Credit managers of U.S.-based companies usually face more challenges when doing business with firms located overseas. However, while the tasks of the credit managers may be more difficult in these situations, the potential financial gains for their companies may be worth the extra effort. Emerging markets in some countries may offer a lucrative area of new business opportunities for American companies.
Latin America offers a robust business climate for some areas of business, such as in the mining, manufacturing and agricultural sectors, which have done well over the last few years. In agriculture, for example, Brazil is poised to become the leading producer of soybeans, eclipsing the top position currently hod by the United States.
Joe Granda, Vice President of Business Development at Credit and Management Systems, headquartered in Lake Bluff, IL, said that getting credit information and assessing credit risk in Latin American countries is a little different than for domestic and European firms. His company provides information and maintains credit scoring models used for analyzing companies located in Latin America as well as other countries.
"Getting the information may take you a little longer," Granda said. "You may have to wait a week. We build a credit scoring model based on the business itself. We take the information that might come from D&B, and other credit rating firms, and based on your risk appetite come up with a score." The credit score, he pointed out, offers a quantitative assessment on credit risk, a credit line recommendation and how to prioritize collection procedures. "We literally help the collector to form a queue on what firms to follow-up first."
The credit modeling technique Granda's firm and others like his use is a rules-based model where various judgments are made about the weight various financial and payment history variables should be assigned. However, he said his company's models, like those of other firms, could incorporate other statistical calculations used in behavior-based models. These models measure the statistical correlations between and among variables as they relate to the credit risk score of a company. "We can incorporate statistical models as part of it."
The risk a country presents is also incorporated in Granda's firms' credit scoring models, he noted. "In Latin America you would typically include country risk. There's not one scoring model that fits everyone. You may want different scoring models for each country." He noted that companies such as Standard & Poors, Moody's and Coface provide company risk assessments. Factors relating to the political environment and stability of a country and economic factors, such as the value of the local currency, are considered in models that score country risk, he pointed out.
Typically though, a company that has been in existence for a long time is usually a good credit risk, Granda said. This is because it has been able to financially endure the swings in political stability and economic conditions that occur over long periods in many Latin American countries. "A company that's been around 20 or 30 years has survived many fluctuations. It's survival of the fittest."
Financial statements, as in any credit risk analysis, should be evaluated as part of the credit-scoring process. Granda said that financial statements on most Latin American firms aren't as transparent; meaning that they don't provide the same level of detail as U.S. company financial statements. The reason for this is that most companies in Latin America don't raise money through stock issuances. Therefore, the financial statements required for equity transactions do not drive the composition of financial statements kept by many Latin American firms. "In Latin America there really isn't a strong equity environment. They rely on banks and long-term debt as opposed to equity markets." Latin American firms also rely heavily on business-to-business credit, Granda said. "They'd rather fund their businesses through accounts receivable."
Also, because the tax laws are different in Latin America than in the United States, companies often keep sets of books that help them minimize their tax liability. "We get taxed on the income (in the United States), versus in Latin America, where they get taxed on their equity." But when I get their information, they're just as honest as anyone. If they offer you another set of financials, that's fine. And if you can, get them audited."
Alan Andrews, Vice President, Global Treasury Management at PNC Bank N.A., noted that the credit scoring process is usually more subjective with Latin American companies. "In some countries you have to rely more on subjective or gut-feeling types of assessments. He recommended reviewing other information about companies, as well as getting first-hand information about them. He said, "Bank and trade references are also valuable. And nothing is more valuable than to meet your company. Go down there, meet them and kick the tires."
Chris Short, Vice President of International & Strategic Accounts for Coface, said that his company provides credit scores on international companies. However, he pointed out his organization utilizes both automated and manual credit scoring models. The automated models have 22 data elements; so for companies outside of North America, where getting the information for the models may be more difficult, manual credit models are often used.
The credit models of Coface also take into account country risk, Short said. Whether an automated or manual credit model is used, he pointed out, the ratings Coface's models produce mean the same. For example, Coface--which uses from single to triple "@'s" in their credit ratings, called "@ratings,"--would indicate a Japanese company with a "@@@" rating has about the same credit risk as a Brazilian company with an "@@@" rating.
James Foley, Director of the International Trade and NAFTA Opportunity Centers at Bradley University, pointed out that emerging markets in Latin America offer credit managers both risks and rewards. "You can't ignore Latin America." However, because of circumstances created by the uncertain political and economic environment in some Latin America countries, conducting business in Latin America may present more of a headache for credit managers as far as late payments and write-offs.
"When I get calls related to a credit risk issue, they have mostly come from (doing business in) Latin America," Foley said. His centers are funded by the state of Illinois and the Small Business Administration to help American firms develop export business through training and one-on-one counseling.
The data that is available to credit managers about businesses in the United States, such as financial statements and credit reports, may not be as readily available on Latin American companies. The credit risk manager may be less knowledgeable about the exact nature of the credit risk a potential business transaction with a Latin American firm presents than with one from an American firm. However, there are ways credit managers can protect themselves or "hedge" financial risk when doing business in Latin America, Foley said. He noted they don't have to take overly risky measures in order to do business there. "Too many (small to mid-size) U.S. companies blindly extend credit to foreign buyers. This puts them at a disadvantage compared to creditors who understand how to use these risk mitigation tools-which, when used effectively, can expand their export sales."
One such risk-mitigation tool is to obtain a letter of credit from a bank that essentially guarantees payment for the goods shipped or services rendered to the Latin American firm. "The letter of credit is such a secure payment method," Foley said.
Foley pointed out that typically both the setter and the buyer pay a fee for a letter of credit. He noted that fees often are set at a minimum of between $300-$500 to both buyer and setter. Other letters of credit may involve paying a fee that is a percent of the business transaction.
However, a letter of credit may not be feasible for transactions of modest dollar value, Foley said. "Even at $300 for both sides, if it's a $5,000 sale, it is unlikely that both sides will use a letter of credit. Letters of credit tend to be used for shipments of some value."
Hans Belcsak, who is President of the international business-consulting firm of S.J. Rundt & Associates, Inc., pointed out that there are confirmed and unconfirmed letters of credit. He said that confirmed letters of credit are backed by the U.S. or setting company's bank, but are costly. "Basically, you take the risk and lay it off to the bank."
"Nowadays, letters of credit are rarely confirmed," Belcsak said. "They're simple, they're secure, but they do add a cost. It is costly. It puts you at a competitive disadvantage to people who are willing to sell on an open account."
Those businesses that use letters of credit for a transaction should also be careful that all documentation relating to them is correct. Belcsak noted that if there are discrepancies between the letter of credit and the product documentation, such as shipping dates, the weight of the shipment, or quality descriptions in the bill of lading, they could invalidate the letter of credit.
"It is based entirety on the underlying documents--and those documents have to match," Belcsak said. "If not, you have to go through an amendment (to the letter of credit) ... and it's time consuming, it's expensive."
Andrews said that using letters of credit for transactions involving the selling of goods and services by American companies to Latin American importers is often not feasible. "They're probably not the way to go for a Latin American importer because they're too expensive. Lain American banks for the most part do not like to issue letters of credit. Most transactions are on open account. The banks are considered ill-liquid. The banks don't like to lend money."
There is also a standby letter of credit that can be utilized to protect the selling company, Foley said. This is a letter of credit that will be used only in the event of a buyer defaulting on the payment. The financial cost of this is typically on the buyer, and "it does tie up funds (for the buyer) for the length of the contract."
Another way to hedge risk is to purchase credit insurance, Foley said. This is a type of insurance offered by private firms or the U.S. government, "That guarantees against the risk of non-payment by a foreign buyer. You pay a percentage (of the transaction) for that insurance."
Coface offers credit insurance, which is also known as accounts receivables insurance. John Gaeta, Vice President of the commercial division of Coface, said credit insurance is a good way for companies to protect themselves from debtors who enter into bankruptcy or insolvency or are involved in a protracted default of payment. He said, "We have over 85,000 policy holders worldwide, in over 90 countries."
Gaeta said the credit insurance policies offered by Coface can be structured in different ways, such as including specific coverage on accounts for certain dollar limits or blanket coverage up to certain dollar amounts. A blanket coverage policy, for example, would allow a company to ship a value of goods within the policy limits on an open account basis, he noted. "It's a combination of coverage that's offered. The policies are very flexible to the needs of the customers."
Foley said that besides centers like the one that he runs, there are other organizations that can assist credit managers to conduct business in Latin America as well as other countries overseas. Such organizations include the Ex-Im (Export-Import) Bank and U.S. Department of Commerce and other state agencies involved in economic development. Contact information on these agencies can usually be found on the Internet. The Ex-Im Bank website, for example, can be found at www.exim.gov.
Another good resource for information on credit management and other issues relating to doing business in Latin America is FCIB. The international arm of NACM, it is a membership organization of executives in finance, credit and international business that provides many forums for international credit-related education and exchange of information. FCIB can be accessed through NACM's website at www.nacm.org.
Learning about the risk mitigation tools available may encourage a credit manager to do business in Latin America that he or she may have avoided otherwise, Foley pointed out. "Given the proximity of many of the countries in Latin America to the United States, I think there are going to be strong growth possibilities for U.S. companies, especially if they leverage these risk mitigation tools. I'd hate to see someone turn away from the market opportunity just because they perceive too great a credit risk. That would be a shame. Develop a strong relationship with your local export center, whether it be local, state or federally funded.
David I. Marsh, Manager of Credit, at Novus International Inc., has extensive experience doing business in Latin America. His company, headquartered in St. Louis, produces a liquid feed supplement for poultry and does about 20 percent of its business in Latin America. Novus' sales volume is about $400 million per year, he noted.
Marsh said it's important to understand what risk factors are present not only with the company, but the country in which it is headquartered. "When it comes to credit analysis in Latin America, it's not that different than anywhere else in the world, except you are not only looking at company risk but (also) country risk." Such risk presented by the country itself includes corruption of public officials and cumbersome government bureaucracies, he pointed out. "In Brazil, for example, it may take five years for a collection lawsuit to go from beginning to end. Just the process of doing business is more difficult in these countries."
Many of the companies in Latin America are weak financially, Marsh noted. "They're producing commodities and not high-tech equipment. Their profit margins are low. Many companies don't have strong balance sheets."
While Latin America has provided fertile ground for new market opportunities for his company, it has also presented the biggest credit risk, Marsh said. He pointed out that for his company, from 1999-2004, bad debt write-offs in Latin America have been .67 percent of net sales. That compares to a write-off of about .16 percent average for all sales. "We're lower in Asia, Europe, Africa and North America. We're taking more credit risk in Latin America. My personal goal would be to have the company below .1 percent."
Last year was particularly bad in terms of write-offs in Latin America, Marsh said. "In 2004, it was 2.16 percent of bad debts in Latin America. A couple of large poultry companies in Brazil and Argentina went out of business in 2004, and we got stuck."
Marsh said that developing personal relationships with company officials in Latin America is necessary, due to the nature of the culture there. "Personal relationships are very important in Latin America--more so than in the U.S., certainly more so than in Europe. The people are very basic and down to earth. I go (to Latin America) five or six times a year."
Meeting face-to-face helps to facilitate remedies to credit problems, he said. On transactions that have problems, he san that he "definitely" fares better by personally negotiating with company officials. Such things as setting up catch-up payment plans, collateral, credit contracts and promissory notes are some of the alternatives Marsh employs to address credit problems with companies and to keep business going with those firms. He also said, "One way to mitigate risk is not to ship until payment is made on the first shipment. If they pay promptly, we may let two shipments go outstanding."
Credit managers should not be reluctant to analyze and try to extend credit to buyers in Latin America. Getting the right information on how to best assess credit risk, understanding the legal system, and utilizing credit risk mitigation tools can help facilitate new business in growing Latin American markets. The time may be right for those companies that stayed away from Latin America to take the market plunge there now.
Andrews said that with recent changes in U.S. dollar valuations, Latin American companies might be looking more favorably to doing business with American firms. "Going forward I see it getting better. U.S. products will look even more attractive. This is the time to strike--while the iron is hot."
NACM's upcoming Credit Congress in New Orleans, June 12-15, provides ample opportunity to learn more about doing international business. Some sessions of interest include Introduction to International Credit, led by Paul Beretz, CICE; Doing Business in Mexico, led by Ignacio Pumarejo Gonzalez, Attorney and President of NACM-Mexico; Credit Insurance: An Ounce of Loss Prevention Is Better Than a Pound of Cure, led by Eddy A. Sumar, CCE, CICE, and Letters of Credit, led by Buddy Baker of ABN AMRO Bank. See pages 38-43 in this issue for more information about Credit Congress, or go to www.nacm.org to register online.
Tom Diana may be reached by e-mail at firstname.lastname@example.org.…