Activity in the forfaiting secondary market is increasing as confidence returns and more banks look to sell on risks, writes Shannon Manders.
Risk appetite is returning to forfaiting, as is demonstrated by the reopening of the secondary market.
“The secondary market is functioning perfectly well,” says David Lilley, head of European trade finance at ABC International Bank. “It’s not difficult to sign transactions at the moment.”
A renewed confidence between banks and their counterparties, coupled with the ability to sell on risks, is welcomed after 18 months of reduced lending capacity.
Such is the appeal of the business that new players are entering the secondary market. When Citi joined the International Forfaiters’ Association (IFA) a few months ago, it reflected the bank’s increased focus on the distribution side of the business.
“Now that there’s a greater need on the secondary side, as well as an abundance of FI and corporate assets available, it gives us a chance to both buy and distribute them down,” says Reena Doshi, Citi product manager covering the Emea region.
But with the current crisis in the eurozone, and the majority of industry players still unclear as to how this will affect their business, some volatility remains.
“The market has been in fits and starts. Just when you think you’re returning to equilibrium in pricing and risk, there are a couple more knock-on events – such as the recent events in Europe,” says Geoff Sharp, managing director, forfaiting and risk distribution at HSBC.
Nevertheless, forfaiters tend to benefit from a degree of instability in the market, and Lucio Matassoni, regional head, financial institutions, at OCBC believes that there is “still a good amount of forfaiting business around”, noting that now more than ever, people require the solutions that forfaiting offers, namely the provision of quick support and the availability of lines.
A recovered market
The forfaiting market is somewhat healthier than it was a year ago, when the banks were still reeling from the effects of the credit crisis, causing a massive drop in both market appetite and liquidity.
“Many in the trade finance market have faced constraints on their ability to book new assets,” says Tom Turney, head of trade finance at Bank of Ireland. “Credit and balance sheet issues predominate but the medium-term business has suffered particularly from funding restrictions. That general lack of liquidity has limited the volumes circulating in the secondary market.”
As a result, there were a number of casualties, with SMBC Europe, Nedbank and Bank of Tokyo-Mitsubishi all forced to close down their forfaiting operations in the last couple of years.
Nonetheless, not all forfaiters agree that the situation that presented itself at the height of the crisis was that dire. Indeed some believe that a year ago, if one wasn’t weighed down with overdues and had enough credit lines and liquidity to purchase new assets, the situation was virtually a forfaiter’s heaven.
“The potential and opportunities on the buying side were unbelievable,” says Marina Attawar, member of the board at DF Deutsche Forfait. “But of course the downside to it was that there was no way to place any assets.”
Despite placing being virtually impossible, Attawar refers to last year’s state of affairs as an “extreme situation where you could ask for margins which you had only dreamt of for a long time”.
Even so, she notes that this situation has gradually relaxed over the last year, and the company has seen a continuous recovery on the placing side. This is especially so for business with a tenor of up to one year, while the placing of medium and long-term transactions are still somewhat limited. As a result, competition on the purchasing side has already begun to increase again.
But even though liquidity has returned to the market, it is becoming increasingly difficult to find good risks. “In fact, there are too few good assets,” says Michael Gilham, director, trade finance, financial institutions at Lloyds TSB. “If we’ve got a good deal on India, for example, there are a number of partner banks that I know that would be very grateful if we showed it to them first.”
New market players
It comes as no surprise that with markets easing, some banks are looking to either set up forfaiting departments within their larger origination departments, or to widen their current scope of business. Those banks focused on the longer term remain committed to the business, and are set to increase their market share.
Citi – which has always been involved on the origination side – has recently been looking to become more active on the secondary market side, while still maintaining their traditional primary remit.
“The focus for the forfaiting business now is asset optimisation, in that as well as trading in the primary markets, we are seeking to actively distribute this asset class in order to increase the facilities we can make available to support our clients,” says Doshi.
What’s more, new players have entered the market; American banks have entered the fore, as have some Asian counterparties. A few funds have also started looking at forfaiting and trade finance again.
“The forfaiting market has always been very resilient, and somehow or another always manages to find a way through – whether it’s adopting new products or countries to finance. There have always been participants that leave the market; or new participants coming in – it’s part of the cycle,” says ABC’s Lilley.
Most forfaiters are in agreement that at least in the short term, they expect to see an increasing number of parties coming to the secondary market, either to sell down or participate in trade flows they otherwise would not see.
According to Damian Austin, director, forfaiting and risk distribution at HSBC, a key reason as to why banks may have faltered and ultimately exited forfaiting business could be due to their lack of origination capability, and an over-reliance on short-term trading of diminishing secondary market business. “Large trade finance banks are more actively underwriting deals directly and adopting measured portfolio management or wider risk distribution of their primary business activities, instead of using ‘old-style’ forfaiting trading intermediaries,” he notes.
Gilham at Lloyds agrees that those institutions looking to turn paper in the way that forfaiters do are facing a major challenge. “There isn’t the abundance of paper that there’s been in the past, and a lot of banks with the lower volumes are looking to work with key partners.”
Origination is key
A common market view is that those forfaiting institutions that run their secondary market function so that it works alongside a strong primary origination capability as part of the overall business are far better positioned.
As such, those secondary market teams that had the support of the banks’ origination capacity – with a steady flow of business and a wider scope – weren’t challenged during the crisis in the same way as others.
Gilham at Lloyds believes that this is a trend that will continue: “You’ll see the teams that have that strong franchise behind them really benefitting. Until such time that there’s a lot more paper in the market, I think that’s going to remain the case.”
HSBC’s Sharp agrees that forfaiting or secondary market trading houses who have limited primary client or deal origination prospects, reliant upon sourcing deals from the secondary market are entitled to every penny they make. “Although if you’re looking to make a quick turn on these secondary deals, and markets are less liquid, then you’re likely suffering more than say, universal trade finance banks,” he says.
Although distribution is, and will always be, important, banks are now finding it imperative to offer all the key components of forfaiting – namely origination, underwriting, structuring and distribution capabilities.
“If you’re only on one side of the equation, the business model may still work but having more than one dimension to your forfaiting activities adds greater value,” says Simon Lay, managing director of London Forfaiting Company (LFC). “This allows you to offer your clients a wider risk capacity and therefore the opportunity for both parties to get more out of the relationship.”
Lay also notes that those who do not have origination capacity you are “held ransom” to the vagaries of the secondary market. “If the market dries up, or sentiment changes, it will be difficult to maintain your business volumes.”
Although the relatively quick recovery in emerging markets – particularly in the Asian and BRIC countries – has helped restore market appetite, volumes still lag behind pre-crisis levels as a result of the smaller physical trade turnovers and counterparties requiring tighter deal structures to assure genuine trade.
“Certainly, volumes are better than they were this time last year,” says Lilley from ABC. “People would like to see more volumes, but we’re not at that stage yet. I think the volumes are reasonable, and growing.”
The majority of forfaiters concur that the funding available in the market has become much more restricted. As such, constraints have largely been caused by increased funding costs rather than restrictions on writing new business.
“All of our funding premiums have gone up,” says an Asia Pacific head of a major global bank. “It is very difficult to buy deals when our funding costs are so high.”
Gilham at Lloyds concedes that the cost of funding is becoming more evident across all of the banks. “In a number of cases, we see that the pricing is bordering on the uneconomical really, which is crazy given all the events that are still happening in Europe and elsewhere. The pricing has come down too quickly in some cases as some banks chase business,” he says.
At the start of the year, when many banks that were out of the market came back in, they had to do their best to win back market share, and to do so, they dramatically undercut those doing business. As such, pricing has become overly competitive and has reached levels below those that reflect economic reality in some instances.
Gilham adds: “We’re seeing some transactions already that we can’t justify according to our pricing models. My hope is that we’ll see a pricing correction again to reflect the actual cost of transacting.”
Austin at HSBC believes that pricing has started to stabilise, if not tick up in markets in the last couple of months, “whether that be a knock-on from PIGS markets [Portugal, Italy, Greece and Spain], or some concentration on institutions’ portfolios, many in the secondary market are now able to pick and choose the deals they undertake and at what price”.
Simon Lay agrees that some developed markets such as Spain, Portugal and Greece are probably more difficult to price at the moment, as prices available in the CDS market never really translated into what was wanted or could actually be achieved for trade finance business.
There has been some discussion in the press and amongst industry players about a fall-out from what is happening in the eurozone, and perhaps a return to banks being less willing to lend to one another in the money market. “In theory that could cause difficulties again in terms of cost of funding,” says ABC’s Lilley. “But personally I haven’t seen any evidence of that. It remains a consideration, but it’s something that we’re monitoring. It might manifest itself in terms of higher margins.”
And so, while the impact of sovereign risk or the Greek crisis on forfaiters is not a direct one, it could transpire indirectly, in terms of the flow of new business, with customers not confident in replacing inventories and doing new trade deals.
For DF Deutsche Forfait, which did not see much Greek risk before the crisis, the situation in Europe does not pose much of a problem. Attawar comments: “In theory, unless you have tonnes of exposure in Greece – and now perhaps Spain – you are likely to see more assets, which in the past, nobody would have thought of selling. Our focus is on the emerging markets, and these in general performed very well during the crisis of the last two years.”
Another mounting challenge is a decline in the number of acceptable counterparties, says Sema Zeyneloglu, global head, financial institutions emerging markets at Rabobank, explaining that the ongoing crisis means that credit departments continue to scrutinise settlement limits and counterparty limits on banks. “The Greek crisis did not help,” she adds. “It may have a spill-on effect on the rest of southern Europe, home to some of the world’s main forfaiters.”
Return of syndicated loans
Although volumes are picking up on traditional supplier credit business, good quality new syndicated loans have been thin on the ground. As a result, reputable borrowers are coming to the market with a faithful following of established lenders, and many of the loans that have been arranged have been oversubscribed.
Moreover, there are facilities being brought to the market to early repay and refinance loans taken out as recent as in December last year.
“We were involved with several arranged at the back end of last year that have been refinanced at substantially reduced margins,” says LFC’s Lay. “While this is somewhat frustrating, it is understandable given the particular circumstances of last year. It probably marks a move towards more settled trading conditions and more good quality loans coming back to the market.”
Lay refers to an African Export-Import Bank loan that was closed in May this year, and was heavily oversubscribed. The final allocations of the facility totalled US$320mn and €134mn for one-year and two-year tranches. As a result of the overwhelming response in syndication, the facility is reported to have closed more than 2.5 times oversubscribed, though commitments will be substantially scaled back.
Lay comments on the success of the deal: “We bid for quite a large amount, but it was significantly scaled back in syndication and pricing was reduced when the tenor was stretched out slightly while the fees were kept the same. This demonstrated the success which can be achieved in the loan market for deals and risks which are priced appropriately.”
The facility will be used to finance an existing one-year term loan, due to mature in November this year. Bookrunners and initial mandated lead arrangers are ABC, BTMU, HSBC, ICBC, RZB, Standard Bank, Standard Chartered, WestLB and Commerzbank (as initial MLA only).
There have also been a number of Russian bank loans in the market, including an oversubscribed US$250mn loan facility from 12 international banks for privately owned Promsvyazbank.
Commerzbank, Credit Suisse, HSBC, ING, OCBC, RBS, RZB, Standard Chartered, UniCredit, VTB and WestLB all acted as mandated lead arrangers for the B-portion club deal – a US$150mn loan with a 12-month tenor, and priced at 275 basis points over Libor.
Banks that remain active in the region anticipate that another five or six Russian banks will come to the market during the second half of the year.
Zeyneloglu at Rabobank believes that borrowers are astutely taking advantage of fast improving market conditions. “As far as lenders are concerned, with credit keeping a watchful eye, approvals need to be backed by a good story, meaning that the relationship card and borrower track record play a major role. Still, with lenders cautiously underwriting again there are clear signs that confidence is returning to the market and that demand may already exceed supply.”
There has been a recent trend towards an increasing diversity of instruments, with products such as commercial insurance becoming more frequently utilised.
Forfaiters have traditionally been sceptical about using insurance, while insurers themselves have typically preferred primary business. Nevertheless, insurance is increasingly being used as a tool for risk mitigation and portfolio management as a result of its evolution over the past few years.
“Underwriting syndicates are quite reasonable and flexible about tailoring a product to suit our needs,” says LFC’s Lay. He explains that while the product may not be perfectly suitable to the business, as it is unfunded, has waiting periods, issues with transferability and involuntary rescheduling clauses, it has developed into something that has “meaningful applications for our business model and as a risk management tool”.
LFC began using insurance five years ago, and according to Lay, is definitely an option that the company considers using when looking at new risks and structures.
“I’m aware of market participants increasingly using the credit insurance market as a risk mitigation tool,” says HSBC’s Austin.
“However, given alternative (cash) sales which provide greater balance sheet liquidity and return on capital than risk indemnities or insurance, this will be less preferential to some institutions.” Yet, both Austin and Sharp believe that insurance should form part of a forfaiter’s overall armoury for risk mitigation.
Last year, insurers proved themselves by readily honouring claims under several headline defaults faced by the trade finance market, thus allowing forfaiters to overcome their reservations. Consequently, insurers have become more aware of the business they write, and prefer to focus on “pure” trade business, but also suffer from the lower trade volumes.
“In order for forfaiters and insurers to meet the challenge, insurers need to become more relaxed about secondary business, and forfaiters need to overcome funding constraints,” says Zeyneloglu from Rabobank. GTR