Features

All dried up?

Wednesday, 01 July 2009

For 16 years, commercial banks have jostled competitively to finance Ghana’s annual cocoa crop. Today, Ghana’s state-run cocoa company and guardian of the world’s second largest cocoa crop, Cocobod, is likely to find it tougher and pricier to raise the money. Cocobod needs about US $900 million, but the big freeze on bank lending refuses to thaw: it’s looking at a funding gap of several hundred million dollars.
"For the first time it looks like there won’t be enough capital to meet requirements," says Tim Turner, director of the private sector department at multilateral lender African Development Bank (AfDB) Group. "We have been asked to get involved in a transaction we would never normally have even thought about."

Low risk, short-term bank lending with goods secured as collateral allows importers and exporters to finance their business and oils the wheels of trade with an estimated 90% of all world trade - worth US $14 trillion last year - financed on credit. Instruments such as letters of credit (see box) cover the shipment of goods and allow exporters cash now, rather then wait for buyers to pay up. In the case of Cocobod, trade finance funds a whole year’s crop as money is lent to farmers up front to buy seeds and fertiliser.

Lending cuts
If Cocobod, Africa’s flagship borrower, isn’t attracting the usual interest it’s a sure sign other businesses in the region are finding it tough to access trade finance. In the past year trade finance has fallen victim to the credit crisis as investors drag their money back home to shore up balance sheets and cut borrowing. IMF experts gathered at a WTO meeting in March estimate a global shortfall in trade finance of $100-$300 billion. Africa, perceived as more risky than other regions is being hit harder than most.
"Our pipeline of business enquiries, which averaged $3 billion over the last few years, stood at $12bn at the end of April 2009," says Jean Louis Ekra, President of Cairo-based multilateral institution African Export Import Bank (Afreximbank).
"Many leading international banks that have been regularly participating in our syndications over the past ten years are no longer expressing interest because they are dealing with their own liquidity situation."

So, just how bad is it? International banks that lent to Africa in the past are defensively cutting their exposure. And although many African banks are on a sounder financial footing than their European and US cousins, their trade finance divisions are suffering just the same. Europe and US banks’ retrenchment slashes the ability of local banks to lend because they rely on international counterparty, or correspondent banks, for credit lines.
"Most of our counterparties offshore have scaled down the lines of credit they used to offer and now require cash margins and only finance a portion of the intended facility," says Wilson Khaniri at National Bank of Kenya. "Requests for confirmation and refinancing facilities from African banks are showing a drastic increase, which is an indication that their other sources have declined," says Ekra.

Cash cushions
Nicolas Clavel, Chairman of London-based hedge fund Scipion Capital believes new regulations introduced in Basel II, the second round of the Basel Accords, which ask trade financiers to set additional capital aside to guard against operational and financial risk make it more costly than ever.
"New capital adequacy ratios mean trade finance requires much greater capital outlay," he says. "The cost of trade finance has increased dramatically and will not revert to level it was in a hurry."

Africa’s small, start-up and untried businesses are suffering most. "Banks are looking for customers with a track record of borrowing," says Geoffrey Wynne, head of International Trade and Export Finance at London-based law firm Denton Wilde Sapte.

Elsewhere, exporters requiring dollar finance are struggling. Kenya’s flower and vegetable producers that sell their wares in pounds and euros pay most of their costs in dollars and like to borrow in this currency to reduce their exposure, says Peter Jones, CEO of Export Credit Agency Nairobi-based African Trade and Insurance Agency (ATI). "Borrowing in euros isn’t too difficult and local currency isn’t a problem but dollars have been in very short supply," he says. "Local banks don’t have the dollars to finance activity. Even if they provide credit guarantees this is not enough to get business going," says AfDB’s Turner.

Africa’s resources bias doesn’t help. Falling commodity prices means banks have scaled down lending because they believe it will take longer to recover their investment. Banks are also asking for more security in deals, raising fresh problems.
"It’s a question of how far down the production line you go in search of security," says Denton Wilde Sapte’s Wynne. "Risk-averse credit committees are asking if this goes wrong, what are we left with? This is proving a deal breaker."

International initiatives
Multilateral lenders are riding to the rescue injecting large amounts of capital into global trade. The World Bank’s private sector arm the International Finance Corporation (IFC) has put up $1bn from its balance sheet and hopes other development finance institutions, governments and export credit agencies will increase that to $5bn globally. In Africa, regional development banks have quickly followed suit. The AfDB has just unveiled a $500m initiative to finance lines of credit for the first time in its history.
"The AfDB didn’t have any trade finance programme before and this should really help," says Turner.

Afrexim Bank has negotiated a $100m trade and project finance line of credit from the Export Import Bank of China to finance short and medium-term trade in a bid to increase faltering China/Africa trade. The bank is also exploring more novel measures such as channelling foreign reserves.
"We are reflecting on how to make Africa’s external reserves valued at around $460bn work for our continent rather than finance developed countries’ economies," says Ekra. He says it is also developing ideas to channel domestic institutional investors, mostly insurance companies, to fund short-term trade finance activities.

These multilateral funds are filtered down through banks where they are being used to finance trade. "The IFC recognised Standard Bank as a partner to get this money into the market as soon as possible. It’s not a soft loan, but for players that have valid and commercial businesses," says Craig Polkinghorne, Global Head and Director of Structured Trade and Commodity Finance at Standard Bank which is taking a $400m IFC credit line. "We’ve been subject to a number of calls from African entities wanting to know how to access this money. They can phone through direct or go through their local Stanbic office."

Standard Chartered, the London-based emerging market bank has taken $500m of the fund to go towards a total $1.25bn towards funding trade finance banks in emerging markets, of which $150m will go to African projects.

Local banking flourish
The crisis has created opportunities for some. For liquid African banks that dodged local currency and stock market crashes, the credit crisis provides an opportunity to steel a march on foreign competition. International players such as Germany’s HSH Nordbank and Belgium’s KBC have cut or scaled back their trade finance teams but the London office of Nigerian group UBA and Lagos-based First City Monument Bank are scaling up.
"Big banks have pulled back and local players are stepping up to the pate," said one UBA insider. Kenya’s Commercial Bank of Africa says it is looking to partner on trade finance projects worth $50m.

Non-banking institutions also see an opportunity. "We’ve seen a massive amount of business in the last nine months; our deal pipeline has multiplied by six," says Scipion Capital’s Nicolas Clavel, who has carved a niche funding short, risky periods of trade where banks are too wary to tread. Big institutions feel safest lending once the goods are "on the water" he explains, yet many soft commodities come from land-locked countries and require storage and overland transport. "It’s a deal breaker if they can’t find finance to cover these periods. We provide a very valuable service."
Other critics believe trade finance is too short term for most hedge funds. "It’s quite labour intensive," says Wynne. "I wouldn’t expect many funds to drill down to small-scale financing like this."

In the current climate companies that don’t require letters of credit are in a strong position. This includes businesses with long-established relationships with their buyers or subsidiaries of multinationals.
"In some cases buyers themselves make advances to suppliers who then don’t have to depend on banks and letters of credit," notes John Humphrey at the UK’s Institute of Development Studies, authors of a recent study into trade finance in Africa’s horticulture and garment industries. "We also found that trade credit, particularly for imported inputs in the garment industry, was the responsibility of the parent company."

Cyprus-based Chartmore Escrow Finance, which offers a third-party service holding money until trade obligations are finalised, also offers a service that is not LC-backed. It’s a business model managing director Charles Farran believes gives his company the edge in the current climate.

Similarly, the ATI’s primary service is to ensure receivables meaning exporters can borrow from banks without requiring a letter of credit. In 2008, it provided $604m in trade credit insurance to Kenyan SMEs. It is now looking to extend its activities beyond simply insuring goods to helping distribute multilateral funds to businesses on the ground.

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www.afreximbank.com
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www.scipion-capital.com
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www.standardbank.com
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Types of trade finance
Letters of credit: importers use LCs issued by their banks (the issuing bank) as a means of assuring exporters that they will be paid. If the exporter submits the required documentation like invoices or bills to its bank (the advising or confirming bank) payment is made to the exporter.
Bank lending: domestic banks provide credit to exporters to cover pre-shipment or post-shipment costs. Such funding is similar to provision of working capital in general, although it may be less risky to the extent that it is loaned against specific purchases and assets.

Trade credit: companies extend credit to each other when buyers delay or advance payments to suppliers. This is called ‘trade credit’, even within the domestic market. ‘Open account’ trade involves importers paying invoices once goods are received. Equally, importers can extend credit to exporters if they pay for goods (all or in part) in advance.
Source: Institute of Development Studies