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Academy of Economic Studies Faculty of International Business and Economics “International Finance and Payments” Academy of Economic Studies Faculty of International Business and Economics “International Finance and Payments” Lecture VIII “International Credit Market” Lecturer Cristian PĂUN Email: [email protected] ro URL: http: //www. finint. ase. ro

International Payments - review • the payments in international business are made using specific International Payments - review • the payments in international business are made using specific techniques, in order to reduce the high default risk; • when the risk is low for the exporter can be used: open account payments, bank drafts or documentary collection; • when the risk is too high for the exporter it is strongly recommend to be used the letter of credit (or cash in advance); • the letter of credit is the most complex payment mechanism ensuring a reduced risk if the operation; Lecture 8: International Credit Market 2

International Credit Market International Market Dimension (2002) Credit Market 9446 bil. USD Bond Market International Credit Market International Market Dimension (2002) Credit Market 9446 bil. USD Bond Market 31000 bil. USD Stock Market 3500 bil. USD A. Credit Market (general situation) Total Credit 9. 446 bil. USD Weight Developed Countries 7302 bil. USD 77 % Offshore Countries 1250 bil. USD 13 % Developing Countries 894 bil. USD 9% Lecture 8: International Credit Market 3

International Credit Market B. Credit Market (by the maturity) Area Total Credit Developed Countries International Credit Market B. Credit Market (by the maturity) Area Total Credit Developed Countries Offshore Countries Developing Countries < 1 year 53, 1 % 56 % 52 % 46, 7 % > 1 year 27, 7 % 24, 3 % 36, 9 % 43 % World Bank: "Global Development Finance", 2000 - 2001 C. Credit Market (by the destination) Area Banks Public Sector Private sector Total Credit 46. 9 % 11. 9 % 38. 7 % Developed Countries 50. 6 % 12. 2 % 34. 5 % Offshore Countries 38. 7 % 0. 9 % 59. 8 % Developing Countries 30. 1 % 17. 1 % 52. 1 % World Bank: "Global Development Finance", 2000 - 2001 Lecture 8: International Credit Market 4

International Credit Market D. Credit Market (creditors by origin) Area EU Banks NA Jap International Credit Market D. Credit Market (creditors by origin) Area EU Banks NA Jap Others Total Credit 57. 8 % 7. 5 % 11. 2 % 23. 5 % Developed Countries 57. 5 % 6. 5 % 10. 7 % 25. 5 % Offshore Countries 54. 9 % 8. 1 % 27. 2 % 9. 8 % Developing Countries 62. 6 % 14. 1 % 9. 3 % 14 % E. Credit Market (country distribution) Countries Weight US 16 % EU 54. 6 % UK 13 % GER 8. 4 % ITA 5. 4 % JAP 5. 6 % Lecture 8: International Credit Market 5

International Credit Market - conclusions • International Credit Market is the second financing alternative International Credit Market - conclusions • International Credit Market is the second financing alternative after bonds; • Last years, credit expansion was higher than bonds; • The developed countries have a net dominant position on international credit market; • In the developing countries the total credit tends to decrease; • Private sector becomes more important on international credit market (instead banks); • Short term credits are dominant (instead long term credits) • Syndicalized loans become more and more important. Lecture 8: International Credit Market 6

International Credit Market I. Short term credits: - Credits in advance; - Export credits; International Credit Market I. Short term credits: - Credits in advance; - Export credits; II. Long term credits: • Syndicated loans; • Eurocredits; • Parallel loans; • “Back to back” credits; • Buyer credits; • Seller credits. III. Special credits: • Leasing / Factoring / Forfeiting Lecture 8: International Credit Market 7

Short term credits Lecture 8: International Credit Market 8 Short term credits Lecture 8: International Credit Market 8

A. Short term credits – Export Pre-financing Producer Exporter 1 4 -5 2 6 A. Short term credits – Export Pre-financing Producer Exporter 1 4 -5 2 6 3 Exporter’s Bank Government 1 – Signing an Export contract; 2 – Obtaining a Credit; 3 – Refinance from public funds; 4 – Delivery of goods; 5 – Payment at the maturity; 6 – Credit reimbursement. Lecture 8: International Credit Market 9

B. Credit based on B/E discount Exporter 1 3 5 Importer 2 4 X B. Credit based on B/E discount Exporter 1 3 5 Importer 2 4 X Bank Other bank 1 – Export contract based on B/E payment; 2 – B/E Acceptance by the importer; 3 – Presenting the B/E to the X Bank in order to be discounted; 4 – Discounting the B/E on the local money market; 5 – Payment of the exporter. Lecture 8: International Credit Market 10

C. Importer Banker’s Acceptance Exporter 4 1 Importer 3 2 Exporter Bank 5 Importer C. Importer Banker’s Acceptance Exporter 4 1 Importer 3 2 Exporter Bank 5 Importer Bank 5 1 – Export contract containing a commercial credit granted by the exporter (the importer will pay at a specific maturity after delivery); 2 – B/E acceptance by the importer bank; 3 – Presenting the B/E to the Exporter Bank; 4 – B/E discounting to an Exporter’s bank; 5 – Payment at the maturity. Lecture 8: International Credit Market 11

D. Exporter Banker’s Acceptance 1 Exporter 4 3 Importer 2 5 Exporter Bank Importer D. Exporter Banker’s Acceptance 1 Exporter 4 3 Importer 2 5 Exporter Bank Importer Bank 5 1 – Export contract; 2 – B/E Acceptance by the Exporter Bank; 3 – Presenting B/E to the Exporte’s Bank or to other local bank; 4 – Discounting the B/E; 5 – Payment at the maturity against B/E. Lecture 8: International Credit Market 12

E. Credit transfer Exporter Importer 1 2 3 4 5 Financing Company Importer’s Bank E. Credit transfer Exporter Importer 1 2 3 4 5 Financing Company Importer’s Bank 1. Export contract. Delivery of goods 2. Credit transfer to a financing company; 3. Payment against the B/E transfered; 4. Payment at the maturity. Lecture 8: International Credit Market 13

F. Revolving Credit Agreements Revolving Credit Agreement -- A formal, legal commitment to Revolving F. Revolving Credit Agreements Revolving Credit Agreement -- A formal, legal commitment to Revolving Credit Agreement extend credit up to some maximum amount over a stated period of time. n n Agreements are frequently for three years. The actual notes are usually 90 days, but the company can renew them per the agreement. Most useful when funding needs are uncertain. Many are set up so at maturity the borrower has the option of converting into a term loan. Lecture 8: International Credit Market 14

G. Line of credit -- An agreement between a lender and a borrower Line G. Line of credit -- An agreement between a lender and a borrower Line of credit in which the borrower has access to funds up to a specific amount during a specific period of time. • - The consumer may borrow as much of the line as needed and pays interest on the borrowed portion only; • - Payment amounts are revolving, based on the outstanding balance amount; • - If the funds are not totally used the borrower is submitted to pay some penalties in the favor of the lender. Lecture 8: International Credit Market 15

Long term credits Lecture 8: International Credit Market 16 Long term credits Lecture 8: International Credit Market 16

A. Syndicated loans 1 Lead Manager Beneficiary 2 Credit Management Group 3 4 Group A. Syndicated loans 1 Lead Manager Beneficiary 2 Credit Management Group 3 4 Group of the participant banks Credit Memorandum Bank A 5 Lecture 8: International Credit Market Bank B 17

A. Syndicated loans – operations description 1. Contacting a leader bank 2. Creating the A. Syndicated loans – operations description 1. Contacting a leader bank 2. Creating the coordinating group (when the amount is important), analyzing the beneficiary, establishing the credit conditions 3. Creating the group of participating banks 4. Creating the credit memorandum (usually the 60% from the credit is granted by leader bank and coordinating group, the remaining amount being obtained from participating banks, if the total credit it is not covered by them, the leader bank will make an offer to international credit markets by this credit memorandum); 5. Obtaining money from other banks. Lecture 8: International Credit Market 18

B. Eurocredits 3 Beneficiary Lead Manager 1 4 Bank A Bank B Bank C B. Eurocredits 3 Beneficiary Lead Manager 1 4 Bank A Bank B Bank C Coordinating Group 2 5 4 Capital transfer from local markets Lecture 8: International Credit Market 19

B. Eurocredit – operations description 1. Contacting a leader bank 2. Creating the coordinating B. Eurocredit – operations description 1. Contacting a leader bank 2. Creating the coordinating group (when the amount is important), analyzing the beneficiary, 3. Establishing the credit conditions by analyzing the beneficiary 4. Contacting different banks that will provide funds trough revolving credit arrangements to the coordinating group 5. Refinancing from local capital markets by issuing stocks and bonds. Lecture 8: International Credit Market 20

C. Seller Credit 5 Exporter 2 3 Importer 1 6 Exporter Bank Guarantee bank C. Seller Credit 5 Exporter 2 3 Importer 1 6 Exporter Bank Guarantee bank 4 Export Credit Agency Lecture 8: International Credit Market 21

C. Seller Credit – operations description 1. Import contract of an equipment; 2. Obtaining C. Seller Credit – operations description 1. Import contract of an equipment; 2. Obtaining a guarantee letter against default risk for the credit; 3. Obtaining the seller credit based on export contract and guarantee letter. Delivering the goods to importer; 4. Refinancing the transaction from public funds (Export Credit Agency); 5. Paying back the import at the maturity 6. Seller Credit reimbursement Lecture 8: International Credit Market 22

D. Buyer Credit 1 Exporter Importer 4 6 Exporter Bank 3 Insurance Company 2 D. Buyer Credit 1 Exporter Importer 4 6 Exporter Bank 3 Insurance Company 2 5 Guarantee Institution Export Credit Agency Lecture 8: International Credit Market 23

D. Buyer Credit – operations description 1. Import contract of an equipment; 2. Obtaining D. Buyer Credit – operations description 1. Import contract of an equipment; 2. Obtaining a guarantee letter against default risk for the credit; 3. Obtaining an insurance policy by importer for political risk associated to the buyer credit 4. Obtaining the buyer credit based on export contract, political risk insurance policy and guarantee letter. Delivering the goods to importer and payment of goofs; 5. Refinancing the transaction from public funds (Export Credit Agency); 6. Buyer Credit reimbursement Lecture 8: International Credit Market 24

E. Parallel Loans 1 Company A USD Credit Contract 2 Company B 3 Subsidiary E. Parallel Loans 1 Company A USD Credit Contract 2 Company B 3 Subsidiary of B GBP Credit Subsidiary of A Lecture 8: International Credit Market 25

E. Parallel loan – operations description 1. Parallel loan contract 2. Granting a credit E. Parallel loan – operations description 1. Parallel loan contract 2. Granting a credit directly from A Company to B subsidiary from USA expressed in USD 3. Granting a credit directly from B Company to A subsidiary from UK expressed in GBP - Lower cost than granting a credit from A Company to A subsidiary and vice versa Simplicity Lecture 8: International Credit Market 26

F. « Back-to-back » loans 1 2 Company B Company A 2 Credit Contract F. « Back-to-back » loans 1 2 Company B Company A 2 Credit Contract Bank A Bank B 3 4 Credit in USD Credit in GBP Subsidiary of B Subsidiary of A Lecture 8: International Credit Market 27

F. Back to back loan – operations description 1. Back to back loan contract F. Back to back loan – operations description 1. Back to back loan contract 2. Obtaining a credit in USD for Company A and a credit in GBP for Company B from their own local markets 3. Granting a credit directly from A Company to B subsidiary from USA expressed in USD based on initial credit 4. Granting a credit directly from B Company to A subsidiary from UK expressed in GBP based on initial credit - Lower cost than granting a credit from A Company to A subsidiary and vice versa Simplicity The interest rates will not be negotiated as it is in case of parallel loan (the main problem) Lecture 8: International Credit Market 28

Special Credits Lecture 8: International Credit Market 29 Special Credits Lecture 8: International Credit Market 29

G. Leasing contract Banks 8 6 9 1 Leasing company Importer 2 5 7 G. Leasing contract Banks 8 6 9 1 Leasing company Importer 2 5 7 3 Exporter Lecture 8: International Credit Market 4 Insurance Company 30

G. International Leasing contract – operations description 1. 2. 3. 4. 5. 6. 7. G. International Leasing contract – operations description 1. 2. 3. 4. 5. 6. 7. 8. 9. Signing a leasing contract for import of an equipment Indicating the provider of equipment Negotiating the contract Insurance policy for the equipment Delivering the equipment Refinancing from banks Paying the equipment Paying the leasing taxes Paying back the credits by the leasing company Lecture 8: International Credit Market 31

Types of leasing contracts 1. Lease-back: the sale of an asset with the agreement Types of leasing contracts 1. Lease-back: the sale of an asset with the agreement to immediately lease it back for an extended period of time. 2. Direct leasing: the producer directly leases the equipment to a company; 3. Leveraged Leasing: – the leasing company borrows from a lender to buy the asset that will be leased to the beneficiary. 4. Financial Leasing: Longer-term, “fully amortized” and the lessee is responsible for maintenance, taxes, and insurance. 5. Operating Leasing: Usually relatively short-term; less than economic life of asset, the leasing company is responsible for maintenance / upkeep / taxes / service. The beneficiary has the possibility to cancel the contract at the maturity. 6. Net Leasing: in the leasing contract are not included the expenses with the maintenance of the leased equipment Lecture 8: International Credit Market 32

Financial Impact of the leasing contracts A. Balance Sheet with Purchase (co. finances $100, Financial Impact of the leasing contracts A. Balance Sheet with Purchase (co. finances $100, 000 truck with debt) Truck Other assets Total assets $100, 000 $200, 000 Debt Equity Debt plus equity $100, 000 $200, 000 B. Balance Sheet with Operating Lease (co. finances truck with an operating lease) Truck Other assets Total assets $ 0 100, 000 $100, 000 Debt Equity Debt plus equity $ 0 100, 000 $100, 000 C. Balance Sheet with Financial Lease (co. finances truck with a capital lease) Assets under capital Obligations under lease $100, 000 capital lease Other assets 100, 000 Equity Total assets $200, 000 Debt plus equity Lecture 8: International Credit Market $100, 000 $200, 000 33

Leasing vs. Debt Financing: Potential Benefits 1) Flexibility and Convenience Leases are easier, quicker Leasing vs. Debt Financing: Potential Benefits 1) Flexibility and Convenience Leases are easier, quicker and require less documentation. n Leases are easier to have approved than capital budgeting projects. n Leasing simplifies bookkeeping for tax purposes. n Leasing allows synchronization of lease payments with the firm’s cash cycle. n Leasing avoids the problems of ownership. 2) Lack of Restrictions Leases usually do not have protective restrictions. 3) Avoiding Risk of Obsolescence? Not really - only in cancelable operating leases. 4) Conservation of Working Capital Leases usually have a lower initial outlay than a purchase.

Leasing vs. Debt Financing: Potential Benefits 5) Tax Savings Leases may provide a larger Leasing vs. Debt Financing: Potential Benefits 5) Tax Savings Leases may provide a larger tax shield than that provided by depreciation. 6) Ease of Obtaining Credit It is often easier for riskier firms to obtain a lease than to obtain debt financing.

Factoring with payment in advance (old fashion factoring) 1 Exporter Importer 2 3 4 Factoring with payment in advance (old fashion factoring) 1 Exporter Importer 2 3 4 5 6 Factoring company Importer’s Bank Lecture 8: International Credit Market 36

Factoring with payment in advance (old fashion factoring) – Operations descriptions 1. 2. 3. Factoring with payment in advance (old fashion factoring) – Operations descriptions 1. 2. 3. 4. Export contract Delivering the goods Presenting the commercial documents for payments (invoices) Paying in advance the presented invoices (less a commission an a guarantee of 10%) 5. Paying at the maturity 6. Transferring the money to the factoring company Notes: - The exporter should pay an interest rate for credit period - The factoring company will be refinanced by the banks - The guarantee will be paid back at the maturity and will cover the default risk - The factor will administrate ALL the commercial transaction of the exporter Lecture 8: International Credit Market 37

I. Factoring with a payment at the maturity 1 Exporter Importer 2 3 6 I. Factoring with a payment at the maturity 1 Exporter Importer 2 3 6 4 5 Factoring company Importer’s Bank Lecture 8: International Credit Market 38

I. Factoring with payment at the maturity – operations description 1. 2. 3. 4. I. Factoring with payment at the maturity – operations description 1. 2. 3. 4. 5. Export contract Delivering the goods Presenting the commercial documents to the factor Paying at the maturity Transferring the money to the exporter (less a commission) Lecture 8: International Credit Market 39

J. . Forfeiting 1 Exporter 2 Importer 3 4 5 Forfeiting Institution Importer’s Bank J. . Forfeiting 1 Exporter 2 Importer 3 4 5 Forfeiting Institution Importer’s Bank - Forfeiting vs. Credit transfer: Forfeiting is a long term financing operation - Forfeiting vs. Factoring: Forfeiting is used for a single transaction - Forfeiting vs. Discounting the Bank’s Drafts: Forfeiting is a long term financing operation and the Forfeiting institution will be refinanced from international financial markets using long term credit techniques or capital market techniques (IPO, securitization) Lecture 8: International Credit Market 40

J. . Forfeiting – operations description 1. 2. 3. 4. 5. Export contract Delivering J. . Forfeiting – operations description 1. 2. 3. 4. 5. Export contract Delivering the goods Presenting the commercial documents to the forfeiting company Paying the transaction against presented documents Transferring the money to the forfeiting company at the maturiy Note: The exporter will pay an interest rate This transaction is used when the Exporter rating is too low and international market is not accessible for him (the forfeiting company will be refinanced from international markets) Lecture 8: International Credit Market 41

International Credit – Final Conclusions Exporters Importers n export pre-financing; n line of credits; International Credit – Final Conclusions Exporters Importers n export pre-financing; n line of credits; n discounting the bank’s drafts; n revolving credit arrangements n credit transfer; n banker’s acceptances; n importer / exporter banker’s n syndicated loans; acceptance; n syndicated loans; n eurocredits; n seller credits; n “back to back” loans; n parallel loans; n factoring; n forfeiting. n eurocredits; n buyer credit; n “back to back” loans; n parallel loans; n leasing; Lecture 8: International Credit Market 42