Looking back to September last year following the International Forfaiting Association’s (IFA) annual conference, the atmosphere in the forfaiting market was uneasy, yet hopeful.
The aftermath of the summer’s sub-prime market turmoil had quickly turned into a global liquidity crisis. Forfaiters hoped to reap the benefits of this crisis, as margins began to climb back up after having dropped to what seemed unrealistic and unprofitable levels over recent years.
However, the true extent of the credit crunch on international banks’ balance sheets had yet to be revealed, and most players were tending to be highly cautious, reluctant to lend to each other. One forfaiter remarked last September that trading had virtually come to a temporary standstill as they waited to see how the crisis played out.
Confidence has now returned and the majority of forfaiters GTR spoke to are reporting high levels of activity in the market.
“We have definitely seen an increase in business, with tightening liquidity people are looking to sell assets into the market,” Lucio Matassoni, head of forfaiting at OCBC, remarks.
Edmondo de Picciotto, general manager at Intesa Soditic Trade Finance, adds: “We seem to have been able to do more “real” forfaiting deals in the past few months, and I would imagine that this is due to the credit problems as fewer exporters and banks want to keep assets on their books.”
As well as increased activity, margins have risen across the board. De Picciotto adds: “I believe that prices in most countries have almost doubled compared to 12 months ago, although now it seems to have settled at a specific level.”
However, the market has not developed in line with all the market predictions made early on in the crisis.
For instance, banks have not necessarily seen a renaissance of the traditional supplier credit-type business, as expected by some. Rather, many are reporting higher activity levels in their bank-to-bank trade loan business.
In fact, one banker remarks that the debates surrounding the definitions of forfaiting and the potential return of the supplier credit business have now become redundant.
Also remarking on the potential return to supplier credit deals, Paul Langford, executive director, WestLB global forfaiting and emerging market loan trading, adds: “This is something we thought might come to the fore as the credit crunch hit, given the view of trade debt as a quality asset class. However, we haven’t really seen this trend develop given our lack of real involvement on the primary market side, but that having been said, neither have we seen a huge flow of supplier credit business coming through into the secondary market either.”
Over recent months there has been a push among many of the major banks to develop their bank-to-bank loan business.
“We are seeing some buyer’s credit business, but above all, we are seeing a high level of bank-to-bank trade loan activity,” comments OCBC’s Matassoni.
Intesa Soditic’s De Picciotto also observes that: “The most popular forfaiting products are standby letters of credit, although the syndicated loan market is also extremely popular with some banks.”
There is a similar story at WestLB where around 30 months ago the forfaiting team took over responsibility for the emerging market loan trading, as well as the forfaiting activity. Langford at WestLB remarks that this fairly new area of business is now beginning to catch up with our regular forfaiting business.
He comments: “At the moment, if you look at our portfolio, it is probably weighted 60:40 in favour of forfaiting, but that differential is diminishing.”
“We are doing an increasing amount of inter-bank lending via the standby LC and facility letter structure,” he adds.
SMBC Europe has been particularly active in this market managing to secure an attractive deal with Nigeria’s Diamond Bank. Acting as mandated lead arrangers SMBC Europe and RZB arranged a US$70mn one-year trade-related loan earlier this year.
The deal was initially launched at US$50mn but following an oversubscription was increased to US$70mn. It had a 360-day tenor and pays a margin of 2.50% over Libor. FBN Bank, Habib Allied International Bank and Zenith Bank joined as lead arrangers. Also participating in the deal were Mauritius Commercial Bank, Bank of Beirut, Ghana International Bank, Banco Internacional do Funchal (Banif), Atlantic Forfaitierungs and Banque SBA.
This was a deal that some others in the market had been keen to secure, and it has opened the door for SMBCE to win further Nigerian deals. As GTR goes to press, the bank is edging closer to winning its second Nigerian mandate.
SMBCE has also worked on some Russian bank loans. At the end of last year it signed a US$60mn facility for Rosbank, raised on a “best efforts” basis, with the bank targeting select participants. This facility carried a two-year tenor.
In April this year, the bank arranged another US$50mn tenor for Rosbank. This facility carried a one-year tenor, and struggled slightly more in the market, which is partly put down to general market turmoil and the fact the bank had been taken over by Société Générale, and was suffering from some of the after-effects of the French bank’s trading scandal earlier this year.
However, it is the Nigerian deal that may come to be viewed as a landmark transaction for the forfaiting community, highlighting the growing interest in doing business in Nigeria and the wider Sub-Saharan market.
As well as SMBCE, other big bank names such as WestLB are beginning to assess the potential of the African market. Langford comments: “We are trying to get things moving internally in places like Nigeria, where there already appears to be an active market, particularly in trade debt.”
Similarly, Marina Attawar at DF Deutsche Forfait observes: “I am seeing some deals in Africa, in countries such as Angola and Nigeria. There hasn’t been a huge increase in business, but the interest is growing and it is becoming far more accepted to work in these regions. We closed an Angolan deal around nine months ago.”
Simon Lay, managing director at London Forfaiting Company also adds: “Regarding African business, we are seeing a lot of business in Nigeria but we are suffering from capacity problems in this region. We are also doing deals in countries such as Mali, Mauritania and Burkina Faso, mainly involving 120-180 day LC business.”
The smaller non-bank forfaiting operations such as Atlantic Forfaiting Company are also looking to Sub-Saharan Africa, and pride themselves on being the forerunners in more exotic markets.
“About two years ago we began to shift our focus to Africa. Around 40% of our portfolio is in Central Europe and the CIS, 25% is in Africa and the rest is in Asia, the Middle East and Latin America,” comments Peter Dornauer, chief executive officer at Atlantic.
“Our strategy is to be first in country when margins are high and first out when spreads go down; we have a different approach compared to many other market participants. For example, we were among the first into places like Romania, Peru and Brazil and no longer so active there now the countries are investment grade,” adds Martin Fankhauser, senior vice-president of the Zurich-based company.
He adds: “We were also among the first to go to Belarus and Kazakhstan. In 2001, margins in Kazakhstan were around 600bp. Up until last summer, margins had dramatically fallen from this level to totally unrealistic pricing.”
Another Swiss forfaiting outfit that is proud of its capacity to do business in more exotic locations is Swiss Forfaiting Company (SFC).
In a similar manner to Atlantic, SFC works against market trends looking to do medium- to-long-term transactions in potentially riskier markets.
“We are able to consider long tenor deals specifically related to forfaiting structured transactions, for example 10-year transactions in Mozambique,” comments Sal Chiappinelli, chairman of SFC. He explains that this capability is what sets non-bank operations apart from the larger global banks.
“We are mainly involved in long-term business, that is the type of parameter the banks do not want to deal with. It is not necessarily immediately profitable, but long-term liquidity is what emerging countries need. Banks often have the attitude that it is better to do short-term transactions, but it is not of as much use to a country such as Mozambique needing to import capital goods to get a 60-day deal.”
He draws on his observations of the Russian market, where investment banks have granted Russia huge Eurobonds when they may not always necessary. A similar pattern is beginning to emerge in Sub-Saharan Africa, with Ghana and Gabon having already issued their first bonds and there is talk that Uganda might be about to sell its first international bond to raise up to US$1bn for various infrastructure projects.
Chiappinelli suggests that arguably forfaiting is a better tool for developing certain emerging countries. “Governmental institutions by means of export credit agencies (ECAs) use taxpayers’ money to develop these ‘transitional economies’, whereas forfaiters can provide capital directly to entities that need it. For instance, a US$10mn forfaiting transaction goes directly to the suppliers of the capital goods, frees up their capital to put back into production or infrastructure.”
Old favourites see renewed appeal
It is not only the lesser-known Sub-Saharan markets that are attracting the eye of the forfaiters, but some old favourites as well, as LFC’s Lay comments: “Current market conditions are providing us with opportunities to re-escalate our activities even in markets like Asia where margins have previously prohibited us from previously finding profitable opportunities.”
“There has been a lot of development in the Chinese market, with opportunities for structured and export transactions,” he adds.
Deal pipelines in the forfaiting market are likely to feature transactions from countries such as Korea, as well as China and India, where previously forfaiters have been pushed out due to slumps in margin levels.
WestLB’s Langford comments: “In countries like Korea you would have seen business at around 20bp 18 months ago, but there has been a substantial increase in pricing in this region, as well as China and India.”
Another banker working for an Asian-based trade and forfaiting bank remarks that his bank’s forfaiting activities have more than doubled from the previous year.
Russia also remains a strong source of business in both the secondary and primary markets, with the region seeing one of the most significant upswings in margins over the last year.
Other areas in the CIS seeing a relatively high degree of forfaiting activity are Belarus and Georgia. As an example, in recent months, SMBCE has worked with a Russian exporter exporting into Kazakhstan, and the bank bought a deferred letter of credit. In Georgia, the bank also has closed a number of supplier credit deals, where they bought an export transaction on behalf of the Chinese exporters.
However, some regions that have been perennial favourites for forfaiters are now seeing their appeal dramatically tarnished by market turmoil. Kazakhstan is probably the best example this trend, where some bankers remarked that that they will no longer touch Kazakh forfaiting paper until market conditions improve.
Managing your books
Yet high margins and a widening regional scope for business does not necessarily translate directly into booming business for forfaiters.
Tightening liquidity means that some banks’ cost of funding is also rising and this can potentially offset the benefits of higher pricing.
“Liquidity costs are a big part of this escalation in prices. If people are forced to pay 20 to 30bp for their funding, it doesn’t make any sense to them to offer 20bp on a deal when it is costing them more to borrow the money in the first place,” remarks WestLB’s Langford.
Some forfaiters remain undeterred by cost of funding concerns. LFC’s Lay comments: “The cost of funding has increased for most players. LFC has seen a slight increase in funding costs, but overall our balance sheet has improved. We have benefited from Fimbank’s recent rights issue and selling of its stake in GTF, the Indian factoring company.”
However, Lay also highlights another factor to consider. Margins have been increasing, but at the same time Libor is falling, and this has resulted in increases in margin being partially absorbed by cheaper Libor rates.
“If interest rates start to rise, margin increases will be less easily absorbed but the current dynamics of the market and lack of liquidity are likely to keep upward pressure on margins for sometime,” he adds.
As well as margin hikes, the liquidity crisis has completely changed the trading books of many forfaiters, with deals featuring far shorter maturities than seen in previous years. Before the crisis hit, most banks were doing medium-term business in order to win deals, but with a lack of liquidity, the majority of deals are now being done on a 12-18 month basis.
SMBCE’s David Lilley remarks: “Since last year, the balance books have been completely transformed. SMBC has sold off all its medium-term deals, and only has short-term transactions on the books now.”
Of course, if the right medium-term transaction came up most bankers wouldn’t usually turn it away, but the tendency is now to err on the side of caution.
Even De Picciotto at Intesa Soditic Trade Finance reports that although the forfaiting house prefers medium-to-long-term financing: “at the moment a big portion of our business is relatively short-term around 12-18 months.”
He adds: “The market has definitely affected the tenor of the transactions, but it’s both a question of unpredictability as it is of a lack of funding available for a lot of banks for medium-term financing.”
By opting to concentrate on short-term deals, banks and forfaiting houses can keep their books churning, and by doing so reduce the risk profile of transactions and make them far easier to sell into the secondary market.
According to Langford at WestLB, the secondary market has also seen a substantial upswing in pricing, reporting that: “At the moment it is very much a buyer’s market. In secondary you can name your price and it then depends on people’s desperation to sell and whether they are prepared to take a hit.”
Furthermore, with a number of banks busily repairing their balance sheets, there are additional constraints on liquidity, which is affecting sales turnover in the secondary market.
“If your balance sheet is relatively small, there is a greater need to churn your portfolio as quickly as possible,” remarks Geoff Sharp, managing director, forfaiting and risk distribution, at HSBC.
He adds that if you can’t churn your forfaiting book through sales, banks need to then look at reducing maturity profiles. However, larger banks such as HSBC have a bigger balance sheet to underpin their forfaiting activities, so there is less need to buy and sell into the secondary market on a day-in day-out basis.
“While we adopt a portfolio management approach to smooth out risk concentrations, we are not so heavily reliant on the secondary market for business growth,” Sharp explains, adding: “To resist market fluctuations in the forfaiting business, banks also need origination capacity and balance sheet capacity.”
Armed with these qualities, banks are in a better position to undertake medium-term transactions in the current volatile market, according to Sharp.
Theory versus practice
In theory, the effect of tightening liquidity could have led to an increase in supplier’s credit deals, as it would be in the interest of the supplier to be able to offer attractive credit terms to an importer as part of a financing package. As one forfaiter remarks, the product can help exporters “dress up” their offering.
However, in practice there has been no revolution in forfaiting, and the wide range of products that fall under the forfaiting umbrella are still being used, depending on the client’s individual needs.
For instance, one Asia-based forfaiter reports that his Asian clients are tending to use structured LC finance to avoid the need for working capital. In other regions, such as smaller Sub-Saharan countries there is more short-term LC business being conducted. This highlights the unique selling point of forfaiting, much espoused by the market, that it should be a flexible financing instrument that can be used to support tailor-made transactions.
Similarly, in theory the current economic climate could prove to be a profitable time for forfaiters, as risks are becoming more rationally priced and clients look to offload their debts to free up much needed liquidity.
However, in reality, forfaiters should perhaps not in be over zealous in their celebrations. Margins may be on the rise, but so too are the risks. Langford observes: “Now is theoretically a good time for forfaiters. Margins are increasing and if you have the nerve to do large volumes of business, and the ability to hold until markets stabilise, then there are opportunities for forfaiters to capitalise on current market dislocation.”