November 30, 2010

Key Considerations in Analysing the Credit of Structured Trade Finance Transactions

Anne-Marie Woolley

AFREXIMBANK SEMINARFundamentals of Structured Trade Finance

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Connecting Africa to the World and the World to Africa

3 Activity driver # 1: Africa inward FDI flows 2009

Data per www.fdiintelligence.comOverseas investment projects above $100m recorded by fDi Markets between January 2009 and March 2010

UAE

EU

$1.0bn

$3.1bn

$1.0

bn

$3.4bn

$30.4bn

$8.4bn

$13.5bn

$39.

7bn$1.1bn

4Activity driver # 2: Africa trade 2009

Increasing trend in Africa’s share of total world trade in last decade**

Consistent organic growth in Exports and Imports from BRIC, US and EU

Strong CAGR across all the regions

− Export to China: 40.2%

− Export to USA : 24.3%

− Import from China : 36.1%

− Import from India:26.6%

Aggregate Exports and Imports from BRIC, US and EU

* EU-Africa trade data from 2008** European Centre for International Political Economy Data per IMF

$21.8bn$110.4bn

$16.5bn

$8.6bn

$1

33.9

bn

$1

30.6

bn

$1.63bn

$5.06bn

$46.88bn

$47.99bn

$12.3bn$4.7bn

5Activity driver # 3: Large donor flow recipients

Total donor flow growth in Africa – 78.6% (2002-2007) Standard Bank presence countries represent 43% of total African donor flow

Data per Africa Economic Outlook

SB presence countries

Non-presence countries

Donor Flows (US$ billion)

  2002 2003 2004 2005 2006 2007

Angola 0.41 0.49 1.14 0.42 0.17 0.24

Botswana 0.04 0.03 0.05 0.05 0.07 0.10

DRC 1.17 5.42 1.83 1.78 2.05 1.22

Ghana 0.66 0.97 1.40 1.15 1.18 1.15

Kenya 0.39 0.52 0.65 0.77 0.94 1.28

Lesotho 0.08 0.08 0.10 0.07 0.07 0.13

Malawi 0.38 0.52 0.50 0.58 0.68 0.73

Mauritius 0.02 -0.01 0.03 0.03 0.02 0.07

Mozambique 2.22 1.05 1.24 1.29 1.60 1.78

Namibia 0.13 0.15 0.17 0.11 0.15 0.21

Nigeria 0.29 0.31 0.58 6.40 11.43 2.04

South Africa 0.50 0.64 0.63 0.68 0.72 0.79

Swaziland 0.02 0.03 0.02 0.05 0.03 0.06

Tanzania 1.26 1.72 1.76 1.49 1.83 2.81

Uganda 0.73 1.00 1.22 1.19 1.55 1.73

Zambia 0.79 0.75 1.13 1.16 1.43 1.04

Zimbabwe 0.20 0.19 0.19 0.37 0.28 0.47

Total ODA into Africa (2007): $38.7bn

$1bn

$1.7bn

$2bn

$1.7bn

$1.9bn

$1.2bn

$1.08bn

$2.4bn

$1bn $1.27bn

$0.7bn

$1bn

$2.8bn

$0.9bn

$2.1bn

$1bn

$1.1bn

6Activity driver # 4: Favourable business environment

Africa’s recent sustained growth has been made possible largely by improved political and macroeconomic stability, a strengthened political commitment to private-sector growth, and increased investment in infrastructure and education

Many African countries have liberalised trade since the early 1980’s, and throughout the continent fiscal soundness and monetary discipline are increasing

World Bank Index: Ease of doing business

Ranked from 1 to 183; the closer to 1, the conducive the regulatory environment

Source: World Bank

Country Moody's S&P Fitch

Rating Outlook Rating Outlook Rating Outlook

Angola B1 +ve B+ Stable B+ +ve

Benin B +ve B Stable

Botswana A2 -ve A- Stable

Burkina Faso B Stable

Cameroon B Stable B Stable

Cape Verde B+ -ve B+ Stable

Egypt Ba1 Stable BB+ Stable BB+ Stable

Gabon BB- Stable BB- Stable

Ghana B+ -ve B+ -ve

Kenya B +ve B+ Stable

Lesotho BB- -ve

Mauritius Baa2 Stable

Morocco Stable BBB- Stable BBB- Stable

Mozambique B+ Stable B Stable

Namibia BBB- Stable

Nigeria B+ Stable BB- Stable

Rwanda B- +ve

Senegal B+ -ve

Seychelles B- +ve

South Africa A3 Stable BBB+ -ve BBB+ -ve

Tunisia Baa2 Stable BBB Stable BBB Stable

Uganda B+ Stable B +ve

Sovereign credit ratings enjoy mainly good outlooks

130 - 159

160 - 183

1 -99

100 - 129

N/A

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Activity driver # 5: Growing Consumer Market

By 2015, 221 million additional basic-needs consumers will enter the market in Africa

Natural resources are driving the boom; Wholesale and retail generated 24% of Africa’s GDP growth from 2000-2007

Africa is nearly as urbanized as China and has as many cities of one million people as Europe does

Breakdown of Africa’s Population

5234

3955

7 9

12

0%

20%

40%

60%

80%

100%

2005 2015 (projected )

Destitute (<$1,000) Basic needs ($1,00-$5,000)

Middle income ($5,000-$25,000) Global (>$25,000)

By income bracket %100% = 792964

(1)

Note 1: Figures do not sum to 100%, because of rounding

Source: Global Insight: McKinsey analysis

Drivers of Africa’s growth Urbanisation of Africa

622

55

66

910

1213

24

0 5 10 15 20 25 30

Other servicesTourismUtilities

ConstructionReal estate, business serv.

Financial intermediationPublic administration

ManufacturingTransport, telecom.

AgricultureWholesale and retail

Resources

Sector share of change in real GDP, 2002-2007100% = $235 billion

Source: McKinsey Global Institute analysis

Share of population by region, 2010, %

100% (mil of people) 1,219 1,032 1,351 830 594 349

48 52 109 52 63 48

Number of cities with >1million people

3040 45

73 79 82

7060 55

27 21 18

India Africa China Europe LatinAmerica

NorthAmerica

Rural

Urban

Source: United Nations

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Trade finance is considered less risky compared to general working capital facilities for the following reasons:

−Parties other than the borrower (Banks/DFI’s ) are also involved and the probability of all of them defaulting simultaneously is low.

−Trade finance is considered self securing and self liquidating

−Trade finance, tied as it is to identifiable cash flows, offers better recovery rates compared to general working capital finance products, such as overdrafts.

−Trade finance and trade cash flows are of critical strategic importance to the borrower. They are therefore less likely to default on these commitments as that could mean immediate stoppage of his business.

Trade finance is the finance of specific goods and services (generally, but

not exclusively) across borders

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Structured Trade Finance Transactions

Self liquidating, receivables-backed transactions with identified repayment sources

−Generally know what you are financing and where in the cycle you are Imports and Exports Generally short tenors, but can be up to 5 years Historically, lower default rate but still require detailed credit analysis Can be “ring-fenced” from other business Counterparty:

−Transactions “With Recourse” to the borrower:

Usual credit analysis: management, financials, strategy, reputation, sector…

− “Without Recourse” transaction:

Analyse the buyer / market

Trade finance is not generally regarded by regulators as posing a systemic risk to banks and as trade levels are consistently growing

it offers a source of low volatility returns to the Bank.

Low Risk Profile with Service as Financial Intermediaries and Providers of Credit

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Role of Banks

The economic importance of trade finance stems, not just from our role as providers of credit, but also from our status as a trusted third-party financial intermediary. By working with Importing and Exporting Clients the role of Banks is:

► Provider of liquidity

(especially in emerging markets where capital market liquidity is low)

► Credit enhancer

(using the rating of a Bank to enhance the credit worthiness of client)

► Risk mitigator

(through structure)

► Management of payments and documents associated with trade

(control of documents through the banking system)

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Risks for Consideration

Industry (Agriculture vs Mining) Management Sovereign, SOE, local Corporate or multi-national Financial/Balance Sheet (gearing) Production / performance risk

− Processing risk ? eg cotton ginners, copper smelters Off-take risk / demand risk/Counterparty risk (who is the buyer?) Tenor short term vs longer Price Risk (can you hedge, should you build in margin calls?) Goods depreciation risk (price risk + quality risk) Transport/Logistics Warehouses (who owns, condition, control) Theft Monitoring / operational risk FX risk Facility structure / legal risk Insurance risk (goods, PRI or PII) Political / country risk Reputational risk (for International Banks)

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Good practices

Thorough due diligence including site visits and meetings with all parties involved

Rely on independent quality and quantity assessments Spot checks on all players in the trade cycle ( borrower, collateral manager,

forwarding agent, shipping company, off-taker) Do not assume two transactions will work in the same manner Know what you finance at all times and where the financed goods are

− Follow the goods

− Follow the cash Seasonal or Annual clean-up Make internal and external processes and procedures clear “Damage control”: plan for if/when things go wrong MONITOR (don’t assume everything will perform as expected)

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The Goods being Financed

There are a great variety of goods financed under trade structures:

“Soft” and “Hard” commodities e.g. coca, cotton, oil, sugar, copper

Raw material and finished goods e.g. capital equipment, palm oil

Services/Intangibles; receivables e.g. overflying revenues

Key questions: Have goods already been produced and pre-sold upon drawdown of the facility? Is the price of the goods volatile? Perishable goods with deteriorating quality? Are the goods ready to be marketed or do they need to be

processed/assembled? Can the goods financed by the bank be clearly identified or are they co-mingled

with other stock? Can they be tracked/traced? Are there substitute off-takers (liquid market) and at which cost can the goods

be sold (discount in case of forced sale)? Location: Are the facilities owned or rented? Approved by insurers? Secured

and clean? Is access restricted but authorised to the banks? Transport: who is taking care of the transport including loading , unloading,

customs clearance? Who has title on goods during transport? Is a license / export permit required to trade the goods?

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The Security Package

Typical security package: Rights/Pledges on the financed goods, Assignment of receivables, Charge over a (offshore) collection account

(there should be no gap in the security package ; controls must be in place at all times including transfer points

Control over revenue collection:

−Domiciliation of receivables into collection accounts

−Approved buyer limits

−Off-takers: credit worthy off-takers with capacity to purchase the whole financed quantity

−Off-take payment terms (L/C or open account, deferred / immediate payment)

−Alternative market/buyers Collateral Management Agreement with a 3rd party Insurances: with a reputable company ; must cover all stages of the

transaction ; is PRI cover included? Hedging through tripartite agreement in case of volatile goods L/Cs: UCP liens Guarantees / Recourse to the borrower or a parent company?

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The Legal & Regulatory frame

Enforceability of the security package

− to be confirmed by local legal opinions Securities can be expensive to put in place in certain countries

− (e.g. cost of stamps for registration of pledges …) Consider FX convertibility / transferability restrictions Required licences / trade permits must be identified and monitored Is Parliamentary approval required ?

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The Importance of the Agent and of Monitoring

Independent quality inspection The lender/agent needs reliable operational capacity to :

−Control CPs and condition subsequents ;

−Monitor insurance documents ;

−Monitor receivables ;

−Do reconciliations between outstanding amounts and reports produced by the borrower, stock monitor, hedge provider

Coverage ratios:

Market value of goods / outsanding under loan

Sales contract value / outsanding under loan

Debt Service Coverage Ratio’s (DSCR)

Loan Life coverage Ratio’s (LLCR) Independent monitoring: CMA / SMA

−Who are they, experience, Professional Indemnity Insurance

CARE – NOT A PANACEA OR SUBSTITUTE TO STRUCTURE

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Current Market Structures

Oil Deals

− BP Angola; classic oil PFX

− EGPC, Egypt and the PXF/PEL deals

− Sonangol, Angola; is it “structured” PXF today?

− PPMC, Nigeria

− OTC in Kenya

− Indeni Refinery, Zambia

Soft commodity

− Ghana Cocoa Board

− Cotco, Zimbabwe

Mining

− First Quantum, DRC

Telecoms

- Zain/Bharti

- ZTE/Huawei (suppliers to sector)

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BP Angola

Financing Structure

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NNPC USD97m Silent Payment Guarantee Facility

NNPCFuel

Supplier

BANK

Claim under gtee

Issues gtee

Copy of B/L & PU

Issues payment undertaking

Supplies Product

FACILITY

Bank issues silent payment guarantees in favour of international oil traders assuming NNPC/PPMC risk and Nigeria country risk – BUT NOT COMMERCIAL RISK.

Fuel Supplier (ie. Vitol) agrees contract, ships refined product to Nigeria and presents Invoice to NNPC; NNPC stamps Invoice and issues Payment undertaking in favour of Fuel Supplier; Fuel Supplier presents copies of PU, B/L and Invoice to Bank; Bank checks shipment is authentic; Bank issues silent payment guarantee in favour of Fuel Supplier for 85%/90% of shipment value; Funding may also be offered under a discounting arrangement In the event of non-payment by NNPC, Fuel Supplier claims from on Bank. Fuel Supplier assigns their claim on NNPC to Bank; Bank claims from NNPC direct.

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Flows and Controls Chart – an Example

Lender(s) and

Agent

Borrower

Off-taker

Collateral Manager +

Quality Inspector

Stock

Collection Account

Insurance

Forwarding Agent +

Shipping Company

Guarantor

Loan

Sale and transport of goods

Repayment

Hedge Provider

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