Pre-export finance activity is soaring in Brazil on the back of crop prices and liquidity, writes Luis Waldmann.

Pre-crop financing is back on the rise in Brazil. Rallying commodities are breathing new life into farmers, who were hit hard by two years of low soybean prices and a sickly US dollar.

The dollar may still be reeling, but soy has returned to the good levels seen in 2004 due mainly to the US planting less of the oilseed in favour of corn, the crop used for ethanol in America.

“High commodity prices are driving the ongoing surge in pre-crop financing in Brazil,” says Ed Hogan, managing director and head of structured trade finance in the Americas, at Standard Chartered Bank in New York.

Similarly, Standard Bank’s soft commodities portfolio is at an all-time high in Brazil, claims Alexandre Toscano, trade finance director at Standard Bank in So Paulo. An improving credit rating, as evidenced by four upgrades from Moody’s since 2002, is helping lure money into Brazil.

As a result, mounting liquidity is sending bank margins to record lows. But for borrowers, this does not equal cheap financing as Libor, the reference rate for trade finance, has climbed to 5.5% from 4% four years ago, claims Hugo Braga, chief financial officer at Sementes Selecta, a Brazilian soybean trading company.

“Growing liquidity has dented bank margins, but the final cost to us has remained unchanged,” Braga complains.

As for guarantees, rural securities known as CPRs, or cédulas de produto rural, remain the collateral of choice backing pre-crop credit, says Hogan, who adds that mortgages on farms is “a structure that is becoming more prevalent in Brazil”.

A primary risk when lending to Brazilian commodity producers is still performance, or the ability of the borrower to produce and export as defined in loan agreements. However, banks are more willing to take such risk than they were three years ago, when trading companies bore it entirely, he notes.

Other perennial risks include commodity price volatility and rising cost of production, which is being heightened by Brazil’s soaring currency rendering local costs more expensive. For short-term transactions, the likelihood of harsh currency movements is lower than commodity price volatility, Hogan ponders.

Local sense

Martin Schmitz, executive vice-president of structured and commodity finance at WestLB in So Paulo, notes an increase in local funding for sugar, ethanol and cotton via local structures like CDCA (agribusiness credit rights certificates) or FDIC, the Brazilian equivalent of a bankruptcy-remote funding vehicle. These make sense in Brazil as producers sell roughly half of their output domestically to top-rated domestic buyers mostly, Schmitz says. WestLB is also active in project financings for new sugar, ethanol and biodiesel plants.

“The agribusiness environment in Brazil changed significantly over the past years, and we want to use our good contacts to diversify into other than export prepayment transactions, for which we see an increasing demand by our customers,” Schmitz remarks.

And Standard Bank’s Toscano reveals that the bank plans to offer warrant-supported inventory financing in the South American country in 2008. In all, Standard finances export flows, production cycles, fertilisers and capital expenditures of mid-sized producers, to whom three to five-year funds are extended. Borrowers include producers of soy, corn, cotton, sugar, tobacco and other soft commodities.

For WestLB, soy, sugar and ethanol are the main soft commodities in Brazil. The Dusseldorf-based lender expects Brazilian agribusiness exports to fetch US$57bn in 2008.

WestLB’s pre-export finance can reach up to three years for leading soybean producing clients and up to seven years for top sugar mills, provided that adequate collaterals such as a mortgage on the borrower’s sugar mill is in place. Sugar fell more than 40% since it reached a record US$497 per tonne in May 2006 in London.

Top cotton farmers are given revolving structures made up of three consecutive one-year loans. As a matter of course, tenors ‘very much’s depend on the creditworthiness of clients and the risk-mitigating structure of each transaction, Schmitz remarks.

Basic guarantees are the CPRs and/or harvest pledges, Schmitz comments. He adds that monitoring by collateral management firms is a must in all structured transactions, while another alternative is insurance products like performance bonds in the case of smaller borrowers.

Schmitz notes that derivatives such as non-deliverable forwards are added to most pre-export transactions in a bid to mitigate interest and foreign exchange rate risks.

Yet, most farmers still do not have access to exchange rate hedging, complains Braga at trading company Selecta. Whereas most of their assets are in dollars, Banco do Brasil pre-export facilities, for example, are in reais, he comments.

“[Hedging to farmers] is something I have discussed a lot with banks,” Braga says, adding that Selecta-conceded financing in dollars is often the only form of protection to them.

Selecta backs farmers with dollar-denominated loans or by financing seeds, and gets paid back in soybeans seven months later on average. Farmers use these loans to buy fertilisers, chemicals and other inputs. As a guarantee, Selecta obtains soybean-backed CPRs, mortgages or other instruments depending on the borrower. Selecta’s lending portfolio peaked in 2004, the year when “the most credit was offered to producers,” Braga notes.

Active banks

The most active banks in pre-export financing are Banco do Brasil, Rabobank, Ita and Bradesco, says Laurence Gomes, chief financial officer of SLC Agr­cola, a cotton, soy and corn producer that raised R490mn (US$270mn) in a June IPO in So Paulo.

In fact, pre-export lending in dollars fits very well into SLC Agrí­cola, whose revenues are entirely dollar-denominated, Gomes notes. Regarding expenses, he says fertiliser costs have climbed 30% in just one year. The most common hedging instruments for SLC are futures contracts, forwards, or often signing future purchase agreements with Cargill. Cotton equates to half of SLC’s revenue.

For Selecta, pre-export credit comes from ING, WestLB, Rabobank, Fortis and other banks, Braga says.

“Some of these [international] banks have very small offices in Sao Paulo, but know more of Brazilian agriculture than many Brazilian banks,” says Braga.

Selecta relies on pre-export loans since 2000, and banks have been offering up to five-year tenors since 2006, a record for Selecta, Braga says. The company gives CPRs or warrants as guarantees for loans, according to Braga.

Liquidity signs

The clearest sign of high liquidity in the market comes from the tenors banks are offering. Top tier traders and processors and non-agricultural players can ‘easily’s access five to seven-year loans, while smaller farmers obtain one to three years financing, says Hogan at Standard Chartered.

“The better credits are getting longer tenors than anyone would have dreamt of,” Hogan remarks. “Five years ago I don’t think you saw many institutions providing pre-crop financing for the farmers to the extent that they are today.”

Meanwhile, the foremost hazard brought by stretched tenors is the possibility of borrowers failing to maintain their production costs checked, “because over time you become more susceptible to increases in costs,” he says.

Hogan remarks: “Despite the fact that there is a lot of liquidity in the market and many alternative sources of financing, the structured trade finance market is still a core financing technique for companies across the credit spectrum.”

In summary, an improvement in Brazilian credit risk, increasing global demand for commodities and record liquidity in the market are allowing medium-sized companies to lengthen debt tenors, says Toscano at Standard Bank. But stretched terms obviously come with beefed up mitigants that include mortgages on properties and farms, pledges over inventories, stock monitoring, CPRs, offtake agreements and warrants.

Toscano highlights a deal closed last September in which Standard Bank lent US$9mn due in 13 months to a cotton growers’s cooperative. The proceeds are being used to buy fertilisers and chemicals. Standard obtained CPRs as guarantee, picked the offtakers and added a collateral management firm to the transaction.

Another deal that took place in September involved Brazilian soy meal and soy oil exporter Granol. Standard Bank led a nine-bank syndication that extended Granol a US$60mn credit due in two years. The transaction has five offtakers that are based in OECD member countries.

Sweepstakes for credit

Brazilian agricultural producers seeking financing first apply for government support, says Carlos Aguiar Neto, chief financial officer at BrasilAgro, a start-up that raised R584mn (US$324mn) in a 2006 IPO on So Paulo’s Bovespa stock exchange.

Second, farmers turn to chemicals and fertiliser-selling companies, which concede roughly one-year tenors and demand a pledge on future crops, Neto says. The third source of credit comes from trading companies like Cargill and Bunge, which often provide farmers with fertilisers rather than cash. Trading and fertiliser firms charge between 8% and 12% a year in dollars, he says, while lenders like Banco do Brasil are the last resort, according to Neto.

“Trading and chemicals companies are like small banks, and their margins are sometimes higher from financing than from trading commodities,” Neto says. BrasilAgro will produce primarily soybeans, corn and sorghum, and has projects in soy, corn, cotton, sugarcane, forestry and cattle. The company also aims at buying soybean-ready farms, for example, and make them produce sugarcane instead. Such a conversion can double a crop’s yield in five years, Neto says.

BrasilAgro sells dollar futures through the local futures exchange BMF, and by way of non-deliverable forwards (NDFs) dealt with Standard Bank, Bradesco, Ita, Unibanco, Santander, ABN and other institutions, according to Neto. NDFs can be as long as five years, he says. Soybean futures are also sold on the Chicago Board of Trade depending on BrasilAgro’s hedging policy.

Mid-size target

Vision Brazil Investment, a firm specialising in structured finance and investment management, has been financing Brazilian agribusiness since 2005. Vision’s niche segment is the medium-size producer of such commodities as coffee, sugar and ethanol.

Vision targets medium-size producers because that is “where the state bank [Banco do Brasil] doesn’t have the same level of penetration or interest in terms of financing in the amount that is necessary,” says Amaury Fonseca Junior, a founding partner of Vision, adding that his firm cannot compete with Banco do Brasil in the financing of small producers.

The company takes 30% over-collateralisation on average from borrowers, meaning that “a great deal of our work is to make sure collateral is monitored and controlled,” he says. Firms including SGS and Control Union are in charge of monitoring crops, he says.

The So Paulo-based firm lends based on commodities, as opposed to a specific currency or rate. If the borrower produces cattle, Vision lends in tonnage of cattle, Junior explains. Average tenor ranges between 1.2 and 1.5 years, while the longest can be about three years.

“Basically our yield is a function of the commodity risk,” notes Junior.

Sugar, which can also be a proxy for ethanol, is hedged on the New York Board of Trade (NYBOT), and grains are hedged on the Chicago Board of Trade. Vision finances until the commodity is delivered to the offtaker, who is in charge of exporting.

“My role is to make sure [an offtaker like] Cargill takes delivery,” he says. Leading problems impeding Brazilian exports from growing further is ‘definitely’s excessive taxation levied on Brazilian producers, he comments.

Junior predicts sugar and ethanol prices will continue to be volatile in 2008 due to excess sugar coming from India. He is neutral on cotton and bullish on grains owing to high energy prices spurring demand for biofuels.

Vision has about half of its investment portfolio in the agricultural sector, 30% in distressed debt trade, and the remainder split among real estate, consumer credit and small special situations, which he did not elaborate on.

Overall, it seems that trade finance in Latin America’s largest economy is slated to hit new records in 2008. Soy, which accounts for a large chunk of Brazilian exports, is a bellwether for trade finance in the country. And strong economic growth worldwide is nothing short of a tonic for the price of the oilseed, a major raw material for animal feed and cooking oil.