Sailing smoothly between a rock and a hard place

Guy Brooks, global head of distribution for trade finance at Deutsche Bank, tackles market scepticism over the future of Eastern European trade finance from both ends of the spectrum.

This is an odd moment in the history of trade-related lending in Eastern European markets. At one end of the spectrum, the occasional pessimist has raised the prospect of market oversupply with trade-related facilities, leading to concern over imprudent lending. At the other end, such an unprecedented period of emerging market stability has led a different group of pessimists to conclude that trade finance will become a dinosaur – with the credits ultimately aiming for the bond market, or at least the unsecured syndicated loan market.

I hope to prove both these views wrong.

Certainly, high bank liquidity has been a push factor on some of the jumbo facilities to reach financial close for FSU borrowers in the past year – helping borrowers such as Russia’s Gazprombank, Kazakhstan’s Kazkommertsbank and Ukraine’s Bank Aval reach record oversubscriptions against the original sought-after sums. And the fact the oversubscriptions are being taken up by the borrowers themselves, suggesting demand exists to absorb the supply, is unlikely to stop those of a more nervous disposition from fretting.

Yet, in my view, the concern is overblown. We are now experiencing the most sustained period of emerging market stability in decades. Not since Soviet times have the markets of the FSU experienced such prolonged stability, and never before has there been the depth of creditworthiness among such an array of potential borrowers. Given this, as well as the highly liquid state of bank lending, it is little surprise that bank facilities are breaking records like never before, as well as offering softer security requirements.

Like all forms of lending, facilities tend to be larger, cheaper and longer for the better credits. Early borrowers are likely to be financial institutions, initially borrowing against strict schedules of their on-lending activities, as well as perhaps additional comfort against their domestic credits (such as proof of hard currency earnings). As lending confidence grows, so the security softens, which in the case of trade-related lending means a lightening of the more onerous conditions, such as the provision of on-lending schedules. And, of course, an additional factor for emerging market lending is that the easing of lending terms is not simply a function of the creditworthiness of the borrower but also of a stable macro-economic environment in the recipient country.

And given this well-trodden route, and the absence of a crisis, it makes perfect sense to be where we are. Indeed, I would expect to see further records broken as the sense of stability in the recipient market deepens. Yet this doesn’t mean that all those jumbo facilities – with the borrowers absorbing sometimes 3.5 times oversubscriptions against easing terms – will go as planned. Under pressure from the client, I suspect the occasional mandated lead arranger may come under pressure for perhaps pushing the terms too far at the wrong moment – causing nothing more crisis-inducing than a renegotiation of terms for that particular transaction.

Of course, systemic risk has not been removed from the market. Another emerging market crisis may threaten this sanguine outlook. However, even in this respect, recent experience suggests a maturing of emerging market financing to the point where once seismic shocks now barely register on the Richter scale. Not only has it been eight years since the last meltdown-generating emerging market crisis – allowing the number and type of those credits at the top of the financing ladder to increase like never before – the differentiation between particular emerging markets, and even particular credits within the emerging markets, has become ever more marked. This is the case even within single regions such as the FSU. Last year’s Yukos crisis, for instance – which coincided with problems at Alfa Bank – created very little ripple-effect among other Russian credits not directly in the firing line of the tax authorities, and was virtually ignored beyond Russia. And we mustn’t forget that this latest emerging market lending bull run has taken place against the backdrop of the largest ever emerging market default – that of Argentina in 2001.

In other words, not only are we witnessing the most sustained period of development in emerging market financing for decades – certainly within the careers of most current bankers – we are also looking at unprecedented levels of borrower market sophistication and differentiation. This can be seen in the individual leading trade-related markets.

Turkey: the original market for trade-related on-lending by the leading FIs has been dogged by serial crises for decades – the last in 2001. These have trapped the market in a volatile cycle of hair-raising situations followed by false dawns, preventing even the top FIs from moving towards genuinely unsecured borrowings. And while the EU application process has, hopefully, anchored the country’s economy – at least as long as the accession process remains current – few non-FI credits appear strong enough to tempt lenders. Indeed, those that are may jump straight into the bond market, although the large number of creditworthy banks should always provide a client base for trade-related lenders – with extended tenors likely for the better credits as 2005 progresses.

Russia: progress has been so significant – from both a credit quality and credit quantity perspective – that in many respects Russia has overtaken Turkey as the region’s key trade-related lending market. The sheer volume of hard currency-earning credits, coupled with the growing sophistication of the FIs, means that Russia is likely to be the central focus for international trade lenders for many years to come, especially as the market rode last year’s potential crisis so well. The Deutsche Bank-led $275m loan to Gazprombank in 2004 – at the time a record unsecured loan for the country – has already been easily eclipsed in terms of size by a new $650m record loan in April this year for the same borrower. Of all the markets, Russia is likely to produce the most credits that meet the minimum criteria to position themselves on the financing ladder.

Kazakhstan: one 2004 deal heralded the arrival of Kazakhstan at the top of the ladder – the Deutsche Bank-led Kazkommertsbank transaction, which signed for over $500m on the one and two-year tranched deal. And while the market may not produce an enormous number of credits capable of attracting such terms, the improving sovereign economy has meant that the market is happier with longer tenors and larger amounts to the few credits that make it.

Ukraine: While at the foot of the ladder, ie, attracting lenders to top-name FI credits with good security, the potential here is perhaps even greater than Kazakhstan. This was shown in 2004 by the Deutsche Bank and RZB-led facility to Bank Aval. The one-year deal was initially launched for $25m, although attracted $45m in syndication – at the time of signing the largest ever syndicated loan for a Ukrainian bank. The trade-related loan won a margin of 3.8% over Libor with a 12-month extension option – all strong terms for Ukraine, which on this rung of the ladder should be doing its best to attract new lenders. Ukraine is a new market opening up and the Bank Aval transaction was intended to show Deutsche Bank’s commitment to it early on.

It is this sanguine view across a range of countries, as much as lending bank liquidity is concerned, that is creating the crowding at the top of the financing ladder, engendering the record-breaking facility sizes and loosening security structures. Indeed, given a clear run, many of the top credits in all these markets should, this time, avoid the post-crisis tumble back to the foot of the ladder and finally graduate into the eurobond market.

This brings us to the second trade finance concern – that our market is no more than an undergraduate market for the bond market. While this scenario offers a more attractive way for the trade finance market to make itself redundant – having achieved its role of producing creditworthy names for the bond market – I still think it not a realistic scenario. Emerging market debt has its own in-built limitations beyond the international banks’ appetite for lending ever larger sums for ever longer periods to ever more credits.

The starkest limitation is provided by the borrowers themselves. One unbreakable credit committee stipulation remains that borrowers must provide accounts audited to International Financial Reporting Standards. And while an increasing number of companies in Russia and other emerging markets are adopting such standards, beyond the key financial institutions (and in the case of Russia the top energy companies), this is likely to be no more than a trickle and certainly not enough to absorb current lending appetites. A further limitation will be the need for non-FI borrowers to be hard-currency earners – again a group slowly increasing in number, although a group where, from a lender’s perspective, supply still lags behind demand. In other words, if trade finance is a dinosaur, we are only just entering the Jurassic age.

And with the gulf between these select names and the rest remaining far too wide for international lenders to bridge, the concentration of lender appetite on a few top names becomes understandable – as are the large oversubscriptions against what some pessimists view as eyebrow-raising terms.

In essence, the prospect of an event-led meltdown is slim, as are predictions that the trade-related lending market is in the throes of making itself redundant.