- Trade-financing funds step in where banks fear to tread
- Octagon sees industry surging to $20 billion in five years
CZ Electronics Ltd. Chairman Oupa Magashula pounded pavements for months trying to drum up a loan to expand plant capacity after winning a South African government contract to supply set-top boxes. No dice.
Commercial lenders weren’t interested. Not even state-owned financiers such as the Development Bank of Southern Africa and the Industrial Development Corp. could set aside concerns that the company’s balance sheet only showed a net asset value of 40 million rand ($2.8 million), he said, not even a quarter of what CZ Electronics needed.
“It was a very frustrating and fruitless experience,” Magashula, 54, who oversaw South Africa’s tax agency from 2009 to 2013, said in an interview at the Johannesburg factory, which also makes bomb triggers for India and electricity meters. “We wasted probably two to three months.”
Enter trade-finance funds, a group of money managers who provide loans typically backed by future sales to support import and export transactions, projects or commodity deals. That is filling a gap in a cross-border market the Bank of International Settlements estimates is worth $12 trillion a year as lenders retreat from riskier structured-debt packages to conserve capital.
In Africa, commercial banks funded as much as $350 billion in trade deals in 2012, with unmet demand because of rejected requests at $120 billion, according to a study released by the African Development Bank in 2014. South Africa’s DBSA didn’t immediately respond to e-mailed requests for comment, while IDC spokesman Mandla Mpangase said the lender couldn’t immediately comment on details around CZ Electronics.
The nascent industry isn’t without its pitfalls. Interest rates are often higher than that of banks and the lenders have to take bets on small, sometimes unproven companies. The funds also have to fill out reams of paperwork to make sure the shipments they guarantee are in order.
CZ Electronics eventually secured a $12.5 million loan from Barak Fund Management Ltd., a Pellegrin, Mauritius-based money manager with $370 million in assets, to meet the 347 million-rand contract, and to fund the purchase of parts to build 2 million mobile phones and tablets. Barak is charging interest of 12 percent, which includes 2 percent in profit sharing, Magashula and Barak’s Johannesburg-based money manager, Giles Hedley, said in separate interviews.
“The interest rates that are charged are ascertained on a deal-by-deal basis gauging risk on each deal, for example the industry, country, and counter-party,” Hedley said.
That compares with South Africa’s prime-lending rate, used as a benchmark to set terms, of 10.5 percent, and 3.5 percent for the U.S. The loan has to be repaid in dollars, which creates currency risk for CZ Electronics, with the rand weakening each of the past five years.
Still, the lifeline meant the company could more than double its workforce to almost 400 people and add new equipment at the plant in Boksburg, an industrial area east of Johannesburg surrounded by shanty towns.
The trade-finance loans are also paying off for Barak, which has returned 11 percent to 16 percent a year after fees since it started in 2009, according to data compiled by Bloomberg. That was the same year the global financial crisis shrank the world’s economy and resulted in unprecedented amounts of stimulus.
The firm has also funded a gas turbine project in Kenya, the production of Zambian fertilizer, Mozambican tomato paste and Tanzanian rice among the 505 transactions it has entered into, with its highest default rate at 4.9 percent in 2012, Hedley said. It was 1.75 percent last year. That compares with impairments as a percentage of loans granted by South African banks of 3.1 percent in 2015, according to data from the country’s regulator.
Barak sees further growth coming from funding suppliers of household goods as Africa’s middle class expands, he said.
In The Beginning
The industry is in its infancy. Assets under management at 19 global funds have doubled to $2.63 billion since 2014, according to data compiled by Bloomberg. Ten other funds didn’t supply data. New York-based Octagon Asset Management LLC, which estimates the industry has $10 billion in assets, is forecasting it will expand to $20 billion in five years.
The opportunity to grow is coming from commodity prices that are down almost 40 percent from their 2014 highs, which has “spooked banks” and limited the type of loans they offer, said Chief Executive Officer Mead Welles, who plans to double the company’s $150 million fund over the next year.
Octagon targets a return of 8 percent to 12 percent. That lags the 13 percent return of emerging-market dollar bonds this year, which in 2015 lost 0.2 percent, according to data compiled by Bloomberg. Global equities have gained 3 percent in 2016 in dollar terms, following a 7.4 percent average slump last year.
‘Can Be Expensive’
Poor access to foreign currency in countries like Angola, Nigeria and Mozambique, and a higher rate of return has pushed London-based Scipion Capital U.K. Ltd. to seek deals in West Africa, rather than places such as Kenya, where low rates aren’t attractive, Nicolas Clavel, the chief investment officer and founder, said by phone.
Scipion, which now deploys $140 million, shifted to financing agricultural products amid a decline in Chinese demand for manganese, chrome and coal. It’s made average returns of more than 9 percent since it started in 2007, beating its benchmark half the time, according to data compiled by Bloomberg.
“They fill an essential niche in the higher-risk end of trade finance that banks often can’t or won’t play in,” said Minos Gerakaris, head of trade and working capital at FirstRand Ltd’s Rand Merchant Bank in Johannesburg. “Their yield requirements are higher as they need to match the risk that their investors are taking,” which “can be expensive for traders and commodity producers.”
In spite of the costs, the loan has paid off for CZ Electronics, which has hired mostly poor black women in a country where more than one in four people are unemployed. The economy’s also heading toward its second recession since 2009.
Aneka Witbooi, 26, works as storekeeper, which may never have happened without the loan from Barak. She had quit night courses and pulled her youngest sister out of private school when their mother’s death from breast cancer left them penniless in 2013.
“Millicent will start again in private school and I’m resuming my studies in human resources management,” she said during a break from the production line, where workers in plastic coats and hats to reduce static go about assembling security systems and detonators for the mining industry. “Things are much better.”