This issue of WurstCaseScenario takes a different direction from our typical case study and, perhaps, delves into prognostication.
Ask anyone and he or she will tell you that this economic boom won’t last forever. But when will it come to an end? Or has it already ended?
This boom economy is now in its ninety-third month. It is amongst the longest recorded expansion periods in our history.
Corporate Debt is at the highest levels since the 2008 recession. Defaulted loans remain very low. This is probably a result of historically low interest rates. But interest rates are now on the rise. The Fed raised interest three times in 2017 and is on track to raise interest three or four times this year.
The Dow Jones Average hit its all-time high on January 26 at 26,616.71. Its low for this year occurred on March 23rd when it closed at 23,533.20. Yesterday, it closed at 24,024.13.
This past Monday, Caterpillar commented that its first quarter profits “will be the high-water mark for the year” and stock prices immediately tumbled followed by some modest upticks as the week progressed.
Logic says that a recession is on the horizon, but when will it come and what can we do to get prepared?
In December, 2006, we were in a similar situation. The economy was strong. Turnaround professionals were like the Maytag Repairman. There was no downturn in sight. That was the last time I ventured into predicting the economy (note: I am not an economist and never took a course in economics. Everything I learned about economics I learned from Father Guido Sarducci’s Five Minute University). At the request of Dow Jones, I published an article in its Daily Bankruptcy Review Small-Cap addressing the softness in the turnaround industry, concluding with encouragement to turnaround practitioners: “Get ready. It is coming. Your skills will be needed — at least we turnaround professionals hope they will.” You all know what followed a few months later.
I suspect that we are in a similar time. From my experience, just prior to upticks in loan defaults, fraudulent activity starts to occur. Remember, desperate people do desperate things. Increased interest rates are picking away at your borrower’s available cash and as their cash dries up some may find themselves getting desperate.
What can you do?
First, increase your fraud radar! Be a bit more suspicious (without showing it) and be sure to verify, especially the unusual transactions and adjustments.
Watch out for increased aging of receivables, drops in sales, increased concentration, decreases in inventory purchases, etc. Each of these on its own is probably not a problem, but when they come in combinations you do need to take a closer look.
The earlier you catch a problem the less likely it is that you will get hurt and more likely that you can save your borrower.
Encourage your borrowers to discuss their business challenges with you. They need to see you as someone who can assist them when times get difficult. You have more experience with companies entering or in financial distress. With your assistance, the borrower will be in a better position to effect a turnaround before it gets too deep into trouble.
Be sure that once you have identified a problem and you need (and are willing) to make adjustments to the way you lend to that borrower, that you do so under a Forbearance Agreement that provides protections to you should the relationship deteriorate as you travel down the workout trail.
Next issue of WurstCaseScenario will return to discussions about court decisions and how they affect you. I thought that this was the right time to sensitize you to what many see coming down the horizon so to better assure that you are ready for it.