From bust to boom, watch your banks!
Much has happened in the commodity trade finance sector over the past two years. Here, Mihai Andreoiu, corporate finance & treasury advisory, head Redbridge Switzerland, assesses the health of the sector in a boom period and asserts that now is the best time to monetise trust and relationships with resilient banks and new financing partners.
Having attended the TXF Global Commodity Finance conference in Geneva in October, I could not help the feeling of getting back to normality, after over 18 months of virtual events. What looked even better was to see everybody more concerned about how to secure liquidity and risk appetite for performing commodity-trading businesses rather than manage problem loans. Both commodity traders and their bankers need to cope with increases stemming from both volumes and prices.
In the past, as a banker the biggest business risk I saw was that of persistent low commodity prices, with credit lines utilised at 20%-30% and revenue seemingly going nowhere. Couple that with a low interest rate environment driving overall limited performance of the transaction banking sector and senior management quickly run their attention to cutting costs. Rather short-term thinking!
An even bigger trigger for banks retrenching was brought about by the pandemic with several commodity trading firms causing billions of losses for the main trade finance banks and some specialised direct lenders. A year ago, some banks were completely exiting the commodity trade finance sector, while others were trimming their portfolios as part of a ‘flight to quality’ (probably one of the most misused sayings in modern finance and banking). Again, this was short-term thinking!
Fast-forward 12 months and we are in a booming world. The commodity traders have learned to play the accordion feature of their syndicated facilities. With many commodity prices 50%–100% higher than a year ago, liquidity is king again – especially for those traders with the privilege of high margin calls, as driven by the rapid appreciation of various commodity prices.
As rising prices go hand-in-hand with increased volumes, line utilisation has also doubled – or more – over the past year. Profits are accumulating for trading companies, as they are for banks too, which means they are likely to have their best year in a decade.
But it’s not been an easy journey. Banks have been allocating a lot of risk capital to other businesses, and cutting personnel while also still struggling with KYC requirements. As I anticipated a year ago, the resilient banks are now reaping the benefits of the current volume and price boom and have successfully passed the stress tests they’ve been subject to.
The ‘exiter’ banks have become spectators and are now re-thinking their approach. A leading European investment bank is even considering re-entering commodities trading after exiting the arena eight years ago due to the reputation risk it perceived and concerns about return potential. But as a commodity structured finance leader stated: “we don’t like banks that come and go”. That perception has a cost too, it’s not just about switching the lights on again.
Is the current business boom sustainable? Some analysts believe that despite the economic rebound, inflation is only likely to be transitory. But if the economic recovery and pent-up demand for commodities are sustained, there will be continued pressure on liquidity management for commodity traders. The well-known global trade finance gap, as measured by the Asian Development Bank, increased from $1.5 trillion to $1.7 trillion according to figures released on 12 October. This is worrisome as it witnesses the incapacity of the providers of trade finance solutions to keep up the pace with growing needs. And into 2022 this gap is probably much higher in reality, also with risk appetite for emerging markets remaining scarce.
All this means that commodity traders will have to both compete for bank liquidity and access new, generally more expensive, sources of capital, such as funds, capital markets, family offices and private equity. The latter represents healthy diversification and a reality check, driving up average cost of borrowing.
Meanwhile, competing for bank liquidity should not mean overpaying for bank financing, especially for established players. No more covid premium. It means understanding who their banks are, the right price for the risks banks are taking, and the way it translates into regulatory capital. Basel IV standards, which are expected in January 2023, are still being formulated, and have the potential to deal further surprises affecting the cost of trade financing (watch out for the credit conversion factors and Loss Given Default levels).
Doors of perception
Any bank is the sum of its people and its business model. The better commodity trading firms understand what drives their bankers’ perception of risk, the higher the chance of increasing their credit appetite and reducing the margin charged. As one of my former managers used to say: “perception is reality”.
The risk perception of your relationship manager and especially that of his business and risk chain will be the reality when it comes to your liquidity and cost of borrowing. Are you spending enough time improving that perception, or do you think it’s simply the relationship manager’s job to write all those memos, perform risk analysis and ensure you receive an optimal deal? What drives banks’ risk appetite remains an ever-green topic! Will your banker help you become more profitable, on a risk weighted basis, for the bank and hence be able to provide more credit? Will the structure of your facility result in risk-weighted return improvements?
On a related note, linking loans for commodity traders to environmental, social and governance (ESG) key performance indicators (KPIs) is becoming the new norm, almost similar to compliance. There is still work to be done educating both sides, and especially in terms of how companies should be rewarded or punished via their cost of financing in a meaningful way. One thing is for sure: the malus premium should not be kept by banks.
Embracing ESG criteria and related mechanisms may alleviate certain internal pressure within banks on the sector. That explains the need to press forward full- steam ahead, embrace the change and learn along the way. But don’t be afraid to challenge what’s relevant and needed in developing the commodity trade finance sector ESG guidelines.
As the pendulum seems to have swung all the way back in a rather short time frame, CFOs and treasurers of commodity traders need to stick to their long-term diligence with the banks! Either way, whether prices keep on surging or demand falls in the new year, NOW is the best time to monetise the trust and increased comfort across relationships with those resilient banks while still investing in newer financing partners.
With a 20-year track record, Redbridge is an independent advisory firm that helps generate savings and efficiencies by reducing information asymmetry between CFO/treasurers and their providers (banks, financiers, vendors etc). Redbridge is able to deploy globally its superior analytical power through proven methodologies. Our 100 person strong team includes subject matter experts from global banks, credit rating agencies, advisory practices and corporate treasuries.
The Redbridge debt advisory team has advised companies on raising and optimising over €30 billion of debt ranging from revolving credit facilities and asset based finance to capital markets. Besides debt implementation consulting, we provide strategic advice on debt mix, credit profile optimisation and risk-weighted bank profitability analysis.
The Redbridge treasury advisory team has helped clients optimise their cash management and card fees, cash pooling structures, as well as trade services. Globally, Redbridge has helped clients generate in excess of €200 million savings. Redbridge also supports its clients’ treasury transformation journey, covering topics such as organisational structure, processes and systems. www.redbridgedta.com