Is Trade Finance dead?

You may have read in my bulletin about Stock Finance that in the broadest sense, Stock and Trade Finance are sometimes linked together.

What is trade finance?

Technically, it is the transaction of financing goods in transit, from the seller’s place of business or storage to the purchasers agreed delivery/storage point of receipt. It involves understanding all aspects of the deal, gaining knowledge of the product/goods, insurances, transportation requirements, whilst recognising and minimising the risks.

Although two independent Trade Finance Houses have recently pulled out of the market, there is fortunately still a hand full of specialist lenders left still doing business.

They are all different, treating each proposition individually on its own merits and all have their own underwriting criteria. However, credit insurance on the buyer is a common requirement.

There are basically two types of contract;

1. the single transaction which is ring-fenced from the rest of a company’s business,
   
2. the line of credit using Letters of Credit to purchase goods, which are normally pre-sold, from one or more suppliers. It is a revolving facility with a pre-agreed limit that can be used as often as required.

The independent market is happy to underwrite both types of contract.

Unfortunately, the clearing banks don’t seem to be able or want to compete in both these markets, unless it is a ‘closed ended transaction’ or ‘vanilla’ type deal needing Letter of Credit facilities on good margins, they don’t seem interested or have the expertise to cope with entrepreneurial trading.

Also bank credit committees look at the balance sheet of a prospect, past performance, asset base and apply lending ratios which are inappropriate to the deal.

It is almost impossible to change them from using their criteria when in fact most companies wanting trade finance will never fit their profile as it is centred on the balance sheet. In fact if they did, it’s most likely they wouldn’t want or need the facility!

I have always stressed that trade finance is not cheap, but it does reflect the risks. Lenders do like to know everything about the goods and flow of events so they can get a clear picture and feel comfortable with the deal structure.

This is perhaps where the clearing banks fail to understand the market, the ‘risk-reward ratio’ (which I call R3) is really what it is all about, a rate which reflects the risk in the deal. Banks have a blind spot over the rating structure trade finance houses charge; 4/5% for 60 day LC’s and 7% for 90 day terms are not uncommon.

Providing good profit margins exist on a deal then everyone is happy. There is no alternative for this market but to use the independents!

For the clearing banks to compete not only is there a need to change the structure of their underwriting, away from existing credit committees, but a need to move to a different cultural platform.

People in this market look forward to a sea-change from the clearing banks as they would be a welcome addition to this sector.