When it comes to default?

How the new definition of default affects companies' creditworthiness.

With 2021, amidst pandemics and gloomy predictions, another source of concern has been added to our burden of anxieties: the new definition of default.

1st January saw the entry into force of a new criterion for the classification of clients by banks and financial intermediaries, which introduces stricter conditions for the default identification. How does this affect  companies' creditworthiness? Spoiler: less than you think.

Is a €100 overdrawn on your account enough to be classified as default?

The entry into force of the new definition of default was announced by the press in the traditional reassuring tones. In particular, it was emphazised that it only takes €100 overdrawn (or €500 for businesses) to be classified as defaulted.

Is it true?
Not really.

The new definition of default applies to exposures 90 days past due if both the following conditions are met:

  • if the amount is over €100 in the case of private customers and SMEs, or over €500 in the case of businesses;
  • if the amount exceeds 1% of the total exposure toward the counterparty
To give an example, a 200€ arrears out of 70,000€ mortgage will be not classified as defaulted after 90 days past-due, as the amount of the arrears is below the 1% threshold of the total exposure. But an overdraft of 100 € on your bank account, with no other credit lines opened with the same bank, will.

Default does not always mean default

The classification of a debt as default does not mean that the subject is in default.

In finance, the term 'default' has different meanings depending on the field of application and can describe a more or less serious financial condition.

In s-peek, for example, the classification of a company as default - marked by the letter D - occurs only in the following cases:

  • if the company shows serious financial distress and is unable to meet its debts: a key indicator is the company's equity, a negative value is a strong warning sign.
  • if the company is under bankruptcy, or under liquidation status, or under administration: these cases are reported in the negativity field within the Flash and Extended reports.

S-peek provides a creditworthiness assessment based on the analysis of the company's balance sheet data and the performance of the sector in which it operates. It is an overall assessment of the economic-financial balance of the company, not of its credit history (which is private and confidential). A past-due payment is not enough to be classified as default, just as the red semaphore does not mean the company is in red.

The Probability of Default is specified in the Extended12M reports and it must always be compared to the one obtained in the previous years; this is the only way to determine whether the company is growing or declining.

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