Time to worry on credit insurance or Relax-ay-voo?

One of the most remarkable things about the COVID-19 global pandemic is how ‘unglobal’ it has been on many levels. Cumulative effects on trade have been seen globally, but the effects have been noticeably different by country. “Extreme heterogeneity,” is how Valerio Ranciaro, director general of SACE SRV, describes the phenomenon, or more precisely, widely different effects seen across geographies and seasons. “Despite the bottlenecks on the supply side in some sectors, linked to criticalities mainly of a temporary nature in logistics and in the procurement of raw materials, international trade in goods will grow by about 10% in 2021, a very fast pace of expansion, close to the rate recorded in 2010.”

ICC’s Global Trade Register 2021, released on 28 September, confirms the impact of the pandemic on trade finance and paints a headline picture for global trade, which it estimates fell by 10% in value in 2020 (with around  8% fall in goods trade and 19% in services trade). “Over a year into the COVID-19 pandemic, its sustained consequences  are becoming more clear, both from an activity perspective – where we expect trade volumes to reach 2019 levels by 2022 after a constrained recovery in 2021 – as well as from a credit risk performance perspective,” the report says.

The ‘unglobal’ nature of the crisis may be seen in the wild swings in monthly and quarterly reported GDP in the OECD countries (other countries don’t necessarily report as quickly or as accurately). In simple terms of global GDP the net effect seems surprisingly flat given the extremes in many individual countries, but consideration of the domestic budget deficits of the major OECD countries immediately and accurately reported shows, an equally unsurprisingly huge, gross impact in terms of falling tax revenues and high financial support to companies. Such financial support is both indirectly into the economy and directly into loans (liquidity availability and employment subsidy). This could be termed the ‘zombie gap’.

Zombies are the living dead of the corporate sector, kept alive only by the influx of government money, namely taxpayers’ funding. The large nationalised zombies of the past that characterised the European markets 20 years ago have for the most part been put to rest [here is not the place to re-enter the debate around French submarines and trade pacts and UK Prime Minister Boris Johnson’s ‘franglais’ “Donnez-moi un break”].

But the new zombies could well be viable established companies, start-ups with huge potential, or perhaps they also include old companies that should be left to fail. Shareholders and lenders (banks and bondholders) will lose out, but productive assets remain. There could be a new and productive round of restructurings – that, at least in theory is what should happen in a well-functioning market economy, and should leave a productive remaining economy. But the process of default, restructuring, recovery is always going to be painful.

“As for zombie companies, the excessive liquidity on the market and all the government stimuli are mystifying the actual risk of companies that cannot serve the debt, that have a low ICR [Interest Coverage Ratio] and that, possibly sooner rather than later, might default on their obligations,” says Ranciaro. “In fact, as soon as the veil of the government stimulus is lifted, there will be a reality check.”

The challenges are the ‘extreme heterogeneity’ this time around as the dislocations in global markets from the pandemic provide no historical examples. And this dislocation also comes on top of a (mixed) desire for markets to evolve towards energy transition in the face of climate change, which is causing distortions in multiple markets.

It has been nine months since I wrote about when the short term turns long, and possibly nasty for trade credit insurance. The bankruptcies are starting to creep up in many markets, but they are still not as bad as many had forecast. Should the market relax?

A sanguine view

“Our members have seen very few loss activities and very few new claims. In fact, hardly any negativity at all, says Richard Wulff, executive director of the International Credit Insurance & Surety Association (ICISA). “I was talking to one of our smaller members in southern Europe earlier in the summer, and he even joked ‘how am I supposed to sell this product because we’ve had no claims.’”

That, Wulff says, is only one pretty extreme outlier and activities are ticking up as governments wind down their support schemes. Will we see a big rise in zombie companies as this happens? “The signs are mixed,” he says. “On the one hand, during the pandemic a lot of small and medium sized companies (SMEs) simply paid down their debts and folded rather than going bankrupt. I’m sure there are a number of insolvencies to come, but whether it’s a reservoir that will burst, we simply don’t know.”  

Credit insurance schemes, a what-if?

An upcoming ICISA research paper on developed economies seen by TXF, ‘Credit insurance schemes – what would the situation have looked like without them?’ looks at 2020 results for the whole sector. “Premiums and written exposures across the industry were down on 2019 levels while claims showed an increase.” The report notes, however that movements in all measures were, “likely not as dramatic as might otherwise have been the case without government support limiting insolvencies.” The report looked at developed countries that had trade credit insurance support schemes, and those that did not – the most notable one without such scheme being the US.

“Atradius reported in March this year that estimates of global insolvencies during the pandemic declined by as much as 14% in 2020. Indeed, looking at estimates from specific countries, we can see significant reductions in insolvencies in countries without credit insurance schemes, such as Singapore (-41%), Australia (-41%) and South Korea (-29%), as well as those with schemes, including France (-40%), Austria (-40%) the UK (-27%). Even the US saw a reduction of 5% during 2020. On the flip side, Atradius also estimates a 26% increase in 2021 as those state support measures are withdrawn around the world. This will likely also lead to an increase in claims for credit insurers, although the market is well-positioned to absorb these impacts and indications are that a return to more normal patterns may soon follow.”

Belt and braces

For Wulff, “this reinforces our idea about ‘belt and braces’ support. State support measures [which were not meant for the benefit of the insurance companies per se, but for clients of credit insurers and the economy at large] were good at the beginning, but probably not in a financial sense, more just to boost confidence. Once we got into September last year, the market had settled down and had realised there were not going to be many insolvencies, confidence rose among credit insurers about exporters.”

If anything, Wulff argues that such state support went on too long. Hindsight, he concedes, is a marvellous thing. For the future, is there still a threat of a flood of claims, of zombies, of insolvencies?

“It doesn’t seem to have been as big as we had feared. There is expected to be an uptick in insolvencies in Q4 2021 and Q1 2022, but as far as a threat of a reservoir emptying all at once, this seems unlikely.”

And in terms of policy renewals – this time last year, there were concerns that the renewal cycle (typically January) would see a contraction in the demand from companies for trade credit insurance if capacity issues pushed up prices, and if the companies themselves were under pressure.

“Here the heterogeneity issues come into play. First, we see capacity levels back up to 2019 levels and secondly a number of credit insurers have grown their books. Prices have increased in certain sectors, but when there is uncertainty, the general feeling is companies go for credit insurance.” Is that uncertainty because of dislocated supply chains? “Supply chain dislocation is limited (for instance to shipping of goods). If you look at candidate number one for supply chain dislocation it would probably be commodity trade. There have been a couple of insolvencies but in terms of dislocation, business simply went elsewhere. It was more a hassle than a supply chain dislocation.”

As state support winds down, there is some lack of clarity about insolvency, but, as Wulff says, his members are not too worried. Also, state support measures were designed to prop up trade, not to support the credit insurance companies themselves.

Reasons for optimism, and pessimism

A ‘normal’ business cycle would have a recovery with spikes of bankruptcies, followed by a long tail of claims and restructuring. This was not a financial crisis in the outset, this is not a normal cycle. The heterogeneity runs wide. Insurance buyers may or may not have had state support, they may be in countries without support schemes. Those buyers may have been adversely affected by the pandemic, they may have even profited from it.

The reasons for optimism and pessimism are well balanced. Domestic trade, or commerce, has become increasingly just in time, because it could be. Language, law, customs don’t travel far, and repairs to a supply chain, especially its financial links, can quickly be affected. International commerce (or trade) is inherently more complicated and more time consuming. Should we relax? I give a proverbial shrug and turn to Dean Martin and Line Renaud:

 “..And when you go they'll take your dough
For the tax-ay-voo ..relax-ay-voo
Get your sneakers and slacks and relax-ay-voo
I don't have to try to relax-ay-voo
Chum I'm much to numb to relax-ay-voo
We French you'll find are more inclined to relax-ay-voo
Relax, relax, relax, relax-ay-voo”

(From Dean Martin & Line Renaud – ‘Relax-ay-voo’]

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