Earlier this month, Brazil’s largest telecom Oi SA announced it is seeking bankruptcy protection for over $19+ billion in debt. This bankruptcy filing comes after failed negotiations to restructure debt and with only a month until its $261 million bond (denominated in Euros) will be maturing. Oi has struggled with negative cash flows for several years and an increasing amount of debt. Along with poor financial stability of the company, Brazil has struggled with a recession for the past two years, a contracting GDP, and issues arising from political uncertainty. On top of all of these challenges, Oi has just brought in its 6th CEO within five years. RapidRatings saw this increasing volatility and risk early – Oi’s FHR steadily declined from a 71 at the end of 2013 down to a 32 – High Risk – at the end Q1 this year.
How Oi’s bankruptcy affects its creditors
With all of these issues plaguing Oi for several years, creditors and shareholders should be prepared to deal with losses from the company. Their largest creditors – Banco do Brasil and Itau Unibanco Holding – have invested significant amounts in their counterparty. Banco do Brasil already took a hit via its stock price, but Itau is a privately-owned bank, so it’s not obvious how its investors are reacting to the news. Rating agencies should be providing warning signals to creditors for a potential default, but many have not provided proper warning, despite all the signals of deteriorating financials. For example, four months ago, Oi was still rated investment grade by Fitch – a -BBB. Three days prior to default, Fitch was still downgrading them to a C – highly vulnerable – which is hardly enough time to make changes to manage your risk.
Early warning for potential counterparty default is essential
Creditors need ample warning time to develop a risk mitigation and contingency strategy for companies declining in financial stability. Looking at our Financial Health Rating (FHR), you would have seen the gradual decline of Oi’s financial health over the past two years.
The FHR has continually declined each year since the end 2013:
- YE 2013 – YE 2014: Dropped 15 points, entering the Medium Risk category
- YE 2014 – YE 2015: Dropped 19 points, entering the High Risk category
- YE 2015 – Q1 2016: Dropped 5 points, sinking further into High Risk
Only having a few months, weeks, or even days can severely hurt your ability to create an effective plan. Having predictive insight into financial deterioration and estimated probability of default can save your company from millions in losses from a counterparty bankruptcy.
Rely on a model that has a low percentage of “at risk” companies
While it is important to have early warning signals, it is also necessary not to have too many companies in your portfolio rated as an “at risk” company. The crucial piece of a credit risk management program is being able to identify the strong from weak without raising false alarms. Our universe has less than 15% of both public and private companies rated as “High Risk” – High Risk includes any company rated under 40 on our 0-100 scale. By having an accurate and timely rating, you can concentrate your efforts exactly where you should be concentrating them. Creditors invested in Oi could have had additional time to develop a contingency plan with signals of deterioration for the past two years, therefore reducing losses from a default in their portfolio.