The consequences of the global downturn in emerging markets have seen private insurance markets beginning to reach deeper into their pockets, writes Kevin Godier.
Underwriters across the whole credit and political risk spectrum are reeling from the consequences of the credit crunch and global downturn. “This is the worst recession since World War II and exceptionally severe in the last quarter of 2008 and the first quarter of 2009,” says David Atkinson, manager, country risk, at Euler Hermes UK, whose parent company Euler Hermes posted a net loss of around €68mn for the fourth quarter and a 79.5% drop in overall 2008 net profit as a result of the deteriorating global economy and greater claims from policyholders.
Atkinson adds: “The downturn is extreme, not just in terms of the scale of the squeeze on banking systems, but in the size of the collapse in consumer demand and investment and the accompanying knock-on effect on trade.”
Economic numbers for the last quarter of 2008 bear him out, showing that GDP in the mighty US economy fell by an annualised 6.3%, pan-European output fell by 6.6%, and the loss in Japan was a staggering 12.7%. With first quarter 2009 predictions almost as gloomy, “these numbers have few precedents in recent history”, says Peter Hall, vice-president and chief economist at Export Development Canada, where net income in 2008 fell from C$267mn to C$206mn, primarily because EDC lifted its provision for credit losses to C$346mn in 2008, some C$150mn over 2007 provisioning levels.
Another respect in which the ongoing financial crisis is different, emphasises Atkinson, is “in the sense that, this time around, it didn’t start within emerging economies, but rather in advanced economies banking systems”.
Nevertheless decoupling – the theory that emerging markets had unhitched from their developed but now troubled peers, as a result of robust south-south economic patterns – has “turned out to be something of a myth’, he notes.
Developing economies have moved dramatically into the firing line as the crisis has taken a turn for the worse, with Eastern Europe – where a series of countries have approached the International Monetary Fund (IMF) for tens of billions of dollars of bailout money – evolving into a particular focus for the financial carnage.
As GTR went to press, the spotlight upon economic deterioration was shining equally brightly upon developed and developing economies. Trade insurer Coface announced in April that it had issued 28 country rating downgrades in 2009, of which 14 were developed countries: Germany, Belgium, Denmark, Spain, France, Greece, Ireland, Iceland, Italy, Norway, Portugal, UK, Canada and Japan. A further 14 were emerging markets: Bulgaria, Estonia, Hungary, Latvia, Lithuania, Romania, Russia, Slovenia, Ukraine, Mongolia, Pakistan, Sri Lanka, Singapore and Botswana.
“We’ll see a big increase in insolvencies around the globe in 2009, when all emerging economies will either show or be near to negative GDP growth,” says Atkinson. “The most obvious region for deterioration is Central and Eastern Europe (CEE). We have a list of countries that are most vulnerable to the global downturn, and a lot of CEE markets are on this list. It is generally the structurally weak countries or those that have followed the wrong policies that run into the worst financing problems.
“However, some may well take sufficient action to avoid major problems, maybe with IMF-led support, the scope of which has recently been streamlined and increased following the recent G-20 summit.”
As emerging markets demonstrate growing signs of duress, the impact of rising default rates among obligors in a range of markets have also begun to impact single risk underwriters in the private political risk insurance (PRI) market, where payouts are mounting to parallel the climbing volume of credit claims and payouts made in OECD markets by credit insurers Atradius, Coface and Euler Hermes.
“Losses racked up in the PRI market during this crisis may already add up to somewhere between US$500mn and US$750mn, says one close market observer.
Atkinson cites losses across several major regions, indicating that some of the largest have come in Latin America, despite the initial resilience shown by the Brazilian and Mexican economies, which have often suffered from capital outflows in times of crisis. “On the structured trade credit side, there have been some problems in Brazil on pre-export finance, with losses felt by insurers on beef, soya and grain transactions.
“Brazil has invested heavily in developing its agricultural sector for exports, and because the sector over-heated, has been more severely hit,” says Atkinson. Other underwriting concerns in Brazil involve a refinery that had gone under but been given a stay of execution, according to one market source, stressing that “a credit default claim in Brazil has also been paid out”.
Other concerns include the resource nationalism policies of left-centrist governments in Bolivia, Ecuador and Venezuela which placed underwriters on the back foot. Confiscation and currency convertibility claims in Venezuela are among some of the reccurring problems facing the market.
In Ecuador, there is ongoing arbitration with an expropriation claim for Occidental Petroleum, and the country’s mining and mobile phone sectors are also concerning insurers.
In Bolivia, Glencore suffered a loss that was paid a year or so ago, and other investments are also at risk. According to one broker, there have also been rumours of a single US$100mn loss incurred on a forfaiting deal in Mexico, plus growing debt service worries on Argentina, and CEN-(confiscation, expropriation, nationalisation) related loss in the Dominican Republic.
“There are no tsunamis in a particular country or region in the PRI/structured credit domain, but rather, specific events on a plethora of deals throughout the world, unlike multi-buyer credit cover which gets hit big when an industry starts to slide,” says Alexander Lotocki, New York-based senior vice-president at IOA.
“The big issues for underwriters are linked to commodities, for which prices have crashed,” says Jerome Swinscoe, senior underwriter, HCC International Insurance Company. “The key concerns aren’t really with the oil sector, but are much more linked with steel, copper, iron ore and coking coal, all sectors that run into cashflow problems.”
Many steel production facilities are located in Eastern Europe, where mills in countries like Bulgaria, and, especially Ukraine have been hard hit, the latter by the lack of available finance from a banking sector struggling to stay afloat against a background where national financial collapse is a possibility. “Ukraine has a mix of all the issues at the moment – political instability, economic turmoil and a poorly performing banking sector where people are nervous about all the second tier banks. The insurance market is expecting to pay claims,” says another London-based underwriter.
Russia, downgraded to C by Coface, is also never far from scanners. “We are seeing an increase in demand on the structured credit side, and the size of the insurance market’s exposure is making everyone keep a very sharp eye on Russia,” says Claire Simpson, political risk underwriter, Hiscox Global Markets.
“But the economy is healthier than 11 years ago, and there are no payment delays or defaults yet. The currency has stabilised after earlier losses in value, they still have the third largest FX reserves in the world, and the local banking sector seems relatively healthy,” she adds.
However another underwriter notes “a nervousness on the increasing number of waivers requested, as some borrowers have not been able to adhere to their quarterly covenants”.
In Africa, meanwhile, confiscation losses in Guinea for Rusal have led to a claim, in contrast to payment delays in Ghana and Nigeria, which one underwriter refers to as “just the perils of doing business in Africa, where late is on time”.
Asia has also spawned losses, notes the underwriter, ranging from soya-linked claims in China; Indonesian problems with credit losses on palm oil and coffee transactions; currency convertibility and confiscation losses in Pakistan; and a contract frustration claim in Mongolia, after the mining law changed.
“Mongolia is one of a number of countries affected by the hangover from high commodity prices, which has prompted the assumption by certain governments that they are in a position to renegotiate reasonable investments,” observes Bernie de Haldevang, head of financial and political risks, Aspen Insurance.
“Venezuela started this ball rolling, and there is now a palpable risk that other large, resource-rich countries will continue to follow suit where foreign investments appear not to provide enough benefits for local people,” he says.
“Yet the market is repricing confiscation risks downwards,” he warns. Looking at the overall picture, de Haldevang compares the current market situation to the 1989/90 banking crisis, which led banks to stop trade finance operations, and reduced the private insurance market down to just a handful of operators.
“The impact of this crisis will however be far less severe because risks today are more diversified and spread over a much larger number of better capitalised and informed carriers, even though the underlying circumstances are significantly worse this time,” he suggests.
In an official statement issued by Coface, François David, chairman of the trade insurer, predicts that: “the peak of the crisis should be reached in the first half of 2009”, with a “sluggish” recovery beginning in early 2010.
Reforms in official creditor lending announced at the early-April G-20 summit have indubitably provided additional cushions and reduced systemic risks for emerging market countries, yet the reality for many credit insurers is already – and will continue for some time to be – one where significant losses must be recovered.
The value of claims seen in emerging markets by Euler Hermes UK was up by 31% in 2008 and by 45% so far this year, notes Phil Mercer, head of collections and claims. “We see a little bit for Turkey – we expect to see around 30 debt placements this year in Turkey, up markedly from 2008. In India there were about 15 cases for us in 2008, up slightly, and Russia is also up – we’ll expect around 10 debts this year. A similar number is expected this year in Bulgaria, the Czech Republic and Croatia,” he says.
Mercer comments: “There is a span of different payment cultures across the world, but once you are into the legal system – even in OECD markets like Spain and Portugal – it’s much harder with legal processes which are slow and expensive relative to our own. The first step is always to negotiate pre-legally where we can, with success depending on a combination of factors – including debtor financial strength, contract terms as well as payment culture of the particular country.”
Yvon Carpiaux, legal team leader, Belgium/emerging markets, at Atradius Collections, cites Turkey and India as among the busiest developing countries’ claims markets. “We have seen a huge increase in claims, especially in Turkey, where we have some 500 cases. All sectors – but especially textiles, petrochemicals and IT – are going through a very difficult time, and companies are going into protection, which blocks us for one year. Any debt collection should be balanced and adjusted to each case if we want to get a satisfactory payment schedule.”
Although Turkish law allows legal proceedings to commence against an unpaid cheque, the latter “are becoming a national sport in Turkey and Greece”, says Carpiaux. “The debtor usually pays a fine and doesn’t pay the debt. If you hold documents like bills of exchange, you can get a judgement, but the debtor can usually organise his insolvency and place his assets elsewhere before proceedings end.”
In India, Carpiaux sees fewer claims than Turkey, and IT is his busiest sector. “Legal action can be time-consuming and not very cost-effective, so you take this route only if you have a strong case, a high value claim and unequivocal documents to counter the debtor’s opposition to paying,” he insists.
“There has been a remarkable increase in our business due to the credit crunch,” says Intrum Justitia’s Marc Bieber, Darmstadt, Germany-based key account manager, international services.
“In Russia, it’s hard to get your money. You must try to get to court as soon as you can, because people wind up companies quickly. You can get half of the debt via a court order, but may need to research to get the successor company. In the Baltics, also, there is a very high risk that money is frozen, and the company closes down. Our payment index ranks Lithuania at 157, which translates into a 3% chance that the invoice never gets paid, compared to a normal risk for exporters that would generally be in the 0.5% to 1% bracket,” he says.
In the Americas, “Mexico is high-risk at the moment, with a 3-5% overall loss rate, and payment terms up to 90 days, which is very bad”, notes Bieber. “We have also seen two or three big claims in Brazil, and have done a few collections in China, where the payment durations are often 120 days.” According to Carpiaux, mainland China is a “very complex environment, where courts take their time and the costs can be huge – and so it is very important to have a local office that can take action and negotiate out-of-court settlements as much as possible”.
Political risk workouts
In the PRI market, those insurers that have taken out comprehensive cover policies are feeling the benefits, because “the policies are responding, whatever type of event has triggered the claim”, says Swinscoe.
He continues: “One hears of a few workouts and recoveries already, but it is probably still too early to be honouring many of the claims in the market, given that the average waiting period for a policyholder is around six months. In late 2008, some cases looked like they might have a positive outcome, and we hear that there are still some borderline cases where things are being worked out, in terms of whether there might be government or IMF support, and whether the obligor can survive that long.”
The speed of workouts can often hinge upon the political consensus within the countries involved, Swinscoe says. “Kazakhstan, for example, used some of its funds to invest in companies and banks, as also happened in Russia. But in Ukraine there is no agreement on how to use their funds.”
Simpson notes that “three to four banks are having problems in Ukraine, so the interplay between the president and prime minister will be interesting in any workout solutions”. She adds that “there is no model for Ukrainian workouts – we are in uncharted waters”.
De Haldevang makes the point that “over the years” both contract frustration and confiscation payouts hold out the possibility of getting the money back. “There is a good record there in the past. Government debt remains valid, and even though there may be a lengthy wait, you still have the right and the ability to get 100% back. And confiscation is the same – we are covering the failure of sovereign entities to compensate promptly and fairly.”
Across the spectrum of recovery potential, unsecured short-term trade credit “can really only be recovered via new premiums as actual recoveries will typically be measured in single digit cents in the dollar”, says de Haldevang, explaining that Aspen’s preference is for structured and secured credits, backed by combinations of cash or guarantees, or assets and pledges that can be liquidated. “Obligors generally don’t want their assets attached – so by taking security you are able to get a better quality of debt, leading to improved recovery prospects through higher priority. But more importantly, you have better leverage to get an obligor to the negotiating table as a cooperative workout option is usually a better solution than an enforced liquidation,” he concludes.