The Importance of Credit Risk Analysis on Export Accounts

In a world that continues to advance and become more integrated than ever before, it is important to recognize the risk associated with this globalization. Globalization is the process of increasing cross-border interaction and assimilation of various aspects of human activity, particularly through trade and financial flows. Companies increasingly do business abroad to diversify and expand their sources of revenue and profitability. As such, a credit professional should understand the aspects of international credit risk. Aside from commercial risk, the two main types of risk in international sales are political and sovereign.

Political risk can be defined as the risk an investment’s return could suffer as a result of political changes or instability in a country. For example, a change in government could lead to discriminatory regulations, contract breaches, currency alterations, or even civil war. If you are wondering if there is an increase in political risk on a global scale, the answer is yes. Between 2007 and 2015, the number of conflicts increased twofold. These events can place downward pressure on your customer’s profits and / or business goals, which in turn could hurt your company’s bottom line.

Any risk arising on chances of a government failing to make a debt repayment or defaulting on a loan is called sovereign risk. The strength or weakness of a country’s banking system, in addition to the depth of its capital markets, are important factors to monitor. Debt obligations have the potential to become a fiscal burden or impair fiscal flexibility. Should a government fail to repay its obligations, it could send its country into a tailspin, having a negative impact on global markets as a whole.

After assessing the above risks, what might a credit professional consider to mitigate such risks? Letters of credit (“LC”) are typically used in international sales, as they provide an increased level of security for both parties. Essentially, letters of credit are “a method of shifting the credit risk from the customer to a financial institution issuing the LC” (Journal of Business Credit). This means that the issuing bank has agreed to cover the transaction and that the seller will be paid subject to meeting the conditions noted in the letters of credit. However, we note letters of credit are costly.

EXIM Bank (Export-Import Bank of the United States), is also another option in this situation. EXIM works with private banks so exporters can secure financing for overseas sales through a working capital loan guarantee. We see many companies choosing credit insurance as a means to eliminate the need for letters of credit, to level the competitive playing field, and offer attractive open credit terms with foreign customers. Export credit insurance will protect your business from non-payment of commercial debt.

Financial and political woes can have significant implications on a company’s business. Although this is often overlooked, a credit professional needs to understand how it could influence their international customer’s credit profile.

Sources: ProfitGuard, Coface, and Standard & Poor’s 

The Importance of Credit Risk Analysis on Export Accounts

Suppliers Can Wait

We thought this article might be of interest as it discusses the push for extended payment terms and explores corporate liquidity levels. It was originally published by our sister company, ProfitGuard, and we hope it can be educational for you.

Company liquidity levels continue to rise in the United States. Cash on hand for the 1,000 largest U.S. companies rose by 17%, or $154 billion, in 2017.  Much of that increase can be explained by exploding debt levels and the effects of U.S. tax reform.

Despite sitting on huge piles of cash, many U.S. companies are still pushing hard to be working capital efficient.  The cash conversion cycle (“CCC”) is a measure of working capital efficiency.  The CCC essentially shows how effectively a company is converting resources to cash.  It consists of the length of time it takes companies to get receivables in the door (days sales outstanding), the length of time inventory is on the books before its sold (days inventory outstanding), and the length of time a company takes to pay its suppliers (days payable outstanding).  Ideally, companies want to have a lower cash conversion cycle.  In 2017, the 1,000 companies in the scorecard reduced their CCC to 36.5 days, the fifth straight year of improvement.

As it turns out, looking deeper into shorter cash conversion cycles reveals that companies are not necessarily getting better at collecting on receivables and managing inventory.  Instead, for the third year in a row, it was the ability and willingness to lengthen payment terms (increasing DPO) that primarily pushed CCCs lower. Unfortunately, this manipulation of the cash conversion cycle is a trend that is not losing any momentum. DPO reached its highest level in ten years, or 57.4 days.  Translation: Many organizations are taking almost two months to pay their suppliers.

As more companies look to extend payment terms, it is important to understand the additional credit risk, and how to minimize that risk, when a customer requests extended payment terms from you. Longer credit terms mean your business will have to wait longer for the cash inflows from the collection of accounts receivable. In the meantime, your business may experience a cash flow shortage. This will require you to cover this gap with borrowings from a lender or tie up cash. While the borrowing cost may seem insignificant at first, in the long term it could affect your working capital and your ability to grow your business.

You have a couple of options to consider that could help offset the additional risk from a customer extending its payment terms. First, it is rational to charge that customer a risk premium to cover your increased credit exposure and cost of capital. Another option could be to reduce your DSO on other accounts to cover the difference. It also might make sense to stop selling that customer if it is not viable from a cash management perspective.

Credit professionals should never just accept a customer extending payment terms without first completing a full review to understand all the risks involved and how it affects the business.

Sources: ProfitGuard, CFO Magazine, and The Balance

Suppliers Can Wait

Fox Capital Managment

Below is a condensed version of an article from Fox Capital Management regarding the developing risk of corporate debt defaults.  With a significant amount of maturities coming due in 2019 and 2020, we thought this perspective would be of interest.

Today, we here at Fox Capital believe a bubble highly vulnerable to collapse lies in the corporate debt market and the passive investment vehicles accompanying it.  While C&I lending from the traditional banking system has been healthy since the last crisis ended, the corporate bond market has absolutely exploded, tripling in size from the peak of the prior cycle in 2007.  As a direct result of the Fed’s zero interest rate policy, investors of all kinds were forced out on the risk curve, scrambling for yields attractive enough to meet their own obligations. Pension funds, endowments, insurance companies and retail investors (through ETF’s and bond funds) gorged on corporate debt for extra yield in a ZIRP world.  Many of these yield-starved “shadow lenders” were new to the corporate debt market, and US companies were happy to tap this additional source of cheap money to lever up for stock buybacks, M&A and dividends given the immediate gratification of such financial engineering (higher stock prices).

Assets in the corporate bond ETF market have grown by over 10X since the last crisis.  With no yield available in Treasuries, investors blindly piled into corporate bond ETF’s with the largest growth in Investment Grade funds (for example the LQD).  Now, however, the Fed’s hiking cycle has made Treasury yields far more attractive, and the yield premium of corporate bonds (especially Investment Grade bonds) is beginning to look less appealing.  This could create a reversal of capital flows back toward Treasuries, and indeed we are seeing early signs of that with Investment Grade bond ETF outflows accelerating already.

In addition to the impact a sustained reversal of flows could have on corporate bond pricing, corporate bond fundamentals are currently on a very precarious perch with US corporate leverage at all-time highs on many metrics.  Further, the average interest rate for corporate America is set to increase next year for the first time since 2009, and nearly 50% of all corporate debt outstanding matures during the next 5 years, with the biggest y/y jump occurring in 2019.  Most troubling is the fact that while the ratio of corporate debt to GDP has never been higher, corporate default rates have never been lower.  This irrational phenomenon is a result of the Fed’s extended period of zero interest rate policy, though with a tightening cycle now under way, this historic divergence cannot last.  These facts are largely ignored now that the economy is strong and corporate earnings growth and margins are at decade highs, but any small reversal of these “peak” fundamental metrics could introduce heightened volatility to the bond market quite quickly.


Parallels to 2008:

No financial crisis is ever the same as the prior one, as policy makers diligently prepare to fight the last war again with effective new measures.  This backward-looking preparation unfortunately leaves them vulnerable to new challenges forming ahead.  Many bulls argue that the banking system is far more robust and that consumer and mortgage debt is healthier than during the 2008 crisis, and they are correct.  What they do not understand is that the bubble has now shifted to a new location, like water finding its own level.  It will not be a consumer debt and banking crisis this time.  It will more likely be a corporate credit and passive investment vehicle crisis, resulting in a bear market for stocks and bonds and a new cyclical economic recession.

The biggest similarity to the 2008 bubble (aside from its primary enabler – the Fed) is that investors are far too ignorant and complacent about the debt products they own.  Today, it is the large amount of BBB-rated debt hiding in investment grade corporate bond mutual funds, and especially ETF’s, that is analogous to all those garbage mortgages hiding in AAA-rated debt product “innovations” during the housing crisis.

While BBB-rated corporate debt is considered “investment grade,” it sits on the lowest rung of the ladder.  When BBB debt gets downgraded just one notch by ratings agencies to BB, it becomes a “fallen angel” and is reclassified from Investment Grade to High Yield (also known as junk).  This is important because many investors, such as pension funds and certain bond funds, are unable to own debt rated below investment grade by charter, so should a wave of BBB downgrades occur, forced selling would be a natural consequence.  It is also fair to assume that much of the investing public, especially ETF investors, could feel misled by the “investment grade” status of products they have acquired, and in turn would liquidate positions, especially with risk-free Treasuries now offering similar yields.

Exacerbating this particular risk is the fact that the BBB segment of the investment grade bond market has grown by 4X over the last 10 years, far outpacing overall market growth.  At the peak of the last cycle in 2007, the total investment grade market was $1.7 trillion, and BBB-rated debt accounted for under 25% of the total.  Since then, the investment grade market has ballooned to over $5 trillion, with BBB-rated debt accounting for over 50% of the total. In fact, when examining the entire corporate debt market, including Investment Grade, High Yield and Leveraged Loans, BBB-rated debt is the single largest component of the entire $7.5 trillion market.  Again, should a wave of BBB downgrades to junk occur, it would now have a far more destabilizing effect given BBB-rated debt’s outsized portion of the market.  The knock-on effect to the High Yield market would also be catastrophic, since even a small slice of the BBB market would swamp the much smaller and illiquid junk bond market with supply.  While corporate health in terms of growth and earnings presently seems very sound, such a downgrade cycle could happen at any time due to the tenuous fundamental state of the credit market, especially with interest rates now on the rise.

Finally, unlike during last cycle, we expect that the ratings agencies will be far more proactive with downgrades when merited given how much scrutiny and criticism they faced ten years ago for failing to meet their responsibilities in the mortgage market.  Several senior credit officers at both Moody’s and S&P have recently gone on record predicting a particularly large wave of downgrades and defaults in the corporate debt market when the next economic downturn occurs.  We suspect these agencies will err on the side of caution in an effort to rebuild credibility, lowering the bar for a wave of ratings adjustments.  As discussed above, it is the mountain of BBB-rated debt that has the biggest implications for a potential downward spiral.


(248) 646-9400


Source: Fox Capital Management 

Fox Capital Managment

Collection from Slow Payers- The Art of Persuasion

While it’s not unusual to encounter slow paying customers, it’s important to be watchful for a slow pay situation that typically foreshadows real payment ability problems.

Having established collections processes will help assure that the routine, “non-credit risk” payment issues are addressed in a timely manner.  It’s also important to have that next set of steps to pursue if a payment problem develops.  Incurring collections fees or filing a claim under your credit insurance policy comes with certain costs that you may be able to avoid if you employ some interim steps to assure you’ve first exhausted your best attempts to get paid.

At GCC, we provide a cost-free demand letter service to our clients.  This very effective tool has been used by countless clients over the years, helping them avoid unnecessary collections costs and claims filings.  A demand letter from a third party allows you to take the role of problem solver and let that third party be the “bad cop”.

Most recently, a client was having difficulty collecting a $188k balance that had aged out to 6 months old.  We prepared a demand letter advising our client that upon review of their current aging, we found the amount was significantly past due and per the terms of their credit insurance policy, they would be required to file the account with the carrier for collection action and by doing so, negatively impacting their customer’s credit profile.  The client shared the letter with their customer and received an almost immediate response indicating that full payment was on the way.

While this approach does not work in every case, we’ve found that if the customer has the funds, these demand letters are very effective at getting you paid.  We’d invite you to talk with your agent or client service representative to discuss this approach if the need ever arises.  We’re always happy to help.

(248) 646-9400 

Collection from Slow Payers- The Art of Persuasion

Rising Interest Rates Pose Threat to Credit

Benchmark interest rates have steadily risen after a decade of slow economic recovery and are expected to continue to rise.  Some economists anticipate four rate increases from the Fed for all of 2018.  Debt is becoming more expensive, which will certainly put more pressure on companies who are heavily reliant on debt to capitalize their businesses. Short-term Treasury yields are rising rapidly and long-term yields, while slower to rise, are seeing increases as well.

Interest expense is an important consideration when evaluating credit risk.  As a result of higher borrowing costs, companies, especially smaller-sized enterprises who aren’t generating enough cash flow to cover their debts, are at increased risk of defaulting on their payments and may eventually fall into bankruptcy.

So, how does this effect corporate credit? In the face of a robust economic climate and rising interest expense, companies find cash flow strained and working capital constrained. Higher borrowings put more pressure on the company’s liquidity. The effect of these financial issues then travels down the supply chain in the form of slower payments to vendors and in some cases unexpected insolvencies. If customers do not have sufficient cash flow to cover their expenses, they begin defaulting on payments to their suppliers. Suppliers then have difficulties absorbing these defaults while still trying to cover their operating expenses, and the risk travels down the line creating a domino effect of slow payments and defaults.

Credit insurance provides protection against past due defaults and insolvencies so you can continue uninterrupted after losses occur. The policy replaces the lost revenue protecting your critical working capital and cash flow. Many credit insurance users also find that it allows you to lower your bad debt reserves with the certainty that comes with the carrier’s assurance of payment. With credit insurance, you will be able to take excess bad debt reserves back into income, allowing you to provision less and giving your earnings a onetime boost.

In short, in times like these, credit insurance will not only help protect your working capital and bottom line, it can also be used to gain financial efficiencies that help free up capital within the business that may otherwise be tied up in bad debt reserves.  Feel free to talk to us today to learn more.

(248) 646-9400

Sources: USA Today, CBS News, Global Commercial Credit


Rising Interest Rates Pose Threat to Credit

Borrowing Enhancement for Better Access to Working Capital

Maximizing access to working capital is a top priority. Ideally, a firm could use additional cash tied up in their receivables to internally support their working capital and cash flow needs. However, most firms don’t have easy access to this cash.

When it comes to credit insurance, most recognize it for its benefit of catastrophic loss protection. However, the benefits extend far beyond this. Recently, we have noticed an increase in the number of companies seeking to better leverage their receivables to gain access to more working capital. Credit insurance can help unlock additional funds tied up because of lending limits due to large concentrations, slower paying customers, export customers, etc.; in other words, receivables that aren’t usually included in the borrowing base. Credit insurance provides both the company and their lender with protection to both increase the percentage advanced against insured accounts and allow ineligible receivables into the borrowing base.

Credit insurance users can expand their working capital by better leveraging the same base of receivables, while lenders have the advantage of targeting advance rates to their specific requirements. Credit insurance indemnifies both the client and lender beneficiary in a borrowing arrangement and can help expand access to funds tied up in accounts receivable.  Please don’t hesitate to contact us if you would like to learn more.
Borrowing Enhancement for Better Access to Working Capital

It was nice while it lasted: Credit outlook weakens once again

According to the National Association of Credit Management (NACM) Credit Manager’s Index report, “data has fallen off from the pace that was set in April. The combined index reading fell from 55.8 to 53.6 last month, the lowest it has been since last November” (Fusco, 1). Favorable factors fell from 63.6 to 60.0 and unfavorable factors fell below the 50-range at 49.3, the lowest it has been since last August, which raises a big concern (Fusco, 1).

As presented in Figure 1, most favorable categories slipped out of the 60s range last month. You can see changes in the sales, new credit applications, and dollar collections categories. This resonates concern from March when there was a similar decline in dollar collections (Fusco, 1). NACM Economist, Chris Kuehl, Ph.D. states “There has been some hope that dollar collections were trending back up and that this was a signal that companies were starting to think expansion again. Now we’re not so sure.”

Combined Manufacturing and Service Sectors
Figure 1 May 2017 NACM Credit Manager’s Index Report
Combined Index Monthly
Figure 1 May 2017 NACM Credit Manager’s Index Report

The rise in rejections of credit applications, in the unfavorables category, could be a result of two things, says Kuehl. “Either applicants that are trying for additional credit are in good shape or those that issue credit are being more generous.” Other changes in unfavorable factors are also demonstrated in Figures 1 and 2.

A specific factor to highlight is the collapse of the dollar amount beyond terms, which fell 51.0 to 45.9 from April to May. “The combination of more slow pays and weaker dollar collection means that there are still considerable struggles in terms of paying and there is renewed worry that other negatives will start to accelerate,” says Kuehl, “the sense right now is that companies are less upbeat than they were earlier in the year. The big growth opportunities have not materialized yet, but there remains some hope they will.

Information derived from the May 2017 Credit Manager’s Index Report by the NACM

For more information, see the full report.


It was nice while it lasted: Credit outlook weakens once again