Running credit operations of banks
Saturday, 16 June 2007
CREDIT is an extremely important function of the bank. What is credit?
Credit is a facility offered by the bank, for a certain purpose--, borrowing for a certain period of time. The principal repayment of credit is outlined at the onset. This involves repayment of certain interest, fees or charges. This may require certain margin coverage or be at nil margin. This may also require certain security or be at nil security and finally may comprise certain terms and conditions.
Credit department consists of junior and senior analysts who are entrusted with the ideology that 'they must protect the bank', in terms of all risks involved in lending as well as 'be fair to the client'. The analysts must keep in mind that the bank has to carry on doing business, not impede business.
To the credit analyst, a clear outline of the 'purpose' of the loan is very important. What is the business or commercial customer going to do with the borrowed money? Is the borrowing in line with the lending norms of the bank? What 'sector of business activity' is the fund going to be utilised in? The bank has a certain percentage of its funds allocated for lending to customers in different sectors of activity --for example, manufacturing of garments, textile, cement, construction, pharmaceuticals, food, dairy, aquaculture, agriculture, fertilisers, toiletries, industrial & household appliances, shipping, steel, etc.
In performing the review of the proposal, the credit analyst amongst other things will study the financials, the management of the borrowing company, the credit standing of the borrower, the market economic conditions surrounding the type of business, and the financial guidelines imposed by the central bank.
The financials comprise of the balance sheet of the borrower, that is, the assets (current assets & fixed assets), the liabilities (current liabilities & long term liabilities) and the net-worth or equity. The most preferred balance sheet is that which has a good size of quality assets, limited liabilities, and a strong equity. An undesirable balance sheet is that which is low in assets, high in liabilities, and shallow in equity.
This is followed by the study of the Income Statement (the profit & loss statement) and the various ratios that reveal the overall performance, the profitability, the test of investment condition, and the test of financial condition.
The study of the cash-flow comes next. Usually, the analyst will study the cash-flow projections for the following three to five years. An important factor in analysis is the study of the credit standing of the prospect through a credit rating, preferrably by an agency that is considered the best and is desirable.
The study of the management is critical. What sort of management is involved in the company? Who are the key players in the company? What are their formal education and terms of experience? What is their hierarchy and succession plan?
Other questions that may arise, while in analysis, is what sort of line of credit is being requested or at the moment the nature of facilities being enjoyed by the customer? Is the line of credit well tiered to the business needs?
A line of credit may comprise of one or more of the following facilities like: overdraft, commercial loan, mortgage loan, letter of guarantee or letter of credit facility. It would be necessary to establish what sort of collaterals are available for any or all of the facilities. Are the collaterals liquid? Are they hard to convert to cash? What sort of insurance coverage is there? Does the insurance cover fire, theft, riot, strike and damage? Are there any letters of subordination? Does any covenant exist? Are there any personal guarantees? Have the guarantors received legal advice in giving their guarantees? Have personal net-worth statements from the guarantors been obtained?
Are the borrowings over leveraged? Is the borrower getting the trade receivables in a timely manner? Are the trade receivables factored? Is the inventory piling up? Is the borrower producing excessively without having sufficient sales? What is the turnover of the borrowing company? Is the turnover-cycle compatible to the type of business it is involved in? Are trade payables paid on time? Do the suppliers pressurize the borrower for payment due to delays in payment? Are the goods purchased (cost of goods) at a competitive rate? Is production cost effective? Is the borrower enjoying any suppliers credit? Are the raw-materials locally supplied or are they procured from overseas thereby subjecting to uncertainty in market price and assurance of regular supply? Does the borrower enjoy a satisfactory letter of credit line? Does the borrower require a revolving credit line? Do they do business on open account basis? Do they do business on collection basis?
Attached to the Credit Department is the Credit Administration, which is the custodian of all the loan processing, loan interest calculation, credit monitoring & compliance, registered hypothecation of collateral security, security collateral inspection & record, insurance record & renewal (from amongst a list of approved insurance companies retained and regularly updated by the bank), making loan loss provisions, preparation of watch-list accounts, preparation of daily or weekly or monthly reporting to the central bank and the Office of the Superintendent of Financial Institutions (OSFI), sending renewal offer letters to customers, follow-up on bad loan recovery from defaulters, etc.
Attached to the Credit Administration is the Legal Officer that maintains liaison with the Corporate lawyers (from amongst a list of approved lawyers & legal firms retained and regularly updated by the bank). Senior credit analyst will usually get the security documentation vetted through Corporate lawyers, keeping the Legal Officer informed, in the case of extension of a new or large facility by the bank. The Legal Officer also receives and executes instruction from the court on garnishing orders.
Bank Corporate culture differs amongst the developed countries (DC) and the least developed countries (LDC) of the world. In the developed world where jurisprudence is strong, the banks are comfortable in extending facilities to individuals like personal loan, mortgage loan, etc., because if the individual is in default, the bank can take the individual to court where upon verdict, the bank can take from the individual to the last penny recoverable including the person's house and belongings (which can be next to impossible in an LDC where the courts are more sympathetic to individuals and where jurisprudence is weak, time-bearing, and may take ages to get a verdict). Conversely, in an LDC it is relatively easier for a bank to recover its funds from a Corporate entity where upon the court verdict can be quicker than against an individual. Interestingly, it is quite difficult to recover from a Corporate entity in a DC where the Corporate entity can afford to hire good legal counsel (sometimes paying very handsomely) that can use loopholes to leverage its way out of the bank's reach.
Mentioned below are some of the experiences that this writer has enjoyed in his banking profession as a credit risk manager and would like to narrate on garment & textile industry funding, loan syndications and merchant & oil vessel scrapping (ship scrapping):
Export of garments to the European Union and to the USA & Canada is a major business for many least developed countries. The mechanism in which garments are exported to these two regions are quite different from each other. The EU is accessed through availing the generalized system of preferences (GSP), whereas there are duty & quota restrictions for market access to the USA & Canada (though some LDCs may enjoy duty- and quota-free access to these North American countries), the Multi Fibre Agreement (MFA) of the World Trade Organisation (WTO) ceased to exist as of January 2005. The EU provides GSP facility for exports from the LDCs to the EU market. The purpose of providing this facility is to help develop the LDCs so as to allow them to compete with exports from the developed countries. Exports from the DCs to the EU are subject to 12.5% import duty; whereas, exports from most LDCs, subject to meeting certain preconditions, are exempt from the duty. Manufacturers are faced with duty & quotas that restrict their volume of export to the North American countries. The quota quantifies the maximum amount of a product category an exporter can export from the exporting country, each year. The US and the Canadian government (though the Canadian government extended the quota-free facility to most LDCs from January 2003) allocates quotas to the government of the LDCs, which the LDC government in turn transfers to the manufacturers.
Garment trade is a specialized business for the banks. Here the bulk buyer of perhaps a major named department store, of the Garment importing country, opens a Master LC in favour of the exporting manufacturer in the exporting country. The Master LC may be a one-time LC or a revolving LC against which the manufacturer opens Back- to- Back LC or Mirror LC to import raw-material fabrics and accessories. Such LCs can be very tricky and require intensive monitoring by the bank. Delays in shipment can create havoc, which may turn out to become 'stock-lot' for the manufacturer, resulting in empty shelves for the bulk buyer, and a nightmare for the banker. In such a condition, cash-flow is stuck, the manufacturer ends up borrowing more without a clear repayment structure in sight. Nevertheless, funding of garment business by the banks, considering everything going well with good turnovers, can be a good source of income for the banks.
Loan syndications are usually participated by two or more banks for large scale funding of projects like a cement industry (lime or clinker based) or a steel industry (hot or cold rolled). The lead bank prepares the project proposal with information on the borrowing customer, the market feasibility, the capital machineries to be involved, their source of origin, total funding required, the cost of funding, and the full repayment structure. The lead bank usually retains a handsome arrangement fee for itself.
The participating banks in the project may not all be extending equal share of funding, that is their level of loan participation may vary in size, while the security coverage may be on pari-passu basis. The banks participation may be in 'consortium deal' or 'club deal'. A consortium deal requires the lead bank to inform the participating banks on all material changes developments on the borrower on a regular basis. The progress report involves full information in relation to draw-down of funds, construction progress, capital machineries instalment progress, technical advancements, changes in legal positions, delays, etc. The lead bank remains in constant touch with the borrower, represents the borrower, and arranges site visit of the plant. In a club deal, once the lead bank has arranged the funding between the borrower and the participating banks, the participating banks correspond on their own with the borrower, may share information with other participating banks for the portion of their funding, to the borrower.
This writer has enjoyed handling loan syndications through counter-party trade in the European and North American market for the Secondary Loan Trade (SLT); Total Return Swaps (TRS); and Collateralized Loan Obligations (CLO); in the Primary and Secondary market.
This involves: issuance of Loan Market Association (LMA) trade ticket confirmation which refers to the Credit Agreement and confirms the trading date, the amount & currency involved, the pricing and margins, the Agency fees, etc.
Transfer Certificates & Accession Deeds - are an essential legal component of the transaction taking place.thorough review of the Credit Agreement - one special feature is the parental consent, of the funding prospect, that may be required for such a transaction taking place between an existing lender and a new lender.
Trade tickets - will stipulate the trade date, information of counter-party involvement , primary or secondary trade, spreads, margins, etc.
Pricing Letters - essential component of the Credit Agreement like the trade settlement date of T+10 days for the European market vis-à-vis T+7 days for the North American market. Delays in settlement is met with delayed compensation and break-cost analysis. Payment remittance is made on BUY trades and receipt of funds on SELL trades. All credit arrangements are programmed through the Automated Commercial Business Systems (ACBS) followed by the fee schedules on gain or loss of sale plus upfront fee or discount schedules.
(Noteworthy, a leading American bank based in New York, through its associate, is a major player in the European market Secondary Loan trade). Preceding all the above are the market reports on the corporate standing of the prospect, its credit rating, financial report and analysis and internal credit approvals, plus sector and counter-party exposure limits.
Here below is a narration of the portfolio of an offshore syndication for the expansion of a major exporting manufacturing industry in a least developed country (LDC). The capital machineries were to be imported from the EU, the finance from a bank in the FarEast (based on three months US dollar LIBOR rates which were cheaper than the borrowing interest rate being offered within the host country), while the project itself happened to be in an LDC in South Asia. The host country required approval of both the central bank and other government entities in allowing funding from a bank based overseas.
Such approvals of the central bank are necessary in an LDC and not in a developed country (DC) because of the constraints of -such foreign currency borrowing may bring to the limited foreign currency reserve of the LDC, should the exporting manufacturing industry, upon completion of the project, be unable to generate sufficient foreign currency fund through exports, and the loan goes sour (cross border risk). The loan was for a specified number of years. Interesting was the legal ramifications involved towards this sort of syndication: the lending bank, 'the Lender', in a third Far-Eastern country, the host bank, 'the Agent', in the host country in South Asia, and 'the Borrower' also in the host country. So apart from the laws of both the host and lending countries coming under the purview of syndication, the final recourse was set for appeal, in case of any wrong doing, to come under the purview of the Courts of England (since English laws were acceptable to all the participating countries).
Another interesting portfolio is ship scrapping of ocean going vessels. These are merchant vessels and oil tankers that have completed their ocean worthiness in full and are ready to be demolished to generate steel. The bank helps in purchase and scrapping of such ships that usually cost a few million US$ and may weigh an average of 40,000 Light Displacement Tonnage (LDT) generating sufficient steel. Steel is made from billets, which is costlier, while steel from ship scrap are cheaper and are mainly used, amongst other usefulness, by the re-rolling steel mills producing rods for construction of concrete buildings and bridges on high-ways. Involvement of the bank can be intensive: from the checking of the minute documentation details to the genuineness of the name of the vessel, the correct year & the place it was built, the type of vessel, the LDT, the flag it carries, and most important its registration. The selling price range is usually tallied through the ship brokers in London. The bank must ensure that the documents have been vetted by international legal experts, so that the risks in the transaction has been mitigated, and there exists no litigation upon the vessel (logged in some third port country that may surface later once the ship has been purchased by the customer). Ship berthing of the vessel to be demolished can be an interesting exercise and is an amazing sight to see. Only a few members of the crew remain on the ship to be berthed and the crew is highly insured. During high tide, the huge ship with full throttle from a distance on the water, runs quite a length up the shore (land), onto the embankment where it is going to be demolished. Even after the berthing, till substantial demolishing is completed, the bank remains at risk against natural calamities like cyclone and tidal bores. High stormy water can pull and remove the bulk of the laden ship to deep down under waters following which not a penny can be recovered by the bank.
In the banking profession of this writer, as a senior credit risk analyst, he has worked within the guidelines on bank transparency and market discipline set out by the Basel Committee of the Bank for International Settlements, Basel, Switzerland. The Basel Committee requires banks to make meaningful disclosures in their financial reports on the bank's capital, solvency, liquidity; adopt risk management strategies involving credit risk, market risk, liquidity risk, operational risk, legal risk, and provide basic business, management and corporate governance information.
The Basel Committee requires banks to take a dynamic risk approach to anticipate possible deterioration of risk and to adapt to changes in the regulatory environment. It requires adherence to internal ratings in order to estimate the probability of complete repayment according to the structure of the transaction and to set out the bank's own provisioning system in order to cover expected and foreseeable portfolio losses and to develop new techniques of security. Important fundamentals of risk control are in decision making and in supervision whereby every decision with respect to credit commitments and the allocation of trading limits are based on the invariable principle of 'dual signature'. The risk monitoring mechanism is the follow-up and reporting of outstanding risks so that portfolios are regularly reviewed and discussed at weekly committee meetings. In Canada, a lot of emphasis, at present is being given by the large banks toward implementation of the recommendations of the Basel Committee.
Some facts to consider in the economic and business environment of Canada. Canada's population is about 32 million as against United States of 300 million. Canada's gross domestic product (GDP) is Canadian $ 1.0 trillion, whereas US's GDP is US$ 10.0 trillion. (Approximate figures are quoted from Statistics Canada and USA Census Bureau).
The Canadian GDP (in approximate figures) comprises of 32% of one trillion in the form of GOODS PRODUCING INDUSTRIES, that is C$ 300 billion, of which 55% comes from manufacturing; 17% from construction, 11% from mining, oil & gas, 8.0% from utilities, while a low input of 7.0% from agriculture, forest & fishing. Another 68% of the GDP in the form of SERVICE PRODUCING INDUSTRIES, that is C$ 700 billion, of which the majority 29% comes from finance, insurance & real estate and 17% from retail and wholesale trade, while other service industries, in smaller percentages.
We observe that a large percentage of the Canadian economy comprising of over C$ 200 billion is controlled by finance, insurance and real estate of which the banks manage a major share. How aggressive are Canadian banks world-wide? An international French bank has purchased the branch of a major Canadian bank in Switzerland as the Canadian bank closed it operation there. Another major Canadian bank had opened a branch in Bangladesh and closed down after one year of its operation (since it failed to understand the operations of the LDC and found them too risky). Banking risks are high in the LDCs but so are the rewards of income. With relatively small capital investment, some of the multinational banks may reap sizeable after-tax income.
Eighty-three per cent of Canada's exports of C$ 400 billion (in approximate figures) is carried out with the US mostly on open account basis, whereas the remaining seventeen per cent is with the rest of the world.
Seventy-one per cent of Canada's imports of C$ 340 billion (in approximate figures) is resourced from the US, while the remaining twenty-nine per cent from the rest of the world and may involve LC transactions. As a matter of fact, most branch's of the major Canadian banks, other than their international divisions at the head office level, are unaccustomed with opening and handling of international LCs.
Canada's strength is in its service and manufacturing industry. Canada may gear its energy in mobilizing its export of service and manufacturing industry to the rest of the world and not just depend on the US market alone. Canadian banks can help in playing a major role by learning from the experiences of the British, French and other European banks that are moderately aggressive and are risk tolerant with long-term goal achieving objectives while the American banks though aggressive may differ in their objective. Patience and perseverance pays off in the end.
The writer, is based in Toronto, Canada, is a senior banker Consultant and pursued career in bankink with American Express Bank, ANZ Grindlays Bank, Credit Agricole Indosuez Bank, Bank of Credit Commerce Canada and the Canadian Imperial Bank of Commerce, Canada. This is a part of the article he has sent to the FE for publication
Credit is a facility offered by the bank, for a certain purpose--, borrowing for a certain period of time. The principal repayment of credit is outlined at the onset. This involves repayment of certain interest, fees or charges. This may require certain margin coverage or be at nil margin. This may also require certain security or be at nil security and finally may comprise certain terms and conditions.
Credit department consists of junior and senior analysts who are entrusted with the ideology that 'they must protect the bank', in terms of all risks involved in lending as well as 'be fair to the client'. The analysts must keep in mind that the bank has to carry on doing business, not impede business.
To the credit analyst, a clear outline of the 'purpose' of the loan is very important. What is the business or commercial customer going to do with the borrowed money? Is the borrowing in line with the lending norms of the bank? What 'sector of business activity' is the fund going to be utilised in? The bank has a certain percentage of its funds allocated for lending to customers in different sectors of activity --for example, manufacturing of garments, textile, cement, construction, pharmaceuticals, food, dairy, aquaculture, agriculture, fertilisers, toiletries, industrial & household appliances, shipping, steel, etc.
In performing the review of the proposal, the credit analyst amongst other things will study the financials, the management of the borrowing company, the credit standing of the borrower, the market economic conditions surrounding the type of business, and the financial guidelines imposed by the central bank.
The financials comprise of the balance sheet of the borrower, that is, the assets (current assets & fixed assets), the liabilities (current liabilities & long term liabilities) and the net-worth or equity. The most preferred balance sheet is that which has a good size of quality assets, limited liabilities, and a strong equity. An undesirable balance sheet is that which is low in assets, high in liabilities, and shallow in equity.
This is followed by the study of the Income Statement (the profit & loss statement) and the various ratios that reveal the overall performance, the profitability, the test of investment condition, and the test of financial condition.
The study of the cash-flow comes next. Usually, the analyst will study the cash-flow projections for the following three to five years. An important factor in analysis is the study of the credit standing of the prospect through a credit rating, preferrably by an agency that is considered the best and is desirable.
The study of the management is critical. What sort of management is involved in the company? Who are the key players in the company? What are their formal education and terms of experience? What is their hierarchy and succession plan?
Other questions that may arise, while in analysis, is what sort of line of credit is being requested or at the moment the nature of facilities being enjoyed by the customer? Is the line of credit well tiered to the business needs?
A line of credit may comprise of one or more of the following facilities like: overdraft, commercial loan, mortgage loan, letter of guarantee or letter of credit facility. It would be necessary to establish what sort of collaterals are available for any or all of the facilities. Are the collaterals liquid? Are they hard to convert to cash? What sort of insurance coverage is there? Does the insurance cover fire, theft, riot, strike and damage? Are there any letters of subordination? Does any covenant exist? Are there any personal guarantees? Have the guarantors received legal advice in giving their guarantees? Have personal net-worth statements from the guarantors been obtained?
Are the borrowings over leveraged? Is the borrower getting the trade receivables in a timely manner? Are the trade receivables factored? Is the inventory piling up? Is the borrower producing excessively without having sufficient sales? What is the turnover of the borrowing company? Is the turnover-cycle compatible to the type of business it is involved in? Are trade payables paid on time? Do the suppliers pressurize the borrower for payment due to delays in payment? Are the goods purchased (cost of goods) at a competitive rate? Is production cost effective? Is the borrower enjoying any suppliers credit? Are the raw-materials locally supplied or are they procured from overseas thereby subjecting to uncertainty in market price and assurance of regular supply? Does the borrower enjoy a satisfactory letter of credit line? Does the borrower require a revolving credit line? Do they do business on open account basis? Do they do business on collection basis?
Attached to the Credit Department is the Credit Administration, which is the custodian of all the loan processing, loan interest calculation, credit monitoring & compliance, registered hypothecation of collateral security, security collateral inspection & record, insurance record & renewal (from amongst a list of approved insurance companies retained and regularly updated by the bank), making loan loss provisions, preparation of watch-list accounts, preparation of daily or weekly or monthly reporting to the central bank and the Office of the Superintendent of Financial Institutions (OSFI), sending renewal offer letters to customers, follow-up on bad loan recovery from defaulters, etc.
Attached to the Credit Administration is the Legal Officer that maintains liaison with the Corporate lawyers (from amongst a list of approved lawyers & legal firms retained and regularly updated by the bank). Senior credit analyst will usually get the security documentation vetted through Corporate lawyers, keeping the Legal Officer informed, in the case of extension of a new or large facility by the bank. The Legal Officer also receives and executes instruction from the court on garnishing orders.
Bank Corporate culture differs amongst the developed countries (DC) and the least developed countries (LDC) of the world. In the developed world where jurisprudence is strong, the banks are comfortable in extending facilities to individuals like personal loan, mortgage loan, etc., because if the individual is in default, the bank can take the individual to court where upon verdict, the bank can take from the individual to the last penny recoverable including the person's house and belongings (which can be next to impossible in an LDC where the courts are more sympathetic to individuals and where jurisprudence is weak, time-bearing, and may take ages to get a verdict). Conversely, in an LDC it is relatively easier for a bank to recover its funds from a Corporate entity where upon the court verdict can be quicker than against an individual. Interestingly, it is quite difficult to recover from a Corporate entity in a DC where the Corporate entity can afford to hire good legal counsel (sometimes paying very handsomely) that can use loopholes to leverage its way out of the bank's reach.
Mentioned below are some of the experiences that this writer has enjoyed in his banking profession as a credit risk manager and would like to narrate on garment & textile industry funding, loan syndications and merchant & oil vessel scrapping (ship scrapping):
Export of garments to the European Union and to the USA & Canada is a major business for many least developed countries. The mechanism in which garments are exported to these two regions are quite different from each other. The EU is accessed through availing the generalized system of preferences (GSP), whereas there are duty & quota restrictions for market access to the USA & Canada (though some LDCs may enjoy duty- and quota-free access to these North American countries), the Multi Fibre Agreement (MFA) of the World Trade Organisation (WTO) ceased to exist as of January 2005. The EU provides GSP facility for exports from the LDCs to the EU market. The purpose of providing this facility is to help develop the LDCs so as to allow them to compete with exports from the developed countries. Exports from the DCs to the EU are subject to 12.5% import duty; whereas, exports from most LDCs, subject to meeting certain preconditions, are exempt from the duty. Manufacturers are faced with duty & quotas that restrict their volume of export to the North American countries. The quota quantifies the maximum amount of a product category an exporter can export from the exporting country, each year. The US and the Canadian government (though the Canadian government extended the quota-free facility to most LDCs from January 2003) allocates quotas to the government of the LDCs, which the LDC government in turn transfers to the manufacturers.
Garment trade is a specialized business for the banks. Here the bulk buyer of perhaps a major named department store, of the Garment importing country, opens a Master LC in favour of the exporting manufacturer in the exporting country. The Master LC may be a one-time LC or a revolving LC against which the manufacturer opens Back- to- Back LC or Mirror LC to import raw-material fabrics and accessories. Such LCs can be very tricky and require intensive monitoring by the bank. Delays in shipment can create havoc, which may turn out to become 'stock-lot' for the manufacturer, resulting in empty shelves for the bulk buyer, and a nightmare for the banker. In such a condition, cash-flow is stuck, the manufacturer ends up borrowing more without a clear repayment structure in sight. Nevertheless, funding of garment business by the banks, considering everything going well with good turnovers, can be a good source of income for the banks.
Loan syndications are usually participated by two or more banks for large scale funding of projects like a cement industry (lime or clinker based) or a steel industry (hot or cold rolled). The lead bank prepares the project proposal with information on the borrowing customer, the market feasibility, the capital machineries to be involved, their source of origin, total funding required, the cost of funding, and the full repayment structure. The lead bank usually retains a handsome arrangement fee for itself.
The participating banks in the project may not all be extending equal share of funding, that is their level of loan participation may vary in size, while the security coverage may be on pari-passu basis. The banks participation may be in 'consortium deal' or 'club deal'. A consortium deal requires the lead bank to inform the participating banks on all material changes developments on the borrower on a regular basis. The progress report involves full information in relation to draw-down of funds, construction progress, capital machineries instalment progress, technical advancements, changes in legal positions, delays, etc. The lead bank remains in constant touch with the borrower, represents the borrower, and arranges site visit of the plant. In a club deal, once the lead bank has arranged the funding between the borrower and the participating banks, the participating banks correspond on their own with the borrower, may share information with other participating banks for the portion of their funding, to the borrower.
This writer has enjoyed handling loan syndications through counter-party trade in the European and North American market for the Secondary Loan Trade (SLT); Total Return Swaps (TRS); and Collateralized Loan Obligations (CLO); in the Primary and Secondary market.
This involves: issuance of Loan Market Association (LMA) trade ticket confirmation which refers to the Credit Agreement and confirms the trading date, the amount & currency involved, the pricing and margins, the Agency fees, etc.
Transfer Certificates & Accession Deeds - are an essential legal component of the transaction taking place.thorough review of the Credit Agreement - one special feature is the parental consent, of the funding prospect, that may be required for such a transaction taking place between an existing lender and a new lender.
Trade tickets - will stipulate the trade date, information of counter-party involvement , primary or secondary trade, spreads, margins, etc.
Pricing Letters - essential component of the Credit Agreement like the trade settlement date of T+10 days for the European market vis-à-vis T+7 days for the North American market. Delays in settlement is met with delayed compensation and break-cost analysis. Payment remittance is made on BUY trades and receipt of funds on SELL trades. All credit arrangements are programmed through the Automated Commercial Business Systems (ACBS) followed by the fee schedules on gain or loss of sale plus upfront fee or discount schedules.
(Noteworthy, a leading American bank based in New York, through its associate, is a major player in the European market Secondary Loan trade). Preceding all the above are the market reports on the corporate standing of the prospect, its credit rating, financial report and analysis and internal credit approvals, plus sector and counter-party exposure limits.
Here below is a narration of the portfolio of an offshore syndication for the expansion of a major exporting manufacturing industry in a least developed country (LDC). The capital machineries were to be imported from the EU, the finance from a bank in the FarEast (based on three months US dollar LIBOR rates which were cheaper than the borrowing interest rate being offered within the host country), while the project itself happened to be in an LDC in South Asia. The host country required approval of both the central bank and other government entities in allowing funding from a bank based overseas.
Such approvals of the central bank are necessary in an LDC and not in a developed country (DC) because of the constraints of -such foreign currency borrowing may bring to the limited foreign currency reserve of the LDC, should the exporting manufacturing industry, upon completion of the project, be unable to generate sufficient foreign currency fund through exports, and the loan goes sour (cross border risk). The loan was for a specified number of years. Interesting was the legal ramifications involved towards this sort of syndication: the lending bank, 'the Lender', in a third Far-Eastern country, the host bank, 'the Agent', in the host country in South Asia, and 'the Borrower' also in the host country. So apart from the laws of both the host and lending countries coming under the purview of syndication, the final recourse was set for appeal, in case of any wrong doing, to come under the purview of the Courts of England (since English laws were acceptable to all the participating countries).
Another interesting portfolio is ship scrapping of ocean going vessels. These are merchant vessels and oil tankers that have completed their ocean worthiness in full and are ready to be demolished to generate steel. The bank helps in purchase and scrapping of such ships that usually cost a few million US$ and may weigh an average of 40,000 Light Displacement Tonnage (LDT) generating sufficient steel. Steel is made from billets, which is costlier, while steel from ship scrap are cheaper and are mainly used, amongst other usefulness, by the re-rolling steel mills producing rods for construction of concrete buildings and bridges on high-ways. Involvement of the bank can be intensive: from the checking of the minute documentation details to the genuineness of the name of the vessel, the correct year & the place it was built, the type of vessel, the LDT, the flag it carries, and most important its registration. The selling price range is usually tallied through the ship brokers in London. The bank must ensure that the documents have been vetted by international legal experts, so that the risks in the transaction has been mitigated, and there exists no litigation upon the vessel (logged in some third port country that may surface later once the ship has been purchased by the customer). Ship berthing of the vessel to be demolished can be an interesting exercise and is an amazing sight to see. Only a few members of the crew remain on the ship to be berthed and the crew is highly insured. During high tide, the huge ship with full throttle from a distance on the water, runs quite a length up the shore (land), onto the embankment where it is going to be demolished. Even after the berthing, till substantial demolishing is completed, the bank remains at risk against natural calamities like cyclone and tidal bores. High stormy water can pull and remove the bulk of the laden ship to deep down under waters following which not a penny can be recovered by the bank.
In the banking profession of this writer, as a senior credit risk analyst, he has worked within the guidelines on bank transparency and market discipline set out by the Basel Committee of the Bank for International Settlements, Basel, Switzerland. The Basel Committee requires banks to make meaningful disclosures in their financial reports on the bank's capital, solvency, liquidity; adopt risk management strategies involving credit risk, market risk, liquidity risk, operational risk, legal risk, and provide basic business, management and corporate governance information.
The Basel Committee requires banks to take a dynamic risk approach to anticipate possible deterioration of risk and to adapt to changes in the regulatory environment. It requires adherence to internal ratings in order to estimate the probability of complete repayment according to the structure of the transaction and to set out the bank's own provisioning system in order to cover expected and foreseeable portfolio losses and to develop new techniques of security. Important fundamentals of risk control are in decision making and in supervision whereby every decision with respect to credit commitments and the allocation of trading limits are based on the invariable principle of 'dual signature'. The risk monitoring mechanism is the follow-up and reporting of outstanding risks so that portfolios are regularly reviewed and discussed at weekly committee meetings. In Canada, a lot of emphasis, at present is being given by the large banks toward implementation of the recommendations of the Basel Committee.
Some facts to consider in the economic and business environment of Canada. Canada's population is about 32 million as against United States of 300 million. Canada's gross domestic product (GDP) is Canadian $ 1.0 trillion, whereas US's GDP is US$ 10.0 trillion. (Approximate figures are quoted from Statistics Canada and USA Census Bureau).
The Canadian GDP (in approximate figures) comprises of 32% of one trillion in the form of GOODS PRODUCING INDUSTRIES, that is C$ 300 billion, of which 55% comes from manufacturing; 17% from construction, 11% from mining, oil & gas, 8.0% from utilities, while a low input of 7.0% from agriculture, forest & fishing. Another 68% of the GDP in the form of SERVICE PRODUCING INDUSTRIES, that is C$ 700 billion, of which the majority 29% comes from finance, insurance & real estate and 17% from retail and wholesale trade, while other service industries, in smaller percentages.
We observe that a large percentage of the Canadian economy comprising of over C$ 200 billion is controlled by finance, insurance and real estate of which the banks manage a major share. How aggressive are Canadian banks world-wide? An international French bank has purchased the branch of a major Canadian bank in Switzerland as the Canadian bank closed it operation there. Another major Canadian bank had opened a branch in Bangladesh and closed down after one year of its operation (since it failed to understand the operations of the LDC and found them too risky). Banking risks are high in the LDCs but so are the rewards of income. With relatively small capital investment, some of the multinational banks may reap sizeable after-tax income.
Eighty-three per cent of Canada's exports of C$ 400 billion (in approximate figures) is carried out with the US mostly on open account basis, whereas the remaining seventeen per cent is with the rest of the world.
Seventy-one per cent of Canada's imports of C$ 340 billion (in approximate figures) is resourced from the US, while the remaining twenty-nine per cent from the rest of the world and may involve LC transactions. As a matter of fact, most branch's of the major Canadian banks, other than their international divisions at the head office level, are unaccustomed with opening and handling of international LCs.
Canada's strength is in its service and manufacturing industry. Canada may gear its energy in mobilizing its export of service and manufacturing industry to the rest of the world and not just depend on the US market alone. Canadian banks can help in playing a major role by learning from the experiences of the British, French and other European banks that are moderately aggressive and are risk tolerant with long-term goal achieving objectives while the American banks though aggressive may differ in their objective. Patience and perseverance pays off in the end.
The writer, is based in Toronto, Canada, is a senior banker Consultant and pursued career in bankink with American Express Bank, ANZ Grindlays Bank, Credit Agricole Indosuez Bank, Bank of Credit Commerce Canada and the Canadian Imperial Bank of Commerce, Canada. This is a part of the article he has sent to the FE for publication