We have been writing for a few weeks that the credit crisis had engulfed letters of credit, a crucial instrument in international trade, particularly of commodities (ex oil) and other raw materials. With banks hesitating to extend credit to each other much beyond overnight (finally changing only by virtue of massive liquidity measures and recapitalizations), they are leery of taking each other’s letters of credit (when used to facilitate a sale, an L/C from a buyer must be accepted by the seller’s bank of title to the goods to pass hands).
However, despite its importance, letters of credit are a low-margin, operationally intensive banking business that seldom gets the attention of senior management. With so many trouble areas competing for attention, this one has been largely neglected.
However, the mainstream media is finally starting to take note, just as it appears (finally) to be getting on the radar screen of regulators and international trade organizations . From the Times Online:
The credit drought is undermining international trade in goods and raw materials with savage increases in the cost of funding for exporters. At the same time, buyers of goods are being denied access to letters of credit – the banking instruments that are the nuts and bolts of global trade.
HSBC, a leading trade finance bank, has said that the cost of guaranteeing a letter of credit, a routine instrument used for payment of goods, has doubled. Concern is growing in the shipping industry that business is foundering because of failures in trade finance, and Pascal Lamy, director-general of the World Trade Organisation, has given warning that the credit crunch is affecting global trade, particularly in the emerging markets of Brazil, India and China. He said: “Trade finance is being offered at 300 basis points above the London Interbank Offered Rate and even at this high price, it has been difficult for developing countries to obtain.”
Mr Lamy has called a group of trade finance banks, including HSBC, Royal Bank of Scotland, JPMorgan and Commerzbank, to a meeting on November 12 with the IMF and World Bank to consider the trade finance problem.
Lack of trade finance is having a disastrous effect on shipping. In a report issued on Friday, Maersk Broker, a subsidiary of the Danish shipping group, blamed logjams in the banking system for the slump in the dry bulk cargo market: “Banks’ refusal to offer letters of credit has resulted in very few fresh cargoes reaching the market, which is adding to the owners’ woes.”
A collapse in the trade of raw materials such as grain and iron ore, after years of frantic activity, is causing havoc. The Baltic Exchange Dry Index, which measures the price of voyages and the cost of chartering vessels, has plummeted. Rates for the largest transporters, known as Capesize, peaked in May at $230,000 a day. It is estimated that the daily cost of running the ships, including depreciation, is about $15,000 but at the end of last week, rates had fallen to $5,982 a day.
According to HSBC, there has been a surge in customer requests for trade tools that can guarantee payment.
Stuart Nivison, an executive in the bank’s trade finance division, said companies that two years ago might have been happy to deal on the basis of simple orders from customers are now insisting on documentary credit.
This addresses a point a reader raised earlier, that a good deal of trade, but I believe mainly finished or intermediate goods (there the trade relationships are longer-standing) are on an open account basis. The comment above indicates that buyers are increasingly insisting on documentary letters of credit, which are used when buyers perceive the transactions to be high risk or do not have confidence in the seller. (ie, either the goods may not be what they were purported to be, or the buyer perceives there to be risk that the seller may not have satisfied certain obligations such as the payment of customs duties or port charges). Back to the article:
Anxiety about payment was pushing companies to ask for greater security, Mr Nivison said, and in such transactions, fees were soaring. He pointed to a recent case of a shipment of industrial equipment from Britain to India, where the confirmation and discounting of a letter of credit, which would normally cost 0.5 per cent of the value of the goods, had risen to more than 1 per cent. “These are big moves and reflect the nervousness in the market. People want to be sure they are paid,” Mr Nivison said.
Distrust of banks is compounding the problem. “We have received requests to guarantee the credit of top-tier banks and we have also seen cases of exporters in China saying to their UK buyers which banks they will or will not accept,” Mr Nivison said. He added: “Trade finance is the oil that keeps the wheels of commerce going. Without it, everything grinds to a halt.”
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Curious detail here…
“We have received requests to guarantee the credit of top-tier banks and we have also seen cases of exporters in China saying to their UK buyers which banks they will or will not accept,” Mr Nivison said.
What are the exporters of China basing their list of acceptable banks on? Are they privy to information that no one else is?
Congratulations on being on the cutting edge of this one. It’s kind of back to the future in banking. One thought. LC’s may be low margin but they are high ROI. It’s great fee business. The banks, save some of the European banks, forgot how lucrative they can be. Probably because the business schools don’t teach them.
I thought it was bad etiquette to copy-paste an entire newspaper article into a blog post. You should use excerpts.
William T, did someone make you an arbiter? Go check out, oh, say Mark Thoma, who at least a couple of times a week lifts material in full. This was a fairly short article, foreign source (so highly unlikely this took traffic from them), and I found the details useful.
Excellent article, did not confuse any parts of the story.
We should see a round of government action to either guarantee lines of trade either around the G20 meeting, or early in the new year. To date government inter-bank guarantees should have helped more, but one of the problems is the companies who have no prior relationship a bank rushing for L/Cs
In the mean time there will both be slower trade, and more reliance on FCA/FAS/FOB terms if it gets to the point where importers see new pricing power
As for raw materials, there was a lot of stockpiling on the way up and that is why a big reason why China for example is holding out for lower material prices.
We should also expect more demolitions with many new existing ships, ships that will be manufactured due to bonds and other agreements, and a lower equilibrium trade level when things recover. However, the scrap prices for ships is also falling now too because material prices are falling as well and that is making recyclers cautious
Every action has an equal but opposite reaction. Everything is related…
———————
China manufacturing conditions at record low: CLSA survey
By Chris Oliver
Last update: 9:45 p.m. EST Nov. 2, 2008
HONG KONG (MarketWatch) — Business condition in China’s manufacturing sector deteriorated at a record pace in October during a sharp decline in orders from overseas customers, according to a brokerage survey Monday. CLSA Asia-Pacific Markets said its China Manufacturing PMI fell to 45.2 from 47.7 in September, marking its third straight monthly decline and the fastest in the survey’s history. The level of new orders received by manufacturers was down at a record pace. The survey also found sharply deteriorating employment conditions as businesses laid off workers in response to falling demand. Input costs also fell sharply after rising at a survey record rate in July. “Chinese manufacturers are seeing their order books cut, both at home and abroad, as the world economy falls into recession,” wrote Eric Fishwick, head of economic research at CLSA in a research note Monday. “Costs are falling but so are output prices. The coming 12 months will be difficult ones for manufacturers, China included.”
Source
Cynical take on this is the banks using this as more leverage on governments to ensure bailouts. I am amazed and astounded by the power being exhibited by the financial sector in the very survival of our citizens.
Yves, I know this one is dear to your heart, but all I see in this article is pretty much what you would expect when there is a lot of bail-out money to be had – a lot of wailing how bad conditions are, and how important you (the shippers’) are, in the hopes that some of that lovely money ends up in your pocket.
Shipping rates are down, but the cost of a letter of credit is up 50 bips. (When the article says 300 bips over Libor, I’d like to know for what duration – if it’s for a couple of months, then that works out to 50 bips as well.) Surely this largely cancels?
Trade is down, because trade should be down – Americans and Westerners in general are consuming less. If the point is just to keep trade volumes up, even when the market is trying to push them down, then we can forget once and for all about “free” trade – what we have really is forced trade, with a small number of winners in the West (who then make large contributions to the politicians, to get their way).
Is it too much to ask for a “Print” button on the blog?
(So that I can read this on the train back home).
I find it tough keeping up with all the updates while at work.
As far as I can make out the shipping industry is rather a tangled web and some of the implications of problems in the shipping industry may be rather more far reaching than it would appear on the surface. Ukraine’s Industrial Carriers Inc who had a fleet of some 50 ships on charter has filed for bankruptcy. Lloyds lists reports that “One legal source estimated 75% of the owners affected had opted to settle, leaving about 10 owners and operators chasing charter debts” and “Industrial Carriers listed Oldendorff, Deiulemar, Bottiglieri, Coeclerici, Pan Ocean, Korea Line, Transfield, BHP Billiton, Armada and Atlas as companies with whom the company did business.” This means quite a few companies will have taken a financial hit and deliveries are likely to be delayed while charters are negotiated with other carriers. This is only the first of the relet carrier businesses to get into trouble.
There are reports of ships currently under construction which will be cancelled by owners as they prefer to write off the 10 percent deposit than find the full funding for their new ships. Typically during difficult times older ships would be scrapped to reduce costs and raise a little money. Buyers of scrap ships however are finding it difficult to get credit to buy the ships and with steel prices so low the returns are not high enough to make a difference.
Not only are their letters of credit problems but there are reports that it is difficult to get affordable hedging on forward-freight agreements. Many companys failed to get sufficient fuel hedging when prices sky rocketed. On top of this the value of their ships has dropped reducing the shipping companys capital.”The whole thing is eerily similar to the subprime fiasco,” says Jeffrey Landsberg, a freight-options broker at Imarex, a shipping-related derivatives exchange.
I cannot help wondering whether this will have an impact on coal stock piles especially for the likes of south africa who have until recently been known to run out and have power cuts as a result. What also happens to the likes of Greece whose economy is closely linked to shipping, with yields on Greek bonds, being appreciably larger than equivalents in Italy and Germany.Michael Klawitter, a credit strategist at Dresdner Kleinwort, said the market flight from Greek bonds marked a dangerous moment for the euro. I am also curious as to what extent road and rail freight is affected as well.
Excellent catch Yves! Thanks for following this story and breaking it ahead of about everyone.
It would be interesting to see a comparison of ‘hours worked’ by longshoremen in US ports. This data should be available somewhere since the longshoremen are union and on time clocks. I searched Google but did not come up with any relevent stats.
In a related story found while looking for port data…
‘FAREWELL TO THE BIG APPLE
October 20, 2008
WILLIAM ARMBRUSTER
Japanese air carriers drop New York freighter service
Air cargo shippers in the New York area looking for direct maindeck space to and from Japan will be out of luck come January.
Nippon Cargo Airlines stopped flying to Kennedy International Airport in August, and now serves the New York market with trucks running between JFK and Chicago.
Japan Airlines will cut back its freighter service to New York from five flights a week to four as of Oct. 27, and will drop its all-cargo service to the Big Apple completely at the end of the year. Like NCA, it will maintain freighter service to Chicago, but it is cutting its frequency there from six flights a week to five as of Oct. 27.’…snip…
It appears that air freight is slowing along with marine freight.
http://www.shippingdigest.com/news/article.asp?ltype=feature
FYI — This was also covered on American Public Radio’s Marketplace. No revelations for readers of this great blog, but a big relief that more attention is being paid to this issue.
Thanks for such fabulous work, Yves!
European banks didn’t forget about letters of credit because they invented them a couple hundred years ago. There are many good reasons why this credit panic is upon us, insane contracts, a complete disregard for accounting principles and corruption to name a few. And while every credit panic is unique, the results are the same; the elites prosper from them and power is consolidated into fewer hands.
I enjoyed my wonderfully cheap week-long holiday on the shores of South east asia. Thenonly bad thing was the crowded shoreline. In Singapore, the 2nd busiest port in the world, the shoreline was literally blocked off by hundreds of empty container and other forms of tankers. The locals were equally stunned, never had there been so many empty vessels moored along their shores. But the local stock markets seem to be blissfully surging along, 5% across most exchanges.