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MaxLimit: A Dynamic Tool for Managing Exposures

In everyday business, defining the appropriate credit limits for customers plays an important role in helping a supplier maintain short-term liquidity, optimize growth opportunities, and manage the risk of non-payment. There are no universal, or generally accepted, approaches for setting business credit limits that capture the risk factors on both sides of the exposure, i.e., supplier and customer. Approaches based on a customer’s financial information are often unfeasible for small and private companies due to the limited availability of information. These approaches also typically lack responsiveness in terms of the macro-environment and, in most cases, do not explicitly consider the supplier’s risk appetite.

At S&P Global Market Intelligence, we acknowledge these problems and the requirement for a pragmatic and flexible solution. Therefore, we developed the MaxLimit framework for assessing the total maximum exposure based on both the customer’s and supplier’s information. The recommended exposure limit refers to the total amount of all exposures towards a customer (i.e., the total of all payment receivables, invoices, bills, and other trade credit lines).

Customer Information

Industry payment behavior: Assesses the payment behavior of the industry the customer belongs to and, specifically, the regularity of paying back outstanding exposures in due time, as agreed contractually, with respect to all other industries. Industries characterized by longer payment delays penalize a customer’s exposure limit.

Credit risk: Assesses the creditworthiness of the customer. Customers with better creditworthiness will have higher exposure limits.

Business size: Scales the exposure limit as a customer’s revenues increases.

Supplier Information

Loss capacity (or average exposure): Scales the exposure based on the supplier’s own exposure loss experience or maximum loss they can tolerate from the exposure losses. However, instead of loss capacity, the supplier can also opt to scale the exposure based on its average exposure within its portfolio of exposures.

Risk aversion: Readjusts the uncertainty of the risk exposure based on the supplier’s judgement of additional systematic risk factors.

Exposure Cap: Imposes an exposure cap with respect to the customer’s revenues.

MaxLimit in Practice

The framework is globally applicable for public and private companies, even in the case of missing financials. Few inputs are required, as the customer’s risk dimensions are automatically sourced from the S&P Capital IQ platform database, and the supplier’s risk dimensions are pre-filled with default values or are available for calibration through the selection of the desired risk appetite.

The visualization of the framework (its inputs and outputs) are contained within the S&P Global RiskGauge Report, available via Credit Analytics. For illustrative purposes, the subject company selected is an industrial conglomerate (industry classification) that is characterized by heterogenic supply chain operations, and one in which its creditworthiness (calculated through Credit Analytics’ statistical credit risk models) is above its industry's median. Figure 1 shows the visualization of MaxLimit within the RiskGauge Report, which provides detailed credit risk views of businesses and investments, for 3M Company (3M). The Average Loss was selected at $10,000 USD, Risk Aversion at Neutral, and Exposure Cap at 10% of the customer’s revenues. The MaxLimit shows a maximum exposure limit of approximately 49.92 Million USD. This is the total maximum exposure estimated for all invoices of a supplier towards 3M.

Figure 1: MaxLimit visualization within the S&P Global RiskGauge Report for 3M Company.

Source: S&P Global Market Intelligence, data as of June 2020. For illustrative purposes only.

Within the S&P Global RiskGauge Reports, the settings can be toggled and the MaxLimit drivers can be calibrated to the user’s portfolio size and risk appetite, as shown in Figure 2.

Figure 2: Setting MaxLimit within the S&P Global RiskGauge Report

Source: S&P Global Market Intelligence, data as of June 2020. For illustrative purposes only.

As shown in Figure 2, the options within the setting command of the S&P Global RiskGauge Report enable the user to:

  1. 1) Define the supplier’s loss capacity from exposure losses, or the average exposure amount of the supplier’s portfolio of exposures. The framework enables the user to manage their risk appetite through two approaches: define the maximum loss capacity that, on average, the user can withstand from the portfolio of exposures, or align the average exposure based on its production/sale capability. Table 1 below shows the MaxLimit value behavior under different values of Average Loss and Average Exposure.

Table 1: MaxLimit exposure values for different Average Loss and Average Exposure, for 3M Company.

Source: S&P Global Market Intelligence, data as of June 2020. For illustrative purposes only.

  1. 2) Define the user’s Risk Aversion level, which is used to embed different levels of uncertainty into the assessment of the exposure loss. This is set at Neutral by default, but can be changed to one of the following values: Very High, High, Low, or Very Low. For example, when a user assesses two customers with identical risk dimensions (i.e., industry payment behavior, expected credit risk, and revenue size) they can assign a lower Risk Aversion to the customer where they see lower uncertainty (i.e., the user either knows the customer well, or the customer operates in a more stable environment). These levels of Risk Aversion are not measured in absolute terms, but are assessed on a relative basis across the user’s portfolio.

Table 2: MaxLimit values for different Risk Aversion levels.

Source: S&P Global Market Intelligence, data as of June 2020. For illustrative purposes only.

  1. 3) Define the source of credit risk information by selecting either the counterparty’s S&P Global Ratings issuer credit rating or one of S&P Global Market Intelligence Credit Analytics models that generate credit scores.[1]

Figure 3: Setting options within the RiskGauge Report to select the scoring model for credit risk.

Source: S&P Global Market Intelligence, data as of June 2020. For illustrative purposes only.

  1. 4) Define the percentage of the customer’s revenues to be used as the exposure cap.

Figure 4: Exposure capped at 0.10% of the counterparty’s revenue given an Average Loss of 1 Million USD under Very Low Risk Aversion.

Source: S&P Global Market Intelligence, data as of June 2020. For illustrative purposes only.

In summary, MaxLimit offers an innovative and transparent solution for practitioners that need a fast and efficient assessment for trade exposures within treasury, supply chain management, or towards other trade counterparties. The MaxLimit framework embeds different information that considers both sides of the exposure: supplier and customer. The output accounts for the customer’s creditworthiness, the dynamic assessment of their industry payment behavior, and additional size adjustments. Moreover, MaxLimit enables the user to readjust the calculation based on a supplier’s risk appetite, creating a tailor-made tool that adapts to different situations and business needs. Its functional structure facilitates managing single or multiple exposures, and its assumptions support applicability to a vast coverage of both private and public companies.

For more information on the MaxLimit framework and other Credit Analytics offerings, please visit our site.



[1] S&P Global Ratings does not contribute to or participate in the creation of credit scores generated by S&P Global Market Intelligence.

 

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