Relegating letters of credit to the dustbin: credit insurance and advanced financing are gaining wider favor in global trade, and sound risk management practices are finding favor with U.S. exporters. Banks and underwriters are cheering because the trend increases lending capacity and enhances an underused asset class
Gregory DL Morris
Overt lack of trust is no way to start any relationship, but that is exactly how international markets are coming to view traditional letters of credit (LC). Once the sine que non of international trade, the LC has largely been supplemented and even replaced in Europe by trade credit insurance. This practice is now gaining currency in the United States and elsewhere in the world.
Trade credit has been around for decades in the United States, but it was never a major business for underwriters because most small and midsize manufacturers did the bulk of their business domestically. There is a significant domestic market for receivables insurance and financing. Indeed, it represents the majority of business in this sector for some carriers. But it tends to be a stable, quiet business. Trade credit was always bigger in Europe because of the many small exporters in many small countries.
“But with a lot of change in the U.S. economy and greater emphasis paid to comprehensive risk management, trade credit insurance is making inroads in the United States,” says Peter Aitken, vice president of trade credit insurance for Chubb. That carrier serves the middle market with a minimum premium of $25,000 to cover $10 million or more in receivables.
By another underwriter’s estimate the total credit insurance market in the United States stands at about $400 million to $500 million in annual premiums, covering sales of roughly $400 billion. That range reflects a wide variation in premiums. In contrast, the European market stands at about 83 billion to $4 billion in annual premiums. Another underwriter cites industry surveys showing the business growing about 10 percent a year. That may be a strong growth rate, but it is out of a small base. And even with U.S. exports flat, they represent a $700 billion market that is nowhere near fully served.
The effects of growing trade credit insurance are large, and in a rare case of true synergy, favorable to almost all parties. Sellers/exporters who technically buy the coverage report no trouble in passing along the cost to the buyer/importers–sometimes as a specific line item in the bill, but more often as part of the overall cost. Buyers, or importers, are generally content to pay the premiums because it usually nets out to substantially less cost in time and money than the traditional letter of credit.
Insurers, of course, are only too happy to write more new business; and in some cases the coverage leads to what amounts to a consulting relationship with the client. Even banks, which obviously stand to lose a traditional revenue stream from LCs, are broadly favorable. The biggest commercial institutions have been doing business on open accounts for years with multibillion-dollar trading partners.
REGIONAL BANKS GAIN THE MOST
Small to midsize exporters and regional banks have gained the most. Sellers of modest size are in a better position than ever to venture deep into international markets. And the regional banks that often serve their local industries and entrepreneurs no longer have to wave from the quayside when their clients do business overseas. With insured or financed receivables, they can now take a larger role in their clients’ business.
One such bank is M&T, based in Buffalo. “Open accounts facilitate trade,” says Charlie Murphy, vice president of international banking. “But people have to think more. It increases options, but it also increases responsibilities. The use of insurance also puts banks into a new role. Instead of just coming to us with or for LCs, clients are asking us to help them do something with their assets. The banks that appreciate the use of insurance are really in a position to help their clients.”
Another option, especially for small businesses seeking export markets in developing countries, is the U.S. Export-Import Bank. John McAdams, senior vice president, says ExIm’s working capital program has been particularly successful in supporting open account financing. Average transaction size is $1 million to $2 million, but there are no minimums or maximums. “We are not in competition with other lenders or insurers,” says McAdams, stressing that is not the ease with analogous agencies in other countries. “We are instead the lender or insurer of last resort.”
TWO MODELS THAT MATTER
There are basically two models for underwriters in trade credit, says Aitkin at Chubb: The American model is a straight transaction where the exporter buys coverage as necessary. Under the European model, the underwriter becomes an extension of the exporter’s credit office–or in some eases for small manufacturers, the entire credit office. “We prefer not to interfere with our insureds,” says Aitkin. “Our customers know their customers. But carriers on both sides of the Atlantic write both styles of business.”
“The use of LCs is extremely unfriendly to the customer,” says Michael Ferrante, president of Coface North America Insurance Co., based in New York. “When you ask a buyer to pay up front or post a bond, you are essentially saying you don’t trust him. LCs also limit trade because they cut into the buyers’ credit.” Coface is a subsidiary of Natexis Banques Populaires and the Banque Populaire Group.
Ferrante says Coface is happy to do business under either basic model. “We offer straight coverage or fuller participation. We even have capability in collections. In either case, the value [to the exporter] is more than just the protection. The whole market runs the gamut from companies with $5 million in sales to billions. The typical client of ours has $75 million to $1 billion in sales.” He adds that while international trade coverage is a vast untapped but fast-growing business, 80 percent of his premiums in trade credit is still domestic.
The big brokers, of course, are big players. “We have a large business in trade credit,” says Claudia Mastrapasqua, client executive and New York financial institution practice leader for Marsh. “Our banking clients see it as a risk transfer tool, and more importantly, as a way to stimulate their own loan growth. If an institution has an internal credit limit in a specific geography or sector, it can use coverage to transfer that risk and thus continue to extend credit to existing customers.”
This embracing of insurance by banks as a way of enhancing their business is a pleasant sea change for carriers. One broker notes, “banks used to think that trade credit insurers were just a place to dump exposure. Now we are talking about banks looking to insurers to help them do more creative or difficult transactions, instead of just walking away from them.”
John Bayeux, executive vice president and industry leader for financial institutions at Willis, says he is indeed seeing more insurance to cover political and trade credit risks, and to facilitate business. “People are creatively going to a carrier to enhance a risk portfolio by getting someone involved who understands that business.
Foreign importers are not exactly idle observers in the equation. “Buyers themselves are putting pressure on exporters to trade on open accounts,” says Ed Brittenham, senior vice president of American International Underwriters, the global trade and political risk insurance subsidiary of AIG. “LCs increase transaction costs and diminish buyers’ ability to borrow. The use of insurance has been a feature in the market, but it is accelerating. We have been participating for some time.”
Brittenham says his firm’s particular strengths are insuring companies with $250 million to $1 billion in export business, which would put AIU at the top end of the sector. Importantly, he adds, “we have recently been expanding into smaller players,” at the growth end of the market. “Larger companies have already addressed the shift to open account terms, and smaller companies are now having that realization.”
AIG writes plenty of straight business, but also has a full suite of enhanced services to operate in the European model. “We can do credit-limit assessments,” says Brittenham, “and we also have collection capabilities. In cases where there is a problem we have capabilities via legal channels.”
As one of the few truly global players, AIU reports that Asia has historically been a very strong LC market, but that is decreasing even faster than the trend in the United States. In contrast, Latin America has always been less of an LC market, despite being strongly influenced by trade with North America.
Even as sellers, buyers, underwriters, and brokers discover the wider benefits of receivables insurance, big banks are exploring the potential beyond straight coverage. “Insurance creates a whole new secondary market for this risk,” says Elbert Pattijn, managing director of credit risk management at ING Group in Amsterdam. “Lenders can create a diversified portfolio of risks based on the underlying geographic and product risks. This offers an alternative to hedging in the interbank market through syndication.”
On a basic level this creates more capacity in the credit markets, as other players have noted. But in the creation of a secondary market, where other lenders and even hedge funds can become involved. This represents a major new development. “If because of the nature of the exports from a home country a lender is stuck with lots of country or industry risk, you can try to lay some of that off,” says Pattijn. More importantly, as a result of the growth of the receivables insurance market, “risks have become more diversified, and risks overall have come down,” says Pattijn. “It used to be mainly LCs. Now there are many more open accounts. The secondary market makes it possible to do more complex deals and preserve diversification.”
Taking the secondary market logic to its next step, three-year-old Finacity Corp. is a joint venture of several big international banks, underwriters, and other interests. “We believe accounts receivable are an underserved asset class,” says Adrian Katz, chief executive officer. “The liquidity is surprisingly poor considering the quality of the assets. If you look at mortgages, equipment leases, even credit-card receivables, those assets have about a 90 percent chance of being monetized or securitized at favorable rates and with insurance. But if you look at $6 trillion in trade accounts receivable, only about $200 billion is securitized. That’s three percent.”
Finacity was founded by Bank of America, underwriter Euler Hermes, and Amroc Investments, a buyer of distressed receivables in conjunction with venture-capital firm evolution Global Partners. ABN Amro has since joined as another global banking partner. Other nonparticipating equity partners include Texas Pacific Group, venture capitalists Kleiner Perkins, and Bayne Consulting.
“We are completely open minded,” says Katz. “We can offer, through our partners, insurance and financing through special-purpose entities. We are still small, but after three years we are already supporting more than $1 billion in receivables financing per year. If you talk to CFOs, they may admit their goodwill is flaky or their inventories are illiquid, but they consider their trade receivables their best asset. That is an underserved class, however, because securitization is complex. There is a lot of friction.”
At heart, however, Aitken at Chubb emphasizes that “open-account sales are an exposure like any other. Good, prudent risk management says receivables are not any different from other risks. Don’t try to guess the next loss.”
RELATED ARTICLE: Banks still lag in non-quantified RM.
Banks and other financial institutions have set high standards for assessing and addressing quantifiable risks. But a recent study by PricewaterhouseCoopers indicates that rather than move on to address nonquantifiable risks, financial institutions have instead concentrated on further refining their risk management in quantifiable areas. This can leave them vulnerable in several significant exposures.
In the late ’80’s banks thought they had credit risk buttoned down, and started concentrating on market risk,” says Shyam Venkat, a partner at PwC and leader of the financial risk-management practice. “Then credit risk came a bit undone, and that problem was resolved when credit risk began to be traded. So banks went back to concentrating on market risk. But in all of this. where have the really big losses come? Barings? Sumitomo Daiwa? Classical operational risk management failures.”
Part of the problem, the study finds, is that “much of the impetus for change in risk management priorities is coming not from self-assessment but rather from pressure from regulators, rating agencies, and the like … A culture of risk awareness has yet to emerge … In only 31 percent of respondent companies de all major decisions require interaction with, or some form of approval from the group risk management committee.”
Ironically, that reliance on compliance is also being turned into something of a liability. The costs of too little emphasis on compliance are obvious, but the study finds also that “too much emphasis on box ticking can also distract a company from Using risk management to create value.”
Another pair of findings show that the importance of governance is underestimated and that quantifiable risks are still absorbing too much attention, “The No. 1 benefit of good risk management is a link to strategic planning,” says Venkat. Far from making risk an obsession, addressing risk at a strategic level, “increases the institution’s ability to take risks.” Any company becomes risk averse if it does not know how much risk it faces. But without taking risks, there is no growth.
Venkat stresses that the somewhat quaint notions of “management,” “judgment,” and “experience” are what C-level executives get paid for, “The focus on numbers was natural, logical, and appropriate in the past,” he says, “Now is the time to respond to things that are not quantifiable.”
–Gregory DL Morris
INDUSTRY RISK REPORT
CITIGROUP New York, N.Y.
Citigroup Inc is a diversified global financial services holding company whose business provides a broad range of financial services to consumer and corporate customers with some 200 million customer accounts doing business in more than 100 countries, The company’s activities are conducted through the Global Consumer, Global Corporate and Investment Bank (GCIB), Private-Client Services, Global Investment Management and Proprietary Investment Activities business segments.
CHIEF RISK EXECUTIVE Stephanie Brydon Sirr, Vice President
CEO Charles O Prince III
CFO Todd S Thomson
BOARD AUDIT CHAIR C Michael Armstrong
NET REVENUE $94,713 million
NET INCOME $17,855 million
NUMBER OF EMPLOYEES 259,000
PRIMARY BROKER Withheld
RISK EXPOSURES Changing economic conditions–U.S., global, regional; macroeconomic factors and political policies and developments in the countries in which the Company’s businesses operate; level of interest rates, bankruptcy filings and unemployment rates, as well as political policies and developments around the world; the continued threat of terrorism; levels of activity the global capital markets.
RISK STRATEGIES The Company manages its exposures to market rate movements outside its trading activities by modifying the asset and liability mix, either directly or through the use of derivative financial products including interest rate swaps, futures, forwards, and purchased option positions such as interest rate caps, floors, and collars as well as foreign exchange contracts.
BANK OF AMERICA CORP Charlotte, N.C.
Bank or America Corp. provides a diversified range of banking and non-banking financial services to companies throughout the United States.
CHIEF RISK EXECUTIVE Adriaan Schieferdecker, Director, Ins. & Risk Management
CEO Kenneth D Lewis
CFO Marc D Oken
BOARD AUDIT CHAIR Mr. Guinn
NET REVENUE $49,006 million
NET INCOME $10,810 million
NUMBER OF EMPLOYEES 133,549
PRIMARY BROKER Marsh
CAPTIVE Tyron Assurance Co. (Bermuda)
RISK EXPOSURES Changes in general economic conditions and economic conditions in the geographic regions and industries in which the corporation operates; changes in the interest rate environment which may reduce interest margins and impact funding sources: changes in foreign exchange rates: adverse movements and volatility in debt and equity capital markets; political conditions and related actions by the United States military abroad which may adversely affect the Corporation’s businesses and economic conditions as a whole; liabilities resulting from litigation and regulatory investigations; mergers and acquisitions and their integration into die Corporation.
RISK STRATEGIES The risk management organization translates approved business plans into approved limits, approves requests for changes to those limits, approves transactions as appropriate, and works closely with business units to establish and monitor risk parameters. Risk management has assigned a risk executive to each of the four business segments who is responsible for oversight for all risks associated with that business segment.
GENERAL ELECTRIC Fairfield, Conn.
GE is one of the largest and most diversified industrial corporations in the world. GE has engaged in developing, manufacturing and marketing a wide variety of products for the generation, transmission, distribution, control and utilization of electricity since its incorporation in 1892
CHIEF RISK EXECUTIVE Scott McCurdy and Nilufer Durak, Managers, Corporate Insurance Programs
CEO Jeffrey R Immelt
CFO Keith S Sherin
BOARD AUDIT CHAIR Douglas A. Warner III
NET REVENUE $152,890 million
NET INCOME $15,002 million
NUMBER OF EMPLOYEES 305,000
PRIMARY BROKER Marsh
CAPTIVE Electron Insurance Co. (Bermuda)
RISK EXPOSURES Withheld
RISK STRATEGIES The company maintained insurance liabilities, reserves and annuity benefits of $136.3 billion at December 51,2003, which wore $0.4 billion higher than in 2002. Exchange rate and interest rate risks are managed with a variety of straightforward techniques, including match funding and selective use of derivatives.
FANNIE MAE Washington, D.C.
Fannie Mae is a private, shareholder-owned company that works to make sure mortgage money is available for people in communities all across America, The company is the country’s second largest corporation, in terms of assets, and the nation’s largest source of financing for home mortgages,
CHIEF RISK EXECUTIVE David Menn, Director, Corporate Risk and Insurance management
CEO Franklin D Raines
CFO J Timothy Howard
BOARD AUDIT CHAIR Thomas P Gerrity
NET REVENUE $53,768 million
NET INCOME $7,905 million
NUMBER OF EHPLOYEES 5,055
PRIMARY BROKER Withheld
RISK EXPOSURES Changes in housing price valuations, employment rates, or other factors affecting foreclosure levels and credit losses; regulatory or legislative changes affected Fannie Mae’s operation or market, such as changes in tax law or capital requirements; competitive developments in markets for mortgage purchases; unanticipated changes in interest rates; political events in the United States and internationally.
RISK STRATEGIES Debt securities and interest rate derivatives to help manage interest rate risk. The company conducted an overview study of corporate financial disciplines in 2003, basing new financial strategies for market risk management on this report
AMERICAN EXPRESS New York, N.Y.
American Express Company is a global travel, financial and network services provider. The Company has three operating segments: Travel Related Services (TRS), American Express Financial Advisors (AEFA) and American Express Bank (AEB). As the world’s largest travel agency, the Company offers travel and related consulting services to individuals and corporations around the world.
CHIEF RISK EXECUTIVE Howard Haggerty, III, Director, Risk Management
CEO Kenneth I Chenault
CFO Gary L Crittenden
BOARD AUDIT CHAIR Daniel F Akerson
NET REVENUE $25,866 million
NET INCOME $2,987 million
NUMBER OF EMPLOYEES 78,200
PRIMARY BROKER Marsh
CAPTIVE Amexco Insurance Co. (Vermont)
RISK EXPOSURES The company’s ability to cost effectively manage and expand card member benefits, including containing the growth of its marketing, promotion, rewards and card member services expenses; credit risk related to consumer debt, business loans, merchant bankruptcies and other credit exposures both in the United State and internationally; volatility in the valuation assumptions for the interest only (I/O) strip relating to IRS’s lending securitizations
RISK STRATEGIES The company provides non management directors with group term life insurance coverage or $50,000 and accidental death and dismemberment insurance coverage of $500,000. Directors may purchase $50,000 of additional group term life insurance. We have an insurance program in place to provide coverage for directors and officers liability and fiduciary liability arising from employee benefit plans.
J.P. MORGAN CHASE New York, N.Y.
J.P. Morgan Chase & Co. is a financial holding company incorporated under Delaware law in 1968. As of December 31, 2003, JP Morgan Chase was one of the largest banking institutions in the United States with $771 billion in assets and $46 billion in stockholders’ equity. JP Morgan Chase is a global financial services firm with operations in more than 50 countries.
CHIEF RISK EXECUTIVE Don M Wilson, Executive Office, Risk Management
CEO William B Harrison, Jr
CFO Dina Dublon
BOARD AUDIT CHAIR William J Moran
NET REVENUE $44,363 million
NET INCOME $6,719 million
NUMBER OF EMPLOYEES 110,455
PRIMARY BROKER Withheld
RISK EXPOSURES The risk of adverse movements or volatility in domestic or foreign debt and equity securities markets or in interest or foreign exchange rates or indices; the risk or adverse impact from an economic downturn or other downturn in trading conditions or markets; the risks associated with increased competition; the risks associated with unfavorable political and diplomatic developments; and the risks associated with acts of terrorism or the outbreak of armed hostilities.
RISK STRATEGIES The risk management committee, chaired by the chief risk officer, focuses on credit risk, market risk, operational risk, business risk, private equity risk and fiduciary risk. The committee has decision-making authority, with major policy decisions and risk exposures are subject to review by the office of the chairman; global credit risk management committee formed to ensure that credit risks are adequately assessed, properly approved, continually monitored and actively managed.
WELLS FARGO San Francisco, Calif.
Wells Fargo is a diversified financial services company providing banking, insurance, investments, mortgages and consumer finance from more than 5,900 stores, the Internet (wellsfargo.com) and other distribution charmers across North America. Wells Fargo Bank, N.A. is the only “Aaa”-rated bank in the United States.
CHIEF RISK EXECUTIVE Doreen Wong, Loss Prevention Manager
CEO Richard M Kovacevich
CFO Howard I Atkins
BOARD AUDIT CHAIR Philip J Quigley
NET REVENUE $51,800 million
NET INCOME $6,202 million
NUMBER OF EMPLOYEES 140,000
PRIMARY BROKER Aon
CAPTIVE Golden Pacific Insurance Co. (Vermont); Great Plains Insurance Co. (Vermont)
RISK EXPOSURES Interest rate risk relating to assets and liabilities; foreign exchange risk and credit risk. Technology and other changes now allow parties to complete financial transactions without banks.
RISK STRATEGIES The company uses exchange-traded and over-the-counter interest rate derivatives to hedge its interest rate exposures; establishment of committees such as the Institutional Risk Committee to identify, monitor and eventually reduce most market, interest rate and equity risks and exposures.
WACHOVIA CORP Charlotte, N.C.
Wachovia was incorporated under the laws of North Carolina in 1967 and is registered as a financial holding company and a bank holding company under the Bank Holding Company Act of 1956, as amended. The merger of the former Wachovia Corporation and First Union Corporation was effective September 1, 2001. Wachovia also provides various other financial services, including mortgage banking, investment banking, investment advisory, home equity lending, asset-based lending, leasing, insurance, international and securities brokerage services, through other subsidiaries.
CHIEF RISK EXECUTIVE Kathy Frachon, Director, Corporate Insurance
CEO G Kennedy Thompson
CFO Robert P Kelly
BOARD AUDIT CHAIR Joseph Neubauer
NET REVENUE $24,474 million
NET INCOME $4,264 million
NUMBER OF EMPLOYEES 86,670
PRIMARY BROKER Willis
CAPTIVE Union Hamilton Reinsurance Ltd. (Bermuda)
RISK EXPOSURES The risk that the businesses involved in the brokerage transaction will not be integrated successfully or such integration may be more difficult, time consuming or costly than expected; the strength of the U. S. economy in general and the strength of the local economies in which Wachovia conducts operations may be different than expected resulting in, among other things, a deterioration in credit quality or a reduced demand for credit, including the resulting effect on Wachovia’s loan portfolio and allowance for loan losses; the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System; inflation, interest rate, market and monetary fluctuations.
RISK STRATEGIES The board of directors evaluates risk and oversees the management of risk through the following committees: Credit and Finance Committee, Audit and Compliance Committee and Merger and Technology Committee. The bank adopted a strategy for establishing control processes and procedures to align risk taking and risk management throughout the company. The control procedures are aligned around four components of risk governance: the business units; an independent risk management function joined by other corporate staff functions including legal, finance, human resources and technology; internal audit; and specific risk committees.
BANK ONE CORP. Chicago, Ill.
Bank One is part of the new JP Morgan Chase created on July 1, 2004 upon completion of the holding company merger between J.P. Morgan Chase & Co. and Bank One Corporation. The Bank One brand continues to be used in the marketplace; the combined JP Morgan Chase/Bank One will have assets of approximately $1.1 trillion and operations in more than 50 countries. The firm is a leader in investment banking, financial services for consumers and businesses, financial transaction processing, asset and wealth management and private equity.
CHIEF RISK EXECUTIVE Brenda Boultwood, Senior Vice President/Managing Director And Head Of Operational Risk Management
CEO James Dimon
CFO Heidi G Miller
BOARD AUDIT CHAIR M Anthony Burns
NET REVENUE $20,724 million
NET INCOME $3,535 million
NUMBER OF EMPLOYEES 71,196
PRIMARY BROKER Aon
CAPTIVE Sterling Assurance Co. (Vermont)
RISK EXPOSURES The risk of adverse movements or volatility in domestic or foreign debt and equity securities markets or in interest or foreign exchange rates or indices; the risk of adverse impact from an economic downturn or other downturn in trading conditions or markets; the risks associated with unfavorable political and diplomatic developments; the risks associated with acts of terrorism or the outbreak of armed hostilities.
RISK STRATEGIES The purchase of Zurich Life increased insurance policy and claims reserves by $6.5 billion to $6.7 billion; establishment of risk committees to ensure appropriate management of aggregate risks and capital, acceptable corporate and line of business risk profiles and the integrity of risk governance processes.
U.S. BANCORP Minneapolis, Minn.
U.S. Bancorp, with assets in excess of $189 billion, is the 8th largest financial services holding company in the United States. We operate over 2,243 banking offices and more than 4,425 ATMs in 24 states, and provide a comprehensive line of banking, brokerage, insurance, investment, mortgage, trust and payment services products to consumers, businesses and institutions.
CHIEF RISK EXECUTIVE Kathryn Weimar, VP, Risk Management
CEO Jerry A Grundhoffer
CFO David F Moffet
BOARD AUDIT CHAIR Warren R. Staley
NET REVENUE $14,571 million
NET INCOME $3,732 million
NUMBER OF EMPLOYEES 51,377
PRIMARY BROKER Marsh
CAPTIVE Midwest Indemnity Inc (Vermont)
RISK EXPOSURES Changes in the domestic interest rate environment could reduce net interest income and could increase credit losses; inflation, changes in securities market conditions and monetary fluctuations; changes in the extensive laws, regulations and policies governing financial services companies; changes in the financial performance and condition of its borrowers could affect repayment of borrowers’ loans.
RISK STRATEGIES To reduce the financial risk of potential changes in vehicle residual values, the company maintains residual value insurance. The catastrophic insurance maintained by the company provides for the potential recovery of losses on individual vehicle sales in an amount equal to the difference between: (a) 105 percent or 110 percent of the average wholesale auction price for the vehicle at the time of sale and (b) the vehicle residual value specified by the Automotive Lease Guide.
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