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
• 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
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Bank Markets offer factoring, invoice discounting and
commercial finance (ABL)
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Capital Markets offer trade receivables securitisation (ABS)
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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
The Market
The Perfect Storm
•Credit crunch
•Basel II
• IFRS
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. White
Professor of Economics
NYU Stern School of Business
May 2, 2008
Financial Market Turmoil
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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
•
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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.
•
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Basel II
(2008)
introduced to keep pace with the increased sophistication of lenders
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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
I. Standardised Approach – based on external rating agencies
II. 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
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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
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
Is Credit Insurance too conditional?
How can Corporates ensure reliable funding in
the Current Environment?
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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
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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
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What has AIG TF Changed?
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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
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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:
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Clear contract language
Legal Certainty
Cover explicitly referenced
Achieve true sale
More Effective Trade Receivables Financing
3. 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
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Finance and Insurance properly linked and new documents are clear and
consistent
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AIG TF approach allows bank to use policy as a credit risk mitigant under
Basel II significantly reducing the capital allocated for each transaction
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100% credit indemnity against debtor failure above deductible
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Improved due diligence processes and information
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Improved data capture, monitoring and reporting
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Improved and independent verification of receivables performance and
credit/buyer limit compliance
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Improved claims handling processes and certainty
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Standardised legal documents with supporting opinion
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Standard Bank requirements and protections incorporated
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Regular receivables verification and data cleansing
Additional Benefits over traditional finance
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Standardised approach by Bank and Insurer, using pre-agreed
standard documentation
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Non payment risk / balance sheet protection covered by AIG
• Large exposure or concentration risk minimised
• Appetite for Emerging Market Risk
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TRIM provides parallel sales ledger review, analysis and reporting at
whatever depth and frequency is requested by Client and Bank
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AIG TF acts as ongoing stand by servicer and has full data to enable
collect-out and early amortisation
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Potential for AIG to offer Client parallel policy for further risk transfer
purposes and balance sheet protection
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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