By Hans Krohn
Last year was peppered with trade finance securitisation issuance. Given the successful placement of these deals in the capital markets, it would appear that investors have finally started sitting up and taking notice of trade finance assets, but why?
Firstly, the opportunity to invest in this emerging asset class has only opened up recently, mainly due to Basel III requirements forcing banks to hold more capital against trade finance loans. This has resulted in banks turning to securitisation to move portions of their trade finance portfolios off balance sheet.
What has also become apparent is the potential yield on offer from these securitisations. Despite the general presumption that trade finance traditionally offers low returns, the securitisation of the underlying assets enables banks to slice up the transactions into tranches and sell off the high-risk portion. The result is a far more attractive yield.
Finally, interest has also been sparked by the realisation that trade finance assets are a particularly stable asset class with low rates of default. This point is backed up by data collated in the International Chamber of Commerce (ICC) Trade Register, set up in 2005. The data show that across 8.1 million short-term trade finance transactions, fewer than 1,800 (0.02%) defaulted between 2008 and 2011. Furthermore, the likelihood of default is consistently low across all trade finance products with transaction default rates of 0.034% or less.
More still to be done
While a smattering of deals have taken place recently, two major barriers still stand in the way of the market’s development; namely, lack of standardisation in trade finance documentation and insufficient diversity in banks’ portfolios of trade finance loans.
Certainly, document standardisation is a concern for investors as there is a multitude of different formats when it comes to documentation for individual deals. To address this, Commerzbank has been working towards implementing master agreements for individual deals for a number of years. However, there is some way to go in this regard and it is up to the individual banks to standardise their documentation.
The second barrier is the fact that very few banks have large enough portfolios to cope with investor demand for granularity. Indeed, most trade finance banks have a relatively small number of trade finance counterparts meaning that concentration risk is a real concern.
Despite this, recent deals prove that well-structured securitisations can address these concerns. Commerzbank’s CoTrax Finance II-1 – a securitisation of pre-export and import financing transactions with financial institutions – is a good example. In terms of the deal structure, a US$500m portfolio was sliced into three tranches with Commerzbank retaining a first-loss piece and offering up a senior mezzanine tranche to the market. From this mezzanine tranche, US$22m was placed with a single hedge fund.
Portfolio diversity was also a key factor in the deal’s success. CoTrax Finance II‑1 was made up of around 150 transactions (around 80 debtors) with an average probability of default of 1.01% at the outset. The pool consisted of short-term trade-related financings from 18 different countries, which brought much-needed diversity to the deal.
For those banks that are not large enough to provide sufficient diversity, an innovative solution is required. In this respect, an initiative proposed by the London Group could enable trade finance securitisations to take place on a larger scale. The idea involves creating a larger inter-bank pool of assets than any bank can single-handedly create, resulting in a tangible increase in diversity and lower concentration risk. If the banking industry were to explore this idea further with a view to growing the market, it could certainly contribute to trade finance securitisation taking off this year.
Hans Krohn is head of trade products at Commerzbank
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