A fierce year
Competition to do business in the trade and export finance markets in 2006 has left players wondering whether 2007 can possibly be as fierce, writes Kevin Godier.
Cheap and plentiful finance was the motto in 2006, as the world economy enjoyed its fifth year of expansion and emerging market spreads fell further.
Yet it was anything but a calm 12 months. War broke out in Lebanon; a coup took place in Thailand; Sri Lanka edged closer to civil war; security problems cut oil production in Nigeria; ‘resource nationalism’ hit Latin America; Iraq’s turmoil grew; and Iran and North Korea defied the international nuclear community.
As US political pressure on Tehran grew, most leading international banks were forced to exit the huge Iranian letter of credit (LC) market. “Any company will tell you that it is now difficult to find a bank that will confirm their LCs,” underlines Norbert Eisenmenger, manager credit department at Germany’s Europaisch-Iranische Handelsbank (EIH) in Hamburg.
Iran’s problems notwithstanding, emerging markets maintained a recent growth rate of around double that of advanced economies in 2006, with most country risk premia hitting all-time lows. “For those businesses exporting to and investing in emerging markets, financing conditions have never been better,” notes Roger Donnelly, chief economist at Australian export credit agency Export Finance and Insurance Corporation (EFIC) in Sydney.
“At a macro level, the emerging market asset class has had another strong year overall. With this backdrop, all types of borrower, from commodity producers to financial institutions (FIs), have benefited,” emphasises Guy Brooks, head of global distribution at Deutsche Bank London. “The ticket size is getting bigger, margins are being squeezed, and the market is being forced further down the credit chain in search of yield,” he says.
In the major Eastern European and CIS markets where syndications were most active, “spreads have been hammered hard”, says Brooks. “In the Turkish FI market, you now have 20 or so banks fighting over mandates. In Russia, the top banks can now get margins of 35bp or lower for three years, and in Kazakhstan international banks are willing to lend top names, such as Kazkommertzbank, short-term money at sub 30bp.” Even in Ukraine, where pricing for top tier banks stood in the 275-300bp bracket in early 2006, “the value has been wiped away – pricing is close to the 150bp mark now, or even lower”, he notes.
Increasing volumes have saved many banks. “Pricing has come down, but global trade has risen by around 8% annually over the past decade, so there is enough business out there,” says Rodney Ballard, global structured trade finance head at Natixis in London. “The most business is being done in Turkey and Russia.”
At trade finance specialist Fimbank, “it was our best year ever”, insists its president, Margrith Lutschg-Emmenegger. Although traditional LC business failed to increase – a trend seen universally in the market – compensations for Fimbank included “an increase in demand for back-to-back LCs, participation in more syndicated trade loans, structured commodity transactions and future receivables deals,” she adds.
The use of trade receivables to enhance credit risk and reduce funding costs marked a key trend, says Klaus Michalak, global head of structured trade and export finance at Deutsche Bank in Frankfurt. “This was driven by Basel II. Clients now have a clear view to cleaning up their balance sheet, and getting the best financing rates.”
Receivables finance was one of a plethora of products offered by Deutsche that meant “we saw growth in almost every market”, adds Michalak.
Trade financiers are unanimous that market liquidity has reached record levels. “I’m amazed by the liquidity, not just among banks but from the different investors looking for attractive, alternative solutions to investing,” says Matthieu Lacaze, head of commodity structured finance at BNP Paribas (BNPP) in Paris.
Asia’s booming trade markets offered up a variety of trade finance opportunities, but innovation is increasingly required for foreign banks to prosper, contends Asif Raza, Asia regional head of trade finance for JPMorgan Treasury Services in Singapore. He flags up a “phenomenal reception” in Asia for JPMorgan’s Vastera supply chain and logistics management engine, and success by the bank in structuring trade finance deals using multiple instruments.
The wider trends in the region “were generally a follow-up to 2004/05,” says Raza. “The Asian economy is substantially growing, with strong performances from commodities companies and far more trade flows within the region, and also strong new flows from Middle East, Latin America and Africa.”
Aside from China, India and South Korea’s obvious success stories, “Vietnam and other countries such as Indonesia and Pakistan have emerged over the last two-to-three years and are becoming ever more important in Asia’s transformation,” he says.
A considerable amount of banks new to the region – especially Middle East-based players – entered Asia’s trade finance markets in 2006, Raza underlines. “This increased the credit appetite and brought extra liquidity – and the resilience of the market was shown by the lack of any price change in response to events in Thailand and North Korea, he points out.
The Asian year began on a high note, with a landmark US$2bn syndicated loan concluded in mid-February by Reliance Petroleum, marking India’s largest ever offshore syndicated financing. Commodity-driven deals in India also included a US$50mn, seven-year transaction arranged by ABN AMRO for steel trader Duferco.
At the more vanilla end of the Indian market, a “huge contribution” to the bottom line at Fimbank was made by its Global Trade Finance factoring joint venture, says Lutschg-Emmenegger.
China remains a far tougher market to crack. “The country generates huge trade volumes, but the traditional trade business is being held by the LC beneficiaries or banks processing these for them. Very little is seen in the secondary market for trade risk,” according to Tom Turney, head of trade finance at Bank of Ireland Global Markets in Ireland.
Mirroring a decline in trade finance prices, paper from China’s third and fourth tier banks is “still priced higher than the big banks, but the difference has declined,” highlights Holger Kebernik, managing director at the China Trade Solutions forfaiting brokerage in Shanghai.
Pricing is also “down significantly for Indonesia, as the country’s credit has improved over the past two years”, says Raza. According to Christian Stauffer, managing director of advisory boutique EuroFinAsia, structured trade deals are assuming more prominence in Indonesian sectors such as mining and energy.
But whilst the overall political and macroeconomic picture has improved, an ongoing wariness remains, says Alistair McVeigh, executive director, political and credit risks team at Willis’s Singapore office. “Indonesia still makes up a significant percentage of the enquiries we see in this region, from short-term trade financings through to project finance transactions.”
Historic Latin lows
Unsurprisingly, Latin American spreads followed the global southwards trend. “Margins continued to decline to historic lows in every market in 2006, with the exception of Bolivia, Ecuador and Venezuela,” says Richard Tull, senior vice-president at HSBC’s forfaiting and risk distribution unit in New York.
Another pattern spotlighted by Tull was the increasing business flows out of South America, most notably the flows of soya, steel and copper to China, Eastern Europe and the Middle East from markets such as Brazil, Chile and Peru.
By virtue of its Latin network, HSBC was able to capture some of this business, and to advise on and repackage some of the higher-risk deals, he says.
|Forfaiters probe for survival routes
Hope springs eternal in the forfaiting market, where players perceive a number of potential solutions to maintain the industry pulse. “The business has been characterised for some time by reducing margins. So although our volumes are increasing, we have to run harder to achieve correspondingly higher profits,” underlines David Lilley, head of forfaiting at SMBC Europe in London.
The forfaiting secondary market “isn’t what it used to be”, stresses another forfaiter, attributing the decline to the raft of financing techniques currently available to traditional obligor banks in emerging markets. “We might see a US$50mn-100mn deal only once a month now.”
Given the intense competition for Eastern European and CIS paper, and the disappearance of Iran from many scanners, a return to traditional supplier credits is one way forward.
“Several recent transactions in this respect have given us optimism,” says Lilley, adding that the quest for fresh markets represents a more perennial forfaiting hope. “People are looking at new countries where a reasonable margin is possible, such as Belarus, Angola, Nigeria and Azerbaijan,” he notes.
Africa is seen in an improving light by forfaiters. “The banks in Nigeria are quite a large target market now. Burkina Faso and Senegal are also improving – we are seeing more business, at relatively attractive margins,” says Margrith Lutschg-Emmenegger, president of Fimbank.
Given China’s increasing exports, business into Sudan and Iran has become a more mainstream focus for China Trade Solutions, as “more Chinese companies and banks are using forfaiting as a risk and finance tool”, says managing director Holger Kebernik.
Another hopeful sign seen by Lutschg-Emmenegger is a greater opening up to non-trade transactions.
The value of structuring was seen in a landmark US$560mn, two-tranche multisourced deal concluded in mid-2006 for Argentine aluminium producer Aluar, one of GTR’s ‘Best Deals of 2006’. According to lead arrangers Citigroup and Natixis, the deal marked the largest loan arranged in Argentina since the country’s 2001 financial crisis, and carried both export credit and pre-export finance components. Export receivables and an AAA-rated bond portfolio mitigated what Natixis’s Ballard described as a “very difficult country risk”.
Meanwhile the oil revenues piling into the Middle East region meant it was less of a trade finance market than ever before. Some 5% of the invoices processed by HSBC Invoice Finance now involve buyers in the region, where “more and more trading partners are looking to buy on open account,” observes John Beaney, HSBC’s head of international invoice finance.
In Iran, trade financiers are now “in virgin territory”, says Eisenmenger, stressing that “all Iranian LCs denominated in dollars are being settled in euros now”, and adding that certain Iranian transactions “now have to be rejected by any bank”.
For EIH – which specialises in Iranian risk – “there is no doubt whatsoever about the ability of Iran to repay its trade debts: it is simply that the political risk is so high,” he explains.
In Africa, two names which perennially keep the pre-export market afloat, Sonangol and Cocobod, concluded new deals with ease (both companies were involved in GTR‘Best Deals of 2006’). More noteworthy perhaps was a US$50mn revolving trade finance facility arranged by BNPP for the Reserve Bank of Zimbabwe, and guaranteed by the export earnings of Zimbabwe’s Bindura Nickel Corporation.
|New trade finance players find slots
The ever more crowded trade finance market has generated a cluster of new players seeking niches. Nedbank set up a London structured trade and commodity finance desk on January 1, 2007, and is targeting a market gap that includes “European traders, producers and manufacturers looking to sell into Africa, especially smaller companies that have a track record and tradition in Africa,” says John Vowell, head of the London desk.
Another key focus will be pre-export structures in Africa. Vowell says the new unit is already working on deals involving fresh produce coming out of Africa, such as a cocoa and a cotton transaction, and on major earth moving equipment and tyres going in.
Nedbank is also eyeing “several innovative structures supporting customers in some of the most difficult African countries”.
At Bank of Ireland (BOI), which has been operating in the London market since late 2005, “we now know that we can succeed, having increased our portfolio threefold in 12 months,” says Tom Turney, head of trade finance there. “What was most pleasing in 2006 was the confirmation that there is a place for new players provided that they cut their suit according to their cloth,” he comments.
Bank of Ireland’s tactics include “quicker responses to clients, maximising secondary market activity, driving up country ceilings, capitalising on BOI’s expansion in the corporate banking market, and a rising focus on import LCs and greater participation in trade loan syndications,” he emphasises.
Helping banks with the tougher business in Africa was the International Finance Corporation (IFC), in whose Global Trade Finance Programme (GTFP) Nigeria has featured prominently as an active import market. Some 65% of the programme’s US$600mn-worth of guarantees during its first 15 months have supported trade to Africa, including deals to Ghana, Kenya, Mauritania, Mozambique, Nigeria, Tanzania, and Uganda.
The GTFP promises to open the door to some of the continent’s most challenging markets, including post-conflict countries, where banks in Liberia, Sierra Leone, and Rwanda are being signed in. “IFC is often the only provider of risk mitigation for certain trade transactions,” stresses Bonnie Galat, principal investment officer at IFC, responsible for marketing the programme, whose capacity was recently doubled from US$500mn to US$1bn
The IFC programme has replicated the much larger Trade Facilitation Programme (TFP) put in place successfully across Eastern Europe and the CIS by the European Bank for Reconstruction and Development (EBRD). This facilitated more than 1,100 trade transactions worth US$931mn in 2006.
“We are still the largest provider of trade finance to banks in markets like Armenia, Georgia, Moldova and Tajikistan, some of which had no trade finance at all three-to-four years ago,” says Rudolf Putz, the programme’s operation leader. In Tajikistan, for example, the EBRD has supported over 260 LCs from local banks, supporting imports from 30 countries.
As in past years, CIS and African markets yielded the majority of the market’s highest-profile commodity-based lending, although 2006 generally proved to be more barren than usual for oil and gas-based pre-export finance deals, according to Pierre Palmieri, Société Générale Corporate & Investment Banking’s (SG CIB) global head of natural resources and energy financing in Paris.
With the exception of Rosneft’s March 2006 deal and one other exception, big Russian oil producers are eschewing the pre-export market, he emphasises. “Oil majors are generally cash-rich, and can go to the capital markets or to the unsecured debt markets,” Palmieri notes. “Aligning with our overall global strategy, we diversified further in soft commodities and metals by increasing the scope of companies,” he says, highlighting the US$400mn facility arranged for Suek (Siberian Coal Energy Company) in October by RZB and SG CIB – another recipient of a GTR‘Best Deal of 2006’s award in this issue. “As for oil, we diversified our portfolio to second tier companies by offering a wider range of products, such as borrowing based financing”
For the most part “the borrowing focus moved away from commodity producers to purchasers and traders,” highlights Deutsche Bank’s Michalak. “These entities can use structured deals to leverage the extra credits they require to maintain their volume turnover,” he says, exemplifying a working capital facility Deutsche structured for copper producer KME (a GTR‘Best Deal of 2006’).
Similarly, SG CIB developed deals with oil importing refineries “in Serbia and African markets such as Cameroon and Kenya,” says Palmieri.
High oil prices set up good conditions for reserve-based project financings, including one of the year’s highest-profile project finance/acquisition deals, the US$1.4bn, seven-year Sinopec-Sonangol financing for the Block 18 licence in Angola. The transaction was priced at just 40bp during construction and 140-150bp post-construction. It has been recognised later in this issue as a GTR‘Best Deal of 2006’.
This type of cross-continental acquisition deal became “more and more regular, as commodity sector integration grew in 2006”, stresses BNPP’s Lacaze, a point echoed by Mike Constant, head of distribution, EMEA loan syndications at Natixis. “Merger and acquisition financings made up roughly 40% of our EMEA loan value,” he comments. Lacaze also notes “accelerated activity in the metals sector”, where BNPP recently syndicated a US$275mn, four-year pre-export deal for Ferrexpo’s Poltava iron ore mine in Ukraine.
|Hedge funds stir the markets
Particularly eye-catching in 2006 was the increasing liquidity that hedge funds added at the trade finance market margins as they hunted for yield.
“We applaud this,” says Texel Finance’s director Andy Lennard, based in London. “They take decisions quickly, and have large amounts of money at their disposal. There are about 10 players that can each bring around US$20mn-25mn to the table, via syndications and silent participations.”
2006 saw the first occasion that a hedge fund led a deal, when New York-based Rosemount Global Trade Finance Fund lead arranged a two-year syndicated pre-export finance deal for Brazil’s Coimex Trading. The deal receives recognition later on in this issue as a GTR‘Best Deal of 2006’.
Underlining the broadening interface between the trade finance and fund communities, a trade finance pricing and index service was taken over from LTP Trade by Markit in November.
Hedge funds are also discovering a niche in project finance deals where they are willing to prop up the low equity capitalisations of certain emerging markets borrowers, says Eli Hassine, global head of export and agency finance at Citigroup. “Hedge funds are looking to take corporate risks in markets like Ghana, Nigeria, Zambia or Ukraine.”
Classic pre-export deals continued to flow in South America, the largest being Brazilian mining giant Companhia Vale do Rio Doce’s (CVRD) US$6bn pre-export loan tapped in December, which will be used to refinance some of an October bridge loan which part-funded CVRD’s US$17.6bn acquisition of Inco.
A more innovative trend at work in the region, according to Prabhat Vira, ABN AMRO’s head of structured lending, Americas, is the application of a mix of commodity financing techniques and supply chain financing to commodity flows within North America, especially where medium-sized producers are involved. “The US has the highest internal commodity flows in the world, encompassing a whole range of softs, energy and metals, and the most advanced commodity exchanges in the world,” he emphasises.
“I believe that the commodities sector as a whole has come of age over the last few years, and has a shine to it, in terms of techniques, participation and interest in the sector,” he enthuses. “All the signs point to a larger and larger business in the next four-to-five years.”
Export credits picture
Export credit financiers are perhaps less buoyant, with most affirming that the market is flat. China’s economic growth has nonetheless spawned a widening remit for Sinosure (the China Export and Credit Insurance Corporation), bankers concur. “China continues to capture some of the capital goods market that was formerly dominated by European, Japanese and US companies,” says JPMorgan’s Raza.
According to Eli Hassine, global head of export and agency finance at Citigroup, agencies from China, Korea and Japan are all receiving continuing strong demand for additional financing and insurance capacity. “The continued focus at Korea Export Insurance Corporation (KEIC) and the Export-Import Bank of Korea (Kexim) is on shipping, and oil and gas for both limited recourse and corporate finance,” he explains.
With the exceptions of Germany’s Hermes and Italy’s Sace, western export credit agencies (ECAs) are perceived as decreasingly active. “When times are volatile and risks more difficult to take, ECA financing is frequently the best alternatives for long-term financing,” observes Pierre-Joseph Costa, head of export finance at BNPP in Paris. “When the risk climate is easier as it is today there are plenty of other options,” he suggests.
Nevertheless business has hardly disappeared. 2006 marked “a record year for our ECA business”, says Hassine, confirming that Citigroup closed deals in 46 countries. “We just closed a US$300mn Nexi untied financing for Vietnam and are working on several large transactions that should come to fruition in 2007,” adds Costa.
Areas of Asia remain in strong need of ECA-backed financings. “In markets such as India, Indonesia and Vietnam, there will still be several multi-billion dollar project financings where market appetite cannot be met by the bank and bond markets,” notes Hassine, pointing to ECA discussions underway for several major projects in Asia in petrochemicals and power. “A big deal is coming along for Russian Railways, where Siemens is supplying equipment,” adds Michalak, noting that Deutsche Bank is mandated for a US$400mn export credit deal being raised by a major player in the Russian metals sector.
Winning such mandates is harder than ever for export financiers, says Frederic Genet, SG CIB’s global head of export finance in Paris. “Pure ECA finance has reached the point where it is such a commodity that nobody makes any money. Pricing is down to a level that’s crazy – too many banks are chasing too few deals,” he contends.
As ever, creative structuring is a key differential. “There are now more ECA deals where political risk coverage sits alongside commodity finance – a good example was Sinosure’s PetroKazakhstan transaction,” says Michalak. “The deal is far less about exports than about combining financing techniques to deliver a supply of commodities into an important country.”
What can the trade finance market expect in 2007, when world growth is expected to fall again
Most financiers envisage a continuation of market trends. “Russian bank borrowers are looking to take tenors out to 18-24 months, and the markets are likely to go with that,” says Natixis’s Ballard.
In the commodity finance markets, classic pre-export business is likely to remain subdued in 2007, contends SG CIB’s Palmieri. “We should see high liquidity, low margins, and lots of acquisitions – it will be quite a good environment for acquisition finance, project finance, borrowing base lending, import financing, and other types of financing for trading companies.”
Lutschg-Emmenegger predicts that “factoring will be the flavour of 2007 in the emerging markets, and very much a key word in the trade finance markets”. She also pinpoints a growing flow of Chinese exports to emerging markets as “a good development from our viewpoint, as is a growing trickle of enquiries for Iraq, which could translate into solid business in 2008”.
And business in Iran has to go on, given the country’s huge number of industrial plants, stresses EIH’s Eisenmenger. “China is going to be a very important trading partner for Iran, which may generate some very large volumes of trade finance between the two markets,” he concludes.
“It would need a huge event to turn the credit cycle around,” forecasts Steve Capon, head of country and credit risk at insurer Ace Global Markets, in London. “In the end it could be a left of field event like a flu pandemic which could catch many out.”
An Iran-related event, “which is far from a dead certainty given the extremely complex situation and range of actors involved, would trigger a sharp oil price rise, which would hit emerging markets just as many of their fundamentals have begun to show signals of deterioration, albeit very modest”.
Capon forecasts that this would, in turn, bring about “a reversal of the staggering level of equity investment flows into emerging markets, which would destabilise the situation even more and could bring about widespread emerging market defaults”.
There are already several signs of trouble, including “trade credits loans under pressure in Russia’s mobile telecoms and pharmaceuticals sectors, and problems with a couple of West African deals”, warns Ace’s head of political and credit risk, Julian Edwards.
|PRI paradigms mirror wider financing trends
2006 saw the trade finance and political risk insurance (PRI) communities undergo parallel experiences.
“The Lloyd’s of London market now contains over 30 syndicates writing PRI, and there is more capacity coming in, because the property and casualty market didn’t harden post-Katrina,” says Julian Edwards, head of political and credit risk at Ace. “PRI and trade credits margins tumbled by about 30% in 2006 and it is far harder to make money.”
The flip side, says Edwards, is that benign risk conditions globally are triggering low levels of payment default claims, and Ace is receiving a record level of enquiries.
An increased awareness of confiscation perils is driving some cover requests. The Latin American scenario – where Bolivia and Venezuela have been particularly aggressive towards foreign-owned private sector assets – is “as predicted last year, now coming home to roost”, says Bernie de Haldevang, financial and political risk underwriter at Atrium Syndicate 609, in the Lloyd’s of London market. “There is more to come – the recent reports of the latest mining nationalisations in Bolivia will impact on the market,” he forecasts.
Banks are also continuing to lay off lending risks. Zurich is seeing “lots of one-off transactions in markets like Brazil, Russia Turkey and China”, notes Dan Riordan, managing director of the company’s political risk and trade credit arm.
Other notable trends in the PRI market include more consolidation and greater use of syndicates, says Andy Lennard, director of Texel Finance in London. “There are also quite a few faces moving around, which usually indicates a healthy industry.”