Well aware of the challenges in Iraq today, some banks are cautiously optimistic about the country’s longer-term prospects. Amanda Greene reports.

Citigroup is, of course, a global financial institution. One reason it is so competitive is because of its extensive global footprint. For this reason, it has been cognisant of the longer-term opportunities that a market like Iraq could present for some time.

It is also, of course, sympathetic to the country’s current struggles as it works to achieve peace and stability.

Recently the bank took a step that satisfies both these instincts: In mid October it announced it would launch a $70m structured credit facility with the US quasi-government agency, the Overseas Private Investment Corporation (OPIC), that will enable the Trade Bank of Iraq (TBI) to issue letters of credit (LCs).

TBI has been receiving steady support for government agencies in partnership with private banks since it was established a few years ago. What is different about this initiative, says Rodrigo Vega, vice president in Citigroup’s export and agency finance division in New York, is that the bank is extending credit terms to TBI.

“Up until now, most letters of credit were done on a prepaid basis. With this facility we will provide guarantees to confirming banks through a trust, confirming LCs issued by TBI up to 270 days,” says Vega.

A new role

When one thinks about Iraq and its efforts to rebuild its private sector banking community, one thinks of US bank JPMorgan Chase. After all, it was JPMorgan’s consortium – a group that included the UK’s Standard Chartered, Bank Millennium of Poland, Credit Lyonnais, Royal Bank of Canada, and National Bank of Kuwait – that won the contract to run the Trade Bank of Iraq in 2003. It outbid six finalists, including a consortium headed by Citigroup. JPMorgan’s initial efforts were widely watched and then, widely lauded: in its first two months of operation, the Trade Bank of Iraq and its international banking partners issued approximately 100 import letters of credit supporting more than $200m in humanitarian and reconstruction-related imports. Indeed, its winning bid landed JPMorgan on Trade & Forfaiting Review’s roster of Deals of the Year that year (see TFR, February 2005, page 28).

Its efforts in the country made it easy to overlook other banks’ activities. Citigroup has remained active in the market since 2003, forming alliances with the private banks in operation there as well as working with TBI. Certainly, there have been steps the bank could have taken but hasn’t: the year following TBI’s establishment, for instance, Citigroup did not apply for a foreign banking licence in the country although other banks did.

The $70m structured credit facility it has offered with OPIC, though, represents a significant step forward not only for TBI but also for Citigroup. It is the first time since 2003 that a commercial lender has supported an LC in Iraq that was not fully cash collateralised. The trust is meant to extend the financing already available in the market and is not meant to replace pre-existing export credit agency cover. Rather, it will serve as a guaranty reimbursement of obligations on TBI letters of credit not supported or only partially supported by ECAs.

Under this new facility, TBI will issue the LCs. The confirming banks will avoid the sovereign risk of the Iraq market as the new trust backed by OPIC and Citigroup will provide guarantees in the event of non-payment by TBI.

But the facility is significant for another reason also. “TBI is beginning to explore more sophisticated markets, looking at structured finance transactions,” says Vega. “It is using the agencies such as OPIC to support that next step.” The same is true for Citigroup, he adds, which regards the facility as the possible precursor to other initiatives in the markets, such as credit default swaps.

Capital markets prepare for better days

Certainly, the terrible violence, which sadly shows little sign of abating, as well as the uncertain political situation in the country – not to mention the future role of the US and allied forces there – all present a giant question about the shape of Iraq’s long-term prospects. Of course, there is little the financial community can do about that – and the reality is ultimately their efforts in the market could be overcome by events. That said, financial institutions and capital markets are preparing for the prospect of a stabilised Iraq. Earlier this year the country reached a milestone that could well pave the way for the products and initiatives Vega described: Iraq restructured its multibillion dollar commercial debt – an effort in which Citigroup as well as JPMorgan participated, and a step seen as integral for future capital markets investments in Iraq (see ‘Secret of my success’).

Much of the debt had been incurred by Saddam Hussein during its war with Iran in the 1980s. The country’s financial situation markedly worsened, of course, when the United Nations imposed sanctions on it after Iraq’s invasion of Kuwait more than ten years ago.

Other successful initiatives over the past year include the launch of a $130m OPIC partial guaranteed loan meant to support private sector Iraqi companies and the prepaid LC facility for TBI.

Indeed, bankers – at least those familiar with the market – are feeling a cautious optimism that events in Iraq will eventually lead to stability and a functioning global economy.

Citigroup, for instance, began to focus seriously on Iraq in 2003, Hashim Hamandi, corporate country officer for Iraq based in Dubai says. Its first goal was to participate in TBI, which was also forming at that time. TBI figured – and still does – prominently in Iraq’s global trade finance infrastructure and it was then, and still is now, for the most part, the only game in town. “The state-owned banks were bankrupt and defunct,” Hamandi says. The lead mandate eventually went to JPMorgan, but Citigroup remained committed to the market.

It developed relationships with the private banks in Iraq, which had remained solvent and surprisingly active, given the lack of investment and depleted resources devoted to them over the years. Today, Citigroup maintains an active relationship with the largest five of the 17 active banks – the Iraq Middle East Investment Bank, Bank of Baghdad, the Kurdistan International Bank, the Iraq Commercial Bank and the Gulf Commercial Bank – providing currency and cash management services to them.

“We have created an Iraq middle-market $130m lending facility, giving these private banks access to credit for loans to small and medium-sized companies in Iraq,” says Hamandi.

Only on a minimal level and with the help of TBI are any of these private banks supporting trade finance, he says. In part that is because they are still undercapitalised and in part because most of the trade in Iraq these days is government and public sector related.

“Iraq continues to be a regionally active player,” Hamandi notes. “I would say roughly 20% of its trade is with Turkey. It is also an active trader with countries in North America, Europe and Asia.” TBI, he says, supports about $6bn in trade flows a year, the large bulk of which is regionally driven and LC-backed. Deal size ranges from $100,000 to $200m.

Citigroup is not deceiving itself about the challenges the country faces. Vega and Hamandi, for instance, decline to speculate on very long term forecasts for the country.

Over the next three to five years, though, the bank plans to continue and strengthen its current strategies. “We plan to continue to be active with the private banks,” says Hamandi. “We will continue to explore ways of providing credit – whether it is through heavily structured ECA-backed deals or on a claim basis.” That said, it does not have any near term plans for entering the country to set up an office.

It is a measured view of a situation that is widely seen as extremely difficult. Hamandi, though, is opting to view the glass as half full. “We do have a sense of optimism for the country, especially its banking sector.”

Secret of my success

In July 2006, Citigroup and JPMorgan completed the restructuring – at an astounding 80% write-down – of Iraq’s Saddam-era commercial debt. The two banks were joint financial advisors and joint dealer managers.

In some quarters it was not expected that the two banks would succeed. There were multiple laws to consider as well as a new constitution. There were also multiple creditors – located in more than 70 countries – with claims that had been in default for over 15 years as well as an ongoing parallel debt reconciliation process. Also, Citigroup has noted in a presentation on its activities, many of the claims had outstanding counterclaims, set-offs, sub-participations, pending legal action and judgments.

The two banks, though, approached these issues in methodical fashion, and were slowly able to develop a viable solution. Small claimants were paid out in cash, for instance, significantly reducing complexity of bond issuance. Also, to conserve cash the large claimants were given an offer to settle either though a 2028 liquid bond or a multi-currency loan. Overall the structuring was completed within an unprecedented timeframe for a sovereign restructuring, Citigroup said, “particularly given the prevailing volatile political backdrop as events unfolded in the new Iraq”. Most of the restructuring was completed within 12 months, with the entire process completed in 18 months

According to Citigroup, among the structure’s winning characteristics were:

-         96% participation by the claimant universe (491 claimants), and 100% participation in the debt exchange;

-         80% write-down of claims, across all debt classes, that will achieve a sustainable debt profile for Iraq;

-         First entry by Iraq into the international bond market;

-         Cash was conserved: $450m of cash used to settle smaller claims;

-         11,776 individual Saddam-era claims were cancelled, with aggregate value of $19.7bn.