Short-term trade finance has come apart in Latin America but banks and governments are focusing on home markets to the detriment of a global solution. The effects are reverberating hard in emerging markets and a dependence on devalued commodities and over-aggressive hedging by exporters are exacerbating the situation.
The summit paper published on January 20 by the Bankers Association for Finance and Trade (BAFT) in London showed the naked fear now gripping the industry. The issue of trade flows has been one of the least highlighted, yet most significant and worrisome consequences of the current financial crisis. With illiquidity threatening to severely inhibit global trade, doing nothing could have drastic implications for the global economy. Already, the World Bank is predicting a contraction of trade this year, compared with growth of 8.5% in 2006 and 6% in 2007.
The problems of trade finance are similar worldwide. Banks have been reducing tenors, bumping up pricing, and are dealing only with the highest quality correspondent names, preferring to spend limited resources on priority clients at home.
Cash for trade financing with emerging market banks has been particularly affected. Typically, banks in these markets acquire funding through remittances, dollarised exports (particularly commodities), foreign debt and funding from international correspondent banks. All of those sources have dried up, with remittances and commodities exports particularly vital for Latin America.
That has led to a huge shortfall in liquidity. Ask banks in Latin America what they want and liquidity, liquidity, liquidity is the answer, says senior trade finance officer João Viani da Silva at the Inter-American Development Bank (IDB) in Washington.
Global banks have slashed credit lines as funding costs have spiralled and decoupled from Libor. Libor has gone as a benchmark. Instead banks are inserting clauses into contracts which state that companies will pay a premium over the own banks cost of funding, says Burkhard Ziegenhorn, head of global transaction banking for Brazil and Argentina at Deutsche Bank.
Export credit agencies (ECAs) are having to step in and help, particularly on occasions when lenders are unable to fund themselves at a rate lower than that contracted and have not been able to re-negotiate interest rates, adds Ken Tinsley, senior vice-president of credit and risk management at the Export-Import Bank (Exim) of the US. Exims role there is part of a broader effort to keep banks involved. These are very unusual times and we want to keep the banks active. It is hard to build a trade and structured finance area, and once dismantled, it is very hard to put it back together again, he says.
Banks are reluctant to talk specifics on reductions in credit lines to correspondent banks but they admit that they are focusing far more on the higher echelons of their domestic client base. Global correspondent banking group Wells Fargo traditionally worked with top-tier banks, global groups and multinationals to support its business, says John Rodriguez, senior vice-president at Wells Fargo. Were focused on key customers in the US market. We have maintained limits that we felt were catering to support trade flows, but we have encountered net limits in certain emerging markets, he says. Mr Rodriguez points out that capital and liquidity costs mean that banks are a lot more careful about counterparty and country risk.
The situation is no different in European banks. In the medium term, Deutsche Bank is keen to develop its commercial bank. But for now, caution is the watchword. Were refocusing on core clients. Much of the attention is on German companies with a large presence, such as automakers, says Mr Ziegenhorn.
We look at each transaction individually, but within the whole client relationship and price accordingly, adds Jorge Tapia, global head of trade finance at Santander.
A wave of mega mergers including Standard Chartereds acquisition of American Express last year, Commerzbanks ongoing purchase of Dresdner Bank, and Wells Fargos merger with Wachovia creates duplicated trade financing lines. After the merger is concluded, companies find that when they try to renew credit lines with the new entity, the amounts are lower than those they obtained from the previous separate entities. That would make the situation even worse, says Mr da Silva.
What weve found is that globally, when two banks merge, one plus one does not equal two. It equals something more like one and a quarter [for credit lines], says Scott Stevenson, regional head of the Latin America Trade Finance Programme at the International Finance Corporation (IFC). As for the Wells Fargo-Wachovia merger, it is too early to tell what the effect will be on credit lines, says Mr Rodriguez. On top of all this, the secondary market for trade finance structures has dried up. That market is crucial, as it allows banks to leverage two or three times their credit lines.
Latin American issues
The situation for Latin America is similar to that of the rest of the world, although heavy dependence on commodities and inappropriate hedging in some of the region have provided a different twist.
Dollarised countries, such as Panama, El Salvador and Ecuador, have avoided the worst of the downdraft as local funding has made up, largely, for the shortfall of dollars. Those that allow nationals to keep dollar accounts, such as Argentina, have also fared relatively well.
Instead, it is the big countries, particularly Brazil, that have fared badly. Brazil, which accounts for more than 40% of regional trade financing for most international banks in the region, received some $80bn-worth in 2008, but this figure has dropped substantially. Leading banks in the region say that they are renewing just 50% to 60% of trade financing lines in recent months, says Mr da Silva. Part of this decrease may be mitigated by less demand from importers and exporters due to lower commodities prices, but it still represents a significant liquidity shortage, he believes.
Pricing and contracts are unrecognisable. Top-tier banks in the region would pay Libor plus 10 basis points (bps) or 20bps one and a half years ago. Now, as they seek to renew their lines, they are paying Libor plus 150bps to 200bps in Chile, Mexico and
Brazil. For second- and third-tier banks, the problem is even worse: they were paying Libor plus 50bps to 60bps and now pay Libor plus 350bps to 400bps. Even so, the figures have been worse in former crises, points out Mr da Silva. Back in 2002, there were banks paying Libor plus 600bps. There is still room to get worse, he adds.
The Japan Bank for International Co-operation (JBIC), the most important ECA in Brazil, has seen demand for loans repackaged through commercial banks become popular, says Takahiro Hosojima, the banks chief representantive in Rio de Janeiro. A couple of years ago, pricing on these guaranteed loans was considered expensive but now there are no alternatives, he says.
The crisis has also turned the clock back on many of the contractual trends that had allowed global trade to flourish. With a return to tight controls and risk aversion, there has been a marked shift away from open account trading to documentary trade financing, say bankers in the region.
The need for more documentation is especially the case for exporters based in countries where banks are more reluctant to take on country risk. Exporters can mitigate margins and lower rates through structured deals, says Santanders Mr Tapia. A whole range of products will be used, he believes. But it bears little relation to the structured products of a couple of years ago, which allowed companies to gain terms of 10 years or more, he adds. Yet the need for such enhancement has been relatively light in Latin America compared with countries such as South Korea, where there has been a notable increase in demands for letters of credit, says Mr Tinsley.
Finally, there has been a significant devaluation in key currencies, including the Brazilian real and Mexican peso. Exporters were taken by surprise and were on the wrong side with relatively long-term currency hedges. Some public companies have already announced losses, including Aracruz in Brazil, which posted $2.13bn in currency-derivative losses. That is potentially just one of many companies in this situation, says Mr Ziegenhorn. The results penetrate far more deeply and include multinationals from the auto to the software sectors, he says. His team is spending up to a quarter of their time in seeking to renegotiate contracts that have encountered problems.
Conservative companies hedged as much as 50% to 70% of exports on a rolling 12-month basis. The situation is particularly severe because exporters will fail to reach anywhere near 100% of their targets for exports. In Mexico, the tactic was used by companies from multinational Cemex to small-caps such as Gruma and Posadas. Losses could total between $4bn and $6bn overall.
Banks are seeking managed solutions to these problems. In Europe, when faced by a derivatives problem, ones next meeting is with 10 lawyers, says Mr Ziegenhorn. That is not the case in Latin America, where resolution is extremely protracted. In Brazil, it can take many years to resolve such a case so banks are negotiating directly with companies over payment terms. That is both distracting for management and makes them afraid to lend.
Demand and supply
With commercial banks largely absent from trade financing and, in some cases, worrying about the overhang of derivatives contracts, pressure has been piled on multilaterals and ECAs, who are being called upon to serve new kinds of companies in the region.
Were seeing bigger, better-quality borrowers that didnt need us pre-crisis, says Mr Tinsley. Even the most creditworthy names are finding funding difficult, for example, in the aircraft and oil and gas sectors, he says.
Banks have reined in their business in long-term financing as commodity prices remain unstable. Latin petroleum exporters, including Pemex and Petrobras, have ambitious investment plans which are now harder to fund. Petrobras is looking at more than $10bn-worth of investments to develop deep oil fields (see page New horizons). A large part of this will be in the form of trade financing as it buys equipment to explore further and for exports of oil products. Usually it would refinance through the bond markets, perhaps with structuring around exports. Even where they are ECA-covered, banks need to take on residual risk, says Mr Ziegenhorn. Credit people look at you as if youre from the moon when you talk about extending out 12 years, adds another senior banker.
Many companies that obtained basics, such as working capital and trade financing from loans or bond structures, need to go back and use trade financing as those sources have disappeared, says Mr Tapia. At the same time, many small and mid-sized businesses are using trade financing less, says Mr Tinsley. Some of their demand has been dissipating as they are no longer buying abroad due to local currency depreciation. It is too early to discern the material impact on their business as the two trends take shape, he says, guessing that there will be a slight increase in his overall portfolio.
Plans and solutions
Providing coherent solutions is difficult, given the parochial tendencies of global banks and the difficulties in over-riding home-first mandates for ECAs. Much of the work to inject liquidity is falling to multilateral institutions (MDBs). Their work is absolutely essential, says Mr Tapia.
Part of the problem is that multilaterals have typically only had small programmes in trade financing due to its relatively fundamental nature and the idea that it was less vulnerable to crises. That means that MDB programmes are small and their balance sheets remain constrained at a time of extraordinary demand for financing in every area.
The IDB raised the limit for its Trade Finance Facilitation Programme (TFFP) from $400m to a maximum of $1bn in January, it added loans and started supporting non- dollar denominated trade financing, says Daniela Carrera Marquis, manager of the financial markets division. In December, the IFC doubled the ceiling from $1.5bn to $3bn in its TFFP, which guarantees credit support to international banks, says Mr Stevenson. The trade programme, in good times, was targeted at frontier countries. With the advent of the crisis, we have had to intervene to supply financing in other markets, he says.
Both Ms Carrera and Mr Stevenson say that they have been working hard to co-opt other multilaterals, ECAs and commercial banks, with the World Trade Organization also playing a pivotal role. We have gained support from other MDBs who have openly shared with us their experiences and, in general, there has been a very cohesive approach between and within MDBs as we move from guarantees to loans and discussing optimal due diligence processes, says Ms Carrera.
MDBs are working hard to solicit support. We are trying to get ECAs to think outside the box, to lend support to their own financial institutions to keep trade lines open. Were asking them to consider joining forces not just through existing programmes but short-term support for trade lines. It doesnt have the sense of urgency from them that we had hoped, says Mr Stevenson.
Export credit agencies are doing what they can. Exim is dusting off its direct loan programme, says Mr Tinsley. The bank is also providing support to companies for indirect exports, where US suppliers of US exporters need capital. And it is considering providing funds to lenders to on-lend and other liquidity measures. Anything that we can do to keep the banks involved, we will do, says Mr Tinsley. But its mandate is to support US exports and jobs. Were already really pushing the envelope from our perspective, he says.
Mr Hosojima also believes that it will sometimes be difficult for the JCIB to work hand-in-hand with multilaterals due to its mandate to support Japanese exports and industry. Even so, the Japanese government recently signed a deal and provided $3bn-worth of funding, with the IFC, to establish a special fund to provide equity to medium- and low-income central banks with pass-throughs to private banks. If it goes well, the government could consider another such fund, he says. The Japanese bank is also working on two-step loans with the national development bank of Brazil, BNDES, says Mr Hosojima.
It is all a little disheartening. Limited resources at the multilaterals, limited room for manoeuvre at the ECAs, and commercial banks that have other priorities mean it is going to be difficult to develop solutions for trade financing. Patchwork moves and boosts to some programmes will help to meet some needs but only the gradual thawing of financial markets and globally low interest rates are likely to prove the cure for ailing trade finance.