Trade Receivables Financing Post the Credit Crunch

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Trade Receivables Financing Post the Credit
Crunch

• Alastair Malcolm

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Trade Receivables

• Trade debt exceeds bank debt by a factor of 31
• An undervalued asset on a Corporates balance
  sheet (every 1 not bank-funded is Corporate
  capital)
• Receivables-backed loans impact Banks balance
  sheet
• Working Capital demands are variable
• Corporate strategy often sales/marketing driven
• Bank strategy usually risk and return driven
• Strength of customer base under-utilised
• The one traditionally self-insured risk

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Traditional Financing of Trade Receivables

• Bank Markets offer factoring, invoice
  discounting and commercial finance (ABL)
• Capital Markets offer trade receivables
  securitisation (ABS)
• Traditional Methods have limited appeal
• High initial set up cost for Originator legal,
  systems and data
• Heavy burden of administration and reporting for
  the Originator
• Covenant compliance a constant worry and cost
• Facility amounts often out of step with business
  activity
• Poor asset visibility for Funder due to
  inadequate data
• Concentration risk and emerging market risk
  reduce advance rates
• Perceived high seller/servicer risk
• Perceived cherry-picking concerns
• No effective risk transfer by Originator

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The Market
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The Perfect Storm

• Credit crunch
• Basel II
• IFRS

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• Clearly in the past few years, there was too much
  short-run focus, too
• Much "take the Money and run" behaviour. This was
  partly driven by the
• belief that housing prices will Always go up and
  partly by the belief that
• if a problem with a loan occurs, it will be
  somebody else's problem.
• What is galling in all of this is that the guys
  at the major commercial and
• investment banks kept telling us, "We understand
  risk and we can
• manage risk and get higher returns" but it turns
  out that most of them
• did not understand anything about risk.

Lawrence J. WhiteProfessor of EconomicsNYU
Stern School of BusinessMay 2, 2008
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Financial Market Turmoil

• Sub-prime mortgage assets packaged into RMBS and
  CDOs
• Growth in the Financial Assets and increased
  credit availability encouraged increased
  appetite in new and complex financial instruments
• Initial problem was liquidity, lack of
  transparency and rapid evaporation of investor
  confidence in structured products
• Liquidity problem caused mainly by mark to
  market and margin calls on SIVs and SIV-lites
  and other types of funds
• Fire-Sales of AAA/AA RMBS and CDOs at depressed
  prices or not at all knock-on effects have
  caused real Credit problems
• Huge damage to banks capital base and
  significantly increased investor anxiety
• Inter-Bank lending market availability of funds
  and pricing disrupted
• All debt financing markets affected and liquidity
  at a premium

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Basel II

• Basel I (1988)
• International accord to set minimum levels of
  capital for banks and deposit takers to ensure
  that lenders were sufficiently capitalised to
  protect depositors and the financial system.
• Basel II (2008)
• introduced to keep pace with the increased
  sophistication of lenders
• Pillar 1 to align required minimum capital more
  closely with lenders real risk profile
• Risk weighted assets will be calculated based on
  credit risk exposures
• Introduction of operational risk capital
  requirements
• To assess Credit Risk banks need to use either
• Standardised Approach based on external rating
  agencies
• Internal Ratings based Approach (IRB) -
  (potential for lower capital requirement
• requires banks to assess residual risks not
  captured in Pillar 1 for which capital may be
  allocated
• Pillar 2 introduces an increased role for
  supervisors of banks (internal and external)
• Pillar 3 promoting greater transparency
• market disclosure on risks and risk management

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Basel II and the Current Environment

• Central banks forced to become the lender of
  first resort rather than last
• pumping liquidity into markets only part of the
  solution significant problems with poor quality
  collateral, transparency and attitudes to risk
  and reward
• Basel II assumed that a bank with sufficient
  capital would always be able to raise cash to
  meet its obligations
• Banks have little choice but either to raise
  money or cut back dramatically on their lending
• Dependence on rating agencies has been undermined
• Assumption that bank models are sufficient has
  been over-optimistic
• Basel II framework determining capital levels
  banks must hold to balance the books has
  contributed to the liquidity crunch
• Banks have taken many significant hits to balance
  sheets
• Minimum 8 total capital requirement (market
  standard for Tier 1 is 6) is deterring banks
  from lending
• to other banks
• to households and businesses

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Is Credit Insurance too conditional?
Will risk bite back if U/W Remove the chains
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How can Corporates ensure reliable funding in the
Current Environment?

• Implications of turmoil are profound
• More corporate demand for reliable funding at
  same time as bank appetite for risk reduces
• Greater bank appreciation of value in information
  on receivables and customers
• Greater bank desire to lay off credit risk in
  assets
• Bank management stressing back to basics
  banking
• More realistic pricing for risk, less reliance on
  structures or models and more appreciation of
  strong names
• Transparency of operations and risk becoming far
  more important

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A New Way Forward An Evolution in Trade
Receivables Financing

• Flexible coordinated approach credit insurance,
  finance and operational controls
• Benefits companies with debtor portfolios of 40m
  
• Global coverage of receivables risk
• Bank has 100 indemnity against credit risk
• New Suite of Documents which are Basel II
  compliant
• New method for sales ledger data to be captured
  and analysed without any IT systems changes or
  burdens
• Extensive due diligence provides good
  underwriting data
• Improved risk management and asset performance
  visibility for Client, Bank and AIG
• AIG Trade Finance can help increase existing or
  new corporate credit facilities with potentially
  better rates

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More Effective Trade Receivables Financing

• What has AIG TF Changed?
• 1. TRIM (Trade Receivables Information
  Management) - web-enabled platform developed
  that
• Requires no Client administration other than
  daily transmission of sales ledger in flat file
  no IT systems changes
• Eligible receivables identified
• Seller compliance tracked
• Granular data for Reporting and tracking
• Ongoing monitoring and reporting of asset
  performance
• 2. New Framework of legal documents and
  operational procedures
• Clear contract language
• Legal Certainty
• Cover explicitly referenced
• Achieve true sale

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More Effective Trade Receivables Financing

• Effective Credit Risk mitigation
• Legal Certainty
• AIG Global Limits Manager
• Discretionary Limits
• Reporting
• Aggregation
• Monitoring
• 100 of banks credit risk transferred

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Benefits over traditional finance

• Finance and Insurance properly linked and new
  documents are clear and consistent
• AIG TF approach allows bank to use policy as a
  credit risk mitigant under Basel II significantly
  reducing the capital allocated for each
  transaction
• 100 credit indemnity against debtor failure
  above deductible
• Improved due diligence processes and information
• Improved data capture, monitoring and reporting
• Improved and independent verification of
  receivables performance and credit/buyer limit
  compliance
• Improved claims handling processes and certainty
• Standardised legal documents with supporting
  opinion
• Standard Bank requirements and protections
  incorporated
• Regular receivables verification and data
  cleansing

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Additional Benefits over traditional finance

• Standardised approach by Bank and Insurer, using
  pre-agreed standard documentation
• Non payment risk / balance sheet protection
  covered by AIG
• Large exposure or concentration risk minimised
• Appetite for Emerging Market Risk
• TRIM provides parallel sales ledger review,
  analysis and reporting at whatever depth and
  frequency is requested by Client and Bank
• AIG TF acts as ongoing stand by servicer and has
  full data to enable collect-out and early
  amortisation
• Potential for AIG to offer Client parallel policy
  for further risk transfer purposes and balance
  sheet protection

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A New Era in Trade Receivables Financing

• Greater value can be created for clients benefit
  by combining bank capital with insurance capital
• banks are not efficiently set up to take credit
  risk insurers are.
• Underlying asset performance analysis can be
  provided to support and reduce banks Risk
  Weighted Asset
• Evolutionary approaches to Risk Management are
  particularly important today
• Technology helps to improve certainty, assists in
  near real-time analysis and provides an early
  warning that allows preventative action to be
  taken

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