Can Insuring Unpaid Invoices Stop the Cascade of Energy Bankruptcies?

Accounts receivable insurance offers peace of mind in hard times. But is it really worth it?

December 09, 2016

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Graham MacLachlan, managing partner at Calgary-based brokerage Global Trade Credit

Unpaid invoices have driven many firms under during this prolonged energy slump. Yet some banks and savvy suppliers will extend their lines of credit if they are covered by the relatively unknown insurance that covers accounts receivables, also known as trade credit insurance (TCI).

The service industry has been hit hard by the cascade of non-payment, which Graham MacLachlan, managing partner at Calgary-based brokerage Global Trade Credit calls the “domino effect.”

“Oil and gas folks use letters of credit and some layer insurance on top of that–others are so big they provision for bad debt. Yet the cost of TCI is usually less then 0.5 percent of the sum insured […] If companies are competing to sell the same service or product to an oil producer, by using TCI one can win the deal—it can offer longer credit term.”
– Graham MacLachlan, managing partner, Global Trade Credit

Mark Salkeld, CEO of the Petroleum Services Association of Canada, says, “Some producers pay 180 days late—it’s ridiculous. No one gives that line of credit, not banks, not credit card companies… If the money were paid in 45 days it would save the service firms money and let them help save the producers money too. We have members carrying producers for up to $50 million for 180 days.” He says, “Let’s just start paying the bills and we won’t need this other stuff.”

Nonetheless, Salkeld says “accounts receivable insurance is an alternative without a doubt.” If they do need the time, at least there’s something to bridge the gap. Factoring is an option where some lenders will position themselves between the producer and the service provider. “For example, a producer needs services to complete a well but the service company needs operating capital to get going. So the lender provides operating capital, collects from the producer directly, takes its cut and gives the balance to the service provider,” Salkeld says.

Factoring, however, competes against banks by getting cash up front, so banks prefer companies to use TCI to protect their cash flow. “Oil and gas folks use letters of credit and some layer insurance on top of that—others are so big they provision for bad debt,” MacLachlan says. “Yet the cost of TCI is usually less that 0.5 percent of the sum insured—it depends on the buyers and the countries they are in.”

TCI also provides other benefits. “If companies are competing to sell the same service or product to an oil producer, by using TCI one can win the deal—it can offer longer credit term,” he says. Furthermore, TCI allows firms to margin inventory up to 75 percent from the usual 50 percent. If a company has a $10 million line of credit maxed out and gets a big order it can’t refuse, if it takes out TCI, margining against line of credit could get up to 90 percent of the original line of credit added to it, MacLachlan says.

U.K.-based HSBC is actively targeting the oil and gas sector with its accounts receivable financing solutions structured with TCI. It is unusual in Canada in that it recognizes the nine top-tier insurance firms that offer TCI here, while not all banks recognize TCI yet.

“Today, we have a handful of very strong companies in most industry segments, and quality reduces from there with a lot of consolidation occurring,” says Andrew Skinner, HSBC’s head of global trade and receivables. “What we tend to see is access to large credit facilities is more selective in the energy sector or associated terms have tightened. Historically companies could access 75 cents against each dollar in receivables with most financial institutions in Canada. Today, with TCI they may be able to access 90 percent or more and include international—not just domestic—sales if they choose the right partner.”
Furthermore, companies can actually sell their receivables and take them off the balance sheet, subject to their auditor’s opinion of the purchase recourse terms. “This in many cases materially improves key working capital ratios,” Skinner says. TCI can also boost the stock price of publicly traded companies as analysts view it favorably.

A letter of credit from a bank is a standby security instrument, usually good for a year, used when a company might not have a healthy balance sheet or its private balance sheet is not disclosed. This TCI policy can be completed without the knowledge of these companies or other competitors. The letter of credit is also independent of the balance sheet and ensures payment in the event of bankruptcy. InRisk Solutions is a Calgary-based credit consultant in the oil and gas sector. President Ian Lydiatt says, “Sometimes companies who are your debtors can’t get one. You can then take out TCI to cover against their default—a non-cancellable TCI policy is like a letter of credit.”

TCI can benefit firms other than service companies. Lydiatt gained his first experience with TCI covering Energy Exchange, the world’s first electronic natural gas trading platform, a North American exchange that competed against Canada’s Natural Gas Exchange. Energy Exchange established credit limits for $2.5 billion—the sum of 150 companies’ credit lines. Under the later name of AlTrade Transactions, it generated US$16 billion in revenues, 99 percent of which was covered by TCI. “Any production sold through the trading system to a third party purchaser had to have its creditworthiness absolutely confirmed as it was integral to the trading system that there were no losses,” he says.

TCI won’t end the crisis of energy busts, but it may defer some for another 12 months—when hopefully the next boom will be on the horizon.

Advantages of Trade Credit Insurance

  • Can get TCI on inventories
  • Risk mitigation – secures balance sheet against potential loss
  • Removes risk of customer defaulting on credit terms or open account sales for up to 365 days
  • Mitigates concentration risk on customers
  • Provides credit protection and information on unknown buyers
  • Financing and securitization – provides better terms than a financial institution
  • Provides access to capital by margining accounts receivable and inventory
  • Supports lower requirements for letters of credit with additional security
  • Provides additional security when factoring accounts receivables
  • Credit Enhancement – provides instant professional credit protocols
  • Provides credit limit for a customer and monitors portfolio performance during the policy period
  • The insurer acts like an extension of credit department lowering admin costs
  • Increase sales – uses extended terms to gain new business
  • Corporate governance – policy demonstrates professional protocols
  • Reduces bad debt reserve
  • Gives a second opinion on customers’ credit limits and monitors customers’ portfolios
  • Reverse no claims bonus option
  • If you go for one year with no claims the insurer will refund 10 to 15 percent of the premium reducing how much your company actually pays for it, keeping you motivated to monitor
  • First shot over secured creditors including Revenue Canada, as TCI coverage is outside of your debtor company assets if they go bust
  • Positively impact share prices along with return on capital invested

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