The initial victims of the liquidity squeeze that began with the sub-prime lending crisis in mid-2007 were businesses and consumers located primarily in the US, now keenly feeling the effects of its first major economic correction in 17 years, along with Western Europe.  As businesses in these markets become insolvent or have defaulted on payment, these woes have translated into rising levels of unpaid invoices and bad debts received by short-term credit insurers, who have found themselves at the sharp end of the ripple effects.

At Export Development Canada (EDC), a spokesman comments: “our claims experience has increased sharply in 2008, both in terms of the number of claims and the value of claims submitted.

“The payment default trends have been most prevalent in the North American markets – Canada and the US primarily, but with recent losses extending into Mexico,” he adds.

Atradius said in June that since the fourth quarter of 2007, suppliers globally have begun extending credit terms in an effort to maintain sales momentum. More recently, claims for bad debt have climbed as the level of unpaid invoices has grown. “The greatest incidence of non payments has been seen in Spain, Italy, the US, UK and Ireland,” stresses Paul McLoughlin, head of group claims and recoveries.

“Month on month throughout 2008 there has been an increase in claims arrivals,” he notes, adding that both the credit crunch and rising commodity prices are driving the increase in claims.

Elsewhere, Coface adjusted its ratings in mid-2008 on Denmark, Spain and Portugal due to a significant deterioration in companies’ payment behaviour. Meanwhile the speed of the claims filed to Italian short-term insurer Sace BT (the short-term credit insurance arm of the Italian export credit agency) has been accelerating since August 2007, leading to an increase in losses, especially in the domestic Italian market.

Tullio Ferrucci, general director at Sace BT, also adds: “In the second quarter, we have seen an increase in claims from outside Italy, mainly in the US, but also in OECD markets like the UK and France.”
Emerging markets outlook
A major question now for credit insurers is whether some of the world’s emerging markets are lining up to appear on the hit list. According to a mid-July Euler Hermes bulletin, entitled The World in 2008, “Emerging economies are weathering the downturn fairly well, though they are not immune”. A July bulletin from Coface similarly observed that the so-called BRIC (Brazil, Russia, India and China) economies “are still withstanding the crisis well, due to a vigorous domestic demand and the absence of any major imbalance”.

But rising credit risks are apparent in the Baltic countries, South Africa and Vietnam, says Yves Zlotowski, Coface’s chief economist, pointing out that companies in these countries, “are suffering from the brutal curbing of excessive imbalances (ample foreign deficits, overheated economies and accelerating inflation), which are no longer sustainable in the current business climate”.

Pinpointing the most fragile emerging countries, where growing credit risks are providing a heavier underwriting hazard, is a task to which insurers are now increasingly turning.  “The crisis situation will also expand to some non-OECD markets, but which ones is a matter of speculation,” notes Ferrucci.

Denmark’s Eksport Kredit Fonden (EKF) has as yet seen no increase at all in claims in 2007 or 2008, but Sandra Blockmann, senior country risk analyst, observes: “We are looking at emerging markets now, and increasing our risk analysis.”

“The three factors of slowing demand linked to the possible US and EU recession, a shrinkage in financing liquidity globally and rising oil costs could give rise to some defaults going forward.”

A similar outlook prevails at the Export-Import Bank of the US (US Exim Bank), where: “we have not seen an increase or anything disproportionate country-wise yet in terms of claims,” emphasises Kenneth Tinsley, senior vice president, credit and risk management. “It is probably still too early to say whether this will change, but we are watching some areas carefully, especially markets and industries sensitive to increases occurring in energy and commodity prices.”

EKF’s Blockmann highlights that: “Emerging markets were initially resilient this time around – spreads have jumped substantially, but not to the levels of other crises.” She argues that the emerging markets most likely to escape the current market volatility will tend to be disciplined on their macroeconomic policy, will have a surplus on their current account, as well as relatively low foreign debt and financing needs.
Eastern Europe focus
One area that fails to display much of this cushioning is Eastern Europe. EKF’s Blockmann points out. “Many Eastern European countries have a large current account deficit and large external debt, so the region is very dependent on hard currency inflows, and more vulnerable to market sentiment. There are also some indications of systemic risk in Eastern Europe’s banking market as the tenors of external loans to banks in the area are decreasing. If banks in the region are unable to get the refinancing they require, there could be a new liquidity crunch here.”

At the trade payments level, Croatia especially, as well as Serbia, Bulgaria, Romania and Russia were cited as principal markets of concern by Karolina Offterdinger, member of the board of directors at Austria’s OeKB Versicherung, whose portfolio has a particular focus on Eastern European countries. “Payments behaviour has deteriorated – we are registering higher payment delays and seeing claims rates increasing,” she adds, with the qualification that “Hungary was at the bad end of the range two years ago but has slightly improved”.

Among other insurers, Atradius has highlighted several payment trends in the Czech Republic that it describes as “alarming,” while Coface has lowered Latvia and Estonia’s ratings to A4 and A3 respectively, predicting that “a brutal landing for business activities is now underway”.

At Belgium’s short-term underwriter Ducroire-Delcredere, Inge Lambrechts, country risk analyst, also sees Eastern Europe as the most vulnerable emerging markets area. She comments that while the overdues seen by Ducroire-Delcredere are not that significant yet, the market could well change as continuing bad news from the US mortgage markets plus higher inflation numbers in the European Union (EU) kick in.

“Based on what we see, emerging Europe may be affected the most if the EU suffers – the markets that we need to watch out for the most are probably Romania, Hungary and Poland, and possibly Ukraine also, because of the current account deficit, but that country is not causing us any worry yet”, she notes.

By contrast she observes that Kazakhstan, which ran into serious liquidity problems in autumn 2007, is coping fairly well.

Vietnam warnings 

In Asia, meanwhile, the theory that the region has de-coupled from the US economy is being put to the test. OeKB Versicherung has significant exposure in Asia, but no problems yet with claims, said Offterdinger.  “However the increasing steel price may be putting pressure on buyers,” she suggests.

For the time being, many of the warnings concern Vietnam, which registered a 25% inflation figure in May 2008, and Coface has put the country’s B rating under negative watch, accompanied by the warning that the country “is facing an important foreign exchange crisis”.

At Euler Hermes, Jef Vincent, Asia regional chief executive, observes that Vietnam’s “construction sector is in difficulties, and there is at least one bank with a problem, which could crash”. Moreover in Malaysia and Thailand, an increase in overdue payments has been noted by Euler Hermes, which sees Thailand’s information technology sector and Malaysia’s furniture industry as potentially vulnerable to any further credit squeeze.

“In both countries, there is a level of political uncertainty, and a rise in the price of rice and palm oil, bringing a shift in consumption away from durables. These are early days, but banks are becoming more cautious in their lending, leading to more defaults and insolvencies among companies with cash-flow problems,” says Vincent.

Although Euler Hermes sees no change in claims and overdues in most Asian countries, Vincent observes that: “the region’s overall mood has changed”.

“Even exports from Singapore have dropped, and growth ratios are going down everywhere,” he adds.

While lower global demand appears to be pushing Japan, now more export-dependent than at any time in the post-war period, towards a recession, Japanese bankruptcies to date are said to be mainly confined to small companies, according to Vincent.

One potential trend lying ahead could be demand from banks for a new raft of letter of credit (LC) confirmation cover. “During the last Asian crisis, US Ex-Im had more than $1bn-worth of exposure on Korean LCs. Banks have been making enquiries recently, especially about Asia, and we may see that again in 2009 for the big-ticket transactions,” forecasts US Ex-Im’s Tinsley.

Elsewhere in the world, Coface has placed South Africa’s A3 rating under negative watch, citing a growth slowdown, a higher inflation rate and volatility of the rand. Latin America remains relatively unaffected, says Lambrechts.  “There have been some payment delays in Venezuela, but not related to sub-prime events,” she elaborates.

Inflation dangers 

Predicting where price inflation will strike the hardest offers one way for insurers to pinpoint future risk. “Up to two-thirds of the global population will experience double-digit inflation in 2008,” says Blockmann, emphasising that the biggest effect will be “in emerging market countries where food and oil takes up the largest amount of consumers’ budgets”.

She continues: “Inflation has very negative social consequences, leading to social unrest and expansionary fiscal policies. “It’s interesting to follow China, India, Indonesia and Saudi Arabia, where prices have shot up between 8-10% over the last 12 months, and at Russia, where it is more like 14%.”

In markets where food and oil inflation tip over into core inflation, second round effects, such as higher wage demands, will also begin to take effect.

“In mature markets, we are not seeing core inflation, whereas in emerging markets we are, but it is a bit too early to pinpoint this accurately, as the tip over into core inflation is hard to determine, especially if the data is not so reliable,” explains Blockmann.

Market direction 

So what can be expected during the remainder of 2008?  “Insolvencies will increase across more of Western Europe,” forecasts Ralf Hillgner, Euler Hermes group commercial and marketing director. “We think it will spread to Eastern Europe – but are not sure yet regarding the bric’s and Asia.”

World GDP growth of just below 3% can be expected in 2008, according to Euler Hermes. At OeKB Versicherung, Offterdinger contends that the market bottom is still at a remove. “We expect that things will get worse in the next few months, and there will not be any rapid change in this trend,” she predicts.

Sace BT predicts: “the high loss situation will go on until at least 2009”. Ferrucci adds: “I don’t think change will come before June 2009, maybe even late 2009. If you look at past cycles, the duration of high default periods has been two years on average.”

Blockmann very much agrees, projecting that “the global economy will not have fully recovered before 2010”.

Inevitable premium hikes 

Credit insurers faced with the steady rise in claims have had little choice but to consider raising their premium structures. Sace BT is said to be looking much harder at all sectors and companies, aiming to tailor its cover as much as possible, tightening its underwriting rules, and asking for wider deductibles or other forms of risk mitigation, rather than automatically increasing premia and cutting back credit lines.

Euler Hermes’ Hillgner underscored that risk management is a pre-requisite for the insurer. “We have better tools now to manage the risk on the pricing and the credit side, which allows us to stay available through these periods. We can give early warning signals to customers, who can then change payment terms to cash before delivery.”

Exporters in Canada are helping their own cause, by adapting to the changing global conditions. As Peter Hall, EDC’s vice-president and chief economist observes: “Fewer [exporters] are passing on higher costs; their ranks shrunk from 27% to just 18% in the past six months,” he observes, citing data captured by EDC’s most recent semi-annual trade confidence index (TCI) survey.

Concluding: “The top coping strategy among Canadian companies has been to ride out the storm, absorbing the loss”.