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4 STRATEGIES TO MANAGE CREDIT RISK Acceptance Limitation TRANSFER
*Most use one of several strategies on a single counterparty
Avoidance
Credit Risk T ransfer Solutions RISK MANAGEMENT 4 STRATEGIES TO - - PowerPoint PPT Presentation
Credit Risk T ransfer Solutions RISK MANAGEMENT 4 STRATEGIES TO - - PowerPoint PPT Presentation
Credit Risk T ransfer Solutions RISK MANAGEMENT 4 STRATEGIES TO MANAGE CREDIT RISK TRANSFER Avoidance Acceptance Limitation *Most use one of several strategies on a single counterparty CREDIT RISK TRANSFER TOOLS TRADITIONAL Letter of
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Letter of Credit Credit Insurance On-Demand Payment Bond Receivable Put Option Credit Default Sw aps
TRADITIONAL PROGRESSIVE
CREDIT RISK TRANSFER TOOLS
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CREDIT INSURANCE
Credit Insurance can cover :
- A single counterparty
- International only
- All receivables
- Key counterparties
- Separate business units
- Domestic only
An insurance coverage that protects the business against unexpected bad debt losses (A/R + Mark to Market) due to counterparty:
WHAT IS IT?
Insolvency Non Payment Political Risk (Exports)
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CREDIT INSURANCE
THE DETAILS
KEY CATEGORY CREDIT INSURANCE CREDIT CAPACITY
Unsecured, does not tie up credit capacity.
COVERED LOSSES
A/R, Price Risk (Mark to Market), Non-Delivery (Pre-Payment)
RECOVERY
Subrogate debt to Insurer. Insurer works with counterparty to collect on debt or through bankruptcy court and any “salvage”
TRIGGER TO CLAIM
Insolvency, non-payment (typically 90 days past due) of debt owed. Political Risk for exports.
SETTLEMENT
The policy holder (beneficiary) must file a claim and prove debt is valid, which is reviewed and evaluated by the insurer. Payment schedule can be negotiated to 30 days upon completed claim filing. Typically 90% Insured.
UNDERWRITING FOCUS
Based on a combination of counterparty credit quality, recovery potential, and credit procedures.
PROCUREMENT
Typically on a ‘silent’ basis. Can be sourced and paid for by either counterparty.
CONTRACT DURATION
Typically renew on an annual basis, Structured Credit Ins may be available for up to 3 years or longer, depending on credit quality.
Optional Features
- ‘Discretionary’ Credit Limits
- Bank Assignment / Loss
Payee
- Preference Claw Back Cover
- Cancellable vs Non-
Cancellable
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CREDIT INSURANCE
Brief Definitions:
- 1. Maximum Limit of Liability: The cap an insurer will pay during the policy period.
- 2. Insured %: The amount of A/R insured in the event of a loss. Typically 10% of risk is retained with the insured.
- 3. Discretionary Credit Limit: The amount per customer the insured can approve based on compliance with credit procedures. Typically
covers everything except the largest 10 – 15 customers.
- 4. Annual Aggregate Deductible: The total credit losses that the insured must take before a claim is paid – a 1 time deductible. Typically
50% of the Discretionary Credit Limit and based on loss history.
- 5. Maximum Payment Terms: The longest credit terms you can sell on and be insured. Typically equal to your longest payment terms.
- 6. Customer Specific Credit Limits: The cap an insurer will pay for a loss to a customer. Typically the peak seasonal exposure.
No Deductible Programs Key Counterparty Basket Single Counterparty
OTHER STRUCTURES
“Hybrid” 1 - Maximum Limit of Liability = $100M 2 - Insured % = 90% 3 - Discretionary Credit Limit = $1M per counterparty 4 - Annual Aggregate Deductible = $500k 5 - Customer Specific Credit Limits
(Counterparty A = $55M, Counterparty B = $20M, Counterparty Counterparty C = 15M…D,E,F…..)
SAMPLE SIMPLIFIED “CATOSTROPHIC” APPROACH
EXAMPLE STRUCTURE
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MOST ACTIVE SCENARIOS:
- Streamline risk management / transfer for large
number of smaller counterparties
- Partial credit approval or exposure breaching credit
approval
- Credit approved for commercial reasons
- Enterprise Risk Management - shift catastrophic
losses off balance sheet
CREDIT INSURANCE
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ON DEMAND PAYMENT BOND
On-Demand Payment bonds are accepted assurance methods that can be called on if the counterparty (principal) defaults. They are designed to be an alternative to Letter of Credit, while minimizing working capital constraints.
WHAT IS IT?
- 100% risk cover
- Unsecured, maximizes working capital
- Callable at any time during the coverage period
- Pays out in short time frame
- Priced competitively with other collateral instrument rates
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ON DEMAND PAYMENT BOND
KEY CATEGORY ON-DEMAND PAYMENT BOND CREDIT CAPACITY
Generally unsecured, does not tie up credit capacity unless required by Surety based on credit risk.
COVERED LOSS
Amount of bond, can include A/R and Price Risk (Mark to Market).
RECOVERY
Surety will require an indemnity agreement which outlines rights in the event of a loss.
TRIGGER TO CLAIM
On Demand - non-performance with the underlying contract
UNDERWRITING FOCUS
Transaction specific, based on a combination of credit quality, capital, capacity, recovery potential (indemnity agreement), and details of the company “character”.
PROCUREMENT
A 3 party agreement requiring involvement from both counterparties and surety.
CONTRACT DURATION
Typically renew on an annual basis, similar to evergreen letter of credit.
THE DETAILS
Optional Features
- Cost paid by the counterparty
(principle)
- Streamline payment flow,
similar to LC
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MOST ACTIVE SCENARIOS:
- Replacement of Letter of Credit
- Transactions / counterparties looking to free up
working capital or reduce costs
- Strong Credits
- Partial credit approval or exposure breaching credit
approval
ON-DEMAND PAYMENT BOND
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RECEIVABLE PUT OPTIONS
A Receivable Put Option is a tool to protect Receivables from a counterparty’s insolvency. They are typically offered by banks or hedge funds, willing to take the risk.
- 100% risk cover
- Pay out on insolvency only, must occur during contract period
- Limited conditionality
- Hedging tools taken by banks or hedge funds (CDS, Short Bonds, etc.)
- Benefits over a Credit Default Swap
- Substantially more expensive than other risk transfer tools
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KEY CATEGORY Receivable Put Option CREDIT CAPACITY
Unsecured, does not tie up credit capacity.
COVERED LOSS
A/R Only
RECOVERY
Subrogate debt to Bank/Investment fund, they will work with counterparty to collect on debt through bankruptcy court and any “salvage”
TRIGGER TO CLAIM
Insolvency only
SETTLEMENT
The contract (beneficiary) must file a claim and prove debt is valid, which is reviewed and evaluated by the Put writer. Payment is immediate generally upon satisfactory evidence.
UNDERWRITING FOCUS
Transaction agnostic. Typically used for highly distressed names with publicly traded debt. Banks or Investment companies may hedge through CDS, 3rd party investors, or shorting bonds.
PROCUREMENT
Can be sourced and paid for by either counterparty.
CONTRACT DURATION
Highly flexible from 2 months up to 3 years.
Optional Features
- Post – Petition coverage,
conversion from Chapter 11 to Chapter 7
THE DETAILS
RECEIVABLE PUT OPTIONS
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MOST ACTIVE SCENARIOS:
- Distressed counterparty - option to Risk Avoidance
- Seeking alternative to other Risk Transfer solutions
- Debtor in Possession
RECEIVABLE PUT OPTIONS
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Counterparty Risk Review Accept Credit Risk Transfer Credit Risk Letter of Credit 3rd Party Risk Solutions Credit Insurance
LC Replacement
On Demand Surety Bond Receivable Put Risk Transfer Limitation- Pre-Pay / Cash Posting Avoid Credit Risk - Decline
SAMPLE DECISION TREE
Credit Default Swap
*Letter of Credit and 3rd Party solutions can be combined
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S&P CHART EXAMPLE
Counterparty S&P Rating Estimate Credit Insurance On Demand Payment Bond Receivable Put Option Credit Default Swap AAA+ to AA
X X X X
A to BBB-
X X X X
BB+ to BB-
X X X X
B+ to B-
X may require portfolio spread X X
CCC+
X X
<CCC+
X X
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KEY CATEGORY LETTER OF CREDIT ON DEMAND BOND CREDIT INSURANCE RECEIVABLE PUT OPTION CREDIT DEFAULT SWAPS COLLATORAL REQUIRED
Generally Secured Generally unsecured Unsecured Unsecured Unsecured
COVERED LOSS
Subject to underlying agreement A/R and Price Risk (Mark to Market). A/R and Price Risk (Mark to Market). A/R Only Notional value of contract less and recoveries on underlying bond. ‘basis risk’
TRIGGER TO CLAIM
On calling, depending on L/C Terms On Demand - Non- performance with the underlying contract Insolvency or non- payment
- f debt owed.
Insolvency only Insolvency / subject to ISDA
ELIGIBLE COUNTERPARTY
Public or Private Public or Private Public or Private Public Public
CONTRACT DURATION
Typically annual with evergreen clause and ability to draw in the event of non- renewal. Typically renew on an annual basis, similar to LC. Typically renew on an annual basis, Structured Credit Insurance can lock cover for 3-10 years. Highly flexible from 2 months up to 3 years. Typically, from 1 to 5 years.
SUMMARY OVERVIEW
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One Source Risk Management David Kinzel 303-945-1486 dkinzel@onesourcerm.com