Did you know companies today are defaulting at more than twice the rate of 2015? In fact, there were more corporate defaults in the first nine months of 2016 (150 total), than there were in all of 2015. (Standard & Poors)
Global corporate defaults reached 104 in 2016 – the fastest pace of defaults since the financial crisis in 2009. CNBC says that S&P expects the U.S. corporate trailing-12-month speculative-grade default rate to rise to 5.1 percent by September 2017.
So what can an organization do to keep its debt compliance in order to avoid default? Immediately, there are several steps a firm can take to mitigate its default risk. While these tactics are fairly easy in concept, they’re tedious and difficult to execute:
- Read all of the agreement – not just parts of it, all of it.
- Understand the agreement by making a categorized covenant checklist. Next, create a checklist for all covenants, no matter how insignificant they may seem to you, because any covenant violation, no matter how insignificant, gives your lenders the option of calling a default and may force your auditors to restate the debt as short-term.
- Use categories to collate like covenants by primary departmental responsibility and subject. Determine the truly at risk covenants that need to be managed quarterly or annually, winnowing out covenants that are boilerplate or a triggered by a lender request or a borrower initiative. Short cure periods are also a major risk indicator.
- Decide who in the organization has the knowledge about the at-risk covenants and can make decision that impact compliance. By doing that, you’re going to actually go out and talk to many people throughout your organization who are right on the firing line.
- Document their statements about the company’s compliance with their covenants.
- Evaluate their responses against the covenant text to determine whether any of the issues that are raised are need to managed, monitored or mitigated to avoid possible future issues or are significant enough they need to be discussed with the CFO, lenders or even the CEO and Board.
Taking these five steps will allow your organization to take a proactive approach with the lender on how to best to deal with any issues. As a result, your organization is less likely to get caught in the draconian process of admitting a default.