Trade receivables financing post the credit crunch
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Trade Receivables Financing Post the Credit Crunch. Alastair Malcolm. Trade Receivables. Trade debt exceeds bank debt by a factor of 3:1 An undervalued asset on a Corporate’s balance sheet (every £1 not bank-funded is Corporate capital) Receivables-backed loans impact Bank’s balance sheet

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Trade receivables financing post the credit crunch

Trade Receivables Financing Post the Credit Crunch

Alastair Malcolm

Trade receivables
Trade Receivables

  • Trade debt exceeds bank debt by a factor of 3:1

  • An undervalued asset on a Corporate’s balance sheet (every £1 not bank-funded is Corporate capital)

  • Receivables-backed loans impact Bank’s 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

Traditional financing of trade receivables
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

Trade receivables financing post the credit crunch

The Perfect Storm

  • Credit crunch

  • Basel II

  • IFRS

Trade receivables financing post the credit crunch

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

Financial market turmoil
Financial Market Turmoil focus, too

  • 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

Basel ii
Basel II focus, too

  • 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

Trade receivables financing post the credit crunch

Basel II and the Current Environment focus, too

  • 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

Is credit insurance too conditional
Is Credit Insurance too conditional? focus, too

Will risk bite back if U/W Remove the chains

How can corporates ensure reliable funding in the current environment
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

A new way forward an evolution in trade receivables financing
A New Way Forward: Environment? 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

More effective trade receivables financing
More Effective Trade Receivables Financing Environment?

  • 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

More effective trade receivables financing1
More Effective Trade Receivables Financing Environment?

  • Effective Credit Risk mitigation

    • Legal Certainty

    • AIG Global Limits Manager

    • Discretionary Limits

    • Reporting

    • Aggregation

    • Monitoring

    • 100% of bank’s credit risk transferred

Benefits over traditional finance
Benefits Environment? 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

Additional benefits over traditional finance
Additional Benefits Environment? 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

A new era in trade receivables financing
A New Era in Trade Receivables Financing Environment?

  • 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

  • Trade receivables financing post the credit crunch

    It should be noted that this presentation and the remarks made by AIG representatives may contain projections concerning financial information and statements concerning future economic performance and events, plans and objectives relating to management, operations, products and service, and assumptions underlying those projections and statements. Please refer to AIG's Quarterly Report on Form 10-Q for the period ended March 31, 2008 and AIG's past and future filings with the Securities and Exchange Commission for a description of the business environment in which AIG operates and the factors that may affect its business. AIG is not under any obligation (and expressly disclaims any such obligation) to update or alter its projections and other statements whether as a result of new information, future events or otherwise.

    This presentation may also contain certain non-GAAP financial measures. The reconciliation of such measures to the comparable GAAP figures are included in this presentation and in the Financial Supplements available in the Investor Information section of AIG’s corporate website,

    Disclaimer Notice: The information on products in this presentation are for general information purposes only and do not constitute advice.All data has been compiled from sources believed to be reliable.  No warranty, guarantee or representation is made about the accuracy or sufficiency of any statement it contains.

    AIG UK Limited is authorised and regulated by The Financial Services Authority. Registered in England: Company Number 1486260. Registered address: The AIG Building, 58 Fenchurch Street, London EC3M 4AB, United Kingdom. A Member Company of American International Group Inc.