Rising insolvencies and funding costs to beset Asia trade, says Atradius
The region is likely to see more credit defaults and insolvencies as banks raise their lending standards and interest rates begin to rise, meaning more counterparty risk.
Trade financing in Asia is set to become costlier and insolvencies among trade suppliers could rise as a result, with Hong Kong already experiencing high levels of unpaid invoices, according to trade credit insurance company Atradius.
A recent survey by the insurer found that 32% of the total value of domestic sale invoices and 29% of the ones for export were unpaid at due date. In an interview with Asiamoney, Atradius also highlighted that Hong Kong companies had seen their day sales outstanding (DSO) reach the double number of average days as the rest of Asia.
“That’s quite a large percentage,” said Atradius country manager Matthew Cockerill. “It either means that people are getting worse at collecting their money or that there is more financial distress in terms of their buyers.”
Such distress could very well lead more Asian manufacturing companies to default or become insolvent.
Atradius notes that a global trend of banks cleaning up their balance sheets to ensure compliance with capital reserve requirements could also accelerate bankruptcies across the region. Without the same level of bank lending support, more companies are likely to default as a result.
“An awful lot of companies out there are being kept alive by the banks, because [the latter] didn’t want to crystallise the loss on the loans,” said Cockerill. “However, as the banks rebuild balance sheets and go back to profitability, there is worry about these ‘zombie companies’.
Further, the ongoing monthly cuts to the US Federal Reserve assets purchase programme is widely seen as likely to reduce or even partially reverse capital flows into Asia, as interest rates in the safer mature economies start rising again. This is likely to result in more difficult, or at the very least more expensive, borrowing for corporates across the region, as many regional interest rates also begin to rise.
“It could definitely lead to some pressure on companies, balance sheets and increases in bad debts,” said Cockerill.
The end of letters of credit
Asian companies have traditionally preferred to use irrevocable letters of credit (LCs). These instruments are considered very safe due to the fact the buyer of a trade has to place the cost of purchase with their bank, where it stays until delivery has been successfully documented and displayed to the lender.
The security of LCs have meant the vast majority of Asian companies have never looked at the potential benefits of trade insurance. But Cockerill said the concentration of risk still makes trade insurance worth taking out.
“It is surprising considering at any one time 30 or 40% of a company net worth is tied up in their account receivables book. They ensure their plant, but some companies take the view not to ensure their account receivables book,” he said.
Should a tightening of credit liquidity actually take place, the natural tendency for Asian companies would be to stick or revert to LCs. But that may not be a possibility anymore, according to the insurer.
“The sea change is that as businesses are globalised, there is more pressure by the sellers on the buyer to offer credit terms,” said Cockerill.
Overseas buyers that use open account terms constitute around 80% of global trade according to Swift, and they will be less than likely to suffer such a burdensome and expensive form of trade settlement as letters of credit.
Many large buyers outside Asia are increasingly forcing suppliers to agree to their terms, or looking for more accommodating partners elsewhere.
“That is driving the change in trade in Asia. A number of companies are realising that the ability to offer open account terms is a huge benefit when pitching for sales. Especially if you have credit insurance on the back of that,” said Cockerill.
Atradius argues that the pressure on Asian companies to adopt open account processing for orders, combined with more expensive financing at home and the increased risk of counterparty defaults, means they either risk losing some of their business to more adaptable rivals or need to consider trade insurance more as a competitive advantage than as a burden.
For many Asian corporates with slim credit control department, trade insurance could perform an additional function: “They look to trade insurers to do the professional buyer assessment for them. In certain respects, it is a cost saving in administration and staff. Basically you are outsourcing a part of your credit management procedure,” said Cockerill.
Despite some evidence of trouble, insurance premiums across the industry are very much towards the low end when compared to the peaks of the 2008 global financial crisis, said Cockerill. This makes it an even more appropriate time for companies to familiarise themselves with the products.
“At the moment it’s a good time to buy insurance in Asia. But if we see a continuing increase in claims in the region, [the rates] could start to harden.”