Pandemic to boost demand for trade credit insurance
Global trade has changed significantly since the financial crisis and the collapse of Lehman Brothers in 2008, which spread protectionism and nationalism amid global economic and political volatility. To fill the gap left by banks shrinking their balance sheets, commercial transactions have been increasingly supported by structured credit modalities carried out by factorings, financing ‘Accounts Receivable’ in local and international currencies.
The Covid-19 crisis is further transforming the trade credit market. The sector may reach USD 10 trillion in volume globally by 2030, increasing investment return by approximately 7% (CAGR), says Peter Mulroy, Secretary General of the FCI, an entity that supports and promotes factoring internationally. While the situation is still fluid, same changes can already be observed and others can be expected, according to Mulroy:
• Commercial bank lending tightens as the institutions become more conservative, pulling lines especially on small and medium-sized enterprises (SMEs), and creating a significant uptick in new business opportunities for the credit insurance sector.
• Less abundant liquidity impacting non-banks and commercial factors reduce liquidity to support SMEs. Corporates will want to diversify their funding sources to ensure stability.
• Collections slow down and portfolios age due to delinquency, breaching eligibility ratios and covenants with funders, leading to the cancelation of committed lines.
• Term extensions rise driven by debtors’ demand around the world.
• Reduced or cancelled credit insurance lines impact customer/debtor credit availability.
• Dilution increases as supply chains become disrupted due to increased geopolitical uncertainty.
• Business volumes dry up as new invoices contract in part due to the declining economy, in part due to plummeting commodity prices.
• Increased efficiency and inventory management allows businesses to borrow less.
• Numerous fintechs are set to go out of business due to losses, frauds and an increased challenge to raise capital.
• SCF / Reverse programmes are likely frozen or eliminated, in particular impacting programmes from non-investment grade companies BB+ or lower.
Trade credit insurance as a form of financing is therefore likely to be in high demand during and after the crisis, as banks tend to reduce credit lines, especially for SMEs, and the demands for new alternative sources of financing for working capital grow exponentially. In an increasingly volatile environment, companies will seek alternative ways to mitigate the risk of their receivables.
The state of the credit insurance market
Like the financial sector, trade credit insurers are also impacted by the Covid-19 crisis. With an expectation of increasing loss trends in the short term, indemnity reserves may need to be established. The market appetite following Covid-19 may be a little different from what we saw in the past decade.
Countries like France, Germany and the Netherlands have introduced measures offering support to the trade credit insurance industry through guarantees backed by public funds, allowing insurers to maintain limits and capacity. In turn, insurers transfer part of the premium collected to the government. This is an interesting and creative tool that if adopted in other countries such as in Brazil could not only protect the credit insurance industry but perhaps most importantly, guarantee access to commercial credit which is vital for the economy.
Independently, insurance companies operating in Brazil are well structured and prepared to face the current storms. Underwriters have been in the country for more than 20 years and have already overcome other crises successfully. With the ability to manage international commercial risks, linked to historical collection and updated information from companies around the world, insurance companies are an essential support for companies and the economy in general.
According to estimates, banks are responsible for more than 70% of business in the credit insurance and political risk market worldwide. The expectation is that they will adopt a long-term vision and support debtors in difficulties and avoid triggering default and losses reported under insurance.
Options for corporates
In stressed asset markets, or distressed markets, the security package in transactions gains further relevance, allowing to split the risk into smaller chunks that may be more attractive for insurers. At the same time, the concept of ‘risk sharing’ is on the rise. Thus, insurers are taking on new risks in a more structured way while offering innovative structures:
• Excess Damage (XoL): An insurer assumes mezzanine coverage over a volume of losses. Although not new, the model has been gaining momentum due to the need to share larger risks and improve the cost of the policy while enabling a satisfactory coverage level.
• ‘Top-up’ Coverage: In a similar format as ‘XoL’, the insurer can offer credit limits complementary to a guarantee (or portfolio), which can be an insurance policy covering the first level of losses.
• Coinsurance: As a risk syndication that is widely used in the banking system, this is a viable option that offers a coverage capacity guaranteed by two or more insurers. Since the coverings can be combined vertically or horizontally, it requires alignment between the parties in the definition of rules for the execution of guarantees and debts.
• Securitisation: The transfer of risk to a securitization vehicle allows for self-financing and promotes corporate credit. Banks and other financial institutions already have a dedicated desk service for these operations. Insurers have still acted timidly, but with great interest in the growing potential of the market.
• Security package: Internationally financed operations require instruments that allow for a 'soft landing' in case of turbulence. The credit appetite depends on how operations are structured and may rely on additional guarantees for the servicing of debt that may or not be shared with insurers.
In a challenging and volatile economy following Covid-19, companies should also find new ways to support their customers and suppliers to avoid their default and enable potential debt issues to be resolved in an orderly manner for example by extending the repayment time. A long term vision and approach will be essential to allow for a sustainable economic recovery.