We are winding down the year 2020. With the rollout of COVID-19 vaccines, the outlook while still grim remains hopeful that there is a light at the end of the tunnel (despite uncertainties of the length of the tunnel.
FutureCFO spoke to three executives for their expressed views on the impact of COVID-19 on the Asia Pacific’s (APAC) credit market: Mike San Diego, chief financial officer at JK Capital Finance; James Ponsford, regional director & growth leader, Credit Solutions, Asia at Aon; and Matthew Wells, APAC regional commercial director for Euler Hermes.
Each was asked to look at the credit market in the region, before, during and challenges that await us in the years ahead.
Before COVID-19, what is the discernible trend in the APAC trade credit markets, and the dynamics shaping the market?
Mike San Diego: Before COVID-19, the obvious trend in the APAC credit markets is fintech and full digitalization. We can see how each member is bragging on how digital-ready their markets are right now. Central banks are also pushing their supervised entities to go digital and prepare for their requirements and rewards.
In the Philippines, the race on who can implement the best digital strategies and increase the use of digital banking among its clients and customers are on. No one was talking or worrying about NPL and reserves. Everyone seems to be happy and assured that the system is working on a normal mode.
Matthew Wells: The impact of China on Asian trade flows is a key one. We have seen how some countries have benefitted from the US/China trade feud and how some have become even more reliant on orders from China.
With China gradually walks out of the COVID-19 shadow, it is taking economies such as Australia, New Zealand, South Korea and Taiwan with it as trade data has shown that exports to China have outperformed those to the US and the Eurozone.
James Ponsford: With the tightened liquidity environment, we have seen a continued drive of corporates using credit solutions to facilitate much-needed bank financing and support working capital requirements. This is across the short-term side, monetising current assets through receivable finance or more sophisticated securitizations, and also on the medium-term side where corporates seek financing under longer tenor individual contracts.
Following the global financial crisis (GFC) of 2007-2009, banks now have improved capital structures and will play a critical role in supporting corporates navigate this crisis. We expect Credit and Political Risk Insurance (CPRI) to play an important and increasing role in supporting lenders in mitigating risk, overcoming concentration issues and improving capital adequacy.
In Asia, we have seen a rise in demand for surety as a liquidity tool to replace bank guarantee and LC instruments. A surety guarantee generally has no or low collateral requirement(s), sits as a contingent liability being an unsecured instrument and does not tie up banking facilities.
Increased demand for credit solutions to access much-needed liquidity does come at a stage where the credit insurance market is naturally hardening due to a wave of defaults, with insolvency rates increasing up to 35% in 2020 (monoline carriers estimated a rise of 3-4% in January 2020).
New structures have evolved to structure insurance capacity and enable bank financing. There has been increased demand over the loss and alternative risk share structures in the multi debtor space, a trend we expect to see continue beyond the crises.
Excess of loss provides non-cancellable cover above a deductible for insureds with strong credit procedures, the certainty of cover is important for financing and protects the financier and corporate against catastrophe losses.
How has COVID-19 impact the APAC credit markets?
Mike San Diego: The impact was way different and this one cuts deep and would result in a long and deep scar. I think the word PANDEMIC is just apt to describe how this COVID-19 is affecting or impacting the global and regional economies. This is a real disruptor most especially in the credit market. Even the government, regardless where, is not sure whether the regulation or new policy or even requests can assure the business that they will be protected and that there will be enough stimulus that would help them thrive and bounce back.
Matthew Wells: We have seen an increase in the trust placed on domestic counterparties and a significant increase in new enquiries from companies looking to protect often the largest assets on their balance sheets.
James Ponsford: Asia and Singapore, in particular, is a commodities hub with commodity trading business accounting to 4.5% of Singapore’s GDP. Singapore is geographically well-positioned, has a well-educated labour resource and excellent logistical capability to position it for commodity trading business.
The pandemic has resulted in distressed major trading companies being tipped over the edge. The wave of commodity default and greater complexity in assessing fraud particularly for physical trading - where no digital confirmation is widely available for the industry – has seen a mass exodus of lenders in this space.
The key question is, will this be a short-term exit in liquidity that returns in 2021? Or can we expect a structural change in commodity finance that transforms the landscape with new alternative lenders coming into the market for a core part of Asia GDP?
More constrained capacity in the short-term credit markets, particularly in the commodity space, has seen an evolution in multi debtor syndication – co-insurance and portfolio top-up structures – where insurers have been unable to provide full limit coverage on a stand-alone basis. The benefit of multi-debtor syndication, being improved coverage supporting growth/financing, expanded insurer relationships and enhanced wordings.
What is the biggest challenge in the credit markets today?
Mike San Diego: For me the biggest challenge in the credit markets today is LIQUIDITY. Just before this pandemic, everyone is doing a normal business. Most were implementing their 2020 business plans which were carefully crafted in 2019 with full assumptions and what-ifs & whatnots.
Reality is showing us that profitability is no longer a target, and in the absence of such, how can we be assured of liquidity. The business chain is broken.
Liquidity is a major issue for the credit markets. It is the lifeblood of the industry. Once the flow is disrupted, it will cause a chain reaction. Even if they will decide to provide moratorium or restructuring of their accounts – the question is the same for everyone – can their clients afford to service the payments, either for interest-only or manage the new amortizations?
If their clients can't pay them because the clients of their clients can't also pay them and so forth and so on... we need to find a way to fix the broken chain to proceed to the better normal, not just the new normal.
Matthew Wells: Adjusting to the “new norm” of assessing credit risk, management information may not be too helpful in judging how a company has worked through COVID-19. The investment that Euler Hermes has made in speaking directly with companies to understand their business has allowed us to make more accurate decisions.
James Ponsford: The pandemic has created a liquidity crisis with certain sectors that have been impacted worse than others. The International Air Transport Association (IATA) identifies that Europe alone is set to lose USD 21.5bn in 2020 with passenger demand reducing by up-to 50%.
The retail industry that is already experiencing major structural change over the last 10 years with digital transformation and multinationals such as Amazon taking market share, has seen consumer footfall stifle because of lockdown. Fashion, furniture, and electronics retailers will be hit hardest as consumers forego discretionary purchases in favour of stocking up on food and household supplies.
Whatever industry you are in with a 5.2% GDP contraction in the global economy, it is difficult to not be impacted with a fall in revenue and profits, resulting in corporates burning through retained earnings and cash flow to pay creditors.
The financial downturn has shown again the critical role of government in free market trade and the importance the credit insurance market plays in supporting international trade.
The average corporate now has more debt. Tying into the point above on how quickly the global economy will recover from COVID-19, with the consensus anticipating a more protracted rebound unlike the swift recovery that followed from the GFC, financial institutions and corporates will continue to find themselves in a challenging credit environment with continued unpredictability and assessment of credit risk in business will remain more critical than ever.