Managing International Credit Risk with Credit Enhancements

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Managing International Credit Risk with Credit
Enhancements

• 23rd Annual Reimer Week
• Scottsdale, Arizona
• September 12, 2006

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Lets Get Started

• Brief introduction to IRC
• Sales vs. Credit
• Credit Insurance
• Alternative Credit Enhancements
• Third Party Financing
• Credit Derivatives
• Put Options

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IRC Worldwide
IRC Headquarters Columbus, OH
IRC Offices Chicago Houston Indianapolis Miami
New York Portland San Francisco Guangzhou
PRC Hong Kong Monterrey Mexico Sao Paulo Brasil
Affiliates Amsterdam Copenhagen Dublin Frankfurt G
eneva Lisbon London Madrid Milan Paris Stockholm T
aipei
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Sales Objectives

• Increase Sales to Existing Accounts
• Penetrate new accounts
• Increase Market Share

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What do customers and sales people ask for?

• Open Account
• Longer Payment Terms
• Vendor Financing

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How Do we Control the Madness?

• Are you feeling like you should put the word
  Bank after the name of your company?
• Are you being pressed on cash flow and DSO goals?
• Are you know as the Sales Prevention Department?

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What are Credit and Finance Objectives?

• Support Sales team in their effort to compete
  with terms financing packages offered by
  competition
• Mitigate political and commercial risk while
  minimizing recourse to your company
• Eliminate effect of longer terms on A/R
  collection performance ratios, and cash flow
• Position your company as the preferred supplier
  that offers competitive, open account payment
  terms
• Recover the cost of financing in the customers
  price

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Type of Credit Exposures

• Open Account Sale of Goods
• Open Account Sale of Services
• Contract Payments
• Capital Equipment Finance
• License Payments

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Traditional Credit Management Tools

• Open Account/Documentary Collection
• Maximum risk to your company
• Uses your companys balance sheet
• Affects ratios cash flow
• No risk mitigation
• Letters of Credit/Bank Guarantees
• Expensive
• Uses customers working capital lines
• Customers becoming unwilling to provide them
• Insured Open Account
• Mitigates political Commercial Risks
• Uses your companys balance sheet
• Affects ratios cash flow

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Traditional Credit Management Tools

• Third Party Financing or Sale of Receivables
• Mitigates political Commercial Risks
• Can be managed on an individual or portfolio
  basis.
• Growing in worldwide popularity
• Improves cash flow and ratios
• Non-recourse Discounting or Factoring of
  Receivables
• Mitigates political commercial risks
• Always done on a customer by customer basis
  (one-off deals)
• Improves cash flow and ratios
• Often difficult or impossible to obtain
• More Expensive than third party financing

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What is Credit Insurance ?

• COVERAGE
• Non-payment of Debt Obligations for Political
  or Commercial Reasons
• COMMERCIAL RISKS
• Default for Risks Not Otherwise Stipulated as
  Political Risks
• Commercial Bankruptcy or Legally Protected
  Reorganization
• Slow Pay/Protracted Default (In Most Types of
  Coverage)
• POLITICAL RISKS
• Government Acts/Political Events that Restrict
  Payment
• Currency Inconvertibility and Transfer Risk
• War or Civil Disorder
• Imposition of Law, Order, Decree
  Embargo/License Revocation

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Why Credit Insurance?

• Risk Mitigation
• Political Commercial Risk- Export
• Commercial Risk - U.S.
• Policy assignable to the financial institution or
  factorer
• Allows companies to offer customers longer terms
  while maintaining a captive relationship
• Combined with Bank Discounting programs and
  factoring programs allows off-balance sheet
  financing
• Ease of administration

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Advantages of Credit Insurance

• Increases credit risk information and knowledge
• Provides risk mitigation
• Can be used to develop financing for customers
• Allows for offering more competitive terms
• Can lower reserve requirements
• Variable outlay
• Limited vs. Unlimited A/R Risk
• Facilitates off-balance sheet sale of A/R
• Can be used for single risk only
• Portfolio approach reduces cost for all areas
• Flexibility to exclude customer via CIA, and
  L/Cs.

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Advantages of Credit Insurance

• Can facilitate local currency financing
• Reduces foreign exchange exposure on A/R for
  dollar functional entities
• Can be transparent to the customer
• Improves collections effort on problem accounts

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Disadvantages of Credit Insurance

• Premium cost
• May create false sense of secuity
• Claim denial
• Increased administration

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Credit Insurance Costs/Pricing

• Sample Company USD 2.0 billion sales
• Four Major Divisions
• Distributor and End User Vendor Finance
• Distributor Terms of Sale 30 day-180 Days
• 30-180 days OECD 0.15
• 30-180 days Non-OECD 0.35-0.95
• End User Vendor Finance
• 180 Day-1 year OECD Countries 0.35
• 1 year- 2 year OECD Countries 1.05
• 2 year- 3 year OECD Countries 2.25
• End User Vendor Finance
• 180 Day-1 year Non-OECD Countries 1.75
• 1 year- 2 year Non-OECD Countries 2.25
• 2 year- 3 year Non-OECD Countries 3.25

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Third Party Financing Options

• Accounts Receivables Financing or Purchasing
• Factoring
• Banks, Financial Institutions and Factoring
  Companies usually mitigate risk
• Obtain Direct Payment for products
• Accounts Payable Financing

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Advantages of Third Party A/R Financing

• Increase Sales
• Floor planning financing for distributors
• Obtain Risk mitigation
• Balance sheet management
• Offer more competitive terms
• Individual and portfolio strategies are possible.
• Local currency repayment borrowing
• Access to lower USD and local currency interest
  rates
• Little or no legal or loan documentation
• Terms/financing can be passed to end-user
• Your company is viewed as proactive, flexible,
  and more competitive

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A/R Financing Costs

• Sample Company USD 2.0 billion sales
• Four Major Divisions- Equipment and Services
• Distributor and End User Vendor Finance (All Cost
  Include Finance and Insurance Costs)
• Distributor Terms of Sale 30 day-180 Days
• Libor 6 month 1.8
• End User Vendor Finance
• 180 Day-1 year OECD Countries Libor 6 month
  2.5
• 1 year- 2 year OECD Countries Libor 6 month
  3.3
• 2 year- 3 year OECD Countries Libor 6 month
  4.2
• End User Vendor Finance
• 180 Day-1 year Non-OECD Countries Libor 6
  month 3.75
• 1 year- 2 year Non-OECD Countries Libor 6
  month 4.25
• 2 year- 3 year Non-OECD Countries Libor 6
  month 5.25

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Credit Derivatives

• Credit derivatives can be defined as
  arrangements that allow one party to transfer
  credit risk of a referenced asset, which it may
  or may not own, to one or more other parties.

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Types of Credit Derivatives

• Total return swap
• The protection buyer (your company) swaps the
  total return from a credit asset for a
  predetermined, prefixed return.
• Credit default swap
• This is a refined form of a traditional financial
  guarantee, with the difference that a credit swap
  need not be limited to compensation upon an
  actual default but can also cover downgrading,
  apprehended default etc.
• Protection seller agrees, for an upfront or
  continuing premium or fee, to compensate the
  protection buyer (your company) upon the
  happening of a specified event. Credit default
  swap covers only the credit risk inherent in the
  asset.

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Types of Credit Derivatives

• Credit Linked Notes
• Credit linked notes are a securitized form of
  credit derivatives. The technology of
  securitization here has been borrowed from the
  catastrophe bonds or risk securitization
  instruments
• The protection buyer issues notes. The investor
  who buys the notes has to suffer either a delay
  in repayment or has to forego interest, if a
  specified credit event, say, default or
  bankruptcy, takes place. This device also
  transfers merely the credit risk and not other
  risks involved with the credit asset.

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Credit Derivatives

• Growing availability
• Diversification of Hedge Funds
• Variable definitions of defaults
• Variable definition of derivatives
• Regulatory issues remain.
• Credit Derivative pricing 1-24 per annum
  depending on individual exposure.

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Factoring

• Many factoring options are available
• Limited risk to your company
• Retain performance risk
• Valuable to smaller companies
• Used for existing receivables
• Wide range of pricing
• 0.5-10 of invoice amount dependent upon buyer
  risk.

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Put Options

• Single Risk Coverage
• Usually used for debtors with challenging credit
  risks
• Limited Availability
• Financial Trading Companies, Investment Bankers
  and Counterparty Risk Traders
• Debtors are usually publicly traded companies or
  companies with commercial paper or bonds
• Priced per month of risk
• Priced on credit exposure.
• Mitigates against bankruptcy only. No protracted
  default.
• Can mitigate existing and future credit exposure
• Options Pricing is sharply higher
• 6-25 per annum

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Managing the ToolsA Discussion

• Global Strategy
• Country Strategy
• Business Unit Strategy
• How do you locate risk mitigation tools?
• How do you determine risk versus cost?

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Contact Information

• Jeff Jankowiak
• International Risk Consultants, Inc.
• Tel [phone]
• Email jjankowiak_at_irc-group.com