Banks in the West Coast of the US are turning to international trade flows as a key source of revenue, as the domestic market, mired by consumer and state-level debt and plummeting house prices, remains stagnant. Ted Kim reports.
The California banking sector is struggling between two opposite forces. On one hand, the growth in international trade – particularly related to the rebounding Asia Pacific region – is giving some optimists hope that the worse of the US recession is behind us. On the other hand, the housing crash, the credit crunch and steep fall-off in revenues from Silicon Valley’s technology sector and tourism – two of the state’s largest industries – and the ensuing fall-off in tax revenues, has left the state mired in the worse budget crisis in the last half century.
The local banking sector, dominated by the newly merged Wells Fargo and Wachovia as well as the Bank of America, have been fighting forest fires on several fronts, including spiking credit card and mortgage defaults – while attempting to grow revenues in the far more solid areas such as international trade finance.
On the international trade finance side, Californian bankers active in financing the export-import business to Asia have been somewhat encouraged by signs that the worst of the global slowdown is passing. However, the fall out from the credit crunch is far from finished.
Over the last two years, world trade has experienced its biggest contraction since the 1930s – much sharper than the fall in US economic output during the same period. Yet behind the continuing headlines of contracting trade, the first signs of a recovery are also evident. Of 18 countries reporting trade data for June so far, almost all show a rise in imports and exports over the previous month, according to World Bank senior economist Caroline Freund.
“Although trade was still 25% lower than in June last year, this is the first generalised spark in trade flows since the beginning of the crisis,” she says.
Like most US economists, Freund is forecasting a powerful bounce. “In terms of the rebound in trade I think it will be fast – that’s what’s happened in previous episodes, so that trade falls fast but it also comes up really fast,” Freund notes.
California first hit – first to recover?
It seems the financial crisis that triggered the downturn delivered a triple blow to both the state and international trade, according to Ronald McKinnon, emeritus professor of economics at California’s Stanford University. McKinnon points out several underlying factors to the crisis all combining at once:
• The nationwide recession created insecurity, and when incomes fall and people and businesses feel less secure, they can easily postpone purchases of manufactured goods and consumer durables – the goods that are traded most. Further, the elimination of that ‘feel good factor’ inevitably led to revenues in tourism, a key California industry, falling sharply and a collapse in spending on consumer electronics and technology – yet more key California economic sectors.
• The risk of bank insolvency dried up trade finance, which is used to fund 90% of the US$16tn in world trade. As a case in point, traffic at the Port of Long Beach outside of Los Angeles, one of the busiest container ports in the US, fell to levels not seen in decades as growing stacks of empty cargo containers lined the docks.
• The freeze in normal operations in wholesale financial markets made it difficult for exporters and importers to hedge currency transactions – particularly to high growth emerging markets in the Pacific Rim.
On top of this, California was nearly victim number one in the subprime crisis and housing meltdown, leaving banking sector balance sheets, the real estate, and home building industries as well as hundreds of thousands of consumers still reeling.
In fact, during the early stages of the housing meltdown in late 2007 and early 2008, unemployment in the southern California region of Orange County peaked. This wealthy suburban enclave was home to some of the largest sub-prime originators in the US.
Their early demise left thousands of white collar professionals suddenly jobless – and also hit the small business sector such as retailers, home improvement, car dealerships and the leisure sector. Given that all these businesses, however small in size, were clients of local banks either through commercial credit, credit cards, overdrafts or even lease financing, California banks were among the first in the nation to feel the effects of the recession.
At the same time, California banks may also be among the first in the nation to benefit from the trade finance opportunities resulting from the rebound now taking place in the Pacific Rim. The fastest growing economies in the region (China, Indonesia, South Korea and Singapore), grew in the second quarter of 2009 by an annualised rate of over 10%. Even the sluggish Japanese economy – the world’s second largest – is far outpacing the US. Part of the reason for the rapid rebound in Asia economies was the unfreezing of the trade finance business which had for most of last year nearly shut down in the aftermath of the credit crunch.
US Ex-Im rescues trade finance
While a degree of uncertainty remains over exactly how the financial sector will rebound and what role in the recovery will be played by California’s once robust export industries, the trade finance business – unlike mortgage lending, high yield issuance or structured credit –is most definitely alive and kicking.
One reason for this is that many types of public sector guarantee programmes are available to private commercial lenders. Unlike most areas of commercial bank lending, the US government is highly supportive in international trade financing through the work of government guarantee agencies which have more or less continued to run smoothly throughout the entire credit crunch. For the banks themselves, lending for trade finance deals with a US government guarantee is highly balance sheet-friendly in that it incurs a minimal capital charge and thin to zero downside risk.
Low-risk high-quality financing deals, such as government-backed transactions, are exactly the type of activity that banks have tried to most aggressively promote over the last year.
Elizabeth Atkins, head of sales and working capital solutions at Wells Fargo HSBC Trade Bank in San Francisco sees something of a silver lining in the current challenging environment. “We are seeing a unique and encouraging dynamic – a flight to quality – as a direct result of the crisis. We have had customers thank us for being able to stay with them through the downturn, and given the strategic nature of this business for us, we are fortunate to have strong support from our senior credit officers, which has allowed us to operate at levels closer to capacity than one might expect,” she explains.
“In addition to business on the commercial side, we have seen correspondent banks in certain markets sending their clients to high-quality US names in trade finance. There is opportunity in crisis.”
By far the largest public sector participant in guaranteeing trade finance deals is the Export-Import Bank of the United States (US Ex-Im). As the official export credit agency of the US Federal government, the agency helps to create and maintain US jobs by financing the sale of US exports, primarily to emerging markets throughout the world, by providing loan guarantees, export credit insurance and direct loans.
“We are seeing more companies contact us now about using our US Ex-Im working capital guarantee programme that would not have considered using this programme a few years ago,” says Pamela Bowers, vice-president of business credit at US Ex-Im.
US Ex-Im’s dollar volume of working capital loans is up 10% compared to the previous year. In 2008, US Ex-Im authorised a total of US$14bn in financing to support an estimated US$19.6bn of US exports worldwide.
With declining demand in many sectors, Wells Fargo advises that it is essential for companies to consider looking at US Ex-Im facilities and utilise alternative export financing tools.
“Traditional financing offered by commercial banks is not always sufficient to meet the needs of US exporters, especially given the repayment risk associated with export sales,” explains Brett Marshall of Wells Fargo HSBC Trade Bank.
“Once a company’s export sales reaches 20% or more of total sales or receives a large export contract, the company may require additional financing to support their foreign sales growth and working capital needs.”
“US Ex-Im’s working capital guarantee (WCG) programme is often a good solution, especially today as most banks are tightening their credit policy, making it more difficult for exporters to obtain financing.”
Wells Fargo HSBC Trade Bank, which holds fast track delegated authority permitting rapid processing of US Ex-Im working capital guarantee loans up to US$25mn, points to several specific features about how US Ex-Im financing can have an immediate effect on operating cashflow:
• It turns export-related inventory and accounts receivable into cash – thereby strengthening corporate credit quality.
• It expands a company’s access to export financing and improves the ability to fulfill export sales orders – thereby diversifying the composition of top line revenues and thus mitigating overall operating risk.
• It utilises additional cashflow to fund export sales and marketing activities
In recent months, there have also been changes to the US Ex-Im’s WCG programme to further benefit exporters.
First, lower collateral requirements have been established for standby letters of credit (LCs) issued as bid, performance, or advance payment bonds. US Ex-Im will consider requiring 10% (at a minimum) of the face amount of the standby LC to be collateralised. For example, 10% of the face amount of the LC can be reserved under a borrowing base.
This frees up significant liquidity for working capital to allow companies to complete their export sales.
Second, indirect exports are also eligible and can now account for up to 100% of the US Ex-Im WCG loan facility. This is particularly helpful for companies that produce goods or services that are sold to US companies and are then subsequently exported.
Trade offers the answer
While California struggles through its public budget crisis and lacklustre job creation in the technology, media and tourism sectors, the state’s bank sector may be in for retrenchment.
Long gone are the days of quick and easy subprime lending and the ubiquitous adverts for HEE (Home Equity Extraction), Heloc (Home Equity Line of Credit) or even Ninja loans (No Income No Job At All).
However, at the same time, given the present revival and corporate prioritisation for growth through exports to new foreign markets, and internal bureaucratic skirmishes for capital and credit lines, the capital and profitability profile of trade finance is becoming increasingly attractive to senior management in the banking sector – who would prefer not to see another Neloc or Ninja-related writedown for the rest of their careers.
Senior bank executives with little or no trade experience are now hearing a tried and true internal pitch: trade finance, with its contingent liability structure, favourable treatment under capital adequacy requirements, and tangible underlying transactions, offers an interesting risk allocation in terms of usage of bank capital and credit lines.