- Structured finance in Mexico: an Innovative solution to integrate small producers in the supply chain - Conference on SME Asset-Backed Financing Instruments: Opportunities in Europe Slovakia, May 2008 Alberto Lara López
Agenda 1. FIRA 2. Financing Agriculture in Mexico 3. FIRA: Creating value solutions 4. Final Remarks 2
FIRA is the leading financial institution for agribusiness and fisheries in Mexico Trust Fund created by the Mexican Government 53 years ago. Operates as a second-tier bank that provides funding and credit guarantees to the banking system to finance agricultural and fisheries in Mexico. Public entity with private behavior and best market practices Summarized Balance Sheet December 2007 (Million Dollars) Assets 9,775.8 Financial Instruments 4,664.5 Loans 3,812.9 Other Assets 1,298.4 Liabilities 5,047.0 Equity 4,728.8 3
FIRA has increased the annual credit flow at a two digit rate during the last six years FIRA s total credit flow and credit to small producers* through commercial banks (Million dollars 2007) 6,500 Growth Rate 13.3% 2000-2007 5,500 4,917 5,176 4,500 3,500 2,500 2,543 3,016 3,788 4,707 1,862 5,044 2,279 Growth Rate 15.9% 2001-2007 1,500 941 1,163 1,838 1,581 500 965 2001 2002 2003 2004 2005 2006 2007 Total Small Producers * Small producers are: PD1.- Producers whose annual income is not more than 1,000 times the minimum wage of the region where investments will be made and PD2.- Producers whose annual income is higher than 1,000 times but less than 3,000 times the minimum wage of the region where investments will be made. 4
Agenda 1. FIRA 2. Financing Agriculture in Mexico 3. FIRA: Creating value solutions 4. Final remarks 5
Agribusiness, rural and fishing sectors in Mexico Agribusiness has less price volatility and has become the sector s driver. Agricultural Price Index 110,000 100,000 90,000 Agricultural&Agribusiness GDP (Millon of pesos de 1993) Agricultural Agribusiness 80,000 70,000 60,000 50,000 40,000 30,000 Also, there are some competitive advantages in highly export oriented products in agribusiness and fisheries sectors. 6 Ene-05 Feb-05 Mar-05 Abr-05 May-05 Jun-05 Jul-05 Ago-05 Sep-05 Oct-05 Nov-05 Dic-05 Ene-06 Feb-06 Mar-06 Abr-06 May-06 Jun-06 Jul-06 Ago-06 Sep-06 Oct-06 Nov-06 Dic-06 Ene-07 Feb-07 Mar-07 Abr-07 May-07 Jun-07 Jul-07 Ago-07 Sep-07 Oct-07 Nov-07 Dic-07 Ene-08 Feb-08 Mar-08 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 150 145 140 135 130 125 120 115 110 105 100 CPI National CPI Agribusiness CPI Agricultural
Agency problems arising from asymmetric information Deriving from asymmetric information a lender faces an adverse selection problem, specially in agricultural and fishing sectors dominated by small and medium size producers. Therefore gathering financial information is costly and difficult, since many of these producers do not keep a formal accounting. Thus, assessing the productive capability and financial strength in an adequate manner is expensive for a bank. Because of the involved risks, banks do not show an active lending activity to these sectors, concentrating their loan portfolios in other activities like manufacturing, housing and consumer lending. Therefore the lack of specialized knowledge about these sectors results in much higher risk perception by the banks than the actual risk: Thus, asymmetric information plays against access to credit markets for agricultural and fishing entrepreneurs. 7
Moral Hazard Problems and Transaction Costs Because of the weak enforcement of property rights in Mexico and to debt relief programs in the past, borrowers in some instances have had weak incentives to repay their loans. This has historically resulted in large non-performing loan portfolios and losses for banks. In addition, the lack of risk assessment capabilities in banks with respect to rural and fishing activities has not enabled them to conduct adequate monitoring to avoid such moral hazard problems. Because of the profile of small agricultural and fisheries' participants and their level of formality, screening is costly. In addition, an important part of the loans are small in size, and therefore, the cost of originating a loan is relatively high. 8 The geographic coverage of the banking system in Mexico remains concentrated in urban areas. Highly dispersed and small clients make it difficult for banks to serve the agricultural and fishing sectors.
Agenda 1. FIRA 2. Financing Agriculture in Mexico 3. FIRA: Creating value solutions 4. Final remarks 9
FIRA s activity is aimed at solving market failures/imperfections with a market approach and a clear vision of financial market development F I R A Transaction costs reduction Asymmetric information solutions Market making Value creation 10
FIRA approached the trading companies and suppliers to offer an innovative solution: Structured Finance Transaction costs redution FIRA Asymmetric information solutions Value creation Main Challenge faced by FIRA was finding solutions to the following aspects: Solving the adverse selection problem by finding a way to make screening effective and inexpensive. Reducing the transaction costs for the banking sector to finance commodities suppliers. Mitigating risk through diversification and adequate collateral that reduce moral hazard problems; Hedging price volatility and commercial risks in a way that can be easily understood and managed by a financial institution. Designing new products that could be easily understood, priced and managed by financial markets. 11 Market making
The solution that FIRA designed involved transferring experiences in securitization of accounts receivables Transaction costs redution FIRA Asymmetric information solutions Value creation Market making FIRA put together a team of experts specialized in agriculture, fisheries, investment banking and legal aspects to find such a structure. The result was a facility that allowed: a) Trading companies to maintain the current relationship with suppliers while reducing the leverage of its balance sheet and its credit exposure, b) The commodity suppliers to receive loans in a timely manner and in sufficient amount that allowed them to reduce their financial expenses and c) The financial system to expand its investment opportunities by creating debt instruments that could be easily assessed and priced by banks, with reduced risk and transaction costs. A description of the facility and its rationales follows: 12
Structured finance: developing financial mechanisms adapted to client's needs Transaction costs redution FIRA Asymmetric information solutions Value creation Market making ABS structures: Account (working receivables loans) capital Stock of commodities FIRA works as a structure agent FIRA Financing provides enhancement and Optimization sheet Liquidity to allow growth of firm's balance Strengthen the supply chain Timely credit for producers New financial solutions for more business opportunities 13
This allowed positioning FIRA like a developer of businesses and link between small producers and big global corporations. (Example: Nestlé - Small Producers of Cacao and Milk of Goat). Inventories Financing: sugar, corn, sorghum, wheat, coffee, soy, nut, orange juice, potatoes and cacao. Fishing: aquaculture and capture of shrimp and tuna. Primary activity in Grains: corn, sorghum, wheat, beans, etc. Structured Financing was developed in three great strategic areas Transaction costs redution Value creation Asymmetric information solutions FIRA 14 Market making
The vision is to leave individual financing and adopt an integral formula Primary Production Storing and Transformation Warehousing 15 Phase Non bank intermediaries Inventory financing Structure of title rights Structure of title rights Pignoratious Structure with CD s titles. off balance sheet inventory financing Sales Point Suppliers development Products CD: Deposit Certificate FIRA Transaction costs redution Asymmetric information solutions Value creation Market making
Example 1: White Corn, Yellow Corn & Wheat Inventory financing solution Transaction costs redution FIRA Asymmetric information solutions Value creation Warehouse Repo of CD Servicer Portfolio sale Other Investors (Rabobank, Deutsche bank) OTC hedge Credit derivative Mexican Banks This mechanism provides liquidity based on farmers inventories. This is a Repo operation, it is not a Credit operation, so it does not impact on financial statements. It does not affect firm s credit lines with other financial institutions. 16 Market making
Example 1: Advantages of grains inventory financing Transaction costs redution FIRA Asymmetric information solutions Value creation Generates a financing instrument for value chains with participation of the private sector. There is a professional agent which handle and manage the collateral The output inventory to market is ordered, diminishing the risk of low prices associated to seasonal excess of grain supply. It creates liquidity from inventories for grains consumer. For the Bank is a low risk transaction with low operation costs, which allows them to obtain an attractive return by operated volume. 17 Market making
Example 2: Sugar financing Margin calls 8 Repo of CD PRODUCERS, DEALERS OR CONSUMERS 3 7 $ Product 1 2 Certificates of deposit WAREHOUSE SERVICER BUYER Transaction costs redution Cession of Rights 4 5 Credit $ Credit with a Guarantee of even 96% PUT FIRA Asymmetric information solutions Value creation BANK 6 18 Market making
Example 2: Sugar financing advantages Transaction costs redution FIRA Asymmetric information solutions Value creation Primary producers have access to technologies, financing, administration of risk and product commercialization. Suppliers, dealers and industries obtain inputs in suitable amounts, with the quality they need and in the required time, which allows them to make its planning of inventories, production and sales. Consumers receive products according to their requirements. 19 Market making
Our structured finance instruments offer attractive investment opportunities in unexplored markets Value chain integration Development financial market Value creation for participants (income ) Development analytical capability financial intermediaries Lower transaction costs 20
In 2007 FIRA conducted operations for US$421.7 millions of structured financing Dollars Millions $ 50 100 150 200 250 Repo s 209.7 Primary Activity 196.7 Fishing and aquaculture 15.3
FIRA also participates in the derivatives market. This has allowed the Institution to offer value added products and to improve the portfolio profitability 22 Informative weekly rate proposal Producer s requests Cash flow grouping Interest rate swap closing Fixed interest rate credit disbursement C.F. Bundling = More Volume = Attractive Interest Rates Low income borrowers are perceived high risk; their size limits their access to risk management instruments. SWAPS let small producers have access to very competitive interest rates. Small amount credits (less than $10,000 dollars ) can get fixed interest rate. The financial risk for FIRA does not increase since The credit offered under fixed interest rate is hedged 100% with interest rate swaps (zero market risk) Credit risk is minimized through a strict selection of counterparts
Agenda 1. FIRA 2. Financing Agriculture in Mexico 3. FIRA: creating value solutions 4. Final Remarks 23
FIRA develops new ways to finance small producers by structured finance facilities that can be understood and adopted by the financial market By structured finance, FIRA is able to coordinate stakeholders, align their incentives and distribute risks along the system with a positive impact on participants that result in an increased access to producers in obtaining loans. Structured-financed solutions can help overcome credit rationing. The key is to design efficient ways to leverage each participants strengths, while creating the right incentives for them to mitigate risks and transaction costs. Through reducing transaction costs and giving solutions to asymmetric information, FIRA creates value added to its clients, including small commodity producers. 24
Points to be considered and lessons learned with structured financed products As a rule all contracts must count on insurances against diseases, climate, robbery, damage, fires and accidents. All the operations will have to be formalized with contracts between suppliers and plaintiffs. Contracts should establish that producers yield the rights of collection by the sale of their production so that the income of their sale is applied in first instance to the payment of the credit plus the generated interests and the surplus is given to them. Contracts and legal documents should be developed by an external legal office, that has the responsibility to give legal certainty to the operation. Companies should be closely supervised and qualified in order to prevent bankruptcies or frauds. FIRA is now focused on promoting vertical integration structures related with supplier development. 25
www.fira.gob.mx 26