What metrics would you look at to figure out if a company is in financial distress

and also What would you look at on a 10k to figure out if a company is distressed or about to be distressed or What is an asset or security that has a negative beta?

Comments (13)

 
Jan 18, 2010 - 1:34pm

Tough restructuring interview question. Usually when a company is in distress you will want to be looking at its liquidity situation and assessing whether or not the company will be able to meet its debt obligations (interest payments and maturity). Interest coverage ratios are great to use here to see if the company is generating enough cash (EBITDA) through its operations. You could also use FCF, fixed charge ratios, etc. Covenant ratios are also very important, but its always a pain in the to read through the credit agreements. If I'm not mistaken, breaching covenants is also a technical default.

On the 10K, you might want to read into the company's notes to figure out how much debt the company has, whether the interest is PIKable, rates, and maturity date. CP is also pretty important, especially if the company is unable to refinance and roll back the debt (one of the many causes of the Circuit City Ch. 11).

Gold is an asset that has a negative beta...

 
Jan 18, 2010 - 1:38pm

Don't you think covenants are somewhat useless because creditors and companies almost always renegotiate their covenants when the company is about to breach covenants?

-------------------------------------------------- "Whenever I'm about to do something, I think, 'Would an idiot do that?' And if they would, I do NOT do that thing." -Dwight Schrute, "The Office"-
 
Jan 18, 2010 - 1:41pm

BespokeAnalyst2010:
Don't you think covenants are somewhat useless because creditors and companies almost always renegotiate their covenants when the company is about to breach covenants?

They renegotiate if covenants were too tight and the company can prove it has adequate liqudity. It's still worth looking at them because depending on the covenant in question there might be a penalty involved. Also breaching covenants is typically a sign that performance has deteriorated.

Obviously it isn't the only thing you'd look at but it would also be unwise to ignore it.

 
Jan 18, 2010 - 8:40pm

BespokeAnalyst2010:
Don't you think covenants are somewhat useless because creditors and companies almost always renegotiate their covenants when the company is about to breach covenants?

The fact that a company has to renegotiate covenants or financing at all is already a sign it's in distress..

Examples: Cemex, HeidelbergCement, Manitowoc - you wouldn't say any of these companies were not in distress..

Common ratios:
Net debt/equity
Net debt/EBITDA (as well as all the variants of this e.g. senior [insert one of a plethora of criteria]debt/EBITDA, etc)
Net debt/FFO
EBITDA/EBIT/FFO interest coverage

Others:
CDS prices
Forecast EBITDA vs. debt maturity schedule
Covenants in general

 
Jan 18, 2010 - 4:07pm

Regardless of whether the company and its lender group renegotiate the covenants through an amendment to its credit agreement, the simple fact that that process needs to take place or the ratios are close to threshold levels will always be an indicator of a company in financial distress

 
Dec 24, 2012 - 1:04pm

mrb87:
Fuck the ratios and look at liquidity and upcoming maturities. You're not distressed if you can't go bankrupt.

if you break a covenant / ratio then creditors can accelerate; you'll have a maturity (a massive one if cross default in play).
"After you work on Wall Street it’s a choice, would you rather work at McDonalds or on the sell-side? I would choose McDonalds over the sell-side.” - David Tepper
 
Dec 26, 2012 - 12:56pm

Oreos:
mrb87:
Fuck the ratios and look at liquidity and upcoming maturities. You're not distressed if you can't go bankrupt.

if you break a covenant / ratio then creditors can accelerate; you'll have a maturity (a massive one if cross default in play).

Yes, I agree with that. But it depends to a large extent who the holders are and how they are spread around (how many guys are cross-dressed vs. holders of a single security/class)? Obviously bank debt carries the most restrictive covenants, and if it's still mainly in the hands of banks, they're probably happy to amend-and-pretend.

That said, if we were 25% holders, we would be happy to look for ways to accelerate :D

 
Dec 24, 2012 - 12:54pm

Besides the good responses above (generally, leverage is the first place to look)... do what the accountants do to predict bankrupcy -- Altman's Z-score: WC/Assets, RE/Assets, EBIT/ASsets, MarketCap/BV, Sales/Assets. Apparently there's some other thing called an O-score but I haven't seen anyone use it.

Currently: future psychiatrist (med school =P) Previously: investor relations (top consulting firm), M&A consulting (Big 4), M&A banking (MM)
 
Dec 24, 2012 - 12:58pm
"After you work on Wall Street it’s a choice, would you rather work at McDonalds or on the sell-side? I would choose McDonalds over the sell-side.” - David Tepper
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