eNews December 7, 2017

Troubled Company Index Drops, Risks Remain Concentrated in Specific Companies

Corporate credit quality as tracked by Kamakura Corporation’s troubled company index ticked down in November, but overall indications are that a strong global economy and low interest rates are likely to keep default levels low in the short term.

The troubled company index, which reflects the percentage of 39,000 public firms with a default probability of over 1%, ended November at 7.61%, an increase of 0.45% from Oct. 31. An increase in the index indicates declining credit quality. November’s reading declined to the 85th percentile of historical credit quality (with 100 being the all-time best) over the period from January 1990 to the present.

Eight of the top-10 riskiest firms in November were in the U.S., including the top-three riskiest: EV Energy Partners LP, Bon-Ton Stores Inc. and Frontier Communications Corporation. Sears Holding Corp., Eastman Kodak Co. and Exco Resources Inc. were also among the riskiest companies.

“Though Kamakura’s troubled company index indicates that corporate credit quality has declined somewhat, positive economic growth continued across regions throughout 2017,” said Martin Zorn, president and CEO for Kamakura Corporation. 

Economic problems and defaults have been company- or country-specific, he noted. Interest rates are so low now that even significant leverage is not a big risk, though that could change if rates start to rise. Telecom, media and retail are three sectors that face elevated risks over the short- and medium-term, but trade creditors shouldn’t lump all firms into one tarnished barrel, he said. In the retail sector, for instance, traditional brick-and-mortars like Sears and Bon-Ton are being challenged by e-commerce juggernauts like Amazon. Firms that offer products that consumers still want to buy in-store, such as auto parts and home repair supplies, or some luxury retailers, are doing quite well in terms of having low risk. “The business model really dictates the risk,” Zorn said.

Performance in the eurozone has been stronger than expected. Moody’s Investors Service recently switched its outlook for nonfinancial companies in Europe, the Middle East and Africa (EMEA) to positive for 2018. New emerging risks such as Catalonia’s struggle for independence, the Qatar crisis and North Korea also seem manageable in light of the fact that few EMEA companies are directly exposed to these issues. In Asia, China’s government bond yields continued to rise in November, Zorn said. “These factors have contributed to benign credit conditions, reflected in our overall troubled company index,” he said. “The strength of the global economy and low interest rates will likely continue to drive a low level of defaults in the short term. The risks seem to be focused around geopolitical worries in the short run. In the longer term, we continue to be concerned about the level of the 10-year cumulative default curve.”

The Kamakura expected 10-year cumulative default rate for all rated companies across the globe improved in November from the prior month by 0.31% to 13.93%. The figure remains above the 13.33% reading from September 2008.

– Nicholas Stern, managing editor

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Avoid Lien Waiver Confusion

Material suppliers and trade creditors aren’t the only parities interested in payment protection. General contractors (GCs) and subcontractors are also looking to benefit from such mechanisms. This is why reading and understanding construction documents is so important. What you think you might be signing could be an entirely different document. Knowing what type of mechanic’s lien waiver and the language that is used could be the difference between getting paid or missing out on money and your lien rights.

It may be obvious, but signing the incorrect waiver or the correct waiver with unfavorable language “could mean giving up future lien rights,” said Connie Banker, CBA, director of operations, with NACM’s Secured Transaction Services (STS). This is why reading the waiver is essential. Trade creditors and suppliers need to pay close attention to understand if the waiver is conditional or unconditional, and if it's for progress or final payment.

“An unconditional lien waiver states that you have already been paid and are immediately releasing your lien rights. If you have not been paid, then you should only sign a conditional lien waiver,” said Matthew Jameson, Esq., with Dallas-based law firm Jameson and Dunagan.

Some states have statutory waiver forms to be used by general contractors and subcontractors. In Texas, they make the process easier and more streamlined, added Jameson. It is fair and less expensive. Prior to the state requiring the forms, lien waivers could differ from GC to GC and from sub to sub, showing a lack of uniformity. This slowed things down and made it more expensive by having to add attorneys to negotiate and review the forms. “The statutory lien waivers have really simplified the process in Texas, and I don’t know why every state does not implement similar forms,” he noted.

Even if you are paid by check and sign a waiver, there can still be hiccups. It is important to make sure the check clears and you have the money in your account before signing a conditional or unconditional waiver. This can also be tricky. A conditional waiver could read that you are waiving your rights to lien once you have received the check, but what if it bounces? This is why STS adds the language to its forms to clarify that the funds must be paid by the bank. But what if the lien filing deadline is around the corner and you are given a check for payment?

Both Baker and Jameson suggest changing the payment method—e.g., from check to wire transfer or certified funds. Making this request can also depend on your customer. If there’s a history of nonsufficient funds (NSF) checks or other payment issues, requiring a different payment type should be the way to go when the deadline to file the lien is approaching. This goes back to knowing your customer. You might not think about changing the payment method if there has never been a problem with payments.

To avoid any confusion, know what you are signing and what you are giving or not giving up when signing it. Understand the difference between progress and final payment waivers, and the variations between conditional and unconditional waivers. This can be done by consulting with a legal professional or carefully reading the document. You don’t want to be stuck with an NSF check after waiving your lien rights.

– Michael Miller, editorial associate

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SMEs Troubled By Brexit, Financial Crisis

Small- and medium-sized enterprises (SMEs) are having a difficult time staying afloat in the United Kingdom, according to recent reports. The British Business Bank (BBB) is looking to fix that problem.

Many SMEs are still trying to rebound from the financial crisis 10 years ago and are facing reduced credit opportunities from traditional lenders, according to British Business Investments (BBI), which is the commercial arm of the BBB. British Business Investments and commercial finance provider Independent Growth Finance (IGF) have partnered to provide $40 million in funding for SMEs struggling to find finance capital.

“The finance we will be providing allows them to unlock the value of the assets they own and use them to borrow funds to expand and create jobs,” said IGF CEO John Onslow in a release. BBI Chief Executive Catherine Lewis La Torre mirrored Onslow’s sentiment, stating the funding will assist small businesses looking to expand.

Brexit has been another key factor, along with the financial crisis, that has caused SMEs to stumble. The Global Trade Barometer from SME Magazine shows more than one million fewer businesses traded internationally in the third quarter of 2017 compared to last year. Looking forward, 70% of respondents expect international trade to stay unchanged or decline in the final quarter of this year. More than two-fifths of SMEs reported Brexit negotiations concerned them, and another third said they are worried about currency volatility. SMEs view international trade as too risky due to a lack of a Brexit deal, said the magazine.

Financial technology (fintech) is a potential solution to SMEs’ problems in the U.K., noted SME Magazine. Companies behind fintech will continue to innovate and create products that will help SMEs expand their footprint globally despite the concerns of Brexit.

SMEs in the U.K. aren’t the only ones looking for help. The European Commission, last week, established a nearly $12 million initiative to support Irish businesses. Enterprise Ireland will run until 2020 and is designed to help SMEs facing financial difficulty. “It aims to avoid situations where value-creating and viable SMEs, with the potential to restore their competitiveness, are prevented from accessing finance from credit markets,” explained the commission.

“Small- and medium-sized companies are the backbone of our economy and it is good that we have been able to endorse this Irish scheme to support SMEs that get into difficulties,” said European Commissioner for Competition Margrethe Vestager in a statement. “These smaller companies employ a lot of people and this scheme should help them preserve jobs without unduly distorting competition.”

– Michael Miller, editorial associate

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DOJ Issues New Corporate Bribery and Corruption Guidelines

The Department of Justice (DOJ) has revised and updated its Foreign Corrupt Practices Act (FCPA) Corporate Enforcement Policy in an effort to further clarify the department’s enforcement decision-making process, as it continues a policy of incentivizing companies to voluntarily disclose misconduct under the act and prompts them to cooperate with law enforcement.

The revised policy is, for the most part, a continuation of the DOJ’s 2016 pilot program for prosecuting corporate cases involving potential FCPA violations. But trade creditors should note: “The new policy, like the rest of the Department’s internal operating policies, creates no private rights and is not enforceable in court,” said Deputy Attorney General Rod Rosenstein Nov. 29 in public remarks at the 34th International Conference on the FCPA. Further, to qualify for the policy, companies also must fully pay any disgorgement, forfeiture and/or restitution resulting from the misconduct, said Brian Hoffman, Esq., a former SEC enforcement attorney, now with Holland & Hart LLP.

Historically, when the DOJ has issued new guidance, it’s done so through memos, which can be superseded by successive memos, said Michael O’Leary, Esq., of counsel for Holland & Hart. In this situation, Rosenstein’s inclusion of the policy into the U.S. Attorney’s Manual provides compliance officials and trade creditors something more permanent and easier to study. Credit professionals interested in a helpful roadmap of what the government thinks of as an effective policy can find it here.

The advantage of the new policy for businesses is to provide more transparency about the costs and benefits available by cooperating with the DOJ if they satisfy the requirements of the policy, particularly as it relates to “voluntary disclosure,” “full cooperation” and “timely and appropriate remediation,” Rosenstein said. If companies satisfy the standards, there will be “a presumption that the department will resolve the company’s case through a declination.” According to the FCPA Blog, a declination is: “an instance in which an enforcement agency has concluded that it could bring a case, consistent with its burden of proof as to all necessary elements, yet decides not to pursue the action.” That presumption may be overcome only if there are aggravating circumstances related to the nature and seriousness of the offense, or if the offender is a criminal recidivist, he said.

If a company voluntarily discloses wrongdoing and satisfies all other requirements, but aggravating circumstances compel an enforcement action, the DOJ will recommend a 50% reduction off the low end of the sentencing guidelines fine range, Rosenstein said. Also, the policy provides details about how the DOJ evaluates an appropriate compliance program, which will vary depending on the size and resources of a business. Specifics relating to an effective corporate compliance and ethics program include: fostering a culture of compliance; dedicating sufficient resources to compliance activities, including well-compensated compliance officials; and, ensuring compliance staff have appropriate access to management and the board, he said.

Hoffman said some other corporate governance measures to follow include proactively assessing and refreshing compliance measures; encouraging and paying attention to internal “whistleblower” reporting; and promptly and cost-effectively investigating and appropriately addressing potential FCPA red flags.

– Nicholas Stern, managing editor

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