Financing Exports – a case study – with tips on what a bank will focus on when considering facilities to support an export business

 

Founded in 1969, McCarthy Metals Limited is a family owned business specialising in recycling and refining both ferrous and non-ferrous scrap metals. The scrap metal is delivered to the company's ten acre site in South Essex by a large number of regular suppliers based all over the S.E of England. The scrap metal is processed on site using a specialist shredding machine which refines the components to a certain level, and following this procedure, the resultant metal is sold to buyers in predominantly Asia (China and India) and Europe (Spain and Belgium).

It is apparent that despite some economic challenges in China and India, and the continuing downturn in their traditional European markets, there are good opportunities to increase sales to buyers in Asia. However in order to take advantage of these opportunities, McCarthy Metals will need to negotiate with their bankers to increase their existing facilities or seek alternative banking arrangements if their current bankers are unwilling to approve these revised facilities.

McCarthy Metal's current bank will need to fully understand why the increased facilities are required and their bank relationship director will consider and scrutinise a detailed financial analysis of the business including latest audited accounts, current and forecasted sales, profitability etc. Once the financial performance has been analysed there are a host of other considerations for the relationship director to deliberate over but this article is purely focusing on the exporting activities of the business. The vast majority of banks will require a trade and working capital specialist to prepare a separate report which will be considered by the bank's credit function along with the relationship director's main report.    

In this case study using McCarthy Metals Limited, the main areas of focus for the trade and working capital director will be;

Brief purpose of the proposal

The report will need to ensure that the credit sanctioner has an understanding of why the increase in facilities is required. It will also cover how the existing facilities have been used and whether there has been any breaches of the limits in the past year.

Trade Cycle Terms of Trade

It is a fundamental requirement for the trade & working capital manager to produce a trade cycle or perhaps a series of trade cycles if the customer's trading activities demand more than one trade cycle. This graphic depiction of a time line, starting in McCarthy Metal's case from when they purchase the metal from their UK suppliers, process the metals on site , hold in stock, ship the goods, and finally receive in the proceeds, forms the basis of the bank's understanding of the working capital requirements of the business. McCarthy Metals will be required to provide some forecasts in terms of their approximate new sales to enable the bank to make some calculations on the size of any potential increase to the facility, using the funding gap as identified in the trade cycle.

The main payment method with buyers in China and India is settlement by Documentary Collections at Sight (D/P) - documents against payment. It is quite common for UK scrap metal exporters, when selling product to Asia, to use Documentary Collections as a method of payment. Goods are shipped by sea, so a full set of Bills of Lading will afford constructive control of the goods, as the collecting/presenting bank in Asia must only release the documents against payment by the buyer of the goods. The bank will have to make an approximation of long it takes for the proceeds to be paid under a collection when it is calculating the funding gap in the trade cycle. The bank must also determine whether the new buyers will settle under Documentary Collections or by an alternative method.

McCarthy Metals also has key buyers in Spain and Belgium but these buyers are on the same terms as UK customers, open account, 30 days from date of invoice. However trade cycles will be required showing the various transit times etc. producing a quite different time line and funding gap compared to the Chinese and Indian cycles.

Stock

The existing bank will be aware of McCarthy Metal's procedures in holding the refined stock, and whether they own or rent their premises. However, increased sales will equate to increased stock levels, so the bank will need to establish whether the existing premises will be sufficient to cater for these larger quantities. The stock will need to be adequately insured and in many instances a bank official will be required to take a short tour of the premises to satisfy themselves that all is in order. All sales to Chinese and Indian buyers are against confirmed orders and stock turns to sales in approximately 50 days.

Suppliers

Details of regular suppliers and any new suppliers required to meet the increased level of supply for the proposed new business will be required by the bank, as the bank is likely to carry out some rudimentary checks on the suppliers to satisfy themselves that they are bona fide companies. The bank will also assess whether there is a reliance on any supplier, as a issue with that company may seriously affect the supply chain.

In McCarthy Metals case, they pay some of their suppliers in cash when the scrap metal has been weighed on delivery, but the majority of their regular suppliers will submit invoices. 

Buyers

Banks are required to consider much more information about their customer's trading partners as financial regulation and compliance increases year on year, and "know your customer's customer" seems to be a common theme. Since McCarthy Metals are seeking an increase in their facilities to help assist a growth in their export trade it is likely that the bank will carry out some basic checks on the key new buyers to ensure that they exist and appear to be viable trading partners and buyers for metals.

As previously mentioned in the trade cycle section it is important that the method of payment is clearly established, and in some cases the bank may wish to view the commercial contracts between the exporter and their overseas buyers. This is common practice in Asia with banks routinely requesting to scrutinise contracts where they are helping to fund deals - it would be quite unusual for banks in the UK to view commercial contracts in the  SME sector, but for large corporates and multinationals this may be a requirement.

McCarthy Metals has built up its export sales based on strong, enduring relationships, and this track record which has developed over a period of years will help the bank with its considerations regarding the increased facilities.

Incoterms® 2010

The bank must understand the incoterm rule used in the contract between the two parties. It is important that a financier understands where the exporter has legally delivered the goods, and that appropriate insurance has been taken to cover the seller up to that legal point of delivery of the goods.  

Operational Risks & Mitigants      

McCarthy Metals invoices its Chinese buyers in US Dollars, its Indian buyers in Sterling and its European buyers in Euros. Since all of the company's suppliers are paid in Sterling and all overheads are in Sterling, the business is subject to exchange rate exposure risk. In line with the FX industry in 2013, McCarthy Metals receives in a number of offers on an almost daily basis from FX providers, quoting near market rates in an attempt to win business. In terms of a hedging policy, forward contracts covering approximately 50% of exposure are booked with two FX providers, and the other 50% is transacted at spot. A bank will generally require some form of exchange rate protection, and may insist upon it, making it a condition of sanction of any revised facilities.

Senior member of the McCarthy Metals staff visit the buyers in China and India on a regular basis and most of the new buyers have been acquired on recommendations from existing buyers.

Any financier must deliberate on the political and economic risks within the buyer's countries, to gauge country risk. This is a very difficult element to evaluate as civil unrest and unforeseen political issues can and will occur. It is a process which is carried out on a best endeavours basis, using the most up to date material which is available at the time. How many banks can say that they predicted the Arab Spring which started to occur a couple of years ago?          

Current export facilities

McCarthy Metal's bankers currently offer a "with recourse" export finance facility with funds being advanced, by way of a loan, soon after documents are presented by McCarthy Metals using D/P Documentary Collections. The loans are repaid when the proceeds of the collections are received in from the collecting or presenting banks.  The advance is for 50% of the value of the documents but McCarthy Metals are aware that other banks may be willing to advance a greater percentage, and since suppliers are paid on average 50 days prior to shipment of goods, these current arrangements are not sufficient for existing needs, even before an increase in facilities is considered. So it is likely that the existing bankers will need to consider revising their offer and providing an alternative structure, or the exporter may seek an alternative financier. It is important to mention that the existing facility has some security provided by McCarthy Metals in the form of a mix of collateral, and if they elect to stay with their current banking provider it is likely that additional security may have to be lodged to support new increased facilities.

Summary

McCarthy Metals decided to talk to a number of potential banking providers, after their existing bank refused to increase the facilities without substantial new security being deposited. After a period of time an alternative financier was identified, who was willing to significantly increase the export facilities, but actually required less security than the previous bank. The decision to support a business is influenced by a large number of factors and the bank's credit function has the task of trying to assimilate all the known facts, consider the risk (and possible mitigants) and then to either support or decline the proposal.             

 

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Written on 9th May 2013 by Richard Casburn Associate at MJ Hayward & Associates- www.mjhayward.co.uk

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