How to conquer Chile
Chilean trade finance can offer both rewarding and challenging opportunities, writes Luis Waldmann.
Commonly regarded as quite a challenge for trade financiers in Latin America, Chile definitely still offers opportunities. Quickly-expanding sectors such as paper and pulp and agriculture are demanding more and more support. Export credit insurance and factoring, for example, are evolving fast.
However, the country’s cash-drenched copper industry needs limited trade financing. Chile is the world’s top copper-producing country and saw exports triple in four years to US$60bn in 2006. Another obstacle remains Chile’s investment-grade rating, which combined with strong global liquidity can make for stifling competition for deals. Energy limitation is a hindrance to projects as Argentina, formerly the supplier to most of Chile’s natural gas, has itself been struggling with an on and off energy crisis.
Overall, the liberal economic policies and tidy macroeconomics pursued by the administration of President Michelle Bachelet, inaugurated in March 2006, provides international banks eyeing Chilean transactions with due confidence. According to Standard and Poor’s , Chile’s foreign currency rating is A, the same as Bahrain in the Middle East.
Insurance booming
Export credit insurance has evolved substantially in Chile in the last few years and now wields tough competition against traditional bank products. The region’s unstable economies including those of Venezuela, Ecuador and Bolivia are helping drive interest for the insurance product.
“Export insurance has seen its importance soar here in Chile,” says Alessandro Scarito, trade finance manager at BBVA Chile. Likewise, factoring is another alternative for firms selling to risky countries, he says.
On exports to Asia, however, documentary credit has an edge over export credit insurance, especially in the salmon sector, Louis des Cars, manager at Coface Chile, cites as an example.
“Exporters want export credit insurance over Latin America because they consider it a risky continent,” Des Cars says. The policies are also used to cover exports toward the US, Europe and even Asia when they are on open account, he says.
The riskiest country in Latin America is “without any doubt” Bolivia, Des Cars says, adding that it is followed by Ecuador and Venezuela. ECI policies have 180-day tenors on average and the longest period for the domestic market is up to one year, he says.
International factoring is not very developed in Chile, making the product all the more interesting, Des Cars says. Export-oriented industries in Chile covered by Coface are food, wine, salmon, other fish, wood and commodities, says Des Cars. Copper exports don’t count as those are backed by futures contracts, he explains.
Coface sells political risk, domestic and export credit insurance in the Andean country. Moreover, it offers domestic and international factoring, business information and debt collection.
To Lin Franklin, president of US-headquartered insurer FCIA, buyers of credit insurance in Chile aren’t different from those in other well-rated countries, who will be primarily looking to mitigate commercial and not political risks. FCIA’s exposure in Chile is composed mainly of short-term supplier credits averaging 60-to-90-day terms for imports of various products and one ‘relatively’s large five-year trade finance exposure, says Franklin.
The primary risks for US companies exporting to Chile are commercial in nature, ie, the ability of the obligor to generate the cashflows necessary to repay its obligations in a prompt manner, he says. While FCIA’s pure credit risk portfolio in Chile may be somewhat weaker than in higher risk countries, the overall portfolio risk including the country risks is probably better, Franklin comments.
The credit insurer’s underwriting approach for Chilean risks is very different from those in Venezuela, Ecuador or Bolivia, Franklin explains. The stable political situation and the well-managed economy allow FCIA to consider going a bit downmarket with respect to the credit fundamentals of the obligor risks.
On the other hand, in Venezuela, Ecuador and Bolivia, FCIA views the probability of a political and/or economic crisis as relatively high and therefore only certain highly-creditworthy obligors in specific low-risk sectors are seen as acceptable, Franklin concludes.
Banks and exporters in North America selling to Chile approach insurance company Zurich when their limits to Chilean customers reach their ceilings, says Dan Riordan, executive vice-president and managing director at Zurich.
The insurer sees demand too for trade credit insurance in Chile, adds Riordan, with inquiries coming from the mining industry. Trade credit insurance can bear as much as US$35mn per policy and terms are between one and seven years.
Waning margins
High liquidity worldwide and Chile’s risk grade have led to squeezing margins as more banks and investors feel encouraged to target the country. As a matter of course, lower tiers have started to be aimed at.
Pre-export financing costs Chilean company Codelco, the largest copper producer in the world, between 5-10 basis points over Libor, while one year ago it was closer to 15-20bp, says José Antonio Alvarez, Codelco’s chief financial officer.
“The investment-grade rating has made spreads very competitive,” Scarito says. BBVA caters to mining, forestry and pulp, fish farming, wine and agriculture industries. Export financing is mostly conceded with 180-day tenors and import financing is done not only through letters of credit, but also with structured transactions for longer-term imports of machinery and capital goods, he says.
According to Scarito, the Chilean top-tier segment one year ago could borrow 180-day loans at 50bp over Libor, whereas today it’s Libor + 20bp. BBVA exposure to trade has increased 25% in early 2007 compared with the same period in 2006.
To Luis Saenz, head of metals and mining for the Americas at Standard Bank, financial institutions headquartered in Chile “are very, very liquid and competitive on their rates”. He adds that many “don’t mind lending with very weak covenants”.
International banks are only able to compete if they are willing to go for very long tenors “because that’s what Chilean banks don’t do,” says Saenz. Chilean banks don’t lend beyond five years, he says.
Top-tier customers are attracting international lenders not only to Chile, but also Peru, Brazil, Argentina and Mexico, says Saenz. Second-tier companies, including lesser-known family-owned businesses, are being eyed too. The only inconvenience is that “it takes a little longer to structure and execute a transaction because it may be the first time the borrower is doing this type of deal,” says Saenz.
Regarding lower tiers, Saenz says: “You just go to the next level which hasn’t hit the radars of the big banks yet. I don’t think it’s necessarily that much riskier, it’s just a different kind of customer that you can be going into.”
Saenz continues: “Probably in Chile you’re not going to pay as much attention to making the structure bullet proof as you would in Bolivia, Ecuador and Venezuela.
ECA absence
Big corporate names in Latin America are less dependent on multilateral and governmental support, especially in investment-grade countries like Chile, says Frédéric Genet, global head of export finance at Société Générale Corporate and Investment Banking (SG CIB).
The trend is no different for Codelco, which last resorted to agency support about 20 years ago. Although export credit agencies played a very important role in the 1980s, other financing alternatives have become more important to the company, says Alvarez.
Presently, the best ways to raise resources are through capital and bank markets, especially long-term bond sales, he adds. The most supportive Chilean banks to Codelco are Banco de Chile, Santander and Banco de Crédito e Inversiones, while JPMorgan Chase, Citigroup, HSBC and Deutsche Bank are the leading international institutions, Alvarez mentions. Codelco has US$12.7bn in assets.
BNDES, the Brazilian state-owned development bank, is not competitive enough to back Brazilian exports to Chile, claims Nestor de Castro Neto, president of Voith Paper in Brazil, a manufacturer of paper-making machinery whose headquarters are in Germany.
To support transactions in Latin American countries, BNDES demands that the deals be held through Convenio de Pagos y Créditos RecíÂprocos (CCR), a four-decades-old trade-settling arrangement comprising 11 Latin American countries and the Dominican Republic. Neto adds that a guarantee from CCR-grade banks in Venezuela and Argentina, for example, are difficult for customers to obtain.
“The level of guarantees demanded by BNDES is quite high,” he says. Besides CCR, BNDES accepts guarantees issued by top-tier banks, he adds.
The big Chilean groups end up finding financing by themselves, he says. The main market for Voith Paper’s Brazilian operations is indeed Chile, where the leading customer is paper-making company CMPC. Exports of such machines have two-year tenors, he says.
To most Asian clients, Voith conducts its sales with backing from Euler Hermes in Germany. It takes a week for Hermes to approve – or not – a consultation, he says. The Brazilian subsidiary of Voith Paper had 70% of its revenues coming from non-Brazilian customers in 2006. And 36% of which was exported to Latin American countries.
Brazil’s development bank BNDES disputes Neto’s claim. It can take as little as 15 days for BNDES to lend to a Brazilian exporter, provided the company has already secured a trade contract and a guarantee, says Armando Mariante, vice-president of the Rio de Janeiro-headquartered development bank.
Blame the red tape
For hefty infrastructure-related exports it may be well over one year until BNDES approves the financing, explains Mariante. In such cases, international bidding and red tape are the culprits, he says.
“It doesn’t take longer for projects to go ahead because of BNDES scrutiny, but in general because of bureaucracy of other countries,” Mariante says. BNDES lent a record US$6.4bn to Brazilian exporters in 2006, 9% more than in the previous year. Concerning guarantees, the Brazilian development bank does prefer projects dealt under CCR.
The first two BNDES transactions done with the four-year-old government of Argentine president, Nestor Kirchner, were the TGS and TGN gas pipelines, both carried out through CCR. BNDES financed the projects two months after Argentina asked the Brazilian government for help in 2004, Mariante cites as an example.
This was a record timeframe for a US$237mn infrastructure deal, says Angela Carvalho, head of the South American integration department at BNDES.
The TGS and TGN gas pipeline projects rely on Brazilian-made pipes, iron slabs and engineering services. Other recent projects include telecommunications systems to Bolivia worth US$27mn, the expansion of the Santiago de Chile underground for US$208mn and the Transmilenio project in Colombia entailing US$25.5mn of buses produced in Brazil.
Further examples are Ecuador importing US$242mn of BNDES-backed Brazilian exports for the San Francisco hydro-electric power plant and US$69mn for Embraer planes servicing local airline TAME.
Venezuela’s La Vueltosa hydroelectric electric power plant had US$212mn of Brazilian-manufactured turbines.
Buenos Aires is interested in energy-related projects including gas pipelines, aqueducts, thermal power plants, as well as roads and sanitation, says Mariante.
“South American integration is being carried out by way of infrastructure projects,” Mariante says. Not only do these projects integrate the countries in the future, but also generate employment and income at present, he remarks.
He says Uruguayan president, Tabaré Vazquez, who took office in October 2004, will demand BNDES support for important infrastructure projects, and also Ecuador and Venezuela. However, large projects are slow to mature in Bolivia because the country isn’t too familiar with CCR, he comments.
When a transaction is done under CCR, a risky country such as Argentina, which is rated seven out of seven by the Paris-headquartered OECD, is then upgraded to level one. Consequently, the price of Brazil’s medium and long-term export credit insurance falls 90%.
BNDES also accepts as guarantee export credit insurance provided by FGE, the government-backed export guarantee fund which is supervised by SBCE, a Brazilian insurance company.
The bank is very flexible in terms of repayment tenors, Mariante says. Its policy is to concede up to 12 years, but ‘eventually’ it can go beyond 15, he reveals.
“BNDES is obliged to adequate itself to the reality of a given project,” Mariante says. The role of an ECA is to fuel national exports whose risks are too high for private banks to take on, he defines.
Natural hedge
Swelling dollar inflows have made the Chilean peso surge relative to the US dollar. One dollar sold for 530 pesos in April 2007, from about 740 pesos four years earlier. Although this bears evidence to the country’s strengthening economy, exporters are watchful.
For a Chilean exporter, the appreciation of the local currency has a negative impact on costs as the firm must spend more dollars to pay for peso expenses. Copper producers, however, have a natural protection against this given that the peso strengthening has a strong correlation with soaring copper prices. Whenever copper rises, the Chilean peso tends to follow suit.
One of the fundamental reasons for the peso to rise has been because copper has gone up, Codelco’s Alvarez says, adding that if his costs are higher due to the exchange rate, that is offset by increased copper revenues.
“There is a natural hedge between copper price and currency appreciation,” confirms Alvarez. Chilean exports hit about US$60bn in 2006 from US$18bn in 2002, boosting the current account balance to about US$5bn from a US$580mn deficit in the same four-year period.
Of Codelco’s revenues, 90% is in dollars. By contrast, 100% of its debt is pegged to the US currency, he adds. Provided about half of the company’s costs are in pesos, Codelco has to spend more dollars to face peso-denominated costs when the local currency strengthens. Hedging against copper volatility never exceeds 9% of Codelco’s production, Alvarez says.
As for exports, open account equals 70% of Codelco’s international sales and letters of credit make up 20% of the company’s foreign income. The remaining 10% is done through bank collection.
Roughly 40% of Codelco’s exports are bound to Asia, making the continent the copper miner’s leading offtaker. Europe buys another 30%, Alvarez says. Copper accounts for 80% of Codelco’s exports and the remainder is made up of copper by products including molybdenum.
Copper is exported with 30-day payment tenors in general, which amount roughly to the shipping time between Chile and the European Union or Asia, says Alvarez. Normally, the importer overseas has to present the payment receipt at the port of destination before taking delivery of the cargo, says Alvarez.
As with Venezuela and oil, Chile’s economic growth prospects traditionally depend on the price of copper, the country’s leading export, says Barclays Capital Latin America strategist Michael Hood, in New York.
Barclays Capital expects copper prices to rise thanks to global economic growth and low international interest rates, says Hood. Besides copper, wine, fishing, pulp and paper present good prospects for 2007, he says.
Energy obstacle
Energy is a major obstacle to Chilean growth due to undependable natural gas dispatches from Argentina. For over a decade Chile invested heavily in gas-only infrastructure, hoping to rely on its neighbour’s energy exports.
“The energy subject is Chile’s main challenge,” says Alvarez. Energy, just like water, is a pivotal input for Codelco to move any project forward, he says.
Much of the Chilean energy supply used to be obtained mainly through coal until the 1980s. But Argentina’s faltering shipments have made copper miners evaluate different options such as liquefied natural gas plants or even back to coal, says Alvarez.
Chile still considers importing gas from Bolivia, another gas-rich neighbour, “but for the time being we decided to set up LNG plants to substitute some supply coming from the neighbourhood that are not reliable enough,” Alvarez says. LNG plants will start to come on line in 2008. Bolivia has vowed not to sell gas to Chile as a result of a war between the two countries taken place over 100 years ago.
Barclays expects the economy to grow 4.8% in 2007. The GDP expanded 4.2% in 2006, 6.3% in 2005 and 6.2% in 2004. Hood points out that Chile differs from other emerging economies in that its public sector has ‘very little’ debt.
The trade balance is forecast to have a US$18bn surplus this year, according to Barclays, about 20% less than in 2006. Hood anticipates an increase in Chilean exports of financial and information services to its Spanish-speaking neighbours as its small population is very well educated.
As for the currency, the government is keen to avoid a ‘huge’ appreciation resulting from high copper prices, Hood says. The Chilean peso will be at 540 per dollar by the end of the year, he forecasts. “The currency looks sufficiently cheap as it is and a major depreciation seems unlikely,” notes Hood.
Free trade
Chile has an extensive free trade agreement network, including accords with the three Nafta countries, the European Union, China and South Korea. It is presently negotiating similar deals with New Zealand, Singapore and Brunei.
Most free trade agreements have had little effect on the country’s economy, says Hood. Such accords are more relevant to countries that are manufacturing centres trying to clear the way for its products abroad. Copper is an exchange-traded commodity whose exports are not boosted overnight as a result of free trade agreements.
Regarding the US, Chile exports copper, molybdenum, lithium, wine, salmon, forestry products like pulp and paper, and agricultural products like fruits. On the other hand, Chile imports mainly manufactured products such as machinery. The US is Chile’s leading trade partner, followed by China, Japan and Brazil.
“It’s a classic relationship between a developed country and another, less developed one,” says Mariano Fernndez, the Chilean ambassador to Washington, DC. Chile exported US$9bn to the US in 2006, and imported US$5.3bn.
If anything, the excellent sovereign rating enjoyed by Chile combined with global liquidity means that the financing needs of bigger exporters and importers are being addressed through new channels such as capital markets. The country’s commerce can still be rewarding, but financiers must endure competition and work on multiple smaller transactions.
