Reducing Bank Regulatory Capital in a Basel II/III world: A Case Study

Sober Look and I had an online discussion regarding his post about the hidden pitfalls of Basel III. He suggested there had been some interest in my comments and could I provide a case study. I duly did this evening (finally)  and sent him a simple version of a generic case which I have amended here to include the commercial objectives a typical corporate would be very keen to achieve in the current market conditions.

Case Study

Commercial Objectives

  • European multinational with Head Office in Eurozone“periphery”
  • More robust funding structures and to adapt their debt repayment profile to their expected cash flow generation.
  • Minimize funding liquidity risk and improve advance rate achieved for their assets.
  • Sale rather than Financing accounting treatment. (IAS 39)
  • Greater certainty of trade credit insurance cover through the economic cycle.
  • Achieve commercial outcomes without increasing administrative burden on treasury.
  • Improve credit risk management for both trade and finance purposes.

Financial background

  • Operations in Europe, Africa, Latin America & Asia.
  • 2010 turnover > €1,000m, ROCE 5%, EBITDA < €100m.
  • Total Trade Receivables portfolio €150m.
  • Working Capital needs €125m (2011) and €150m (2012).
  • Concentration risk – 22 major buyers with sales > €7m p.a.
  • Increasing counterparty credit risks within EU.

Existing Funding

  • Funding via Bonds, Revolving Credit and Asset Backed Commercial Paper.
  • €120m ABCP program funded by UK bank through Jersey-based SPV.
  • Advance rate 79% on €150m driven by Rating Agency Criteria (unrated buyers, country limits, loss history, stress)
  • The daily information feed from client sales ledger to the Bank Funder however failed to:-
  1. offer granular detail or “static pool data.”
  2. offer detailed ageing profiles.
  3. Effectively track concentrations/customer aggregation, credit notes, dilution and disputes.
  4. Help reduce reporting requirements/costs for treasury resource.
  5. Enhance confidence in data flows and consistency.
  6. Support holistic Credit Risk Management
  • €27m “allowance for doubtful debt” (creating “Going Concern” issues)
  • Credit insurance purchased separately in each territory. No benefit to external funding cost.

Solution

  • Improved risk analytics (points 1-6 above) benefits Company and Funder.
  • Committed facility of €150m (additional headroom) & reduced all-in funding costs by 25 Basis Points.
  • Advance rate on total trade receivables portfolio lifted from 79% to 95%. Increased cash available for investment and growth plans by €15m p.a. (additional €45m over a 3 year term).
  • Reduced Bank Funder Risk Weighted Assets for transaction by approx. 50%.
  • Sale treatment achieved for transaction under IAS 39.
  • Cell captive established to build cash allowance for doubtful debts and support funding.
  • ROCE improved by 110 Basis Points.
  • Improved Enterprise Risk Management and Internal Controls supporting Corporate Governance.

Example Structure

Structure diagram

 

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