Magazine article Business Credit

Red Light, Green Light: Obeying the Rules When a Customer Signals Insolvency

Magazine article Business Credit

Red Light, Green Light: Obeying the Rules When a Customer Signals Insolvency

Article excerpt

Even if you can spot when a customer is about to become insolvent, knowing what to do in such a case is another matter altogether. Just what resources and protections are available to the credit professional if he or she suspects that a customer is in trouble? Even if the warning signs are not red flags, a yellow flag is a signal to slow down and take some cautious steps.

The first step, however, is to see those warning signs in the first place. "If they don't want to pay in full or are looking for an excuse to pay later, anything along those lines might be a sign of trouble," said Jason Torf, Esq., of Horwood Marcus & Berk Chartered of Chicago. Perhaps the customer is making phone calls to try to make payment arrangements. One call may not be a red flag. "Maybe it's an orange or yellow flag," he said. But if they call more than once, "maybe the flag starts to turn a darker shade."

An internet search can turn up a lot of information on a company. "Google is your friend," Torf said. "If you get concerned about a customer, the first thing you should do is hop on Google and look them up." A Google search can reveal not just news articles and blog posts, but whether the company has hired restructuring advisors. It doesn't necessarily mean a bankruptcy proceeding is in the works, but it may indicate things are not moving along problem-free. "It's a useful thing to look for, because restructuring advisors typically are hired well in advance of any proceeding," he said. "If you catch signs of trouble early, you can take proactive steps to utilize the powerful rights and remedies that are available to you as a creditor." You don't even have to search the web yourself. Google alerts can be set up and customized to notify you of any new or changed web page on which the customer's name appears.

Payments getting slower and orders not being placed if they have a regular schedule are other warning signs, according to Wanda Borges, Esq., of Borges & Associates LLC of Syosset, NY. So is the customer placing a lot of orders. "Debtors tend to stockpile when they are preparing to file Chapter 11," she said. "Or they place orders of an unusual size, for the same reason."

A change in payment pattern; a change in key personnel; layoffs or a change in work hours, such as reducing shifts; or a change in banks are more signs to look for from a customer in trouble, according to Val Venable, CCE, director of credit at Ascend Performance Materials of Houston. Also keep apprised of "industry group news on the customer or changes within the industry," she said. Declining sales, margins and cash flow; increased reliance on debt to fund operations; late Securities and Exchange Commission (SEC) filings; ratings downgrades to junk status; and delays in the release of financial information are some warning signs of future bankruptcy, according to Bruce Nathan, Esq., of Lowenstein Sandler LLP of New York, NY. Sources of publicly available information include industry reports, lien searches, searches for pending litigation and agency credit ratings, Nathan said.

Attend credit group meetings. As factual information is passed around the table, you may find that you are behind in what others know. "Then you need to wake up to the fact that everyone else has reacted and you have not, and something has gone wrong," Borges said.

"If there's a red light or a yellow light flashing and you ignore the signal, ultimately that's going to cost you," said Donald van Deventer, Ph.D., chairman and CEO of Kamakura Corporation of Honolulu. "We believe every credit manager should take advantage of default probabilities on behalf of their counterparties. The best and most accurate predictor of insolvency in the big-data era is an index or default probability." A breakthrough in statistics occurred in the 1950s with the Steins Paradox, van Deventer related, which says that if you want the best prediction for insolvency for one company, look at the default probabilities of thousands of companies. …

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