Shop talk: The reflections and forecasts of Peter Luketa

TXF: What would you consider to be your finest achievement in your years as an export financier?

Peter Luketa (PL): Overall, putting the ECA product firmly on the map within the bank, and within the banking community. When I started, it was considered a niche product. When I finished, the product had been elevated to the very top of many organisations, and garnered some CEO understanding. I've always considered the business as one where you could pioneer deals and structures alongside client development.

And I would say that over the 20 years that I have been in the ECA business, there have been plenty of moments of pioneering, whether it’s been the first transaction with a particular client or country, or whether it’s been the first rouble or renminbi transaction. And that’s all because of the product, without question.

TXF: Can you pinpoint a particular transaction which you would consider your favourite deal?

PL: I think this would have to be Kaluga Cement in Russia. It is one that was politically-driven, and supported by the then premier of Russia, and took place in 2011. And for me, as I had started my career cutting deals in Russia in the 1990s, this deal was very much a culmination of working in that market. The deal was denominated in roubles also, which added to its uniqueness. [The Kaluga Cement deal was a €160 million equivalent transaction involving Denmark’s EKF, exports from FL Smidth and the loan made available through Russia’s VEB.]  The deal itself had added poignancy in that it was signed in Denmark's Parliament building before the Danish PM and President Putin (in his then capacity as chairman of the supervisory board of VEB).

In the Middle East, the Landmark deal in 2016 was also exceptional, because of its size and the fact that it was with the private sector. Again, it reflected the importation of high-tech equipment into an industry – retail – which was not a traditional sector for this type of equipment. Landmark is a retail sector customer but they continue to invest in state-of-the-art capital equipment to support the efficiency of their business - in this case a highly sophisticated warehouse operation.

But then again, there have been many great deals – and we could quite easily mention here the first deal we ever did with Reliance in India.

TXF: So can you tell us a little bit about that deal and what made that so special? And, given that the deal was in 2009 at the beginning of the global financial crisis, it must have been a challenging time within the business?

PL:  I recall actually sitting in the Hilton Molino Sticky Hotel – where TXF is having its 2017 Export & Project Finance Conference in June – with SACE, and talking to our bank’s credit re the concerns that Italy could be a potential default. The fact that we did the deal and it was highly successful changed our relationship with Reliance.  We have subsequently done more than 12 deals with them now – around two-thirds of all Reliance ECA deals – and as a lead arranger. And this is all came about because we held our nerve at a very tough time – sometimes you just have to do that. But India has always been a very tough nut to crack.

The GFC was a double-edged sword though. Not only did it produce challenging moments with intense internal credit discussions, it also meant that we started to deals that we had never seen before. A pinnacle of that was doing a deal with GE Capital Aviation in 2010 at a price in excess of 150 basis points. I don’t think we will ever see an ECA-backed aviation deal priced like that again. Cash-strapped blue-chip companies also started coming to the market. So that period was both challenging and rewarding at the same time.

TXF: How do you view the way that banks provide export finance has changed? And, over the course of your time at HSBC, what would you say have been the key broad issues that have influenced the development of export finance?

PL: Clearly, the fact that most banks have been pulling out of long-term lending (seven years plus) has had a big impact on the ECA market. Liquidity has been a major issue, and regarding sourcing [more costly] US dollar liquidity, we suddenly had to price it as part of the equation.

Prior to the GFC, we all saw some export finance deals hit rock-bottom pricing. As an example of that I remember one deal done by a big export finance bank with Mexico’s Pemex back in 2006 that was priced at 1 basis point. Even we did deals at that time where pricing was 8 basis points. And the reason that banks did this at that time is that they wanted to do the swap. The swap had a value, but the problem was that you then had the swap on your books for 15 years earning nothing! So the value was all up front.

At the same time the GFC was a balance check as it showed that deals could still get done cross-border.

I also think that the major impediments to business have been more political than regulatory. Regulation has certainly been an issue – in terms of the cost of credit, the cost of liquidity. But this hasn’t limited us from doing business. However, reputational risk has been a bigger risk to manage than regulatory issues. And recent cases in the market where banks have been fined heavily are a good case in point – those cases revolve around process, but have certainly disturbed the reputation of those institutions.

I think it’s fair to say that export finance follows global recovery and the patterns of that. But we know it’s an anti-cyclical product. When times are good the ECA product tends not to be so heavily used. A change to that was that prior to the crisis all the investors were banks, but subsequently we have started to see the rise of non-bank investors – whether it be pension funds or insurance companies etc. The GFC crystallised the opportunities for newcomers.

TXF: Can you pinpoint specific events that have really been instrumental, or could be instrumental in giving export finance a lift?

PL: The evolution of currency – use of local currency – has been highly instrumental in changing the business. As an example, rouble deals in Russia really made a difference in that market before sanctions kicked in.

In addition, the actual size of transactions has been a game changer in the market. Before the GFC deals of $100 million were seen as big, but since then we have seen deals of $10 billion (Saudi Aramco), and now we see deals of $15 billion. So we are seeing much bigger transactions, and because of that we are actually seeing a reduction in the number of transactions. Volumes have declined in 2016, but I don’t feel the pressure for future years.

Countries that have come back to the market, or are on their way back – such as Argentina, Iran, Myanmar – will require export finance to meet many of their goals and help develop their economies.

Iraq has always had a big question mark over it because it is still defined by political segmentation. Yes, we have seen some deals in Kurdistan, but for Iraq if there was more central control then we might see more traction.

Regarding Iran, we have seen that the ECA community has concluded that the country needs to be supported. I also think that governments in Europe will want to see Iran supported, and over time we will see a breakthrough. Whether this is through direct lending, or whether we see relaxation from Donald Trump – there will be some degree of breakthrough in the coming years – more likely within the next two years. As one single country Iran could easily be a $20 billion ECA market, and that is just the beginning.

TXF: What can you say in relation to the way ECAs have had to be innovative in order to support their exporters?

PL: One of the biggest things has been the introduction of direct lending by ECAs. This is entirely necessary today because of the size of deals and banks restricting their balance sheets.

Clearly the eligibility has changed – so we are now seeing more of ‘made by’ rather than ‘made in’. Today, we are even seeing US companies come to the UK to seek support from UKEF for parts of capital equipment produced here that may be part of a bigger package – and Boeing with Rolls Royce engines is a case in point. That’s innovation in itself.

In addition, we have seen the introduction of a number of capital market elements which some ECAs are using successfully.

TXF: What about the role of say an institution such as SEK in Sweden and the way that operates with EKN and Swedish industry?

PL: I think you have to look at this as a unique case. Sweden is a small market, with a few big exporters using ECA support. EKN and SEK have worked well together for many years now, and the buy-out which sometimes takes place is a Swedish answer to a Swedish scenario.

Clearly the US Treasury would like to have an absolute level playing field. But that is never going to happen, because the level playing field doesn’t exist.

TXF: Why do you think corporates should consider using export finance?

PL: A company can use the ECA product as an integral part of their financing armoury, and Reliance in India is a great example of that. ECAS provide financial security from a very reliable base. It makes sense.

And during a crisis the one product that has always maintained its status is export finance. During these times the ECAs have usually not increased the cost of insurance even though the banks have had to up the cost of lending. Even in a crisis this product has maintained its support, its profile and maintained its nerve.

If I go back to when I first came into this business back in the early 1990s, the export finance process was entirely rigid. This has changed dramatically, clearly during the financial crisis. Then again back between 2004 and 2006 we had all the discussions of would ECAs exist going forward. It was also a time when there was talk of utilising the capital markets more in order to bring in liquidity – and some of these early attempts failed because of lack of yield.

And even today, if we want to attract new investors into the sector it is not easy because the banks are very liquid again, and therefore very competitive. Other investors since the GFC have looked at the product and like the structures – but the big question is: is the yield relevant? I would argue yes, because there is still significant volume in the business, albeit skewed to a particular geographic sector – the Middle East.

But if you take just two big projects in the Middle East – Expo 2020 in Dubai and the extension of Dubai Airport – you are probably looking at ECA activity worth between $15 billion to $20 billion. They are investing heavily in infrastructure. And the government is just the tip of the iceberg in relation to all potential projects in Dubai.

And that is just Dubai. HSBC recently did the first deal in Sharjah – a pipeline coming out of the state. Then you add to this deals and developments in Oman, Kuwait, Saudi Arabia and Egypt and the basket s immense. Looking at Kuwait, in the past this is a market that has traditionally not required any form of finance – but now it does as it realises that to get some of these big projects done – ie petrochemicals - the ECA route provides a much more compatible form of financing.

ECA financing is compatible with projects. Why would you issue say a bond for $15 billion, when the ECA route makes more sense? If you issued a bond for that amount, it would have a carry cost, whereas an ECA route allows you to align the financing properly with the construction schedule, with say a 12-year repayment. With a bond you can draw down the money, but you pay the interest when you may not actually be using it. That’s the reality.

Whereas if you have an ECA credit on a $15 billion deal, day one you draw nothing, year one you draw half of it and the rest when you need it. And that’s the beauty of export credit – it aligns the structure of the project to the cash flow of the project.

TXF: What sort of default or near-default experiences have you had over the years?

PL: Over the past 20 years I can count the number of bad debts as opposed to actual provision on one hand. Percentage wise, I would say around 0.01% or less of the total book that we built over that period of time. This shows the real stability of the product. And out of all lending products this is the most viable and consistent performer.

TXF: Which of the ECAS do you most admire?

PL: When I started ECGD of The UK was the one I most admired, but they lost their way in the 1990s. However, now they are firmly back and being particularly innovative and showing great support for industry and their exporters.

Again, along the way I would say that SACE has been particularly supportive given the economic climate of Italy.

And the ECA leader I most admire would be Fred Hochberg, the previous chairman of US Ex-Im, because he always put it in terms that the layman would understand. And one of the biggest examples of that was when he had on stage at US Ex-Im the Saudi Aramco deal which had created 18,000 jobs, and on the other hand an SME company which had created 17 jobs. It was a classic example of how US Ex-Im is able to support the entire range of US industry.

TXF: As we are talking about US Ex-Im, how do you view the current state of play re US Ex-Im, with it not fully re-authorised, without a chairman and without even a full quorum on the board?

PL: As you have recently stated in one of your articles, US Ex-Im and the ECA world has lost one of its most influential and charismatic leaders of recent times in the form of Fred Hochberg, and he will be a hard act to follow.

Having said that, I would predict: 'expect the unexpected'. President Trump has shown his character by going with the flow and I would be very surprised if he cannot be persuaded to support an export business which has a tremendous track record, as well as a positive value to the US economy and jobs.

Given the growth in overall ECA volumes I am certain the US administration will see the need to remain competitive in all aspects of the export business and one which is underpinned by finance. I continue to argue that few commercial banks have the appetite for long-term lending for the levels required in many of the major infrastructure programmes in the world, so ECA remains the fulcrum for success.

Many US companies are diverting sourcing to other ECAs and this appears to neither logical nor sustainable. However it is a positive for the flexibility of the ECA product.

So, my guess will be a full quorum during the second quarter of this year with full re-authorisation by September. 

TXF: What do you think are the next steps for the ECA industry globally?

PL: I think that here will be new markets as I have already stated. I think there will be big demand for the product particularly with some large scale projects in the Middle East.

Yes there has been a downturn in the volume cycle in the last 12 months but I would foresee an increase in volume over the next couple of years reflecting the cycle as new markets come back. Three years ago, two of the largest ECA markets – Saudi Arabia and Russia – are no longer dominant, but they will return. If you add to that the aviation and shipping markets, which are experiencing a massive withdrawal, but again I think these will come back and will be helped when US Ex-Im is back on line too. These doors could open a further $40 billion to the market annually.

I still maintain that the global ECA market could easily be $100 billion annually. Prior to the GFC it was a $35 billion market. Very few businesses can generate a threefold increase in such a relatively short period.

TXF: How do you see the future for bank business models and for ECAs?

PL: Well, I think we will see other investors. We will have other funding vehicles established as banks seek to control liquidity and control risk-weighted assets. It doesn’t mean that the banks are out of the business, because they are in the business to support their clients – and a good example of that is Siemens which required a range of financial support for its activity in Egypt and HSBC is one of the banks supporting them.

From a bank perspective the cost-income ratio is far lower than most other product areas that I’ve come across. On average I would say the cost-to-income ratio of an ECA department is around 30%-35% (ie for every dollar you lend you are making 70 cents after costs, including liquidity costs), and if you say compare that to a bank’s M&A department the cost-income ratio can be as high as 80% or even higher so the incremental revenue is often modest.

M&A may be capital efficient, but if you look at it over time they are  not winners. Most business lines would be around 80%. Although for DCM within a bank their cost-income ratio would probably be fairly close to that of an ECA department. So a good ECA department within a bank makes exceptionally good returns for the bank – when compared to other product areas.

Those banks that completely understand the business will continue to exploit it

TXF: What is next on the agenda for Peter Luketa?

PL: I still believe I have the experience and energy to contribute to the overall project and export finance industry in the coming few years. I have therefore set up my own consultancy (CB Advisers) with a specific geographic focus on MENA, Russia and Eastern Europe. I am beginning work with a couple of clients on specific deals, but I will also focus on smaller transactions (where the banks have limited interest) as well as attracting new investors to the ECA product utilising some of the techniques of the Fintech evolution.

Given my broad range of knowledge around price, currency and optimal sourcing I believe I can contribute to the efficiency and success of different counterparties within the industry. My website contact is: cbadvisers.co.uk and contact number 00 44 7710 503211. I will also be supporting TXF at the next export finance global event in Venice from 7-9 June.