Z-Score Creator Altman Builds Model for Small Business Defaults

(Bloomberg) -- Edward Altman, who created the Z-score method for predicting bankruptcies 50 years ago, has built on the model to assess creditworthiness of small- and medium-sized enterprises.

Together with Gabriele Sabato, previously head of risk appetite decisioning at Royal Bank of Scotland Group Plc, Altman founded London-based Wiserfunding Ltd. to calculate the 12-month default probability for businesses with less than 150 million euros ($168 million) of revenue. Their methods cover 19 European countries and have correctly forecast whether a company would default or stay solvent in about 90 percent of cases, Altman said in a phone interview.

Altman and Sabato are seeking to tap into private-debt markets, which have exploded as traditional lenders retreat from smaller businesses in the aftermath of the financial crisis. They use artificial intelligence to analyze corporate governance and management capacity along with financial and macroeconomic metrics to help lenders identify companies ahead of a downturn that he sees being characterized by more and bigger corporate failures.

“We are increasingly talking to investors in these lenders who are sensing a change in the economy and want to see the credit quality of the companies the lenders they invest in are lending to,” Altman said. “In the next two to three years, there will be a shake up in the credit industry.”

Non-Bank Lending

Non-bank lending has grown in recent years, with 151.8 billion euros raised for a range of private-debt investment strategies in Europe from 2014 to 2018, according to Preqin. That compares with 49 billion euros raised from 2009 to 2013.

Wiserfunding’s clients include invoice-financing firms, peer-to-peer lenders and other traditional sources of small-business credit. Altman and Sabato also plan to target larger private credit managers and SMEs themselves.

Altman and Sabato started looking at small- and medium-sized companies after 2013, when the Italian government changed rules to allow non-listed firms to issue bonds and diversify their funding away from domestic banks. They created a model with the Milan stock exchange to rate companies and lure more investors, which they’ve replicated for other European countries.

“We’ve come from an extremely long cycle of benign credit, with massive leverage growth on the back of the low cost of finance,” Altman said. “We hope that our techniques will help identify appropriate and inappropriate borrowers.”

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