How to Check a Privately-Held Company's Creditworthiness

I begin with the following assumptions:

• Bondholders and secured lenders have access to information to which unsecured creditors typically do not.
• It is in the interests of bondholders and of secured lenders for the debtor to extract as much credit as possible from trade vendors. Their preference is for trade vendors to help finance the company through a period of financial stress or distress.
• If secured bond prices or bank loan prices are materially below par, it may mean that the banks or bondholders do not expect to be fully paid in a liquidation.
• If unsecured bonds are trading substantially below par it is likely that vendors are out of money in a liquidation of the debtor or in a Chapter 11 bankruptcy.
• Bankruptcy newsletters contain valuable information. They report information that are signals that you need to pay closer attention to an account.

Reevaluating credit:

• Start watching a company more closely if they have institutional debt (principal or interest) that matures within the coming year. Keep watching until you are convinced that refinancing will occur.
• Periodically check bond pricing and bank debt pricing. Pricing is indicative of what more informed people in the market are thinking. Journals like Debtwire, ReorgResearch, Bloomberg and Markit are examples of journals that carry this information. Start watching the company more closely if bond debt or bank debt prices are declining. Look at pricing over at least a 90-day time period. The lower it goes and the more consistent the decline, the more nervous you should be.
• Periodically run a lien search. Did a secured creditor demand and receive more collateral as the price of an amendment or forbearance? The additional collateral effectively reduces the size of the pot otherwise available for unsecured creditors.
• If you are told that payments are slow due to the debtor refinancing the company, it likely means that the debtor is having difficulty refinancing the company.
• If the debtor has hired attorneys or turnaround consultants well known for their bankruptcy expertise, it is a warning sign. The names of certain professional firms are closely associated with insolvency. The journals mentioned often carry this information.
• Periodically conduct a litigation search to see if any other creditors have commenced litigation. If vendors have commenced litigations, it should cause further inquiry even if the claims are settled or relatively small.
• When initially granting credit, calendar the maturity dates of the customer's term loan(s), revolving loan(s) and bonds. Also obtain the dates of interim principal and interest payments.
• First ask for updated financial statements. If you cannot receive written financial statements, then try to ask the questions below.

Questions to ask and why:

• When is the customer's next principal payment due on its bonds? A debtor may be current with vendors but not have adequate cash to make a principal payment.
• What is the maturity date of outstanding bank (secured) debt?
• Has an ad hoc committee of creditors (usually bondholders) been form? This indicates that creditors are worried and feel that they must engage with management to protect their interests.
• Has anyone received additional collateral recently? Granting additional collateral can be an indicator that the current lender feels inadequately collateralized.
• Is the debtor seeking to refinance any bank debt with a new lender? If so, difficulty may indicate  the current lender's lack of confidence in the debtor's creditworthiness,
• Is the debtor party to a forbearance agreement? Forbearance agreements indicate that the borrower may be in default.
• Is the debtor in a grace period with regard to its institutional indebtedness? A grace period is exercised by a borrower in order to defer the lender exercising its rights and remedies.
• Has the debtor hired a chief restructuring officer, turnaround consultant or crisis manager? Engaging a professional firm that specializes in insolvency or turnarounds indicates that the debtor or its lender feels that management cannot achieve a turnaround without outside assistance.
• How long have the debtor's current auditors been engaged by the debtor? Have auditors resigned in the preceding __ year(s)? Auditors resign because they may not have confidence in the client's financial record keeping or that the auditors have been asked to refrain from issuing a going concern opinion.
• Have any board members resigned in the preceding __ year(s)? Sometimes board members do not want to serve on the board of a financially distressed company.
• Does the debtor have any independent board members? Independent board members often are appointed due to the lack of confidence in the current board by key stakeholders.
• Has the debtor lost any customers in the preceding __ year(s) that accounted for more than __ % of annual sales? The loss of a major customer can destabilize a company.
• Has the CEO, COO, CFO or CEO changed in the preceding twelve months? Is anyone in the "C" suite serving in an acting or temporary capacity? Resignations or terminations may indicate a failure to achieve satisfactory results.
• Have the current equity holders provided the debtor with more working capital (debt or equity) in the preceding __ year(s)? If yes, this is a basis for confidence. If not, then does it indicate an unwillingness to further infuse capital or a preference to just have the debtor borrow more funds from its banks?
• Did the company pay any dividends to equity holders in the preceding year (+). If so, how were the dividends funded (cash on hand, new financing or refinancing)? This is especially important if the company further encumbered its assets in order to do so.
• Does the debtor pay a management fee to its equity holders or to a party related to an equity holder? If the debtor is doing so during a period of distress, such payments may be an indicator that equity holders are putting their own interests ahead of being timely on payments to vendors.
• Is the debtor current with the payment of all local, state and federal taxes? Smaller companies often take involuntary loans from the government when cash is tight.
• Has the debtor issued a WARN Act notice? WARN notices often are reported in local community newspapers. These notices can be indicators of a downsizing or belt tightening in order to deal with financial distress.
• Is the debtor current with all of its employee obligations including union obligations, severance and wages/salaries? Holding back on union dues and pension obligations is effectively an involuntary loan — which the debtor may prefer to do if it cannot obtain additional funding from its main lender.
• Is there a guarantor for any of the debtor's indebtedness? It can be comforting if the guarantor thinks that a successful reorganization is the only way to get out from under their guarantee. On the other hand the guarantor may be deliberately pushing funds to the company lender and stretching out vendors in order to reduce their personal exposure.

Of course, extracting answers is easier said than done. Management of a distressed company usually does not want to share much information with vendors.  And, your contact with a customer may not fully be aware of what is occurring in the "C" suite. Do the best you can. Ask questions anyway. And, be well aware of the warning signs.

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