The appeal for export finance remains strong, despite there being discrepancies in terms and pricing, agreed participants at GTR’s roundtable.
- Veronika Koroleva, partner, SNR Denton (Chair)
- Andreas Mehl, head of ECA advisory Emea, JP Morgan
- Chris Mitman, head of export and agency finance, Investec
- Max Niesert, managing director, head of trade and export finance, WestLB
- Kai Preugschat, managing director of international origination of structured trade and export finance, UniCredit
- Simon Sayer, head, structured trade and export finance, Europe (ex-Germany), Deutsche Bank
- Alex Taylor, Emea co-head of export and agency finance, Citi
Koroleva: In the last two or three years we have seen quite a lot of activity in the export credit agency (ECA) market. Have there been any changes in the last 12 months? After the crisis everyone was keener on the ECAs than they were before the crisis; has that changed?
Preugschat: Twelve months ago I was head of underwriting at Euler Hermes. Demand was breaking all previous records in terms of volume. What was remarkable back then was the conversion speed from presenting a transaction to financial close; I have never seen it that swift before. It appears now that the demand levels for this financing option as a percentage of larger export deals are still very high, but conversion is definitely slowing down, with investors having second thoughts about going ahead, and certainly issues around pricing of transactions. The demand is still growing.
Sayer: Some of the urgency has gone out of the market. People are still concerned about risk and how they are going to finance investments in projects. There is still tremendous interest in the product. But the urgency to close transactions has gone. We are probably back into a cycle which has a more normal deal lifetime than we saw in 2009/10 when things were getting done very quickly.
The other slight distinction I would draw is that during 2009 and 2010 we saw this product become extremely popular, not just in emerging markets, where it has always had a good home, but in developed markets as well. That is still there, but demand from the developed market has tapered slightly. It is a product that still works for anything outside of the single A credit rating. If you are looking at BBB and down, it works as a product in the developed markets, and we are as busy as ever in our traditional home of the emerging markets as well.
It is a business, as we all know, that has quite long lead times, so my expectation is we will see things slip a little bit, before people realise that we are, once again, entering a cycle where liquidity and cash are king, and inking these transactions is going to be important. There will be some urgency again when people realise just how challenging the market conditions are currently.
Taylor: We have also seen a tremendous amount of ECA activity in developed markets across multiple industries. Over the last few months there has been a resurgence of the product in the shipping industry where conventional bank capacity is constrained. We are seeing continued demand for export credit financing in aviation; we have seen banks go through cycles in their appetite for this segment, largely based upon their liquidity position, causing them to step in and step out of this part of the ECA market.
In a broader context, immediately post-crisis we saw many banks having problems with their capital position and operating under severe constraints. Agency support was extremely valuable in this context. We are now moving to a situation where people have concerns related to funding where an agency wrap is less useful and where funding support schemes differentiate the agencies. As a consequence of the funding situation we are seeing liquid new entrants, who have never played a role in ECA financing, enter this space.
Koroleva: Which sectors would you say are more active now?
Taylor: The aviation and shipping industries are the two that stand out and that are active across the board. Within these sectors there are huge variations across regions in terms of pricing and how the product is applied. For example, Latin America has a very liquid bank market and has the ability to access the conventional bank market and use bank debt without needing to seek recourse to ECA financing. However for an identical asset in certain countries in Emea, for example, ECA financing would be required to circle a financing. It is not necessarily about credit, it is a reflection of the competitive position of the local market and liquidity of local banks.
It has been fascinating to watch the pricing of deals. There are huge variations between regions, between countries and between borrowers. It is not driven by the ECA wrap; it is now driven by relationship, liquidity, country, currency and the banks involved.
Mitman: Absolutely; we only do so much volume of hard currency lending because of our rating, but we do a lot of advisory work for our project development teams as well as third party clients looking to tap the export credit market.
The spread of pricing we are seeing is unprecedented; certainly I have never seen anything like it. To date it does not appear to be driven even by the credit downgrades; it is more by tenor, currency, the natural home base of the bank concerned – where they are comfortable they are going to be able to sustain funding in the long term; is it euro or is it dollars? As regards sovereign downgrades, is it their home market ECA or one remote from their principal operations? The closer to home you get to a bank’s home market ECA and currency, the more confident the terms. It is similar to the nationally orientated export product market of many years ago.
Mehl: I see the ECA business as being relatively stable, mainly because of the lack of alternative funding. From our perspective, there are markets you don’t need to go to; as long as the investor is able to get funding at a cheaper rate locally, they will not go down the ECA route, or they will take the ECA route only as an alternative. On the other hand, tenor is our friend – always has been and always will be. It’s a huge incentive for investors to tap these time brackets and the product will be around for the next 10 or 12 years.
Liquidity is what it is. There is more liquidity in some places than others. If I was in a certain jurisdiction and married up with my ECA, I would support my client relationship and make liquidity available for a transaction. I would probably go down to a price that I would not normally go down to. When very rapid price movements happen, people say, ‘How can a bank do that?’ They do that for relationship purposes.
Koroleva: Is that the general view among the panel?
Niesert: The export finance instrument has become one of many alternatives in the overall market; we are less special than we used to be, and we are driven by the same factors as everything else. We are just one alternative, nothing more. We see that in the mature markets, but we will see that in the emerging markets, and we see that in Latin America. In Latin America nobody needs us; it may be helpful to use this instrument instead of another one. But if this one is not available they will take another one; it will not ‘kill’ a given project.
The second thing we have seen in the 12 months is a lot of shipping. There is a lot of aircraft, but when you look to the more traditional industries, the increase was not as impressive as one would have thought a year ago. In the end, aviation and shipping are the big volume providers for the industry, but it’s not really what export finance is about, because it’s simply a way to embellish competition for funding – that is it.
Koroleva: How did sectors such as manufacturing equipment or telecoms feature in the last year? Are these the ones that you mentioned grew as promised?
Niesert: It is a lot more modest than I would have hoped for, and there are not so many infrastructure deals in the markets. We are seeing new countries reorganising themselves, and in two years’ time they will start to do something for their people, which is infrastructure.
Sayer: Just on the sectors, I probably see it a little bit differently. To aircraft and shipping I would add telecoms and power, and then two industries which are related to commodities, one is steel – there is still a huge demand for steel investment and iron investment – and then the extractive industries.
We have seen a lot of demand out of Australia and South Africa in that respect. Previously the miners had always been very cash rich and did not have to think too hard about where they were getting their money from. They are still cash rich, but they are being smart and savvy about how they are financing the investments they are making, because there are so many investments to make. Those are hot sectors where in the past we have not seen as much activity as we are seeing today.
Mitman: One more thing to mention in the Sub-Saharan region is the entry by regional and local banks into the market in a concerted way. I have seen the other South African banks also try to make an effort to get to grips with the export credit product. They seem to have got over the fact that because they are based in Africa, and their hard currency costs might be slightly higher, means they cannot play a role in the market – they can. They own the relationships, they know the market, they have risk insight, they have local currency, and various other products they can bring to bear. They also do a lot of local export finance out of South Africa into the continent, so they are increasingly seen as valuable players in the market.
Koroleva: Have ECAs lived up to the pledges of their respective governments to ensure an export-led recovery? Are ECAs still seen as an essential component of deals?
Niesert: It facilitates recovery, but recovery must start from somewhere else.
Preugschat: In the heydays of importance of our product, ECAs supported a share of 8 to 12% of exports in some countries. Now, with this level on average below 3%, ECAs have and will continue to contribute strongly to a recovery, but cannot systematically lead as such.
Mehl: I would not discount the importance of ECAs to the economy, but ECAs will not lead us to recovery on their own.
Preugschat: It is always important to put the overall numbers in perspective. Overall global volume of long-term export finance stands at US$550-600bn. This is less than half of the lending book of HSBC. ECA cover is a very important facilitator to stimulate lending; it really contributes in challenging times. However, from an institutional perspective this applies only to a small fraction of the lending book.
Mehl: We have to give credit to ECAs for the remarkable speed of response in product development and underwriting flexibility during the crisis. We were saying that aircraft is not really what export funds are about but this sector has seen tremendous product development. US Exim stepped up to address the liquidity shortage. That has made a massive difference at a time of need.
Taylor: There is also huge differentiation between the agencies now, which never existed. It used to be very much that you had an ECA wrap, and pricing was broadly on a par. We have seen a complete schism where pricing comes out. It is at complete variance between the agencies depending on who you talk to.
Mitman: Is that the rating? Is it the quality of the product? Why is Italy, for instance, more expensive now than Germany or France? Is it the rating or is it something else?
Mehl: It depends on the project. If it is financially mainstream, the moment you get a downgrade the internal pricing goes up and you have to use underwriting. However, this is less likely to happen if a bank is dealing with its home ECA, with which it has a different kind of relationship and perception of risk.
Sayer: We have been factoring in downgrades, not because we necessarily think they are going to happen, but because what we have to remember with our book is, unlike a short-term trade book, or even a commodity trade finance book, when we are signing our deals, most of them are with us for a very long time: 10, 12, 15 years in some cases. There are a number of changes coming up in the market that are going to take place within that timeframe, and we are going to talk about some of them, like Basel III, and potential downgrades to sovereigns, and change in status of the sovereigns.
Anticipating what might happen in a 10 or 15-year horizon is very difficult, but what one could probably expect is, in the fairly short term, that there are going to be some sovereign downgrades, and people are pricing those into their transactions. We certainly are. Those ECAs with ratings close to the tipping point at which you have to start putting capital against the transactions are the ones that are being priced most highly at the moment.
Circling back to the point on whether ECAs have really delivered on supporting an export-led recovery, I think they have done a huge amount, and almost all ECAs have been very responsive. The ones that have scored a big hit are those that have been prepared to provide liquidity as well, and those guys have been incredibly supportive. They have seen the same increase in volumes as everybody else, and not only that, but they have provided liquidity on transactions when the whole sector has been struggling. That particular part is an extraordinary response.
Generally we are seeing ECAs returning to the sort of levels of flexibility of about 10 or 12 years ago. In the late 1990s, ECAs would compete aggressively against each other and would do quite extraordinary things, cover swaps, derivatives. A lot of that had been taken out of the market as part of less ambitious trade policies, part of the OECD harmonisation and as part of the level playing field. Suddenly we have had an environment in which it is OK to be a bit nationalistic and protective, and a lot of the things that were not on the table are back on the table now, because it is for the very good reason about trying to get an export-led recovery going.
Taylor: With respect to liquidity, we have seen a number of agencies take the view that funding programmes are less important to the market and we have seen some that have allowed their programmes to elapse. Those agencies that have a funding capability, as you say, have a massive advantage. For example, Sweden is one country whose ECAs can fund in huge size and, as a result, we see them as being at a distinct advantage compared to those agencies that simply provide credit support.
One of the things that has been mentioned is capital markets issuance. Some people were quite in favour of this while others felt it competed with the banks, especially on the ECA side. Given that Citi has a large capital markets group, we were comfortable with capital markets issuance providing liquidity to ECA transactions. What was the view on the introduction of ECA-supported capital markets issuance from everyone else?
Niesert: There was always a big debate in those countries where traditionally the ECA is only granting cover but not liquidity.
In the short run you are always happy to have liquidity which is tailor-made and provided by the government, but, of course, you are killing the tree you are sitting on. The worst example is the US; US Exim does it all, whatever they think is suitable, and the consequence is that there is little room for US banks to develop capacity and track record in the field of export finance.
In other regions, for example, in Europe, banks have a real role to play in the export finance value chain with governments granting cover and often interest make up, but actual liquidity only in a limited way or not at all. As a consequence, many banks have capacity and track record in the industry to the benefit of the industry and the banks themselves. If we long for liquidity provided by governments too successfully, we destroy the basis of banks’ role in the industry.
Mitman: For me, the old market gap definition has changed. We have to recognise there was a short-term liquidity crisis, banks saw Basel III and their funding costs rise, and suddenly they are not the most efficient funders of export finance. ECAs responded really well in terms of redefining the role they played in the market from just pure risk mitigators to providers of liquidity in some circumstances.
Preugschat: One of the biggest challenges we have is really the mere fact that ECAs, by definition, have a national mandate. The OECD has given a very good framework for what taxpayers, banks and borrowers should expect, and individually they defined the national value-add level that needs to be contributed to qualify for cover.
However, we still have to go a long way to define the common requirements for the funding side. Naturally, most ECAs are developing products with a focus on asset coverage. As banks, generally, we are able to demonstrate that we have very decent cover in place. ECAs are regarded as highly reliable risk counterparties. Clearly where it goes well beyond the national side is our liability management. As an industry, we have failed to develop common standards and platforms to ensure that we can access third party liquidity. Some of us have a securitisation vehicle, some have successfully placed synthetic covered bonds, and some do one-off transactions with aircrafts, to tap off-balance sheet funding. But if you go to an institutional investor and ask him: ‘Do you want to buy my asset?’ He says: ‘Show it to me on Bloomberg,’ and he will not find it. If we want to take advantage of the placement environment to access liquidity and create an asset class, this is something that we really need to jointly develop with the ECAs in order to unlock the commonalities.
Mehl: We all know that it is one thing what the ECAs and the banks want, and another thing what the legislation allows. The ECAs, together with banks and exporters, could be working harder to have a constructive dialogue to further develop the ECA product.
Sayer: On this point, necessity is always the mother of invention, and even over the last two years where conditions have been extreme, the securitisation model has not properly taken off because there have always been banks that will price transactions more cheaply than they can be priced in the capital markets. Some deals have been done, and people have got vehicles on the shelf, ready to go, with huge volumes to back them up and provide cover pools on assets, but it has not happened, because there has not really been a requirement.
I am with Kai on the point that it is in all of our interests to ensure, going forward, that there is another source of funding for this as a product. If we anticipate where the industry is going to be in two or three years’ time – coming to the question of Basel III, constraints around the size of banks’ balance sheet, how many assets they can hold on their balance sheet – we are clearly going into a direction that will lead us to structured solutions distributing assets off the balance sheet. Most of the dangers around Basel III for this business do not necessarily come from the business being less attractive in itself; it is just that the competition for resources in institutions is going to be so much greater, ie, the battle for the balance sheet, for risk-weighted assets.
Working in an environment that has a very low risk, relatively low return business, such as ours, is going to get squeezed out by businesses that have a slightly higher risk than we do. That steers us into the direction of securitisation. If we do not go with that then you are potentially locking yourself out.
Mehl: ECA doesn’t stand for bank credit agency, it stands for export credit agency; so the industry has to step up as well and play a leading role. The exporters need to step up to the plate and say: ‘Look guys, these are our jobs, this is our employment, this is our economy,’ but they haven’t been doing this over the last couple of years.
Niesert: As banks we cannot wait for the ECAs to do something. Either we do it or it will not be done, but we need to view it as an industry matter.
Preugschat: We will not do it 100% alone – that is what I mean – we need to define those commonalities with the ECAs. A beautiful example is the German securitisation guarantee, which is a fantastic product helping you to tap more liquidity, under cover, either via using your highly-regulated German-covered bond book or by placing it with investors. The banks used a product that already existed for a narrowly defined purpose, and jointly with Euler Hermes, it was re-engineered in stages to address the requirements of a broader capital market investor base. But we do not have a working body where ECAs and export financiers get together where we jointly develop products – this is what we need as an industry going forward, not least in the light of the Basel III challenges.
Taylor: The market point is interesting; there should be a fully transparent market for these assets to trade where you know the value of, and have the ability to buy and sell. Citi does sell in secondary, and occasionally we buy. As an industry, however, many institutions get a deal, book it, and sit on it forever. If we can establish something that is much more visible and much more open, that would be very valuable in itself. This will, however, shift the industry focus to the arranging side.
There are occasions when we will look to take large holds in deals, and there are occasions when we will look to distribute aggressively, but our focus is primarily the arranging – putting the deal together, closing it. Once a deal is closed, who is booking that deal ought to be immaterial. We are receiving feedback that certain clients are sensitive to who holds a deal, where it goes and resultant changes in delivery risk and funding costs. If we can establish a model whereby we are putting deals together, and we are distributing it into a deep and liquid market, that will address many of these concerns and help the bank market overall.
Mitman: Anecdotally, we were sounding banks recently on a long-term export credit and one of the responses went along the lines of: ‘This is not an asset for a bank’s balance sheet: this is for institutional investors – pension funds or similar who have long-term funding positions.’
It is a question of getting from where we are now, which is in transition, to there, and it is going to have to happen at a national level, because the national interest argument is going to come on board, and banks in the country get together with the ECA and actually talk about these issues. I would like to think there could be a European solution.
Preugschat: It is a long way off at the moment.
Niesert: It will not be organised by governments. We may create a market, where, let’s say, the traditional behaviour of Citibank becomes mainstream. Traditionally we see banks who are more on the investor side, who never manage anything, and simply participate without any closer interest for a particular transaction or the cross-selling opportunities that a given transaction may provide. Why not? In Basel III environments, participating and funding institutions are likely not to be regulated banks but other financial institutions. We have all done transactions where these different roles have been assumed by different institutions, in line with general market practice in the loan business. However, for the bulk of the ECA business, we still see that banks originate, book and wait until repayment without distributing assets later on. If that is no longer suitable for us, it is up to us to organise a market where export finance assets become liquid.
Mehl: We also need to be price sensitive. Everybody was looking at his or her balance sheet, and deciding on a case-by-case basis whether or not to make the balance sheet available and in most cases only making it available to clients. I do not think that there are a lot of corporate banks out there making their balance sheet available to non-clients. I would like to see a situation where we have non-bank investors looking at the risk return and the money they can earn on the quality of the asset.
Preugschat: We need to show ECAs how it works and where the gap is.
Taylor: I do not think that we would see a situation where banks are not highly relevant, from a structural and balance sheet viewpoint, at least to that point where assets can be distributed. I would hope that there will always be a space, and then there will be the small deals where it simply does not work, where the borrower does not understand what it is all about, and cannot cope with the capital markets issue. Even if they could, maybe the market would not want to do that particular deal, because there are two credits involved there and they do not understand one of them. There will always be bank lending.
Preugschat: One of the challenges is that banks’ chief risk officers coming in these days may have never heard about our products, and they do not buy your story: ‘Can you show me evidence about the default history and the indemnity behaviour of the ECAs?’ It is very clear that we do not have a major product for any risk officer. He will increasingly benchmark us against other mainstream products in the market.
Niesert: This is a general issue; we are the exotics in the European banking landscape. All of us are capable of pretending that business with Gabon can be low risk and profitable. It is an exotic idea for everybody else.
Sayer: I do not know how colleagues around the table have seen their business measured over the last few years, but we have seen a tremendous change over the last six months in the way our business is measured, and we have always been measured on the basis of return on equity or risk adjusted return on capital (RAROC). That model has been prevalent across the industry. Six or eight months ago it changed, partly in response to what is happening in Basel III, but partly in response to the market. We are now a business that is measured on return on assets, and return on risk-weighted assets, and return on leveraged capital, which does not yet exist, but is expected to exist under Basel III.
When I first joined the industry a long time ago, return on assets was the stock measure for how you measure the business. It is a very blunt instrument; it is not a particularly sophisticated measure, but in an environment where everybody’s balance sheet is going to be of a finite size, it again becomes one of the most important calibrations about how well your business is performing.
RAROC and return on equity was an appropriate measure in the past as well. Banks could be as big as they liked, because you could get as much capital as you wanted; it was all about how much return you can get on that capital. You can no longer do that, capital is going to be restricted, the size of banks is restricted, and it is now all about your balance sheet, and how much return you can get on your balance sheet. Return on assets is a measure for that. Again, this is not a product that has been well known over the years for having fantastic return on assets. It has got a beautiful return on equity, a beautiful return on capital, a fantastic return on risk-weighted assets. For return on assets, it is not a great performer, and that alone is going to drive us down an off balance sheet route.
Mitman: Particular banks’ operating models would have to be adapted to reflect the market reality, so banks who currently have the product and the capability sitting in project finance, you need to look at that model again and say: ‘Perhaps we should be in with the trade guys’ and look at more of an end-to-end trade finance proposition, which includes the ECA capability, and balancing the export credit activities as a capability versus a business. These are things that are going to have to be looked at case-by-case as the market evolves.
Koroleva: Will sovereign downgrades (such as in the US) affect the creditworthiness of ECAs and the market generally? Will it make credit committees wary of ECA-backed financings?
Sayer: Nobody had to think very hard in the past about sovereign issues – it was not an issue. Five years ago, Greek bonds were priced almost at German bonds. How crazy does that seem now?
I do not think that anybody is genuinely concerned about the risk of losing money in any of these, and in this market we are at least one step, and possibly two steps, removed from a real sovereign risk, because we have an underlying obligor in a very creditworthy market like Brazil that we would be happy to lend to anyway, and they would have to go into default before we even had a claim on the sovereign. Then you have got to think, is the sovereign really going to default on its trade obligations when everyone is trying to export their way out of the recession? I do not think so, and I do not think even our credit committees think so.
It is all about how much return we are making on the capital that we have to allocate to a sovereign that has widening spreads, and your rating tells you one story, the CDS tells you another.
Taylor: In our view the recent credit downgrades have not driven price increases. Instead, these pricing trends are a result of concerns over liquidity and Basel III. So the genesis was actually the funding costs.
Mitman: On another note, the US has certainly been quite prolific in terms of its profile and supporting US exporters, government at the speed of business and trade delegations down to South Africa. Also some well-publicised instances of matching from some of its non OECD competitors. In terms of what we discussed about national interests, I am not close enough to have a view, but I am wondering whether you see that: US exporters and European exporters, competing against non-OECD competitors. Are you seeing instances of matching; are they prepared to do that like the US apparently are?
Sayer: There has been a tacit recognition over the last two or three years that it is a little bit like every man for himself through the crisis, and ECAs have done what it takes to get the job done.