A credit-management outsourcing company has seen a sharp decline in credit quality for unsecured trade creditors during the past two months. According to Pam Krank, president of Credit Department Inc., the cash flows of small and midsize commodities firms weakened significantly in November and December, and the firms are having a harder time getting credit.
Krank’s experience mirrors the monthly Credit Managers Index, which fell for the fifth consecutive month in December, suggesting the economy is slowing, according to The National Association of Credit Management. NACM reported earlier this month that its index is at its lowest level since April 2003.
The results of the NACM data are another early indicator that 2007 will see a further slowdown of the U.S. economy and an increase in failures by small and midsize businesses, according to Dan North, chief economist with Euler Hermes ACI, a trade credit insurance provider. “Business failures have been at a historically low level in the past year, and that’s bound to deteriorate over the next year,” he told CFO.com. North bases his negative prediction on weak GDP growth for two consecutive quarters, the inverted Treasury yield curve, and the fall of median house prices during the past four months — a trend that looks to continue.
It was also a trend noted by credit managers in the latest NACM monthly survey. One manager described the residential housing sector as “almost at a standstill”; another reported an increase in customers who “cannot pay.” The survey asks credit managers to rate favorable and unfavorable factors in their business cycle — unfavorable factors include rejections of credit applications, dollar collections, and amount of credit extended.
Credit Department, which grants credit lines of between $5,000 and $5 million based on a company’s cash flow, has also seen an increase in such “unfavorable” activity. In the past year, the credit-management company has stepped up its evaluation of bank renewal rates — failure to renew is often an early signal that a business’s credit quality is hurting — and has rejected twice as many credit applicants as it did just one year earlier. Krank has also observed that increasing numbers of vendors are delaying their payments.
Considering the recent negative activity, Krank anticipates a flurry of loan defaults in the next 18 months. Standard & Poor’s recently forecast that 2007 will be a transition year that will see a decline in credit quality, but Krank suggests that conditions may be even more dire, noting that many of her clients have low gross margins and are showing a renewed skittishness toward doling out credit. “We’ll see it before other businesses out there that don’t have such stringent requirements or that don’t monitor that credit risk until it’s past due and it’s too late,” she told CFO.com.
Unsecured trade creditors are becoming more wary of taking on even marginal risk from their business customers, says Krank — a huge difference, she notes, from the high-risk stances of the late 1990s and early 2000s. Like North, she attributes this wariness partly to the housing slowdown, which has greatly affected the construction industry, but she has also seen a negative impact in other sectors, such as hospitals. “You can’t have two trends going negative at the same time, such as sales going down and profits cut in half, and survive very long,” she says. “When those changes are happening and cash flow is negatively impacted,” those businesses will have “a difficult time turning that tide.”