Anda di halaman 1dari 54

TODAYS SESSION

UNCONVENTIONAL MEANS OF
FINANCING
FORFAITING
FACTORING
SECURITIZATION

INNOVATIVE CONCEPTS IN
PROJECT FINANCING

FORFAITING

FORFAITING.

This method of financing is mainly used in case of Import Export


transactions though the method can be used for domestic transactions
as well.

Forfaiting is a specialized technique to eliminate the risk of


nonpayment by importers in instances where the importing firm
and/or its government is perceived by the exporter to be too risky for
open account credit.

The essence of forfaiting is the non-recourse sale by an exporter of


bank-guaranteed promissory notes, bills of exchange, or similar
documents received from an importer in another country.
THIS IS ONE OF THE UNCONVENTIONAL METHODS BY WHICH A
PROJECT COULD BE FINANCED!

Typical Forfaiting
Transaction
Step 1

Exporter (from Europe)

Importer (say from Africa)


(private firm or government
purchaser in emerging market)

(private industrial firm)

Step 2

Step 4

FORFAITER
(usually a subsidiary of a
European bank)

Step 5

Step 3

Step 6

Investor
(institutional or individual)

Importers Bank
Step 7

(usually a private bank in


the importers country
4

How it works?

In forfaiting, the importers bank usually guarantees


a series of promissory notes or bills of exchange,
which cover repayment of a suppliers credit,
provided by the exporter to the importer, for a
period of 180 days to 7 years.
These promissory notes or bills (notes) are usually
structured to mature semiannually, and the face
values / amounts of such notes include principal,
and a fixed interest rate paid by the importer for the
suppliers credit.

How it works?

The notes are initially given to the exporter at the time


of shipment (or performance of other services) and
become his property. The notes represent the
unconditional and irrevocable commitment of the
buyer and/or his bank (where the latter has added its
guarantee) to pay the notes at maturity.
The payment of these notes is independent of, and
without any direct relationship to, the underlying
commercial contract, which usually provides for other
remedies to ensure the exporters due performance.

How it works?

Once the exporter becomes the bona fide owner of


the notes, it can sell them to a third party at a
discount from their face amounts, for immediate
cash payment. This sale is without recourse to the
exporter, and the buyer of the notes assumes all of
the risks. The buyers security is the guarantee of
the importers bank. The notes can be denominated
in U.S. Dollars or almost any other major currency.

WHEN IS FORFAITING USED?

Forfaiting is used for international trade transactions.


When transaction expected to be handled is worth more
than $100,000.
Traditionally, Forfaiting is fixed rate, medium term
(usually one to five years) finance, but Forfaiters may
accept a period between 180 days to seven years
depending upon the country/importer to be financed and
the guarantor involved.
Payments will normally be made semi-annually in
arrears, but could also be quarterly, annually, or on a
bullet basis.

IN INDIAN CONTEXT

Products Suitable

High Value Exports

Heavy Machinery / Capital Goods

Consumer Durables / Vehicles

Bulk Commodities

Consultancy and Construction Contracts


Low Value but repetitive business

Drugs & Pharmaceuticals

Dyes and Chemicals

Textiles / Leather

Granites

CHARACTERISTICS OF FORFAITING

100% financing without recourse to the seller of the debt


The payment obligation is often but not always supported by a
bank guarantee
The debt is usually a legally enforceable and transferable payment
obligation such as a bill of exchange, promissory note, letter of
credit or note purchase agreement.
Transaction values can range from US$100,000 to US$200
million
Debt instruments are typically denominated in one of the worlds
major currencies, with Euro and US Dollars being most common.
Finance can be arranged on a fixed or floating interest rate basis.

BENEFITS OF FORFAITING

Eliminates Risk

Removes political, transfer and commercial risk, NO CREDIT


RISK
Provides financing for 100% of contract value
Protects against risks of interest rate increase and exchange rate
fluctuation

Enhances Competitive Advantage

Enables sellers of goods to offer credit to their customers, making


their products more attractive without losing the benefit of cash
sales.
Helps sellers to do business in countries where the risk of nonpayment would otherwise be too high

BENEFITS OF FORFAITING (CONTD.)

Improves Cash Flow

Forfaiting enables sellers to receive cash payment while offering


credit terms to their customers
Removes accounts receivable, bank loans or contingent liabilities
from the balance sheet

Increases Speed and Simplicity of Transactions

Fast, tailor-made financing solutions


Financing commitments can be issued quickly
Documentation is typically concise and straightforward
No restrictions on origin of export
Relieves seller of administration and collection burden and related
costs

FORFAITING V/S EXPORT CREDIT

Forfaiting has some advantages over export credit


from EXIM Banks:

Forfaiting is a complimentary method of financing to EXIM banks


export credit facility.
Forfaiting allows the exporter greater flexibility in structuring a deal
If a buyer insists on 100 per cent financing (only 85 per cent finance is
available under EXIM rules), then Forfaiting could supply the remaining
l5 per cent.
EXIM bank takes longer to commit unlike a forfaiter.
Forfaiting is 100 per cent without recourse. Once the Forfaiter has
bought the paper, the exporter can collect the cash and even forget the
entire transaction.
Forfaiter may accept countries that are not covered by EXIM banks
policy.

STILL TO CATCH UP IN INDIA-----

Despite the obvious merits of forfaiting as a


financing method in emerging markets, its appeal is
far from universal and many exporters, especially
smaller ones, still cling to the use of export LCs for
a wide range of reasons, such as prohibitively high
minimum transaction amounts and pricing.

BEGINNING MADE
Export-Import Bank of India, (EXIM Bank) has started with a
scheme for the Indian exporters by working out an intermediary
between the exporter and the forfaiter.
The scheme takes place in the following stages:
1. Negotiations being between exporter and importer with regard
to contract price, period of credit, rate of interest, etc.
2. Exporter approaches EXIM Bank with all the relevant details
for an indicative discount quote.
3. EXIM Bank approaches an overseas forfaiter, obtain the quote
and gets back to exporter with the offer.

IN INDIA
4.

5.

6.

Export takes place shipping documents along with bill


of exchange, promissory note have to be in the prescribed
format.
Importers bank delivers shipping documents to importer against

acceptance of bill of exchange or on receipt of promissory note


from the importer as the case may be and send these to
exporters bank with its guarantee.
Exporters bank gets bill of exchange/promissory note endorsed
with the words Without Recourse from the exporter and
present the document(s) to EXIM Bank who in turn sends it to
the forfaiter.

IN INDIA
7.

8.
9.

10.

Forfaiter discounts the documents at the predetermined rate and passes on funds to EXIM Bank
for onward disbursement to exporters bank nostro
account of exporters bank.
Exporters bank credits the amount to the exporter.
Forfaiter presents the documents on due date to the
importers bank and receives the dues.
Exporters bank recovers the amount from the
importer.

2. FACTORING

FACTORING

One of the problems usually faced by new ventures


is the extension of trade credit given to its
customers. Cash crunches created by the accounts
receivables can be at times disastrous threatening the
very survival of the venture.
Potential narrowing of the gap between the booking
of a sale and receipt of the related cash is thus very
important. Larger gap implies higher risks.
The practice of factoring helps to reduce this gap.

FACTORING

It is an arrangement in which receivables created out of sale of goods


or services are sold to an agency (known as a factor).
Factoring was introduced in India during 1991 on the
recommendations of Kalyansundaram Committee.
The factor performs following functions:

purchase of receivables,

maintaining the sales or receivables ledgers,

submitting sales account to the creditors,

collection of debt on due dates,

returning the reserve money to the seller and

provide consultancy services to the customer in respect of


marketing, finance and production.

FACTORING (contd.)

Factoring is a method of converting credit sales into cash.


In factoring, a financial institution or a bank, usually referred to as a
factor, buys the accounts receivable of a company (Client) and pays
up to 80% (and under rare circumstances up to 90% depending on the
quality of the receivables) of the amount immediately on agreement.
The Factor pays the remaining amount (Balance 20%-finance costoperating cost) to the Client when the customer settles the entire debt.
Collection of debt from the customer is done either by the factor or the
client depending upon the type of factoring.
The account receivables in factoring can either be for a product or for
services rendered.

How does Factoring work?


1

Customers

credit sale of
goods
Invoice

Client
Comapany

3
5

Pays the amount (In recourse type


customer pays through client)

Pays the balance


amount
Submit invoice
copy
Payment up to
80% initially

Factor

TYPES OF FACTORING

Factoring could be of two types viz. Disclosed factoring


and Undisclosed factoring. In the former, the customers
are informed about the agreement between the Client
Company (Seller) and the Factor while in case of the later,
they are not informed and the Client would keep collecting
the dues.
Both the above types of factoring could also be further
classified as recourse or without recourse

TYPES OF FACTORING

In Recourse Factoring, the client would have to collect the debts


from the customers. If any customer does not pay the amount on
maturity, the factor will recover this amount from the client. This is
the most common type of factoring. Recourse factoring is offered
at a lower interest rate since the risk for the factor is low. Balance
amount is paid to Client when the customer pays the factor.
In Non recourse factoring, the factor agrees to collect the debts
from the customers on behalf of the client. Balance amount is paid
to client at the end of the credit period or when the customer pays
the factor whichever is earlier. The advantage of non recourse
factoring is that continuous factoring will eliminate the need for
credit and collection departments in the organization.

CHARACTERISTICS OF FACTORING

Normal period for factoring is 90 to 150 days. Some


factoring companies may allow even more than 150 days;
but it is rare.
Factoring is considered to be a costly source of finance
compared to other sources of short term borrowings.
Factoring receivables is an ideal financial solution for new
and emerging firms without strong financials. This is
because credit worthiness is evaluated based on the
financial strength of the customer (debtor). Hence these
companies can leverage on the financial strength of their
customers.
Bad debts will not be considered for factoring.

CHARACTERISTICS OF FACTORING

Credit rating is not mandatory. But the factoring companies


usually carry out credit risk analysis before entering into the
agreement.
Factoring is a method of off balance sheet financing.
Cost of factoring=finance cost + operating cost. Factoring cost
vary according to the transaction size, financial strength of the
customer etc. The cost of factoring vary from 1.5% to 3% per
month depending upon the financial strength of the client's
customer.
Indian firms offer factoring for invoices as low as Rs1000!!
For delayed payments beyond the approved credit period, penal
charge of around 1-2% per month over and above the normal
cost is charged (it varies like 1% for the first month and 2%
afterwards).

Advantages of factoring

All the sales practically become cash sales for the seller
Factoring is thus a method of off balance sheet financing.
Money blocked with sundry debtors becomes available
for business.
The seller also can get rid of collection of the receivables
Sellers working capital management becomes efficient,
which also reduce his cost and in turn improve the
possibility of better profits.

FACTORING COMPANIES IN
INDIA

Canbank Factors Limited


SBI Factors and Commercial Services Pvt. Ltd.
The Hongkong and Shanghai Banking Corporation
Ltd.
Foremost Factors Limited.
Global Trade Finance Limited.
Export Credit Guarantee Corporation of India Ltd.
Citibank NA, India
Small Industries Development Bank of India
(SIDBI)
Standard Chartered Bank

DIFFERENCE BETWEEN
FACTORING AND FORFAITING
1. Suitable for ongoing
open account sales, not
backed by LC or
accepted
bills
or
exchange.
2. Usually
provides
financing for short-term
credit period of upto
180 days.

1. Oriented towards single


transactions backed by
LC or bank guarantee.
2. Financing is usually for
medium to long-term
credit periods from 180
days upto 7 years
though shorterm credit
of 30180 days is also
available
for
large
transactions.

DIFFERENCE BETWEEN
FACTORING AND FORFAITING
3. Requires a continuous
arrangements between
factor
and
client,
whereby all sales are
routed
through
the
factor.
4. Factor
assumes
responsibility
for
collection, helps client
to reduce his own
overheads.

3. Seller need not route or


commit other business to the
forfaiter.
Deals
are
concluded transaction-wise.
4. Forfaiters
responsibility
extends to collection of
forfeited debt only. Existing
financing lines remains
unaffected.

DIFFERENCE BETWEEN
FACTORING AND FORFAITING
5. Separate charges are
applied for
financing
collection
administration
credit protection and
provision
of
information.

5. Single discount charge/rate is


applied which depends on
guaranteeing bank and
country risk,
credit period involved
and
currency of debt.
Only additional charges is
commitment fee, if firm
commitment is required
prior to draw down during
delivery period.

DIFFERENCE BETWEEN
FACTORING AND FORFAITING
6.

Service is available for


domestic
and
export
receivables; but mostly for
domestic receivables.
7. Financing can be with or
without recourse; the credit
protection collection and
administration services may
also be provided without
financing.

6. Usually available for


export receivables only
denominated in any
freely
convertible
currency.
7. It is always without
recourse and essentially
a financing product.

DIFFERENCE BETWEEN
FACTORING AND FORFAITING
8. Usually no restriction on
minimum
size
of
transactions that can be
covered by factoring
.
9. Factor can assist with
completing
import
formalities in the buyers
country and provide ongoing
contract with buyers.

8. Transactions should be of a
minimum value of USD
100,000
to
250,000
depending on the forfaiter.
9. Forfaiting will accept only
clean documentation in
conformity
with
all
regulations
in
the
exporting/importing
countries

3. SECURITIZATION

2. SECURITIZATION

Securitization started in the US in the


early 1970s with the repackaging of
Residential mortgages. It spread to Europe
and the UK in the mid-1980s.
Today, it is growing rapidly in the developing
world too.

What is securitization?

Financial payments (e.g. a claim to a number of mortgage


payments) which are not tradable, and can be repackaged into
other securities (e.g. a bond) and then sold. These are called assetbacked securities. Securitization is thus a process of pooling
and re-packaging illiquid financial assets (preferably with the
same characteristics in terms of yield, maturity and geographical
spread) into marketable securities that can be sold to potential
investors. For example, a collection of similar commercial loans
could be packaged together, and sold on to investors. The
originator of the loan will still continue to collect repayments on
the investors behalf, but can now use the cash originally tied up
in the loans for other purposes.

What is securitization?
It is the process by which assets on a companys
balance sheet are converted into marketable securities.
Definition
Securitization (literally: to turn into securities) is
the process by which a company converts various assets
on its balance sheet into marketable securities which
can then be sold to investors and traded in the capital
markets.
We can say that Securitization is the process of
transforming collateral or obligations into traded
securities.

EXAMPLE

Assume a bank has made 100 mortgage loans ranging from


Rs. 500,000 to Rs. 85,00,000 each to new homeowners this
month. The homeowners have agreed to pay interest rates
from 9.00% to 10.00% for 20 years on their various
mortgages.
Instead of holding 100 different mortgage loans of different
sizes and coupons, and having risk to the credit of these
homeowner on their balance sheet, the bank can use
expected cash flows on the mortgages to securitize the
mortgages into a mortgage-backed-security (a bond backed
by the cash flows of the mortgages).

EXAMPLE

In this case, assume the average loan size was Rs. 20,00,000/and the average interest rate was 9.5%. The 100 loans could be
packaged together to create a Rs.200,000,000 security paying
9.25% or lower rate.
Such a security would have a prospectus, which outlines the
terms of the bond, and also would get a credit rating. The
process of securitization transforms those smaller loans into a
larger, more uniform, liquid security.
This security could then be sold to an investor, such as a hedge
fund, insurance company, mutual fund, or even another bank.

What can be Securitized?

Predictable cash flows is a key factor Generally, the type of assets


securitized are those with a relatively predictable cash flow. This is a
financing technique that allows almost any asset, or pool of assets, that has
a reliable, contractual or predictable cash flow to be repackaged, purchased
and then funded as debt securities and sold to institutional investors.
e.g. Home Loans, Auto Loans, Trade Receivables. Aircraft Leases, Auto
Leases, Franchise Loans,, Business Loans, Commercial Loans, Commercial
Real Estate Loans, Consumer Loans, Corporate Loans, Credit Cards
Finance Loans, Leases Rental Streams, Royalty Streams, Take-or-Pay type
of Contracts, etc.
There is no formula that determines whether a business is suitable for
securitisation. However, in whole business securitisations to date the
businesses in question produced stable, predictable cashflows.
The paper (securities) resulting from a securitization issue is also known as
Asset-Backed Securities (ABS) because the rights embodied in them are
backed by the underlying cash flows of a pool of assets.

MORTGAGE BACKED SECURITY

A typical example of securitization is a mortgage-backed security


(MBS), which is a type of asset-backed security that is secured by
a collection of mortgages. The process works as follows:
First, a regulated and authorized financial institution such as HDFC
originates numerous mortgages, which are secured by claims
against the various properties the mortgagors purchase. Then, all of
the individual mortgages are bundled together into a mortgage pool
, which is held in trust as the collateral for an MBS. The MBS can
be issued by a third-party financial company, such as a large
investment banking firm, or by the same bank that originated the
mortgages in the first place.

MORTGAGE BACKED SECURITY

A new security is created, backed up by the claims against the


mortgagors' assets. This security can be sold to participants in the
secondary mortgage market. This market is extremely large, providing a
significant amount of liquidity to the group of mortgages, which
otherwise would have been quite illiquid on their own.
Further, at the time the MBS is being created, the issuer will often
choose to break the mortgage pool into a number of different parts,
referred to as tranches. These tranches can be structured in virtually any
way the issuer sees fit, allowing the issuer to tailor a single MBS for a
variety of risk tolerances.
Pension funds will typically invest in high-credit rated mortgage-backed
securities, while hedge funds will seek higher returns by investing in
those with low credit ratings.

How does it Work?

The Seller provides goods and/or services to its customers (the "Obligors") with
payment to be received at a later date and in doing so, creates an asset. (e.g.
HDFC giving housing loans against mortage of houses. Loans are assets on the
books of HDFC). A pool of assets is then sold to the special purpose
securitization vehicle ("SPV") which funds the purchase of the relevant assets by
issuing debt instruments to Investors.
To meet investor requirements, the debt instruments are typically structured to
meet the highest possible credit rating levels as provided for by the
internationally recognized ratings agencies. This approach also benefits the Seller
in that these highly-rated debt instruments attract the finest pricing.
In general, the credit rating of the debt instruments is dependent upon the credit
quality of the pool of assets to be securitized and also on the credit and liquidity
support provided to the SPV.

How does it Work?

Ratings agencies determine whether the income levels generated from


the assets can be maintained, by stress-testing the business's ability to
continue to generate revenues through different economic and market
dynamics. Credit rating is for the assets and not for the obligor.
Credit enhancement provides protection for investors against losses
arising from the non-performance of the assets securitized. Liquidity
support ensures that the SPV will always be able to meet the timely
payment of its obligations.
The cash flows received from obligors in respect of the underlying
assets are then passed through to the Investors in the form of interest
payments and to repay the principal amounts outstanding on the debt
instruments issued.

Mechanics of a securitization issue

A securitization issue is usually structured by an arranger (e.g.


Investment / Merchant Bank), and involves three key steps:
the company that originally owns the assets (originator or
obligor e.g. HDFC) sells them to a newly formed company or
trust known as the issuer / seller. The issuer / seller is typically
a governmental, quasi-governmental, or private entity
the issuer issues securities (either bonds or notes) secured on
the cash flows of the underlying assets; these securities are
usually rated (AAA or AB or)
the securities are purchased by investors, mainly institutions,
who either trade them or place them in their investment
portfolios.

MECHANICS OF
SECURITIZATION

Source: Wikipedia

Who owns the assets afterwards?

In a physical securitization, the assets are sold and


physically transferred off the balance sheet of the
originator, and the issuer is the new owner. In a
synthetic securitization, the underlying risk is
transferred through the use of derivative
instruments; the assets themselves are not
physically sold. Either way, the economic rights
embodied in the assets are owned by the issuer, and
therefore ultimately the investors.

Benefits of Securitization
For the Seller...

A company that securitizes certain of its assets obtains cheaper, long-term


funding.
It all comes down to the assets

It is ultimately the quality of the assets securitized and their underlying


cashflows and risks that determine the full extent of the benefits. This matters
more than the size or financial strength of the originator.

Diversification of funding sources


Securitisation provides the Seller / Obligor with access to a new class of
investors and therefore, source of funds.

Improved financial ratios


As the transaction is generally an asset sale, the Seller's asset base is reduced
which may improve return on assets (ROA) and return on equity (ROE)
without adversely impacting revenue streams. This would also result in an
improved EVA position.

Benefits of Securitisation

Flexible finance
The Seller can vary the level of funding required dependent on
its financing needs and the volume of assets available for sale
to the SPV.
Invisible to customers
As the sale of assets is typically by way of equitable
assignment, there is no notification required to customers and
the Seller maintains the direct relationship with those
customers.
Limitation of risk
As the transaction is an asset sale, recourse is generally limited
to the level of credit support provided by the Seller.

Benefits of Securitization
For the Investor...
The main benefits flowing for an Investor in acquiring debt
securities issued under an asset securitization programme
include: High credit quality
Asset securitization typically results in the securities issued
carrying the highest possible credit ratings accorded by the
internationally recognized rating agencies.
A diversification of investment opportunities
Asset securitization allows investors to indirectly invest in a
variety of asset classes.

REVIEW QUESTIONS

Write short notes on:


Project Financing
Forfaiting
Securitization
Factoring
Explain the concept of forfaiting. What are the advantages of
forfaiting over the traditional financing in the form of export
credit by Exim Bank?
Forfaiting is a novel way of project financing that offers unique
benefits to seller as well as the buyer of fixed assets. Explain the
statement with a suitable example.

REVIEW QUESTIONS

If you are buying a Mortgage Backed Security from the capital


market, it means you are indirectly funding the borrowers. Do you
agree with this statement? Explain in the context of process of
Securitization.
Explain the concept of securitization with the help of a suitable
example. What are the different assets that can be securitized?
What are the benefits of securitization?
Explain the concept of factoring and its significance to a new
venture.
What is factoring? What are its characteristics and advantages?
Compare forfaiting and factoring.