Shuttering the economy to combat covid-19 has already led to several notable bankruptcies. Not surprisingly, they have mostly been in the retail, travel, and oil and gas industries – the industries hit hardest thus far by the global pandemic. Notable bankruptcy filings include:
These early filings were predictable. They are entities with weak balance sheets burdened by excessive debt in industries most vulnerable to an economic shutdown. We can expect many more bankruptcies from nearly every sector of the economy, though predicting these will be more challenging.
One bankruptcy indicator is Accounting Standard Codification topic 820 (“ASC 820”) and its application to derivative contracts. ASC 820 is part of the Financial Accounting Standard Board’s generally accepted accounting principles. It provides guidance on the fair value measurement of a reporting entity’s assets and liabilities including derivative contracts such as swaps.
Under ASC 820, entities must consider non-performance risk or “counterparty credit risk,” including their own, when reporting the value of a swap contract as either an asset or liability. This is commonly referred to as credit or debit value adjustment (“CVA” or “DVA”). The adjustment itself is based on entity’s own credit spreads or prevailing market-derived, credit spreads for the sub-sector wherein the entity operates.
When an entity experiences financial difficulty, the CVA/DVA component of the entity’s fair value will change in a way that will make a swap in an asset position to the entity less positive, and a swap in a liability position to the entity less negative. A period-over-period increase in the CVA/DVA amount is a sign that the entity's credit is deteriorating.
At HedgeStar we are experts at measuring fair value of financial products. We have significant experience working with creditors, debtors, trustees, CPAs and bankruptcy attorneys providing valuations of financial instruments. Call us today to learn more on how we can help you identify companies that are approaching a point where bankruptcy may become an action they need to consider, and position yourself as early as possible to advise your clients on actions they should take prior to a potential bankruptcy filing.