Euler Hermes Trade Talk: Takeaways from Bankruptices and B2B Payment Disruption 

Recorded: November 2020

In this episode of our Euler Hermes Trade Talk, host Andrew Gertz talks with guest Steve Georgetti, VP and Regional Director of Information and Grading, about payment default trends and takeaways from bankruptcies in the last 12 months.

Leading a team of 30 credit analysts spread among the US, Canada, and Brazil, Steve has a unique perspective on the current trade risk landscape, which he'll share with you during this interview. Check out the recording and transcript below. 

Topics we cover:

• Steve’s perspective on payment default trends
• Sectors showing signs of financial improvement
• Assessing the payment risks of your customers
• Which major bankruptcy stands out the most to Steve?
• Takeaways from recent business bankruptcies
• How financial leaders can combat cash flow uncertainty

Andrew Gertz: Hi, everyone. I'm Andrew Gertz, Digital Marketing Manager for Euler Hermes and your host for today's session of Euler Hermes Trade Talk. This time around, we're going to be talking about payment risk trends and bankruptcies, insolvencies, and all the uncertainty in the market today.

To set the stage for that a little bit, Euler Hermes and Allianz Research, when they looked at what to expect in 2021 and compared it to 2019 data, they're projecting that we can expect a 57% increase in U.S. business insolvencies over that two-year span. So a lot of uncertainty, a lot to digest there.

Fortunately, we're joined by an expert today at analyzing the risk data here at Euler Hermes. That’s Steve Georgetti, Vice President, Regional Director of Information & Grading. Steve, thanks for joining us. How are you doing today?

Steve Georgetti: Doing well, Andrew, thanks for having me on. Appreciate it.

Andrew Gertz: Yeah. Absolutely. Thank you. So, Steve, as I mentioned, you, your team, you look at a variety of data sources, including Euler Hermes claims data. You assess credit risks every day. We're obviously not expecting great news here, but… can you talk a bit about the payment default trends you're seeing right now?

Steve Georgetti: Yeah, for sure. So within the claim space, it's been a very challenging 2020. Claims are up pretty dramatically year over year. 45% in number, 60% in dollar amount. So clearly, that indicates that the claims are becoming more severe. They're becoming larger, right? And that's no surprise. So the reason for that is quite obvious with the sudden stop in trade, the sudden stop in payments. It was very unexpected across the board.

With that said, claims is also very much what I would consider a lagging indicator, right? These tell us about things that have already happened. It's a reflection of what the economy has already been through, right? It's not a reflection of what we're seeing forward-looking and I know we'll probably get into that a little bit later.

But our clients also submit to us on a monthly basis what's called past due reports. We call them PDRs. And for us, that is the single most important leading indicator of what we will experience in the coming months or quarters. And it's a little bit of optimism there, right? We're seeing past due reports are actually slowing down 15% in aggregate.

So yeah, I mean some bad, right? The claims we've already digested, we've already seen. But we do have room for optimism looking forward from a payment behavior standpoint.

Andrew Gertz: Well, thank you for that optimism. That is very interesting. So let's turn our attention for a second to sector risks for a moment, if we can. So where are you seeing improvement there and where do you think challenges still exists?

Steve Georgetti: Yeah, so I would say the first one that's the prominent – and the largest part of our portfolio – is retail. Retail is where we've seen some of the largest claims incurred, but it's also where we see – again, coming back to the past due reports as a leading indicator – it's where we see some optimism where that's actually down 20% month over month and even on a rolling six-month average basis.

And so if you think about that, it makes sense, right? Stores are reopening. Companies are generating cash. They're starting to repay suppliers. If we go back in March, May, June, you had some of the strongest companies that, you know, were renegotiating leases, that were extended in terms of suppliers, right? So it was a very painful environment and we saw that in our numbers.

Another sector where we're seeing some improvement: construction. Again, that's improving by around 25%. Again, more logic, making sense, right? You had a lot of companies putting projects on hold, not really understanding the uncertainty in the marketplace.

Now I'm not going to say, improved dramatically, but things are more settled. You know, projects are opening up, people are starting to rebuild, and construction is doing quite well now.

And the third improved sector I would say is machinery equipment. So think of big industrial machinery investing. They're spending their money CapEx. So, we're also seeing that improve. You know, companies are starting to utilize that cash that they might've put on the sidelines during that summer and spring months. Now they're starting to open up a little bit and maybe invest in and take advantage of that.

Andrew Gertz: We'll take any good news that we can get, so thanks for sharing that. You touched on this a little bit before, but I can't imagine how difficult it must be right now trying to stay ahead of risk in this environment, especially with COVID-19 and everything that's causing in a variety of markets. You talked about claims data a bit and some of the things we look at, but can you take us through more of the data points, the marketplace factors, things of that nature that go into actually assessing the risk behind a business and what its credit worthiness might be?

Steve Georgetti: Yeah, it's a big question. So I'm going to try and give you a not-so-big answer but try and go through it a little bit.

So if we go back to March 2020 when the world really changed, you know, the way we segregate our portfolio is we have call it 20,000 to 30,000 buyers that are sensitive, whether that be because they've all had exposure or because the grade of the company is such that we need to keep a close eye on them. So we made the decision at that point in time that we needed to revisit and reanalyze all 20,000 of those buyers manually. It was quite an undertaking and it's not something we did overnight. And so we really had to do a stress analysis on, "Okay, what sector are these companies in?" right?

If you're in hospitality or you're in the cruise line industry or airline, your demand literally went to zero or close to it. So you could have had a company very strong that, okay, their demand is now zero for the foreseeable future. How much cash liquidity do they have to sustain themselves? We were much more forward-looking with what could be the impact?

Clearly, the need to have financial disclosure is important. If we don't have financial disclosure, that presents a challenge to us. With that financial disclosure, we could look at, you know, all of the classic credit fundamentals and then stress that over time.

So that's the first thing.

So that's the main part of our portfolio. But the other big part of our portfolio:  frequency claims – that where there's a high volume of claims, but not necessarily for a high dollar amount.

And so luckily for us about a year ago, we subscribed to an exchange called the Small Business Financial Exchange. And it gives a lot of insight to how companies are paying their bank. Are they paying their credit card late? What's their balance? What's their average days of payment? And that information is absolutely critical on the SME part of our portfolio, which is over 200,000 buyers. So that is one major source of data.

And then, of course, you have the traditional sector subscriptions we belong to, standard and -- all of this, of course we have classically, but honestly the biggest part of information that we use is the information that clients give us by way of claim filings, collection filings. The past due report, again, is another big indicator.

So putting all this together provides a very compelling picture of how a business is doing.

So the second part of that question is: okay, looking forward right now that we're sitting here in November 2020, what do we do going forward?

And again, it's a continual monitoring of that risk. It's not just, "Hey, we looked at it in March or April, and we're done.” We're looking at these sensitive risks constantly every quarter.

Like we were forecasting negatively with the [economic] crisis that we were seeing {although no one knew in March the magnitude). We're doing the same thing now, right? When are things going to reopen? Which sectors are more prone to benefit? Which sectors still have a lot of headwinds in front of them?

So that's what we're in the middle of right now is a regrading, again, after we just did the massive one back in March, which carried us through to today.

Andrew Gertz: Yeah. That’s a ton of valuable work for ourselves, our clients, and the entire market, really. Thank you for doing that. So let's maybe dive into some specifics, if we can. So I know we can't really go a day without seeing headlines about bankruptcies or companies dealing with cash flow problems. There are a lot of examples we could talk through, but for you, are there any major bankruptcies that stand out more than others? And, if so, why that one?

Steve Georgetti: Yeah. I mean, you know, we see a lot of bankruptcies on a regular basis and I know everyone does. And, and we hope to see that slowing in 2021. Fingers crossed. But if I go back in time this year, the biggest one, the most prominent one is J.C. Penney.

This was a company that we've monitored very closely. It's had its share of troubles and management turnover in the past few years. And at one point, not too long ago, we had over a $100 million of coverage on this company – clearly, a significant amount of exposure on a pretty sensitive risk. It's a company that, in the past few quarters in 2019, was showing some signs of recovery, right? You were seeing adjusted EBITDA of $500 million. But in the end, they had an extremely leveraged balance sheet, which means they were carrying a lot of debt – eight times – which in our world is very leveraged. And ultimately, they were a victim of COVID.

Now we could sit here and say, “You know, would they have gone bankrupt anyway?” It's hard for me to say. I think that COVID was the final nail in the coffin. Again, it’s one of those companies that demand dried up, and their online platform was not very robust.

The omni-channel approach that has the ability to fuel online sales helps many retailers. J.C. Penney was not that.

So yeah, that one – luckily, we got off of risk. We advised our clients and partners in the right amount of time. We didn't sustain any losses. And I think we managed quite well, but at one point in time, we had nine figures of exposure. So quite significant.

Andrew Gertz: Sticking with that topic, when we talk about these major bankruptcies – J.C. Penney being one of them – what do you think are some of the major takeaways for financial leaders? Anything that you think they should know about red flags that you commonly see that they kind of indicate, "Okay, we have a real problem here. We should lock in on this?”

Steve Georgetti: Yeah, that's a really good question. And we asked ourselves that question about a year and a half, two years ago, when we had a team of four to five analysts that really did a great deep dive into the 30 most high profile bankruptcies in I think the year was 2018 or 2019 timeframe and saying, "Okay, what were the major factors that led that company to go bankrupt?"

So they looked at the public information. They looked at the bankruptcy filing itself, which you find a lot of very interesting, detailed information that the company self-reports. We looked at our own information. And what we found out of those is 30 to 40% of the time, the company had a major liquidity issue. And that was even mentioned by the company in the bankruptcy filing. The other 20% to 30% or so was because they had upcoming maturities.

So what that tells you is that cash is king. If the company does not have the liquidity to either raise additional capital through the capital markets or they don't have financial flexibility with their current bank, they don't have a lot of headroom with their revolving credit facility, they don't have the ability to sustain a shock. Working capital and that ability to access and tap into liquidity is absolutely hugely important right now. And if a company doesn't have that, that's a red flag.

The second part is the upcoming maturities, right? So what does that mean? Just like you have a credit card bill and a mortgage bill to pay every month, a company has a maturity to pay, right? They borrowed money at a certain point of time at a certain interest rate. And 12 months, 24 months, five years down the road, whatever that amortization schedule is, they have to pay it. And if they don't have the ability to pay it, they could file bankruptcy early.

In the case of a few prominent retailers, they knew they didn't have the ability to pay that upcoming maturity and they didn't have the ability to go to a bank and refinance, because the bank saw them as way too risky.

[The red flag] is a combination of their current liquidity, their ability to raise additional liquidity, but also what is on their balance sheet in terms of upcoming maturities. Those two things together were huge takeaways for us that we still implement in our analysis today.

You know, it was the case many, many years ago, where if that maturity is coming up and it's a year away, they'll deal with it. If they're not talking about refinancing at, you know, 18 months away from that, that's a serious red flag for us. 

Andrew Gertz: That's a good point about not just having to look for a red flag, but a red flag that is a moving target. COVID-19, everything we're dealing with, has been the worst kind of stress test for cash flow. And that creates a domino effect of course as we've hit on with payment risk for other businesses. What about the people selling to them and how do they protect their own liquidity? A lot of people out there are trying to figure out, “Well, how do I navigate this uncertainty?” You covered what you look at already, but any takeaways for financial leaders that might be watching based on the uncertainty you're seeing? Any tips for how they can navigate this situation?

Steve Georgetti: Yeah, I used to run the Claims department here, so I've had a lot of visibility on the risk side, but also when things go wrong – that’s the claims side, right? So what did I see? We call it post-mortem. And I think for financial leaders, whether it's CEOs of large companies or CEOs of small companies, or you're the CFO or controller, or just you're an accountant, it's know who you're selling to. Don't superficially know who you're selling to. I mean, really know who you're selling to, right?

Do you get financial disclosure, or do you just ask for trade and bank references? You ask them who they're selling to and buying from, right? So do they have a concentration issue with a particular company that creates that domino effect?

You oftentimes hear that domino effect in the supply chain. And so knowing your buyer at a more intimate detail level is really important because if you don't, oftentimes it creates negative surprises for you.

And in the many claims that I've seen over the years I've been with Euler Hermes (it's more than a decade now) it's oftentimes when I talk to our clients, I’d hear “I had no idea they were in financial distress.” All of these things where it's like, “Well, did you ask the question? Did you try and get information?”

You know, for us, that's where we provide a lot of value from a company standpoint – we have all of these analysts globally that are in contact with thousands of buyers collecting this information. While you might not get the information, we have this ecosystem of information. And so I think oftentimes that's where our value comes in.

Wrapping it back to your question: ask those direct questions to those companies you're doing business with, or you want to do business with. Oftentimes, it's very telling in what they will share, what they won't share, and maybe why they won't share it.

Andrew Gertz: Right. Yeah. I think that's a great point to wrap up today's session. Obviously, having the complete picture, going beyond what you might be experiencing, is so important. You and your team are doing a great job of helping people navigate that as best as possible. Steve, I want to thank you for joining us, for sharing all that information with us today. So for those of you watching, if you're interested in learning more about navigating bankruptcies, we do have an eBook and other things on our website on our website about this topic. And we will see you next time on Euler Hermes Trade Talk. Thanks again. Have a good day.