Despite massive fluctuations in Korean risk pricing over the past year, Lloyds TSB has managed to close a well-priced structured letter of credit and guarantee facility to support UK exports to South Korea. Rebecca Spong reports.
Arranging Bank: Lloyds TSB
Korean Bank: Shinhan Bank
Amount: £1,460,000 (US$2.4mn) letter of credit
Purpose of transaction: To support the export of leisure trains to a tourist park in South Korea.
Exporter/customer: Severn-Lamb (UK)
Buyer: Beachhill Resort (South Korea)
On a small island off the coast of South Korea, a leisure resort company is building an eco-park, complete with animals, lakes, forests, and a 5km train track that will transport tourists through the resort.
For Severn-Lamb, a small family-run company in the UK, specialising in manufacturing leisure trains, road trains and monorails, this tourist development represented an important opportunity to secure a large export contract.
To ensure it won the contract with the potential Korean client, Severn-Lamb turned to its bank, Lloyds TSB, to work with their trade finance team and come up with a suitable financing solution.
“We have had a number of successful trade finance transactions with Lloyds TSB over the last three years,” explains Patrick Lamb, director of Severn-Lamb.
“So when a contract like this comes up, at a very early stage we get in touch with Lloyds TSB to get advice and assistance to meet the security needs both we and the customer need to close the contract,” he adds.
Lloyds TSB’s involvement in the deal began in July last year, and the bank structured a letter of credit (LC) and guarantee transaction to cover the full transaction amount of £1,460,000 (US$2.4mn). The letter of credit was raised by the Korean bank, Shinhan Bank.
Neil Jones, international business manager, Lloyds TSB Commercial, comments, “Patrick brings me into the deal at an early stage. I prepare the wording and structures for letters of credit and guarantees so we can go to their buyers and say this is what we want.”
He adds, “There isn’t much room for manoeuvre in terms of the structure of the LC and the guarantee. This is so we protect both our and our customer’s interests.”
Originally, the Korean buyers were prepared to pay 30% of the contract value upfront, which they initially wanted to keep separate from the LC.
However, the view Lloyds TSB took was that if this 30% was kept within the confines of the LC, they would have better control over the transaction.
“So, the 30% became payable as an advance payment against our issue of advanced payment guarantees,” Jones explains.
Lloyds TSB also needed the advance payment guarantee to reduce in liability as Severn-Lamb shipped the trains. The trains are to be shipped as soon as they are ready. The deal was structured so that upon presentation of the documents required under the LC, the LC becomes payable immediately, and as the bank had built in reduction clauses into the advance payment guarantee, Severn-Lamb’s liability under the advance payment guarantee simultaneously reduced.
As well as releasing the 30% payable under the LC, Lloyds TSB also agreed to pay another 20% of the value of the LC in the form of an export loan, with the condition that the loan would not kick in any earlier than six months after the letter of credit is issued.
This export loan is optional, but the aim of it is to allow Lamb some flexibility in terms of forecasting his cashflow.
After having dealt with the shipment of the first train, Lamb could use the loan to purchase raw materials and cover other necessary costs while he finishes the last four trains under the contract.
Lloyds TSB’s Jones remarks, “We’ve freed up 50% of contract value, covering the liability of guarantee and provision of an export loan, if needed.”
“If they do take up the loan, it will be repaid pro-rata as they ship the goods,” he adds.
“Also funds will become available under LC and be used to pay back the export loan and reduce guarantee liability.”
The export loan is also intended to potentially alleviate a key problem afflicting smaller firms across the globe, namely a lack of liquidity.
As Lamb explains, “Our main priorities right now are concerning liquidity, ensuring we have enough cashflow and working capital to keep the company operational.”
The firm’s business involves the production of high-value items and requires high material purchase costs.
“We need to balance these costs with stage payments on individual contracts. We need to ensure we have enough cash flowing through the business as well as expanding our markets in terms of locations we are selling into as well as products we offer,” he adds.
It is this need for liquidity and controlled cashflow that the Lloyds TSB transaction targets.
“When we are structuring the guarantee and LC, we are looking to deliver working capital and deliver it at key points when it is required to pay suppliers,” explains Mike Gilham, director, international finance solutions, Lloyds TSB Corporate Markets.
“We are not providing funding and services that the customer does not need and charging them for it. It is a very well considered and targeted facility.”
Alongside liquidity concerns, cost is another issue. Since Lloyds TSB were first introduced to this deal last year, up until the deal closing in the second quarter of this year, there has been huge volatility in Korean pricing.
However, due to the long-standing relationship with the client, Lloyds TSB varied the price it charged very little from its original quote.
“The deal is priced very competitively and more in line with previous pricing levels,” Gilham remarks.
“Given that one-year credit default swap (CDS) pricing for Korean risk at the time we closed the deal was above 500 bps, it demonstrates Lloyds TSB’s commitment to support our clients. If we base our pricing purely on market indicators such as CDS, Severn-Lamb is unlikely to have been able to conclude the transaction,” he adds.
This deal represents one of the biggest contracts won by Severn-Lamb to date. Previous deals Lloyds TSB has worked on with the company include export contracts with customers in India and Egypt. In some form or another, Lloyds TSB has been working with Severn-Lamb since 1958, and its trade finance team has been working closely with Patrick Lamb for the last five years. “It is great to see how the business has grown,” remarks Jones.
And no sooner had this transaction closed, signs of another potential contract for Severn Lamb are also now on the horizon.