ROUGH SEAS FOR L/Cs
Convincing bankers to issue a letter of credit is simple - assuming your company has endless receivables, a reservoir of excess cash and an impeccable balance sheet.
By Lynne Curry

Trade - the lifeblood of Asia - is on the rebound. According to a report from Standard Chartered Bank, imports in South Korea rose around 20 percent in the second quarter of the year. Imports in China rose 21 percent during the same period. Government authorities in Taiwan and Hong Kong are also reporting much-improved trade figures. Meanwhile, exports from South Korea, the Philippines, Taiwan, Thailand, Malaysia and China are on the increase, with total volume in those countries jumping about 10 percent in July and August, compared to the same two months last year. "We're seeing quite a dramatic improvement in Asian trade," says George Leung, a senior economist at HSBC in Hong Kong. "And not just from the region to industrialized countries, but intra-regionally as well."

Don't try telling that to Alfred Chow, however. Sitting in his crowded office in Hong Kong's Tsuen Wan industrial district, the CFO at Karrie International Holdings says his company is still reeling from the upheaval caused by the recent financial freefall in Asia. Profitability at the publicly listed Karrie, which makes computer casings, remains anaemic. The company's aftertax profit in 1998 slipped 4.3 percent to around HK$25 million (US$3.27 million) on sales of HK$592 million (US$76 million). Worse yet, credit in Asia is dry as a bone.

Companies trying to open letters of credit (L/Cs) to buy goods from Karrie face frustration and failure. "In the last few months, there has been some relaxation of lending policies," Chow concedes. "But they are still very, very tight." Moreover, the Karrie CFO says banks are demanding more documentation than ever before. "Not only do they want to see a financial statement," he points out, "but they want more operational data and a forecast for one or two years ahead."

Chow's experience is not unique. Across Asia, increasingly cautious bankers are examining letters of credit on a deal-by-deal basis - demanding more documentation, closely scrutinizing the underlying transaction, and in some cases, simply refusing to help customers open a letter of credit. In Hong Kong, bankers now routinely ask for cashflow forecasts from potential borrowers. In China, finance managers must present identity cards to lenders to prove that their companies are financially sound. And in Indonesia, banks are demanding up-front money from local corporates in exchange for letters of credit. Says Joseph Kwan, finance director of United Can, a Jakarta-based can manufacturer: "It's still very difficult to open an L/C. Banks now require a 100 percent deposit up front to open one."

Comforters

Such an arrangement tends to defeat the purpose of a letter of credit. Before the financial crisis, most CFOs in Asia simply took the instrument for granted. Some companies had open credit lines with banks and were even bypassing letters of credit altogether. L/Cs, sent by an importer's bank to an exporter guaranteeing payment for goods when the proper documents are presented, were often seen as too bureaucratic and requiring too much paperwork. Some business executives were convinced they represented a dying form of finance. "Money was easy," says Chow. "Banks were lending on names. You didn't need collateral."

After the Thai government devalued the baht in July 1997, all that changed. Defaults and rollovers soared. Non-performing loans, once about seven percent of the total capital of an average bank in Asia, jumped to 35 percent - and higher. International rating agencies downgraded the credit rating of local banks and central banks tightened their credit policies. Trade financing for imports simply disappeared. "Even if you had the capacity to produce, you were still unable to get financing to produce," says HSBC's Leung. "That's why orders were not fulfilled."

Today, orders are being filled - but only for companies with ample cashflow. It's hard to fault bankers for their newfound caution. "Banks are much more risk averse than they were two or three years ago," explains Daniel Scanlan, senior vice-president of global trade services for Bank of America in Hong Kong.

"This has caused liquidity problems which have hurt companies' ability to trade." This crunch has some CFOs rethinking their opinions about letters of credit. "Letters of credit are experiencing a re-birth and renewed importance," reports Alan Wilkinson, head of trade services (Asia Pacific) at HSBC. "Major importers who had been moving away from L/Cs suddenly realized their value as security to get credit lines from banks." This rebirth is hardly surprising: letters of credit shift the risk from a company's trading partner to the issuing bank. "L/Cs," Wilkinson says, "generate a degree of comfort."

Such comfort, however, costs money. Bank charges for letters of credit vary, depending on the amount of money the letters are guaranteeing. Generally, the larger the customer, the better the deal. "Banks give better terms if the amount is big," says Y.W. Wong, group finance director at Hong Kong property developer and retailer Stelux Holdings. "Most multinationals can open L/Cs anywhere, but smaller companies have to rely on domestic bank rates." And rates can be high if a company doesn't do a volume business. "It's definitely harder for local companies," says Nancy Susanti, finance manager of Reebok International in Jakarta. "That's why they are bankrupt. They can't get financing. No bank wants to give L/Cs or financing to local companies."

Seoul on Ice

While L/C terms and conditions have improved in Singapore, Malaysia and Thailand, observers say it's a Herculean task to line up letters of credit in some of the harder hit markets in the region. Notes Barbara Ismail, regional trade head at Citibank, in Singapore: "People are now much more aware of the problems in local banking systems in Indonesia, China, Vietnam and Pakistan."

Same thing for South Korea. Indeed, the country serves as something of a primer on the difficulties of trade finance in the cash-strapped pockets of Asia. Despite a mighty rebound on the Korean Stock Exchange, and despite the country's ongoing economic surge, South Korea is a trouble spot for CFOs hoping to find funding to cover the risk of their imports. In fact, some CFOs in the country say the trade finance climate remains downright chilly.

The signs of distress are everywhere. Local papers run stories practically every day about non-performing loans threatening the solvency of one Korean bank or another. And the restructuring of the near-bankrupt Daewoo Group, one of South Korea's biggest conglomerates, continues to drag on. If other chaebols are dragged down by the troubles at Daewoo, notes Amita Jhangiani, managing director of Asia Pacific Trade at Chase Manhattan, the price of L/Cs could go up in South Korea. Adds Bank of America's Scanlan: "CFOs can't assume all chaebols are created equal. They need to do their homework."

Good study habits may not be enough. Customers of Bayer Korea, a division of the German chemical and pharmaceuticals giant, are asking for 90-day terms instead of 60-day terms to open L/Cs with the company. "It is much harder to get an L/C, and payment terms are being extended," admits Andre Mueller, Bayer's CFO, in Seoul. During the recent financial crisis, Mueller says Bayer decided to give additional credit to its customers, but at the same time, the company did not deliver products like chemicals and medicines to many new companies. Even before the recent crisis, Mueller notes that local South Korean chemical companies had difficulty obtaining L/Cs. One reason: customers in South Korea have traditionally had 130 days or longer to make payments. That's unacceptable for most L/C issuing banks.

For his part, Mueller insists on promissory notes and cash collections for locally produced drugs. Bayer also sells agrochemicals to wholesalers on long payment terms, but does not directly open L/Cs for customers. The Bayer CFO explains that opening L/Cs is not a common practice in the agrochemical business in Korea. Mueller also points out that Bayer trusts the creditworthiness of its customers - and simply sells to them on an open account.

Suspicious Minds

Finance executives in China may not be so trusting. The October 1998 collapse of Guangdong International Trust and Investment Corporation (Gitic), the province's flagship fund raising vehicle, left scores of foreign banks with bad debts and little appetite for lending in China.

Eager to make sure another Gitic doesn't happen, government officials have tightened lending policies. Finance managers at foreign joint ventures and domestic importers, for instance, must prove their businesses are financially sound by showing relevant company records to bankers, including balance sheets, income statements and projections for the following years. Not all applicants are created equally, however. "If a foreign joint venture doesn't show a profit for the first two years, the banks are still willing to lend," explains Kelly Zhou, financial controller at Shanghai Eaton Engine Components, a US-China maker of vehicle components. "Banks base their decision on your forecast. However, banks are suspicious of state-owned enterprises."

Apparently, so is the state. All domestic Chinese companies - as well as foreign operations - must now present a Bank of China identity card to a Chinese bank before the bank will approve a loan or letter of credit. This identity card contains a company's current record of outstanding loans. The card is designed to prevent companies from pledging their assets as collateral with one bank, and then using the same assets to obtain loans at a different bank - a not uncommon practice prior to the Gitic collapse. "Banks are more selective because of Gitic," confides a CFO at an agricultural chemical manufacturer in Beijing. "They are very selective in terms of customers. In the past, there was more trust with a foreign joint venture."

Yin Ming, financial controller at Shanghai Valmont SST, a Sino-American lighting pole manufacturer, agrees. "It's easier to get an L/C if a company has a parent company guarantee. But without collateral or somebody to guarantee the L/C, it's extremely hard to open one." That, in turn, can make it tough to help secure funds from local Chinese lenders. "You open an L/C in dollars with a foreign bank," Yin explains, "and then use the bank to guarantee renminbi loans. The L/C from the foreign bank is used as collateral for other loans."

But a number of foreign exporters to China say they are now finding that some Chinese banks are refusing to allow their L/Cs to be guaranteed by letters of credit from foreign banks. In this situation, foreign bankers say they offer "silent confirmation" of L/Cs - a procedure where bankers quietly evaluate the financial solvency of Chinese banks and agree to pay in the event of a default. The big four Chinese banks - the Bank of China, the Industrial Bank of Commerce, the Agricultural Bank and the Construction Bank - normally don't require confirmed L/Cs. But executives at some foreign companies say they simply reject letters of credit outright from smaller local Chinese banks.

Unexpected Factors

CFOs at companies that can't get letters of credit have had to think creatively. Chow says that Karrie International, along with other Hong Kong corporates, has turned to factoring.

Developed in the US, factoring allows an exporter to sell its invoices to a specialized financial institution or a bank for up to 80 percent, or an agreed upon percentage, of the invoice value. Upon receipt of the invoice, the factoring company pays the exporter the agreed upon percentage of the invoice value minus a commission, which is deducted up front. The balance is paid to the company after collection of the debt from the importer. The importer generally pays the financing company within 30 to 60 days. The accounts receivables or inventory act as collateral from the exporter. One of the benefits of factoring is that, unlike letters of credit, factoring requires little documentation and the supplier gets the cash in advance.

Although factoring yields less than 100 percent of an invoice, Hong Kong-based East Asia Heller, a joint venture between Bank of East Asia and Heller, a US-based factoring specialist, reports that business is booming. Before the crash in 1997, the company received about 200 requests annually about factoring. That figure jumped to 500 by October.

"Factoring is necessary," says Chow. "For many companies, there is no alternative source of financing." He pauses. "If you want to survive, you've got to find a way."

Lynne Curry is a contributing editor at CFO Asia.