By Frank Knight
Debtors’ books correlate closely to interest rate hikes.
Every 0,25% increase in the interest rate in South Africa ultimately increases the number and value of trade credit insurance claims.
This is a phenomenon of the true cost of credit.
Consumers who bought cars or houses at the limit of their affordability a year ago are finding their repayments a lot more today as a percentage of their disposable income.
It’s not just consumers.
We've seen the debtor delinquency rate creep up monthly - in aggregate by 25% year-on-year - as the number of companies struggling to pay increases.
We measure delinquency as being any instance of a debtor that goes into a legal recovery process or business rescue or liquidation.
Furthermore, all the trade credit insurers in South Africa are currently reporting an increase in claims lodged both from a frequency and a severity perspective while adding to the evidence. Global credit insurers all forecast an increase in insolvencies and report rising credit insurance claims.
Behind all these factors is that businesses are suffering a triple blow of high interest rates, high inflation and high load shedding.
The cost of credit is calculated as a factor of the interest rate, plus the inflation rate, plus opportunity cost.
The prime lending rate is 11.5%, inflation is currently at about 7.5%, while the opportunity cost consists of what that business could do differently with its available cash: such as getting a discount from a supplier or buying some unique stock.
If you add all three elements together, the cost of credit has increased over the past year from about 15% year-on-year to in excess of 20% year-on-year.
This means that every R1 million debtors account outstanding for a 12-month period actually costs the creditor R1.2 million - and this difference implies that in many cases, there's no possibility of making a profit from that account anymore as that is in excess of most trading margins.
In light of these heightened risks, we at Debtsource have shifted our credit stance from ‘liberal’ to ‘conservative’. Among our own clients, the overall credit rejection ratio has worsened from a rate in the mid-teens late last year to approximately 20% now.
Locally, this is only partially to do with interest rate hikes but also the uncertain political climate as well as low business confidence in the market – and particularly load shedding. This latter event is alone costing private companies billions in turnover, which translates to lower profitability, which, in turn, leads to lower tax receipts for government.
Nonetheless, it’s worth bearing in mind that South Africa has actually not done too badly compared to our peer group of developing countries, including Brazil, Argentina and Türkiye, which are all worse off. Unfortunately, there is no sign of global inflationary pressure easing as there's still lots of inflation at the moment in the American and European markets.
For businesses, the key strategy right now must be to better protect cash flow, as a debtors’ book represents a large source of funding capable of readily being converted into cash.
I recommend all companies in the business of offering credit to be extra vigilant in their selection of new credit customers, to manage existing customers extra tightly and to ensure their collection day cycles are as short as possible.
A danger lies in businesses trying to drive turnover in these trying times and thereby, allowing the quality of their credit book to deteriorate – perhaps sharply.
If ever there was a time to pick quality debtors, it is now. I further recommend companies that haven’t already insured themselves to look seriously at taking out a credit insurance policy. Surprisingly, this type of insurance is not yet that expensive, given the cycle hasn't fully turned. Cover may become more expensive in the medium term.
Finally, businesses should make sure that all their credit processes are properly in place, their credit data is regularly assessed and monitored properly, for instance, as to whether there is sufficient security. A debtor approved five years ago may be in a much different risk condition today.
While this worsening risk profile is fairly general, it is not entirely across the board.
Some companies have been more creative in managing their debtors’ books.
During the Covid lockdown period, many businesses had become more risk averse and kept cash on their balance sheet to weather potential storms. That has stood them well in the current market.
One surprisingly robust sector is agriculture, which has improved markedly since late 2019, when it was considered high risk.
The mining sector, too, has been buoyant, in both cases driven partially by increased commodity prices and the export-favourable exchange rate for them.
Despite the woes of the construction sector, we have not seen a significant deterioration of debtors’ books in that sector. The sectors mostly suffering are consumer focused. Other sectors are beginning to lag, particularly retail, clothing, luxury goods, and while new vehicle sales have held up so far, we think they will probably be affected in the not too distant future.
Fundamentals can rapidly alter: a drought or fall in the commodity process would rapidly affect those sectors currently looking robust. There’s lots of potential for a quick change in either direction. If Putin were voted out or the Ukraine war stopped, many problematic issues could vanish.
Frank Knight is the CEO of Debtsource.
BUSINESS REPORT