Companies Paring Exposures to Risky Counterparts

As much as some optimists would like to find evidence of recovery, it is far more likely that the US will see a further deterioration in economic activity. We have not yet seen much in the way of bankrupticies and debt restructuring. Until this sort of thing becomes sadly routine, the bottom is not yet nigh.

One sign that conditions are worsening is that major companies are cutting their exposures to business partners they deem to be in peril. This is a corporate version of the paradox of thrift. While this activity may seem laudable as far as each actor is concerned, it will have the effect of pushing some enterprises over the edge. And those failures feed the downspiral of activity and psychology.

From the Financial Times:

The world’s biggest companies are terminating contracts with customers they fear will collapse, a report will show on Monday in a sign of the turmoil spreading through global supply chains.

Of the 337 international corporates surveyed by accountancy firm Ernst & Young, most of which turn over more than $10bn a year, the majority said important customers were in financial distress and were taking longer to pay than usual.

A quarter said one or more key customers had gone into bankruptcy while almost on in ten said suppliers had gone out of business. As a result, a third of the companies surveyed have stopped trading with customers they perceived as high risk.

John Murphy, global managing partner of markets at Ernst & Young, said managers would have to scrutinise the health of even ultra-safe trading partners very carefully. “A company’s risk profile can change almost overnight,” he said.

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  1. Anonymous

    This is particularly true of banking counterparties. Yves has been pointing out the difficulties GM and Chrysler will have with closing deals. The same is true with Citibank and RBS, among others. I write from direct experience.

  2. Timo

    Maybe I should start (re-)selling the sign with “In God We Trust, All Others Pay Cash”. I could make a fortune! :)

  3. Anonymous

    Most companies will be actively managing customer credit limits and I doubt whether anyone will be surprised if weaker companies go under as a result. Companies do however face a dilemma with the too big to fail customer. The customer who represents more than 10 percent of a companies sales and is clearly in difficulties poses a real problem. Quite often they will dictate terms of payment rather than the other way round. This is squeezing lots of smaller businesses as larger businesses just pay later and later. It almost gets to the point that if a law was passed that companies must pay for goods within 3 months that many of the Dow stock market companies would get into serious trouble. Highly leverage big buyout companies look set to topple whole supply chain structures as a result.

  4. DoctoRx

    An implication of this phenomenon is that doing business within your own region becomes favored. Doing business with a foreign company adds a level of risk to any already risky time.

    Are letters of credit for international trade still hard to get, as they were after the Lehman collapse?

  5. Anonymous


    LCs depend on where you are.

    Chinese Banks did an about face and started to offer a sizable amount of trade financing in December, reversing the freeze there.

    But that is only for exports originating from China.

    Elsewhere in the world, the picture is much murkier.

    Presumably, LCs from Developed to Developed countries is OK. LCs from Developed to Developing are OK though it may have to go through a government Export Agency.

    What I suspect, but do not have documentation to show, is that developing to developing trade that use to be intermediated through a developed country bank is in trouble.


  6. Don

    This is bad news, since it is the definition of a Calling Run. It basically defines Debt-Deflation. Companies have been doing this for a while, but it might actually be getting worse. Yikes.

    Don the libertarian Democrat

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