Retail is facing a credit crisis. In recent months trade credit insurers have pulled or reduced cover on some of the biggest businesses on the high street.
Historically the pulling of credit insurance has sounded the death knell for many retailers. Without protection from insurance, many suppliers will stop trading with retailers or demand payment upfront on goods.
This can put immense pressure on retailers and can require multi-million-pound payments, which most simply don’t have.
“You’d struggle to find someone that’s had their credit insurance removed and has survived,” says one retail chairman. “It’s impossible. They have to find a huge amount of cash they haven’t got.”
But with seemingly half the high street suffering from a credit crisis, are insurers being too tough on retail?
Kris Macauley, director of risk, information, claims and collections at the world’s largest trade insurer Euler Hermes, insists its approval rates on new credit limits in the retail sector has only fallen by 2% in 2018.
“This more prudent stance is in reaction to the elevation in risk, which is no different to the approach any other provider of financial services would adopt,” he insists.
“Retail sales have faltered generally this year and the impact has been most evident among those pure bricks-and-mortar players that have been slow to move online. We see this trend continuing over the next 12 months.”
So what criteria does an insurer look at when deciding whether to cover a retailer?
Macauley says it looks at the financial performance of the retailer along with the strength of its business model: “The points we routinely evaluate include product offering, the mix between online and bricks-and-mortar sales, route to market, stock levels, corporate structure, payment practices and the ability to regenerate a customer base.”
There for the good times but not the bad?
Credit insurance is a bone of contention for some retailers, which complain insurers should be there for the bad times as well as the good.
“It’s a total con,” the chairman of one high street retailer fumes. “Anyone who can legitimately walk away at any time from any liability they think might arise – what’s the point? What are they paid for in the first place?
“They’re the umbrella when the sun’s shining. You don’t need insurance if there’s no chance of having a car crash. The fact that they can just withdraw cover is ridiculous.”
However, retail analyst Richard Hyman defends the practice.
“It is not the responsibility of credit insurance to keep desperately ill businesses afloat,” he points out. “If you’re in the business of providing credit insurance, you’re not going to take the decision to withdraw insurance lightly.”
A spokesperson for trade credit insurer Atradius says: “Our insured customers rely on us to support their risk management, and whilst non-payment protection is an essential element of our offering, risk mitigation is also vital.
“If their potential customer is a poor risk, they want to know that upfront so that they can make informed decisions. Any change to our cover is proportionate and conducted in the best interest of our insured customers who we are committed to protecting.”
Can you trade without credit insurance?
Poundland had its trade cover reduced last year following the accounting scandal at parent company Steinhoff. Almost a year later, Poundland is notching up solid sales growth – in the six months to March 31, its last reported period, like-for-likes advanced 2.4%.
Poundland spokesman Nick Agarwal admits that reduced cover has posed challenges for the retailer and at times “supply was patchy”, however, he says businesses have learned how to manage through such situations.
“We’re able to do it because of our partnerships with suppliers. A lot of Poundland suppliers took on the risk, it’s testament to our relationship.”
Debenhams had its cover cut in July. The department store’s chief financial officer Rachel Osborne says half of its suppliers have never used credit insurance and the impact of having cover reduced has been “exaggerated”.
“Suppliers’ maximum exposure is at Christmas and the conversations we are having are that this is the period of maximum cash inflow and that we’re set up well,” says Osborne, who insists that Debenhams’ shelves will be full over the festive period.
One chairman says his business has been trading for a number of years without cover in place.
“We have proper relationships with our suppliers. We keep them informed and we talk to them every day. They’re happy to continue and we’re happy to continue. We don’t need it,” he insists.
However, he admits it can put immense pressure on the business when cover is pulled. “You’ve no idea how complex it is to reconstitute the supply chain just because a credit insurer has withdrawn cover,” he admits. “The supply chain is immediately shot to pieces.
“You have to manage the cash day to day, find extra cash to pay creditors earlier or find new suppliers.”
Catch 22 for suppliers
Asking suppliers to trade without cover puts them in a very precarious position. The collapse of House of Fraser earlier this year left unsecured creditors almost £500m out of pocket, with the impact felt by high street fashion names such as Oasis, Kurt Geiger and Coast – which has since fallen into administration.
This has left many suppliers wary of trading without cover.
Meanwhile, many suppliers’ banks insist they have trade insurance in place in order to fund their business, says one retail chairman.
This leaves some suppliers in a catch 22 situation – a big retailer might account for the majority of its turnover.
“Suppliers have a concentrated customer base. You might only have half a dozen customers so it’s a matter of life or death,” says Hyman.
Macauley insists that when Euler Hermes reduces credit limits it does so on a “structured basis” to minimise disruption.
“Any reduction or withdrawal in cover is only delivered when a situation looks untenable and is done on a structured basis to allow our customers time to agree new terms and minimise disruption for both parties,” he says.
Retailers may be forced to search for new supply partners willing to trade with them on longer payment terms or on a ’sale or return’ model, whereby the retailer only pays when goods are sold. However, Hyman says this is unusual.
“Suppliers have overheads too. How do they pay their rent, staff, machines?” he asks.
For most retailers extra cash will be needed to pay suppliers upfront or on shorter payment terms. This could amount to “tens of millions” of pounds, according to one banker.
Retailers with a strong balance sheet may be able to absorb these one-off payments, however, the banker points out it does have “massive working capital implications”.
In its full-year report published last week Debenhams said given the actions of “certain credit insurers” in recent months it had “further sensitised” its forecasts for “a number of extreme working capital scenarios, which…reflect the theoretical impact on liquidity should the group experience a sustained deterioration in trade associated working capital”.
The banker says smart retailers should have planned for events such as credit withdrawal and have the liquidity to trade through.
“When you assume credit insurance is always going to be there it’s tough. The worst time to ask a bank for money is when you need it. You want to put additional headroom in place when you don’t need it,” he says.
He also puts forward the idea of retailers using asset based lending (ABL), whereby financiers lend against the assets of a business – such as stock or property – to help boost working capital.
The banker recommends that all retailers, regardless of their strength, look into how their business could cope without credit insurance. He uses an example of a “strong retailer” which recently approached him to borrow money despite having substantial headroom.
“They said one of the scenarios they’re working up around Brexit is that the UK consumer confidence is hit, we’ve got inflation, decline in real wages and because of that all credit insurance across retail is pulled. What would that mean for their working capital? They wanted more headroom to be able to absorb it.”
The banker admits that is an “extreme” scenario, but preparing for all eventualities in this increasingly unpredictable market is becoming the new norm.
While some retailers may be proving that credit cuts don’t have to result in collapse, strong supplier relationships and money in the bank are needed to stay afloat.
Building relationships with insurers
How easy is it to get credit reinstated? Not very, according to the retailers Retail Week spoke to.
One retailer that has been trading without insurance for some time says: “We had a lot of meetings with credit insurers in the early days to try to start a relationship but they all proved fruitless, even though we provided our numbers to them.”
Another retail chairman says it is “near impossible” to get credit reinstated mid-turnaround. “They [credit insurers] wait until a business is fixed and the sun’s shining again before they’ll come anywhere near it,” he complains.
One problem is that retailers have little-to-no relationship with credit insurers.
“The first we heard our cover was being cut was in The Sunday Times,” says one retailer.
One banker advises retailers to work closer with credit insurers. “You’ve got to treat them like an important stakeholder and keep them sweet. They’re less relationship driven than a bank. They’re less concerned about the long-term relationship as it’s very transactional but retailers have got to keep them on side.”
The Atradius spokesperson recommends retailers be “open and transparent” with them.
“We operate an open door policy to retailers and are proactive in seeking information to enable us to make informed credit decisions in support of our customers.”
Macauley adds that Euler Hermes is happy to discuss “the elements that need to be addressed for cover to be reinstated”.