A NEW CROP IN COMMODITIES: Emerging market banks
With balance sheet clean-ups continuing in Europe and the US banks in emerging markets have grabbed the opportunity to forge stronger relationships with local commodity producers. David Wigan reports.
The region with the most eggs in the commodity basket is Africa, where rich resources of land, metals and energy are said to offer the best opportunity for economic transformation in the continent's history.
Amid signs of surging confidence in the world's second fastest growing region, Moody's Investors Service recently launched its first sovereign ratings for Nigeria, Kenya and Zambia, a move it said was a likely precursor to a booming capital market in those countries, Underlying Moody's decision was a commodity price boom that has attracted investors fr om around the world and provided a huge opportunity for the region's banks.
FOLLOW THE MONEY
"Africa and commodities are central to our strategy’” says Mark Sumner, managing director and global head of mining and metals corporate finance at Standard Chartered Bank, "There is demand for commodities coming: out of China, Japan, South Korea and India and a new area for us is to follow Asian clients into Africa, offering mergers and acquisitions, leveraged finance on acquisitions, project and trade finance, and funding for operations".
Chinese investors are famously active in Africa, looking to obtain physical off-take through minority stakes in local operations, often leveraging the lower interest rates and larger balance sheets of Chinese policy banks (or tapping the China-Africa Development Fund) and combining that with local knowledge. “We are on the ground in Africa and they look for us in terms of regulatory expertise and understanding of how things work," says Mr Sumner.
Among the biggest growth areas has been the coal industry in Mozambique, where one
recent deal saw UK-based Anglo American buy a $555m majority stake in Minas de Revuboe, an undeveloped deposit sandwiched between a mine owned by Brazil's Vale and another owned by London-listed RioTinto.
In Botswana, Standard Chartered recently funded Australian copper mining company Discovery Metals, for which it holds local accounts. The bank also works with London Mining in Sierra Leone, where recent discoveries of iron ore have helped rebuild an economy shattered by civil war. The Democratic Republic of Congo is attracting increasing levels of attention, says Mr Sumner, although the destination remains challenging.
Of the international banks competing with Standard Chartered in African mining, BNP Paribas and Credit Suisse are among the leaders. In Francophone west Africa, the French banks are particularly active. "In countries such as Cote d'lvoire they are giving us a run for our money," says Chomba Sindazi, a director in structured agricultural finance at Standard Chartered, “For example, where we look for security fr om cocoa producers in return for financial guarantees, other international banks are happy to waive that.”
A notable trend developing is that local banks are becoming more active. Togo-based Eco-bank, present in 32 African countries, has made a virtue of its pan-African footprint. “Commodities are low-hanging fruit for us because we are able to capture trade flows between African countries," says Rolake Akinkugbe, head of energy research at Eco-bank. “The business is growing, but there are infrastructure challenges that remain."
A common tool is hybrid long-term financing, combining Chinese investment with local bank syndication. That type of deal has helped build gas pipelines in Ghana and Tanzania, supported by investment fr om the China Development Bank. "African banks often do not have the capacity to finance these huge infrastructure projects alone, but they can participate as syndicate partners," says Mr Akinkugbe.
With commodity prices recently coming under pressure, African banks have to work hard to make the business pay. However, that is partially offset by the higher margins available on the continent, bankers say, with returns on capital in commodity financing running at 500 basis points over Libor, compared with about 100 basis points in Europe.
One sector that has stood up well to the economic slowdown is sub-Saharan energy, where activity in Angola (wh ere Goldman Sachs is a major player) and Nigeria has expanded over recent years to exploration in frontier countries, such as Ghana, Liberia, Sierra Leone and Uganda. Kenya, Mozambique and Tanzania also have seen sizable offshore discoveries.
There has been a natural progression and we are now at a point wh ere there has been a lot of exploration success and those hydrocarbons are moving toward development, when capital requirements are at their highest," says Martin Kelly, lead sub-Sahara upstream research analyst at commodities consulting firm Wood Mackenzie. "That means financing opportunities for local banks.”
Among Africa's fastest growing commodity segments is agriculture and Standard Chartered is one of the banks working with collateral managers to offer structured warehouse financing solutions for clients, including farmers in Kenya, tobacco producers in Tanzania and coffee growers in Uganda.
A new product is input finance, aimed at helping agricultural producers finance seeds and equipment. The solution is aimed in particular at west Africa, wh ere governments are acting to restrict imports and support local production. Nigeria alone imported $6.2bn of wheat and rice in 2010. African investors are increasingly turning to structured products, with commodity exposure combined with capital protection in underlying local currencies, says Nick Calabrese, head of commodity sales at South Africa-based Absa Bank. "In Africa, we still have yield and these types of structured deposits offer African-based asset managers and pension funds an opportunity to get exposure to commodities and currencies, such as the Botswana pula or Mauritian rupee," he says.
Absa also offers hedging solutions, with a high proportion structured as swaps or options in the form of collars. "Again, it is a matter of being able to offer local currency hedges to end-users, who can get hit by the double whammy of rising oil prices and a weakening local currency against the dollar," says Mr Calabrese. "Transport companies and miners are big users"
As African banks make hay across the commodities asset class, Russia by contrast is focused on oil and gas, supported by metals and mining. State-owned banks dominate these activities. The 75.5% government-owned VTB, Russians second largest lender, is at the forefront of the oil business, while state development bank Vnesheconоmbank provides project and trade finance support, and Russian Agricultural Bank specialises in soft commodities.
"There has been a long-standing connection between Russian banks and commodities," says Farangiz Rahimova, eastern Europe credit strategist at BNP Paribas. "Russian Agricultural Bank, for example, is built on providing loans to the agricultural sector, operating with subsidies from the government."
The largest Russian commodity producers, such as Gazprom and Rosneft, have access to domestic and Eurobond markets, and obtain pre-export financing from local and international lenders. Since the financial crisis, however, local banks have gained market share.
"In 2012, our global precious metals and our client risk management businesses have seen the bulk of the growth" says Thierry Groell, head of global commodities at VTB Capital. “Both businesses rely on domestic clients and as a result have been sheltered from the latest developments of the global financial crisis. The bank has gone through a strong and successful expansion abroad, and we follow the same trend in our commodities business with a focus on the Middle East, Africa and Asia."
The commodity derivatives business is relatively undeveloped in Russia, although VTB has seen increased levels of activity, with the International Swaps and Derivatives Association documentation used widely, with some Russia-specific modifications. “VTB used to say it wanted to be on the same level as Western banks; now it says it just wants to be a good investment bank, says Ms Rahimova.
As commodity markets have developed, Russian bank balance sheets have expanded rapidly, with VTB reporting total assets of $211bn in 2011, compared with $120bn in 2009.
Asia is a great consumer of commodities and Asian banks are fast becoming major players. While international revenues still represent a tiny fraction of earnings for Chinese institutions, the country's lenders have used its insatiable appetite for commodities as a springboard into global markets.
The leading institution has probably been Bank of China, the country's third largest lender, which in 2012 became the first Chinese corporate member of the London Metal Exchange, which handles more than 80% of industrial metals futures trading. Around the same time’ the bank formed a liaison with the Chicago Mercantile Exchange, the world's largest futures exchange, with a view to carrying out commodity settlement and clearing in renminbi. Meanwhile, the bank has been on a hiring spree, snapping up traders from rivals in London and Singapore, as it seeks to become the number one player in metals and energy trading in Asia, after launching its global commodities business in 2011.
The scale of the opportunity for banks with strong balance sheets is impressive, with Western bank commodity earnings estimated to be down by about 50% since the peak. Banks focused on Asia have lost no time in stepping into the breach. Standard Chartered posted annualised growth in commodities of 20% between 2007 and 2011, along the way picking up key hires such as Arun Murthy from Lehman Brothers in 2008 and Tim Wilson from JPMorgan this year. The bank is set to launch a wholly owned foreign entity in Shanghai in the first quarter of next year to trade on exchanges and in physical commodities.
"Everything that we have put in place over the past few years is coming to fruition, so that we are able to cover every aspect of the client across multiple touch points," says Mr Murthy, global head of commodities at Standard Chartered. "We are looking at a 25% headcount increase this year, mainly driven by client demand.”
Meanwhile, Singapore-based DBS Group Holdings announced in October that commodities financing has become its fastest growing business, just two years after it entered the segment. At the opening of the bank's new headquarters in Singapore, DBS chief executive Piyush Gupta said the bank, south-east Asia's largest, has built a $20bn loan book, which funds trade in energy, base metals and soft commodities. He noted that the timing of this was opportune, as eurozone banks scaled back commodities finance in the second half of 2011.
In India, local banks are set to take advantage of new rules allowing financial institutions to trade in commodity derivatives, Supporters of an amendment expected to be passed by the Indian parliament in its next session say it will lead to a massive increase in volumes.
"Banks have a lot of exposure to the commodities sector, so the inability to trade m forwards and other derivatives has been a real handicap in terms of hedging risk" says Suman Das Sarma, senior vice-president at Mumbai-based metals and energy exchange Multi-Commodity Exchange. “This is the third attempt to change the law, so we are hoping it will be successful."
While banks in Africa and Asia have taken advantage of the withdrawal of some international players, the picture in Latin America is decidedly more mixed. BTG Pactual, Brazil's only listed investment bank, is one of the leading players after bolstering its commodity teams with the purchase in 2010 of energy trading company Coomex. This year it increased its stake in oil rig operator Sete Brazil through private equity funds run by its asset management business. Banco Itau is also active in the commodities space.
Still, some observers say that Brazil's banks often lack the experience to work on complex deals. "Many of the local banks and flinders are not used to managing the international deals with China and the US, and this is leading to more complex financial transactions that take far longer than they should," says Hakan Olsson, co-founder of Rio Investment Consulting." Our strategy is to offer straightforward deals to the local banks with Brazilian development bank guarantees, while the more complex deals are being offered to international banks in Asia and the US.”
That sentiment is reflected by a senior risk manager at a Sao Paulo-based producer of agricultural commodities. "International banks were previously more competitive in commodity financing than Brazilian banks. Now we do not see that difference in terms of pricing" he says. "However, some local banks also lack commodity expertise, for example, in derivatives and clearing, and have not been able to take advantage."
Alternative solutions are instead often provided by trading companies, such as Car-gill, which has incorporated its own bank in Brazil to provide a wide range of financial services." One thing that helps us compared with the other banks is that we have a great number of employees working in the countryside, in local offices and warehouses, which gives us a good knowledge of the producers and farmers,” says Marcos Abud, a director at Banco Cargill,
Some Brazilian banks have been hampered by slow adoption of international contract language, according to one analyst. But given that commodity exports hit a record $235bn in 2011, compared with $105bn in 2005, it is likely to be just a matter of time before they catch up.