ECAs have been adapting their guarantees to allow export-related bank loans and bonds to be sold to investors in the capital markets. Sarah Rundell reports on a growing trend.
Export credit agency (ECA) support for financing through the capital markets is typically offered via financial guarantees on repackaged bank export finance exposure, direct bond issuances and securitisation structures, explains Sandrine Sauvel, partner at law firm Norton Rose Fulbright.
Venturing into the capital markets involves ECAs amending their policies to tackle issues around how the guarantees work and what the rights of the investors are, but it is a growing trend.
Some of the best-known examples of ECAs assisting with capital markets issuances include the selling of US Exim-guaranteed aviation assets to institutional investors in recent years. Exciting developments in South Korea have seen Kexim provide guarantees on bonds for the shipping industry as an alternative to bank finance in a structure modelled on the guarantees issued by US Exim for the aviation industry, and ECAs in Belgium, Switzerland and the Netherlands have also developed financial guarantee schemes for the capital markets.
Security in volatile markets
German ECA Euler Hermes was one of the first to adapt its guarantees on bank debt for the capital markets in a securitisation guarantee programme. Securitisation guarantees have been mainly used to make Hermes cover suitable for covered bonds (German Pfandbrief). Banks found the conventional cover Hermes provided wasn’t enough to attract external institutional investors when the time came to refinance, recalls Andreas Gehring, deputy head, product management, at Euler Hermes. “The banks were saying that our buyer credit cover left some question marks with institutional investors. They needed something extra to go to the refinancing market with.”
Hermes developed an add-on guarantee for the refinancing market that provided a 100% separate guarantee in favour of the institutional investor, and repayment on first demand in the case of a default. “Our guarantee makes these assets more attractive to those investors because it offers 100% cover and is fully guaranteed by Germany with its AAA-rating. If there is a problem, the refinancing entity can go to the federal government and present a securitisation guarantee and the government will immediately pay the full amount, while the regular conditions of the buyer credit cover remain valid for the financing bank,” says Gehring. In this respect the only risk for the government would be if the bank became insolvent. “If markets are fine, and there are sufficient refinancing solutions in-house, there is a reduced need for this kind of securitisation guarantee. But a key function of the securitisation guarantee is security in volatile markets.”
Bank demand to repackage and sell their exposure in this way is growing, notes Gehring. Banks are under pressure to reduce their balance sheets in accordance with capital adequacy and liquidity requirements imposed by Basel III, yet credit and liquidity have become scarcer: there is limited appetite from banks particularly for long-tenor financing, making it costly to match maturities in the same currencies – access to US dollars is also getting more difficult for some. It puts pressure on banks’ lending capacity, and sees them lending only to their best customers and avoiding riskier regions. “If they have this kind of [securitisation] cover they can continue with all trade relations,” says Gehring, adding that most demand for Hermes guarantees comes from banks looking to refinance trade deals in emerging markets. Moreover, these guarantees allow banks to approach German multilateral bank KfW for refinancing if they can’t refinance in the private market. “To access this KfW funding source, Hermes cover and a securitisation guarantee are pre-conditions,” explains Gehring.
A solution for risky assets
Danish ECA EKF introduced securitisation guarantees in 2012. They are used on bank debt on single assets being sold to institutional investors. They can also be used as a credit enhancement of a project bond, explains Christian Dam Pedersen, chief legal advisor, legal affairs and claims, at EKF. The ECA launched guarantees following demand from banks and local investors interested in export finance assets but reluctant to take on project risk directly – particularly around the financing of wind farm assets. Wind power now accounts for nearly 40% of electricity consumption in Denmark, and around 60% of EKF’s portfolio is wind-related. “We had requests from banks wanting to enter into deals without the deals having a major impact on their balance sheets and investors wanting to invest in the asset class,” says Pedersen.
The success of EKF’s programme has been down to getting institutional investors comfortable with the asset class. “These assets are distinct from a Danish government bond despite the guarantee because they are not nearly as liquid. It has the same security but you can’t sell it tomorrow,” says Hedvig Susanne Eckhoff, deputy manager, large corporates, at EKF.
Four years on, half of the institutions buying banks’ EKF-guaranteed debt are foreign, say Pedersen and Eckhoff. In an unexpected development, the process has even encouraged some institutional investors to make direct loans to large projects after having initially invested in EKF-backed paper. Moreover, EKF’s securitisation guarantees help Danish exporters win contracts, given that so much of the competition in exports rests with the cost of financing. “When our companies submit bids it helps bring in the finance if lenders know these guarantees are available for Danish exporters,” they add.
ECAs are venturing into the capital markets with other products too. Securitisation isn’t a real area of activity for Sace yet. However, the Italian ECA is active in the capital markets through “Sviluppo Export”, a new debt fund with a total capacity of €350mn designed to raise finance for unlisted Italian companies, mainly SMEs, pursuing export projects. Recently this facility allowed SCM Group, a Romagna-based industrial group making machinery, to raise €10mn. The seven-year bond with bullet redemption is fully guaranteed by Sace and allowed the company to access the capital market for the first time in order to finance international growth.
Investor interest in export finance assets is growing for a number of reasons, believes Mark Looi, head of export finance transaction management at HSBC, a bank arranging and placing both UK Export Finance (UKEF) and US Exim paper, mostly aviation assets, to US institutions. “US Exim produced a product aimed specifically at the capital markets; it was known to investors; they analysed it and there was a large market for it,” he recalls. Looi says institutions like pension funds with long-term liabilities seek the long-term nature of the paper and the guarantee acts as a proxy sovereign, reassuring they will be paid regardless of the performance of the underlying asset. ECA-backed paper is a more illiquid and therefore better-yielding asset than government bonds, and offers investors the ability to diversify because it is uncorrelated to other markets. “They are also a tradeable and regulated security,” he adds.
Gordon Welsh, head of aviation at UKEF, explains: “We have done a lot of work to educate and help investors come to this new market. Our first bond had 10-12 investors; in our latest, 49 investors got a chunk of the deal.” UKEF broke innovation levels last year when it guaranteed an Islamic bond issue for Emirates, the Dubai-based airline, in support of Airbus in the largest-ever ECA-guaranteed debt capital markets offering in the aviation sector. “We have led in the aviation section,” Welsh says. “We will increasingly use the capital markets, and Islamic structures, in non-aviation markets too.”
But investors remain wary of some characteristics of ECA-supported paper. The amortising nature of some ECA loans, whereby the interest generated reduces as the loan matures, is one challenge. “Most bonds don’t have amortising debt but the OECD requires it of ECAs,” points out Welsh. “Pension funds like the long 12-year tenor, the single bullet drawdown and the quarterly repayments. The amortising element is one of the challenges,” adds HSBC’s Looi.
Moreover, ECA-supported bonds have worked particularly well in the aviation sector because airlines like the lump sum, or single disbursement of a bond. “They can pay for the aircraft on the day,” says Welsh. In contrast, using ECA-guaranteed debt or bonds to finance projects like, say, a power station, where development is drawn out over years is more challenging. “This would typically require a bank-funded draw down and then a take-out to the capital markets. The capital markets are most relevant on completion of the product,” he adds.
The role of ECAs in helping exporters access alternative liquidity via the capital markets could also begin to ease if bank lending picks up. German multilateral KfW offers banks the possibility to refinance their long-term export loans granted to buyers of German goods as long as they have a Hermes securitisation guarantee. A wide range of German and international banks still use Hermes guarantees to refinance with KfW, but compared to 2010 and 2011, when more than €1bn worth of funding was provided annually, demand has tailed off. Now, on average, KfW refinances €700mn in this way, according to Fiona Fleischmann, head of the export funding team at KFW.
“ECAs have opened up another channel of liquidity via the capital markets but the issue is whether capital markets pricing is equal to or better than bank pricing: are investors wanting to buy it and is it cheaper than bank financing?” asks Looi. Attaching guarantees and selling debt or bonds is also a time-consuming process and experts note the lack of uniformity, or sufficient commonality, in the asset class with documentation varying enormously from deal to deal. “It takes between three and six months; it’s not something that can be done tomorrow,” says EKF’s Eckhoff.
According to Norton Rose Fulbright’s Sauvel, ECAs are likely to continue to evolve and develop their support of capital market products. “It is a market that should grow,” she says. “The view at the moment is that any investment guaranteed by a sovereign that has a yield is good news. The ECAs are looking to support the capital markets and securitisations and are more and more innovative in their approach to these products.”