What to do when one of your Major Buyers is Distressed

In this uncertain economy, every sale to a business carries with it the risk the buyer will not pay. If the buyer goes into bankruptcy, you have your receivables tied up in court. Retailers of course are one sector that sees many companies go into distress, but problems are not limited to retail – think food and beverage, paper and packaging, auto parts, etc.

Receivable puts add another credit risk management option to manage exposure to a sellers’ buyers. Basically what you are doing when you as a seller “buy” a put is that in a credit event scenario, the Receivables Protection Put (RPP) will pay out a pre-agreed level of protection (can be set at 100% of face amount. Of course you pay for that protection. The product is about 10 years old, and enables many Private equity firms who have distressed companies in their portfolio the opportunity to have those companies still purchase goods. If you can’t buy goods, you can’t sell and have enough cash to manage your distress.   Sears is a good example today.

When would a company use Receivable Puts?

  • Credit Default swaps do not provide a perfect credit hedge for receivables and CDS settlements typically require the delivery of customer’s bonds (which is not required with the Receivables Put).
  • Trade Insurance contracts may be cancelable, not available for distressed names, and requires deductibles and claims waiting periods.
  • Factoring may not be available for certain names or just may be uneconomical for certain receivables.

This is not a transparent market, so you need to know who are the players. The overall market is currently estimated at $5 billion in notional. The number of players includes Hedge funds as originators and risk underwriters, investment banks, and a few large banks.  JP Morgan is a big player. Their Credit Liquidity Solutions team (CLS) delivers this innovative risk mitigation product which also includes other speciality puts like Lease Puts and Alternative Letters of Credit (ALOC). The volatility experienced in the markets over the past few years has prompted many of their clients to broaden their approach to risk management beyond more traditional areas of FX, Rates and Commodities.

Depending on your own views and those of credit rating agencies like S&P & Moodys for corporate defaults, this can be a good tool for corporates to use for risk management. In cases where you face a stressed customer, an RPP allows you to maintain an uninterrupted relationship with that customer on consistent trade terms.

Source: JPMorgan web site

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