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Forfait Financing

Introduction

The International trade market is currently over US $9 trillion dollars a year. Of this trade over US $3 trillion is financed. Forfait financing is a specialized fixed-rate trade financing method that is estimated to exceed USD $40 billion a year. Forfait financing is defined as the selling, at a discount, of medium-term accounts receivable, bills of exchange or promissory notes of a foreign buyer. The debt is normally associated with international trade of goods and services. The debt obligation of the foreign buyer is commonly guaranteed by the buyer’s bank, but may also carry the guarantee of the buyer’s government. Forfait financiers characteristically purchase the debt instruments from exporters without recourse. This means that in the event that the borrower defaults on the debt, the exporter will not be held liable.

The financing system has been widely used primarily by the trading nations of Europe over the last fifty years. The centers for Forfait financing are London; Zurich, and Frankfurt.

Example

In 1999, Northwestern Turkey, the county's most densely populated region and industrial heartland, was struck by two massive earthquakes. The first, on August 17, 1999 measured 7.4 on the Richter scale. Izmit, a city of one million, was nearest the epicenter. The death toll was over 18,000, with some 44,000 people injured, nearly 300,000 homes and more than 40,000 business buildings were either damaged or collapsed. Tens of thousands of the survivors were still living in tents or makeshift housing a year after the tragic earthquakes.

Select Homes, a housing manufacturer in Sacramento got a call. A cement company in Turkey had heard of Select Homes and their housing technology which revolutionized the way structures are built. Select company produced insulating concrete forms that are hollow blocks or panels that crews stack into the shape of the exterior walls of a building. After the forms are fastened with adhesives, reinforced concrete is poured inside. The end result is a foam-concrete sandwich that is water, termite proof and wind, earthquake resistant. Select Homes ultimately sold a license agreement to a Turkish cement company, which became a joint-venture partner.

Together, the joint venture received a contract from the Turkish Housing Ministry for 52 schools. The joint venture purchased a manufacturing facility from Select for $649,000. The Joint venture could not qualify for 3 year financing on its own, but was able to get a Turkish Development Bank guarantee. Select found a London Forfait House willing to finance the transaction through forfait trade financing. The transaction took the following steps:

  • The Commercial contract was signed with the Turkish Housing Ministry.
  • A Forfaiting agreement was signed with the London Forait House.
  • The manufacturing facility was shipped and delivered.
  • The promissory note drafts were delivered to the forfait House.
  • The drafts were endorsed according to forfaiting agreement along with shipping and trade documents including the invoice.
  • Select was paid the total amount of all drafts less discount.
  • London Forait House made presentation of drafts for collection at maturity to the Joint Venture.
  • The Joint Venture.made payment of all drafts as agreed.

Characteristics of Forfait

Forfait financing may be structured creatively and adaptable to the needs and cash flow characteristics of the borrower.

  • Forfait financing is most commonly related to international trade transactions.
  • The exporter extends credit to his customer for some period of time commonly from six months to 5 years but may reach 10 years
  • The exporter must agree to stagger the repayment schedule of the receivables.
  • The buyer agrees to the repayment of the debt.
  • Debt obligation is usually documented by bills of exchange or promissory notes.
  • Bank guarantee normally required to secure the buyer's debt obligation.
  • Documentation is simple, and quick.
  • Exporter receives payment after shipment of goods and submission of required documents.
  • Typically the debt will be evidenced by a series of notes (such as ten notes due six-monthly over five years).
  • Payments structure is normally semi-annually in arrears.
  • Payment schedules are flexible and can be structured to accommodate the buyer’s cash flow.
  • The size of forfaiting transactions varies from US $100,000 - to US $50 million.

Advantages To Exporter

  • Exporter can offer credit to buyer but receive cash payment.
  • Exporter receives cash immediately upon delivery of the goods or services.
  • No country of origin restrictions as required by Sovereign Export Promotion Agencies.
  • Up to 100% of sale can be financed.
  • Forfait financing is 100% non-recourse to the Exporter.
  • Eliminates the two key risks – political and commercial credit risks.
  • Protects exporter from foreign exchange fluctuations, interest rate increases.
  • Simple documentation, rapid, flexible deal structuring.
  • Improves competitive advantage by providing vendor financing.
  • Facilitates expansion of markets to riskier countries.
  • Commitments can be received within a few days depending on country of import.
  • No credit administration, collection efforts with related costs.
  • No contingent liability, enhances balance sheet ratios.
  • Eliminates export credit insurance premiums and commercial banking fees.
  • Financing is transacted confidentially, unlike commercial loans.

Disadvantages To Exporter

  • Forfait financing does not cover pre-delivery risks.
  • An export shipment is effectively open account until a commitment is obtained from the forfaiter and exporter fulfills their obligations.
  • Exporter has the responsibility to ensure that the debt is legal and enforceable.
  • Exporter must insure that the debt instrument is properly guaranteed.
  • The cost of forfait financing can be higher than commercial bank financing.

Advantages To Importer

  • Importer gains access to extended term financing with fixed or floating interest rates.
  • Forfait financing has simple documentation and is very flexible.
  • Can receive financing for up to 100% of cost of goods.
  • Provides access to major hard currency financing.
  • Repayment can be tailored to the buyer’s cash flow profile.
  • Goods from a variety of sources can be financed.
  • There is no acceleration clause in the case of non-payment of one bill, which is traditionally featured in commercial loan agreements.

Disadvantages To Importer

  • The importer must pay for both forfait financing and the fee for bank’s guarantee.
  • Cost for financing and bank guarantee can be more than direct credit loan.
  • The bank aval or guarantee may be counted against and reduce availability of Importers bank credit lines.
  • Importer may need to cover foreign exchange risk over repayment period.

Advantages To Guarantor

  • Guarantor bank earns a fee for providing its guarantee or aval on debt instrument.
  • Guarantor bank does not have to utilize own funds to finance its client.
  • The forfait guarantee transaction may appear as a contingent liability or off balance sheet item.

Typical Applications and Tenors

  • Commodities (oil, coal, rice, grain, etc.) financed from 90 days to 18 months.
  • Services (engineering, design, maintenance, etc.) financed from 180 days to 3 years.
  • Technology (software, computers, communications, etc.) financed from 180 days to 5 years.
  • Construction Project (hospitals, airports, factories, etc) financed from 3 years to 7 years.
  • Capital equipment (machine tools, generators, tractors, etc.) financed from 2 to 7 years.
  • Turn Key Plants (power generation, asphalt production, etc.) financed from 3 years to 7 years.

Typical Required Documents

  • Copy of the sales contract.
  • Copy of the signed commercial invoice.
  • Copy of shipping documents such as bill of lading evidencing delivery and receipt of goods.
  • Letter of assignment and notification to the guarantor.
  • Letter of guarantee, or the “aval”.

TEFO Forfait Agency

The market for forfait financing is essentially in Europe with London serving as the primary center. Virtually all of the forfait companies in North America are representatives or brokers of the European Forfait Houses. The forfait market is dynamic. The Forfait houses are characterized by a continual change in country risk appetite and financing cost. Active and experienced exporters in Europe and in North America often prefer to work with a Forfait agent familiar with the market trends. TEFO Trade Finance Specialists can assist California exporters to access competitive rates for most markets in the world. We can also assist the exporter to structure the trade transaction to conform to Forfait market parameters.

Copyright © 2004, 2005 Ted S. Eastman. None of the contents of this article may be reproduced or republished without the express permission of the author


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