Half way into 2002, we have seen signs of a rebound in the metals industry. On the heels of one of the most difficult periods in memory, both the economy and the metals sector appear to be turning upward. Lower inventory levels across the board coupled with tariffs in the steel industry are gifting the metals sector with firmer pricing and greater capacity utilization.

However, there is still significant cause for concern. Credit risk experts find this time period to be almost equally as volatile as the recent down period due to several factors. First, the environment over the past year has left many companies without the necessary liquidity to meet the demands and opportunities currently developing. They don’t have adequate capital to make the moves necessary to capitalize on sales opportunities or to make essential investments. This adds to the risk of further shakeout among weaker market participants. Additionally, credit markets are still extremely conservative in posture and this makes securing additional liquidity for working capital purposes very difficult or impossible for some companies. As a result, analysts predict a relatively high degree of volatility to continue at least through the balance of the year. In the broader economy, defaults are expected to exceed even the torrid pace of 2001. We are not out of the woods yet, and these risk factors do not even take into account potentially catastrophic world events that we are now exposed to.

Possible Ways of Dealing with Credit Risk

The handshake-In this type of environment, there are many credit risk factors at play. Most firms in the scrap industry have relied on personal relationships to manage credit risk. This, unfortunately, will no longer work, as too many suppliers have recently found out the hard way. Every sale puts capital, profit and net worth at risk. Companies truly need to focus significant attention to this area of their business in the attempt to find an effective way to manage the risk, especially in the current environment.

Payment history-Unfortunately, too many firms rely on historical payment experience as a means to manage credit risk. We have all witnessed too many bankruptcies where the debtor firm has continued to pay vendors timely up until the filing date. This could result if you are one of the firm’s major suppliers, they have current availability under their line (lender has yet to call the loan due), or the owners continue to put capital into the business waiting for things to improve. As a vendor you will see nothing but prompt payment until a sudden and unexpected default occurs. And, since payment history tends to be a major deciding factor in granting credit, the customers who pay you best are likely to have the largest credit lines resulting in greater risk for you.

It is also important to note that you not only have to be concerned about who you are selling but you also need to focus on who your customers are selling – can they withstand a potential loss if one of their larger buyers were to default? This is one added layer of credit risk most firms pay little to no attention to – or at least until it is too late. It is difficult to monitor for anyone but industry credit analysts who do nothing but follow this type of information.

Credit insurance-Currently, much of the credit insurance marketplace is “shut-off” to the metals industry. Several carriers have stopped accepting applications and the few remaining others have very limited appetites for credit risk in the metals sector. Credit insurance is a “proactive” tool – it needs to be implemented in better times when coverage approvals can be secured. It is not an umbrella that will be available after the storm starts. You can’t expect a credit insurance underwriter to accept a small premium for the large risk to be hedged in the current environment. If you have it now great. If you don’t have it, it will be nearly impossible to come by.

Secured terms-The other options are too restrictive with regards to sales. You can start requesting buyers to put up letters of credit or pay cash in advance; however, these terms do not play well for the buyer’s working capital because it ties up their availability. Unless you are willing to offer a deep discount, or you have something others don’t, you will most likely lose the buyer to competitors who were fortunate enough to have secured credit insurance a while ago, or are willing to take the risk.

The only true option available is to start managing credit risk more aggressively. Suppliers need to realize that credit risk is an important part of their business and start to set-up procedures to deal with it on an ongoing basis. Someone within the organization needs to be put in-charge of managing credit risk, and most importantly, have access to the proper tools to do the job.

Available Credit Tools

The internet has made information much more accessible to anyone with a computer and the time to go searching. Unfortunately, unless you plan to hire a full time credit manager that does nothing but evaluate credit risk, you will not have the time to effectively find the information you need to help with your credit decisions or evaluate the quality of implications of available information and still have time to manage your business.

You can start requesting copies of your customer’s financial statements; however, chances are this could offend your customers, and many companies prefer not to have that information available for their vendors to view, even though they will release the information to a more objective credit analyst or lender. Additionally, who will review the statements even if you were able to secure them?

Credit reporting agencies offer various types of information and reports. The bigger problem here is that until recently, the only available options reported information that may have been limited and more importantly, need to be reviewed and analyzed. These types of reports are fine for a full time credit manager because they have the time and hopefully the experience to evaluate the information. Unfortunately, for many scrap suppliers these reports provide little to no value and have not been widely valued or used. Most services available do not specialize in the metals industry, and are not providing anything more than publicly available information.

Conclusion

No doubts about it, the landscape has changed and will continue to do so. In order to survive and prosper, a company needs to identify major risks and effectively deal with them. Credit risk is a current major risk and will continue to remain a risk in the metals industry as the marketplace becomes more “Global”. If you have not started to search for possible solutions to the growing level of credit, we strongly recommend you do so – before it is too late and you find yourself involved with a major buyer left unable to pay. Remember, a sale is not a sale until the cash is collected. Cash is oxygen to your business – you need to manage this resource effectively or you may be jeopardizing the long-term survival of your company. 

(This online sidebar was submitted by Victor Sandy, Vice President of scrap credit decision support firm ProfitGuard LLC, on the Web at www.eprofitguard.com.  He can be reached at (866) 990-1099 toll free.)