EQUINOX
GLOBAL
NEWS
AUTUMN/WINTER 2011
Return of the
Credit Crisis?
So what does the index of credit default swaps
currently predict? In the graph of two indices
(see right), the white line is a portfolio of larger
(but sub investment grade) European companies
and the yellow line is the equivalent portfolio
of US companies.
A credit default swap
is a bit like a capital
market version of
a credit insurance
policy.
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You can see that the average price has
increased from 400 basis points (4%) on limit
to 800 basis points (8%) on limit over the past
eight weeks. This is a very steep increase in just
a few weeks from an already high starting point.
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Much media coverage has been given in
recent weeks to the turmoil in the financial
markets. From a credit insurance point
of view however, we are more interested
in the effect this turmoil might have on future
bankruptcy rates.
How can we predict what future bankruptcy
rates will be? There is one measure which proved
very reliable in predicting credit insurance losses
prior to both of the last two crises (in 2001 and
in 2008/9). This measure is the index of credit
default swaps on weak (sub investment grade)
buyers.
A credit default swap is a bit like a capital
market version of a credit insurance policy. The
transactions are usually on a single buyer basis,
and, very usefully, the prices (premium rates) of
these transactions are published on a daily basis.
For predicting future bankruptcy rates overall,
it is best to look at the pricing of a portfolio of
many buyers – such a portfolio is called an ‘index’.
The US index has already matched and
exceeded its previous most stressed point
(in March 2009 when it was 706 basis points).
The European index is still some way from its
previous worst point (1153 basis points, also in
March 2009). However, both are already worse
than they were following the Lehmann collapse.
As a reminder of the balmy days of 2007 – these
indicators were then at just 120 basis points (US)
and 170 basis points (Europe) – meaning they
are predicting the bankruptcy risk roughly five
times higher now.
So, based on this measure at least, we should
be prepared for another period of much higher
credit insurance losses over the coming months.
No unpleasant surprises
With this autumn’s financial crisis as the
backdrop, no doubt many companies will
be dusting off their credit insurance policies
to make sure they have peace of mind. In this
environment, it is more important than ever
that the insurer does not have the ability to
withdraw or cancel credit limits just when the
insured needs the cover most.
A F O R C E F O R C HAN G E I N
T HE T R AD E C R E D I T M AR K E T
Equinox Global has an established team with
over 150 years of trade credit experience
between them. As part of the Lloyd’s family
Equinox Global can offer the expertise,
experience and security that has kept Lloyd’s
at the head of the international insurance
market since 1688.
www.equinoxglobal.com
An honest insurer will admit that there are
times when the insurer and insured will disagree.
The credit insurance sector is unusual in that the
insurer may remove cover on a buyer without
the insured having any right to state a case or be
involved in the decision. This is a standard feature
of a whole turnover credit insurance policy. It is
assumed that the insurer knows more about the
buyer and the commercial relationship than the
insured does.
But suppose that the insurer does not know as
much as the insured, or that a sudden withdrawal
of cover leads to problems with the insured’s
bank? Insureds need to have credit insurance
policies with no nasty surprises.
Under a Trigger Policy the credit limit is
non-cancellable unless one of the Triggers is
activated. If one of the Triggers is activated then
the credit limit will be called in for review. It may
be, for example, that whilst a buyer’s interim
results show a deteriorating trend, the insured
might know of new investment or a new contract
which will transform the situation at the end of
the year, meaning a cancellation or adjustment
of credit limits would be unnecessary.
Equinox Global has a range of options for
non-cancellable and secure cover – ranging from
the fully non-cancellable limit to those which are
non-cancellable unless a pre-agreed Trigger
occurs. These policies do not necessarily require
a large deductible, nor do they have to be built
on complicated credit procedures. We cannot
promise that we will never disagree with an
insured, but with Equinox Global it is guaranteed
the insured is always going to be part of the
decision-making process.
E qui nox G l oba l L td Sutherland House 3 Lloyd’s Avenue London EC3N 3DS
T +44 (0)20 3036 0523