Esteem for the art of credit diligence and the price of risk mitigation are bound to rise together

By Rob Downey

Some say the "fairy tale" of global finance has ended badly; others say the unhappy endings have not yet played out. Whatever the painful details still to come in the epilogue, we know very few companies will get to "The End" unscathed, and that all the surviving characters will eventually start a new story under new rules in the near future. Two aspects of credit insurance and trade finance will likely be changed for the better once we embark upon a fresh new narrative.

First, credit analysis at the corporate level – as well as credit-risk underwriting by insurers – will rise in both intensity and esteem. It may be that old-fashioned credit diligence in internationally-active corporations will never return to the lofty heights seen in American big business during the final three decades of the last century, but several alternatives to the so-called ”5-Cs” of credit work (i.e. Capacity to repay, Capital invested, Collateral, Conditions of intended use, and Character) have lost their luster in the current turmoil.

Trade credit no longer seems like a no-loss or low-loss business. Credit scoring models, plug-in algorithms, and ratings formulae that worked in low-risk environments have all proved deficient under pressure. Even the previously reliable touchstone of geographic risk diversification seems to have lost its utility as a sure-fire indicator of reduced overall risk.

As we see an unwinding of the severe and mysterious leverage shot through all levels of economic life, concerns about “price”, and “rating” are likely to be replaced in 2009 with the search for “capacity” and “risk-sharing partners”. Experienced credit managers, and CFOs who appreciate the highest standards of credit diligence, will be relied upon heavily during the coming prolonged period of recovery, and probably for years thereafter.

Second, the price of shedding, spreading, sharing or mitigating risk in any way will rise significantly and probably stay elevated over the coming half-decade. Risk is the only asset in the world economy that has remained under-priced for the last thirty years.

Government bailouts on the one hand, and crashing market values on the other, mean that risk mitigation vehicles have been consistently under-utilized, under-priced when used, and avoided too easily for decades. Just looking at the American economy, since 1983, we see a series of business sector or market crashes related to: Latin America (Brazil, Venezuela and Mexico, primarily), Chrysler, pension funds, Savings & Loans, Asian debt, Long Term Credit Management, Latin America again (this time Argentina), the NASDAQ-internet bubble, Enron/Worldcom/Adelphia failures, housing price bubble, auto industry woes, Fannie and Freddie bailout, Bear Stearns bailout, etc.

About every thirty-six months there is a crisis that hits the U.S. economy with an impact that lasts twelve to eighteen months. Though it is unlikely that the U.S. system will become more volatile than it is now; it is unwise to predict that it will become more stable.

Our message to clients is simple, obvious, and in two parts:

1. Take your credit manager to lunch, after upgrading his or her software and systems
2. Expect implacable market pressures to increase your credit insurance premium rates all across-the-board, in every market

(Rob Downey is one of the founding partners of International Risk Consultants, Inc. (IRC) www.irc-group.com – a globally-integrated trade-finance and credit insurance specialty brokerage, which serves as the operating member of ICBA for Mexico, Brazil, India, China and the U.S.)