The volume of trade business in South Africa has diminished since the onset of the crisis. But opportunities are emerging for banks to provide structured trade finance, inventory finance and working capital solutions. Shannon Manders reports.
The local trade outlook is extremely challenging,” says Lizanne Case, trade economist at First National Bank (FNB) in Johannesburg. “South Africa can expect exports to contract even further in the next two quarters of 2009. Imports too are set to moderate, contained by domestic demand.” Exports for the first six months of the year are 17% lower than the same period last year, while imports are down 20.8%.
The number of players in the commodity finance market – the country’s key sector – has diminished over the last few years. There have not been many new players for quite some time, and some foreign banks have withdrawn their services from the market. More recently, in October last year, HSH Nordbank announced that it was discontinuing its commodity finance activity worldwide.
Although trade volumes have dropped, the decline in agricultural commodities has not been that significant, says Gregory Havermahl, fixed income, currency and commodities at Rand Merchant Bank (RMB) in Johannesburg. Havermahl notes that the consumption of maize and sugar, for example, has not dropped considerably – specifically in terms of deals that take place in Africa.
However, a significant drop has been recorded on metal exports, particularly in items such as copper and cobalt, says Havermahl. But, he goes on to explain that more recently, as prices have started to recover off their previous lows, the quantities have started to increase. “It is as if the miners are now trying to produce as much as possible because they are selling it at a lower price, so for some producers you are actually seeing an increase in volume to make up for the lower prices.”
As signs of an upturn emerge, it is becoming increasingly evident that there are now opportunities for banks to provide much-needed finance in the form of structured trade finance.
Diminished global demand has taken a severe toll on the South African economy, though this is not the only factor that hinders exports from the country. Case at FNB identifies competitiveness as a major aspect. She explains that one of the legacies of the country’s past political dispensation and the previously closed nature of its economy, is that South African producers were shielded from global competition protected by domestic demand.
“When the economy opened up to the rest of the world, the inefficiencies within many of our industries were exposed and the drawbacks of protectionism are still resonating in our economy today,” Case says. She notes that while great strides have been made, these drawbacks “have manifested themselves in several industries that are uncompetitive, inefficient, lack capital, technology and innovation, are haemorrhaging jobs and grappling to survive in a climate of increased global pressure from cheaper (predominantly Asian) imports”. She mentions the clothing and textiles sector as an example.
While the effects of the crisis have been broad based across all sectors, it has been most pronounced on the production side of the economy – namely the mining and manufacturing sectors. Case relates this to the fact that the country is still a commodity-based economy with commodities comprising approximately 60% of its exports. “The multi-sectoral strikes prevalent in recent times are also indicative of the widespread nature of the problem,” Case adds.
As a result of the crisis, the majority of South African banks – both local and foreign – have reported a dramatic decline in transaction volumes.
“We started feeling the pinch towards the end of the fourth quarter last year,” says Neville Hanekom, head strategy and solutions at FNB in Johannesburg.
In many instances, commodity prices have halved, or declined way beyond 50%, says André Strydom, head of structured trade and commodity finance at Absa in Johannesburg.
“The maize price is nearly half of what it was last year. We’re big grain financiers, so that’s affected our business. Our deal pipeline in Rand value has declined dramatically as a result,” Strydom says.
This sentiment is echoed by Hasan Khan, managing director of Standard Chartered’s transaction banking business in Africa, based in Johannesburg. “We have seen a reduction in the value of trade transactions. The number of transactions remains somewhat consistent on a month-to month basis, but transaction values have been affected with the fall in commodity prices.”
Different types of financing
As South African companies struggle to cope with the economic downturn and there is a reduction in their financial activities, banks will need to take up the slack by finding different types of financing to offer their clients.
“Much focus is now on maintenance and retaining what you’ve got,” says FNB’s Hanekom. “This is in addition to finding alternative solutions on how one would facilitate and support the customer in terms of the pressures they are facing on the working capital side.”
Although inventory levels have been high since the crisis began, activity in the last few months has resulted in what one banker terms “inventory right-sizing”. Craig Polkinghorne, global head of structured trade and commodity finance at Standard Bank in Johannesburg, explains that the first impact in the drop in demand was so steep that many companies were caught with huge inventories. Now, companies have used up those inventories and are starting to order again – because even at lower demand levels, inventory is essential for a trading pipeline.
“We have been speaking to our client base about solutions that are relevant to the region and industry in which they operate, as well as appropriate to the current credit environment in which we find ourselves,” says Polkinghorne.
The demand for working capital solutions appears to be widespread. “There’s a greater need for debtor discounting and invoice discounting opportunities, so people are in fact putting up assets as a security, where traditionally they hadn’t been,” says Absa’s Strydom. “Previously we would probably have funded on an unsecured basis, but nowadays, more of our funding is on a secured basis, which lends itself to the structured trade and commodity finance (STCF) space.”
The bank is also concentrating on inventory financing in South Africa, and is trying to apply a little more ‘science’ in getting the right loan:asset ratios. Though they admit that the volatility in the marketplace is making it particularly difficult. “Inventory financing offers a lot of opportunity,” says Nigel Cole, STCF specialist – Africa at Absa. “We are developing appropriate valuation and monitoring tools to fund against the security of inventory.”
Another local bank is also experiencing such a trend. RMB’s Havermahl, explains that as a result of the credit crunch, a number of large multinational organisations with strong balance sheets who are present in several countries in Sub-Saharan Africa are finding it more difficult to raise medium-to-long-term funding. As such, they are becoming more partial to the bank’s SCF product.
“In the past they funded their working capital from balance sheet, but they are now preferring to use SCF to fund their working capital, and using what balance sheet they have for their capital projects,” says Havermahl.
Despite this tendency, there is a recurring concern felt amongst local bankers that there is a general lack of awareness of trade finance products in the South African market. More specifically, many believe that customers do not specifically look to carve out the trade and commodity finance component of their financing. “Many people finance their working capital, which includes a trade component, through overdrafts or short-term finance. While it might seem blurred there are advantages for recognising the trade elements that make up working capital. Trade debtors might be structured in a funding solution that is advantageous to general short term finance,” explains Polkinghorne at Standard Bank.
Pricing for risk
Many financial institutions have adopted a more risk averse approach in lending. To illustrate this, the trend away from documentary trade to more open account financing appears to be reversing.
Approximately twelve months ago, there was a clear tendency of moving away from documentary trade to more open account financing. But this seems to be slowing down, says Standard Chartered’s Khan. “Clients are adopting a more risk averse strategy given the current market conditions, and therefore demand for letters of credit and guarantees is increasing.”
Standard Bank’s Polkinghorne agrees: “We’re seeing a move back to more traditional trade products, such as letters of credit, and the next step in that will be structured trade products.”
There have also been challenges with the risk averseness within credit committees, says Sekete Mokgehle, global head: structured trade and commodity finance at Nedbank in Johannesburg. “Of course, we have to report breaches in covenants where clients do not move stock over a particular period as they had agreed to. And it’s difficult to bring to credit the next deal if one deal in the same jurisdiction is struggling. That risk averseness permeates throughout most banks – including us.”
The new risk element that the world is facing is evident in the pricing attached to deals in the market.
In the last nine to 12 months, prices have been driven steeply upwards. But Standard Chartered’s Khan says that they are more likely to plateau for a period, before dropping again.
“Has it been the same for all the banks, or within a bank, the same for all the clients? No. Every bank will price based on the underlying risk of the transaction, and take into account factors such as the availability of funds and industry performance,” says Khan.
“The shift to more traditional forms of trade finance presents us with the opportunity to provide more innovative mechanisms in risk mitigation, for example, receivable services,” Kahn adds. “Standard Chartered has the capacity and expertise to offer a range trade finance products which minimise risk for our customers whilst maximising business potential.”
RMB’s Havermahl believes that the banks have only just reached a point where pricing and risk are being matched accordingly. According to Havermahl, banks had been under-pricing risk, and as a result, spreads were becoming thinner and thinner. “Now I think we are correctly pricing risk and spreads have widened,” he says. “I think we are reaching the bottom of that swing.” Nevertheless, Havermahl confirms that since the start of the crisis, in some instances, risk has in fact been overpriced. “But that’s human nature – it’ll get drawn back as more liquidity enters the market and competition intensifies.”
In many cases, tenors are still short-to-medium term (between 60-270 days). And the general consensus is that anyone looking to do a longer term finance or project will in all probability defer it for the next three to six months until they are clear on where things are heading.
“We’ve seen prices in Sub-Saharan Africa shooting well above 3%, whereas a year ago, we were happy with 150-250 basis points,” says Nedbank’s Mokgehle.
Ato Gyasi, infrastructure financing, at RMB believes that tenors are still a problem in that the foreign currency market is reluctant to lend out more than three to five years. “Even though the signs are positive, I don’t know when that’s going to turn around – it may take a while to get to where they were 18 months ago,” he says.
Deals in the pipeline
Challenges aside, the majority of banks in South Africa are looking to broaden their business and take on more deals.
According to Mokgehle, Nedbank is considering participation in the annual Sonangol deal. As GTR goes to press, the general syndication for the facility is still in the market.
A source close to the deal says that commitments for the Angolan state oil producer’s US$1bn amortising financing facility are still trickling in, and the deal is likely to close at the end of August, or the beginning of September.
The deal is being underwritten by Calyon, and three banks have already pledged their commitments in the senior phase of syndication – Banco Espírito Santo, BNP Paribas and Société Générale. According to GTR’s source, a number of other banks are also looking into participating in the syndication in the general phase of syndication.
Commenting on the deal’s 40-month amortising tenor, Mokgehle says that there is the issue of “getting pricing for that tenor to match that which the client can live with”.
According to GTR’s source, the facility pays a margin of 300 basis points over Libor.
Craig Polkinghorne at Standard Bank confirms that the bank will once again be participating in the annual Ghana Cocoa Board (Cocobod) pre-export financing deal, which is set to be massively oversubscribed. Polkinghorne verifies that the pricing is “an improvement on last year and reflects current market conditions”.
While Standard Bank has been a participant in this transaction for a number of years, this is the first time that it has introduced Industrial and Commercial Bank of China (ICBC) – one of the bank’s shareholders – into the deal. Commenting on the partnership, Polkinghorne notes that where there are trade links to China, the more likely the Chinese banks will be to participate in African transactions.
Nedbank has also committed to the Cocobod syndication, and Mokgehle says that the bank has increased its US$50mn commitment from last year to US$75mn. Mokgehle notes that the deal’s pricing margin and fees are indicative of the fact that “the world has changed”.
Although the year has been tough, South African bankers remain optimistic, and are looking to broaden their horizons in the field.
Absa’s structured trade and commodity finance division has earmarked the grains market as one area where they intend to grow their book quite substantially. “The idea is that we essentially get back to where we were four or five years ago,” says André Strydom, adding that this used to be a niche market for the bank. On the mining side, the bank has a couple of export finance transactions of large amounts out of Sub-Saharan countries on the east coast of Africa. This is an area where Absa has a presence, and as a result, this is where their focus lies.
Nedbank too is looking to grow its expertise – particularly in metals and minerals projects. “This is where we want to play, and we want to play big time,” says Mokgehle.
He adds that the bank is keen to take advantage of the gap left by foreign banks who have been forced to pull out of Sub-Saharan jurisdictions, most likely to concentrate on the markets on their own doorsteps “We found a lot of clients who are suddenly sitting with lines that were given by banks who have since left the market. Importers and exporters still need those lines, and we’ve had a lot of people knocking on our doors.”
The role of ECAs
South African financial institutions have traditionally not made much use of international export credit agencies (ECAs). This is, however, starting to change as banks see the value of a risk-mitigating partner, and as ECAs – such as Sace – show a growing interest in providing coverage for local currency funding.
The Export Credit Insurance Corporation (ECIC) is South Africa’s state-owned national export credit agency (ECA). The agency was established in 2001 to provide export credit insurance and political risk insurance for outward investments from South Africa.
In global terms, the ECIC is still a relatively small ECA. Therefore, very large high value projects may put a heavy strain on their balance sheet capacity and increase their concentration risk. As such, according to the ECIC’s 2008 annual report, the agency welcomes the re-entry by leading international ECAs into the African market. “Not only will the participation of these ECAs increase the funding capacity for projects, but they will also bring with them a wealth of experience built up over decades,” the report says.
The international ECAs, such as Sace, which established an office in Johannesburg last year, are becoming much more aggressive in terms of marketing their products, say a number of local trade finance bankers. The European ECAs are especially active on infrastructure-related project support.
“They have recognised that there is a gap – particularly for long-term funding,” says Ato Gyasi, infrastructure financing, at RMB. “If you’re looking for three to five year money, you can find it. It is more expensive than it used to be, but you can find it. The ECAs primarily bring tenor. Suddenly, in a constrained environment, 10-year money becomes available, which is very important for infrastructure projects.”
The ECAs are also offering more flexible terms, says RMB’s Gregory Havermahl, who notes that Sace, for example, is becoming a lot more accommodating in the currency that they use.
According to Yusuf Khan, head of structured trade finance for Sub-Saharan Africa at Citi in Johannesburg, the Chinese ECAs (China Exim and China Development Bank) continue to be active in the region, and are aggressively supporting their exporters on the telecom and power sectors.
Though ECAs are becoming increasingly important in the wake of escalating project values, many bankers claim that the role of the ECAs is not yet properly understood. “The problem is that a lot of people don’t understand the ECAs, and don’t know how to access their funding,” says RMB’s Gyasi. “So the ECAs are going to have to do a lot of educating and marketing to get people to take up the product. But there is definitely a role for them to play in this market.”
Current users of ECAs in South Africa include state transport utility Transnet and power utility Eskom. Transnet secured an approximate R915mn financing facility with the Finnish ECA Finnvera, for the procurement of equipment for the ports of Durban, Ngqura and Cape Town as part of its five-year R80bn capital expenditure programme.
South Africa’s trade account
The impact of the global economic downturn is evident in the country’s trade figures, with both exports and imports running well below those recorded for 2008.
But in June, the country’s trade account stayed in surplus for a second consecutive month. According to the South Africa Revenue Service (SARS), the trade surplus widened to R3.22bn (US$404.7mn) in June from R2bn the month before – the first surplus recorded in two-and-a-half years.
In a statement released in July, SARS said that exports in June rose by 3.82% compared with the previous month to R43bn, partly due to a 12% increase in exports of precious metals and stones. Imports were up 0.96% at R39.8bn.
According to FNB’s trade economist Lizanne Case, the recent trade surplus is indicative of a diminished demand for imported goods, while exports have somewhat continued to maintain their presence on international markets.
“Monthly trade data is notoriously volatile, and the overall trend emerging appears to indicate a considerably anaemic global trade system,” Case says, adding that South Africa’s surplus is unsustainable given global conditions.