As talk of the sequester on the part of the federal government crept into the national dialogue, so did concern for potentially heightened insolvency risk for companies dependent on ongoing government spending. Perhaps no industry had more reason for worry earlier this year than mid-market defense contractors. In fact, the sector made the short list of returning Credit Congress speaker Ed Altman, PhD, when in January he informally outlined those facing a tough path to continued solvency health. During an interview with NACM, he noted that nothing has shaken his pessimistic outlook in said area.
The budget showdown in Washington and sequestration put mid-market defense contractors in the crosshairs of those looking for industries where key companies could experience struggles in 2013. While there has been little to speak of in the way of defaults in the sector to date, it is becoming increasingly clear that the government spending cutbacks are going to hurt the mid-level players in a manner far deeper than their bigger counterparts, which have more options for keeping cash flow and profits afloat. Altman, the Max L. Heine Professor of Finance at the NYU Stern School of Business and director of research in credit and debt markets at the NYU Salomon Center for the Study of Financial Institutions, as well as creator of the vaunted Z-Score bankruptcy/insolvency predictive metrics system and a newer smart phone application for the Z-Score, told NACM that overreactions to the threat of government spending cuts may have hurt the industry as much as the cuts themselves.
“In preparation, a lot of the companies that buy from defense contractors cut back, and more than they needed to,” Altman said. “Sales went down; investment went down. In some cases, overreacting is self-reinforcing.” He added that the subsequent dive in requests of credit from banks may have had the collateral damage of influencing banks to cut back on what they offered, leading to chilled availability and poorer terms for business borrowers. All this will only cause the mid-markets to lean more heavily on trade creditors, going forward. Trade creditors need to be aware of the dangers in dealing with an industry heading into what appears to be a stiff headwind, barring a change of heart and unexpected cooperation within the U.S. Congress, before granting credit on debtor-friendly terms.
In addition, Altman fretted about the potential for a spike in mergers within the defense contracting industry as mid-level players begin to exhaust their cash positions. What that means to credit professionals in this sphere is the likelihood of fewer credit jobs, and, as the industry becomes dominated even more by larger providers, the spread of the “do more with less” culture.
- Brian Shappell, CBA, CICP, NACM staff writer