
  • Elevated bankruptcy risk is identified 12 months in advance of the filing.

The PAYCE® score is only used for private companies where financial statement data is unavailable. The model employs deep neural network AI to produce a 70% accuracy rate by considering payment behavior and federal tax liens. Just like the FRISK® score, the PAYCE® score also uses a “1”-to-“10” scale to identify levels of risk.

Bottom Line

Even if your bad debt expenses have been minimal because of today’s benign credit cycle, your company invariably has exposure to risk. It’s imperative that your accounts receivable be monitored with timeliness and accuracy which is why CreditRiskMonitor® award-winning service is used by thousands of large companies worldwide including more than 35% of the Fortune 1000.

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