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The debtwatch beetle
April 2008
Paul Melly, International Trade Today
Time to tighten seatbelts and prepare for a bumpy business ride. While companies across the trading world have had time to adjust to the steady rise in oil prices, with knock-on effects for power and transport costs, the global credit squeeze was completely unexpected. Few but the best briefed and most farsighted business and financial planners can have had any idea that it was coming.
But the impact is already being felt, as Clemens von Weichs, management board chairman at the credit insurer Euler Hermes, recently pointed out: ‘The financial crisis has undoubtedly rendered the economic environment more uncertain. It will contribute to an increase in the cost of credit for companies seeking bank loans.
‘Business access to bank loans is changing as banks will tend to be more cautious when it comes to risk taking. After having reached extremely low levels in the past, the cost of credit is now increasing again.’
Coface, another of the big credit underwriters, has issued a series of warnings over recent months, pointing to a deterioration in business performance and an increase in payment risks in Western economies.
Heavy levels of personal debt have been a major factor behind the underwriter’s decision to place the US, UK and Spain on its negative watchlist during 2007. In Britain, Coface notes, personal debt now averages 163 per cent of disposable income; in a tightening financial situation, this can put the squeeze on household spending.
‘Spain is sharing the dangerous cocktail of real estate bubble and household over-indebtedness with the US and UK,’ explains the insurer’s chief economist Yves Zlotowski.
Such a situation can cause problems for the retailing sector, especially for shops selling home fittings and furnishings; and if they suffer a fall in sales that could put supplier companies – both importers and manufacturers – under financial pressure.
In France, the household debt situation is less fragile, but there has been a worsening of risk conditions in the food and agricultural sector, where payment conditions are usually robust.
Conditions in many emerging markets remain favourable, and Coface has upgraded its risk assessments for Argentina and Poland. But there are exceptions: the outlook for Romania is worsening, while many poor countries are feeling the strain of high oil import costs.
But although economists can identify countries or sectors that have seen heavy borrowing and those where bank liquidity may come under pressure, they cannot tell a UK exporter or importer which of its individual customers and business partners will be under financial pressure, starved of credit or bruised by payment delays.
That makes it hard for managers to pick out the particular situations where they face a real risk of payment delays or customers becoming insolvent.
In such a situation, the only rational response to pursue is the precautionary one.
UK firms engaged in international trade need to take a careful look at their working relationships to see if they can spot any obvious potential problem situations, such as customer companies whom they already know to be in difficulty.
In theory, it might also make sense to attempt to spread risks, developing new business opportunities to reduce overreliance on particular clients or markets; but, of course, this is easier said than done, and many exporters are trying to pursue such diversification anyway. It is a strategy for the long term, but of limited practicability as a safety net for the near future.
So this brings businesses back to the main precautionary line of defence – self protection, through better research on customers, and the use of credit insurance or payment arrangements that offer cover against payment failure.
Credit information is a useful first step. Credit reporting agencies such as Dun & Bradstreet, Experian, or Graydon, and insurers such as Coface, offer a range of report services, allowing businesses to brief themselves on the financial strength and credit standing of potential clients before they commit themselves to supplying them.
The cost of such services may be a deterrent and, in deciding whether or not to buy reports or subscribe to credit monitoring services, companies have to weigh up the amounts of business and payment exposure they expect to be putting at stake.
In some cases, the cost may not be justified. But where a business sees that it is becoming substantially exposed, it clearly makes sense to be well-briefed.
As a supplement or an alternative, one can take the ultimate precautionary step of investing in payment protection anyway – through a credit insurance policy, without recourse factoring service, forfaiting (for larger, one-off transactions) or letter of credit payment.
In some cases, the cost of such protective measures may be prohibitive. Many companies still don’t bother with either credit insurance or secure payment arrangements.
But the penalty for getting this judgment wrong is costly and, sometimes, terminal. Moreover, banks, factors and insurers have all developed forms of service that offer varying levels of protection and support, tailored to the varying budgets, administrative capacities and risk appetites of business clients. Some insurers, for example, have begun to develop schemes under which they combine information and credit cover; where the latter seems genuinely unnecessary, transactions may be left uninsured.
But it is also worth remembering that the use of secure payment techniques or insurance can also bring financial savings. Euler Hermes’ Von Weichs has pointed out how, by using insurance, companies can effectively use credit from their business counter-parties, reducing the need to rely on expensive bank financing.
‘The cost increase of financial loans brought by the sub-prime crisis represents 50 basis points for interbank credit and, most likely, about at least as much for company bank loans. Businesses are, therefore, more inclined to move towards inter-company credit instead which, thanks to credit insurance, can be developed whilst controlling the risk of non-payment.’.
