Banks Make Quick Decisions When Better Credit Quality is the Goal

By Ron Doyle

In Canada, we have recently seen two well-established companies filing for protection: Hart Stores Inc. and Norgate Metal. In neither case did the creditors nor the credit insurers suspect that the companies were about to file. In the Hart Stores case, two credit insurers reviewed the portfolio just prior to the company filing and found, that while the company had experienced a small loss at year end and another small loss at the end of the first quarter, there wasn’t any reason to reduce coverage. What wasn’t anticipated: these small losses resulted in the company’s bank refusing to renew the Line of Credit and then the company’s inability to find new financing in today’s market.

In the case of Norgate Metal, the company lost money on a contract due to the last minute withdrawal of a subcontractor. The loss caused the debt-to-worth ratio to increase substantially and the company’s bank immediately pulled the Line of Credit. Prior to this one loss, the company had operated successfully for many years and had a reasonable balance sheet.

It appears that the liquidity crisis in the banking system and the banks’ objective of raising Tier 1 capital is forcing banks to focus on credit quality and whereas, they were previously prepared to be patient and waive violations of covenants, they are now reacting more quickly. In a December 1, 2011, article in Canada’s Globe and Mail, Report on Business, Central banks in bid to pull Europe from the doldrums, Marius Kloppers, CEO of BHP Billiton is quoted as saying, “trade finance - a cornerstone of the international banking industry long dominated by European lenders - has become harder to get.” This statement supports the premise of my November 2011 blog post that described how banks are now seeking more support from credit insurance markets to support their normal documentary credit business, which is critical to smooth transaction of international trade.

Credit capacity is a finite amount. This is particularly true in the credit insurance industry. If banks and major commodity exporters use the market to support their sales and lending capacity, credit is going to become scarce very quickly. This situation will be exacerbated if banks become more adverse to risk and begin calling loans or refusing to renew credit lines on reasonable terms. Such a situation would again result in high levels of claims and overdue accounts being submitted to underwriters. As we saw in 2008, a similar situation resulted in a reduction of capacity and the withdrawal of credit limits on buyers around the world.

Credit management in too many companies, especially in North America, is often reactionary and based on historic experience and information. I don’t think even the most optimistic economists are forecasting strong growth over the next five years, which will allow the countries and the banking system to reduce enormous debt loads. The most radical of austerity measures will only reduce the deficits in most countries. The bleeding continues. Now is the time for prudent and professional credit managers to develop a strategy to not only survive, but to improve market share.

The fact that banks are striving for credit quality will result in more companies either having their Lines of Credit pulled or not renewed. The economy suffers. Bankruptcies are going to happen quicker and with less warning. What is your company doing to position itself a winner?

(Ron Doyle is a founder of Millennium CreditRisk Management – credit and political risk insurance specialists – www.mcm.ca. ICBA is the world’s largest team of independently-owned, specialist trade credit insurance brokerages. Partners combine local service with global coordination to provide credit and political risk insurance solutions for multinational companies.)