How Mitigating Trade & Currency Risk Can Foster Success in the Global Economy

How Mitigating Trade & Currency Risk Can Foster Success in the Global Economy Kathy Jiang SVP-Int l Trade Specialist Oscar Arriaza SVP-Int l Foreign Exchange Specialist April 23, 2014

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Agenda Overview of Global Trade and Trends in Finance Structure Favorable and Acceptable Payment Terms With Vendors Expedite Export Payments While Mitigating Risks Trade Finance Case Study Summary Mitigate Currency Risk by Developing a Workable Foreign Exchange Policy Address the Hidden Risk of Transacting International Payables and Receivables in US Dollars

Overview of Global Trade and Trends in Finance Texas Exports Set New Record in 2013 Texas merchandise exports reached $279.7 billion, 5.7% increase, a record high level for the state U.S. goods and services reached $2.3 trillion, an all-time record, supporting nearly 10 million American jobs Texas top export markets: Mexico ($101 b); Canada ($25.9 b), Brazil ($10.8 b), China ($10.7b), Netherlands ($9.6 b) Texas key merchandise export categories: Petroleum, computers, electronic products, chemicals, machinery and transportation equipment

Overview of Global Trade and Trends in Finance Free Trade Agreement The US has free trade agreements with 20 countries, which account for $168.9 billion (60%) of Texas exports During the past 10 years, exports from Texas to these markets grew by 130%, with NAFTA, Colombia, CAFTA-DR, Chile and Korea showing the largest dollar growth during this period

Overview of Global Trade and Trends in Finance Total U.S. Imports via Texas in 2013 Texas merchandise imports reached $311.6 billion, down by 5.7%, representing 13.7% of share of the total US imports U.S. goods and services reached $2.7 trillion, down by 0.1% Texas top import markets: Mexico ($94.9 b); China ($42.8 b), Saudi Arabia ($22.6 b), Venezuela ($16.2 b), Canada($14.5 b), South Korea ($9.3 b) Texas top dollar commodity & merchandize imports include: Crude oil, cell phones, TV, digital processing units, wireless & data products, parts & accessories for machines, etc.

Overview of Global Trade and Trends in Finance Global & Regional Trends in Trade Finance Trade Finance empowers the engine of global economic growth Trade Finance deals mainly in short-term maturities; the security is held in the underlying goods moved in the transaction The center of gravity of world trade is shifting to Asia from Europe and ASEAN Markets are the primary region for financing trade The outlook for Africa s trade is positive with a persistent demand for many of the commodities Africa produces, coupled with rising imports of food, fuel and consumer goods The global trading system will be re-arranged in coming years Source: ICC survey 2013

Overview of Global Trade and Trends in Finance Global & Regional Trends in Trade Finance The ICC Banking Commission s 2013 survey reviews: - Trade finance is more available, but the increase is marginal - The alarming rise in fees for trade risk after the 2009 trade collapse has abated - A large gap remains in the market for trade finance and risk coverage even while trade finance pricing is lower or unchanged - KYC principles are seen as hampering the smooth flow of trade finance - Basel III regulations affect the cost of funds and liquidity

Overview of Global Trade and Trends in Finance Export Trade Finance Mix Import Trade finance Mix Figure 12: Export Trade Finance Mix Figure 13: Import Trade Finance Mix Commercial Letters of Credit Standby Letters of Credit 19% 2% Commercial Letters of Credit Standby Letters of Credit 18% 4% Guarantees 43% Guarantees 39% Collections 17% Collections 15% Open Account 14% 5% Open Account 16% 8% Other Other AN ICC PRIVATE SECTOR DEVELOPMENT PERSPECTIVE

Overview of Global Trade and Trends in Finance Standby Letter of Credit Standby Most often used as a default mechanism - other payment type used as primary payment method Uses: o Financial (for payment default) o Advance Payment Bonds o Bid and Performance Bonds o Insurance o Real Estate ICC Uniform Customs and Practices Publication - UCP 600 ISP 98 Commercial Letter of Credit Commercial (Documentary) used as a payment mechanism Sight Time/Usance Deferred ---Uses: Primary mechanism for payment Import Export Domestic shipments ICC Uniform Customs and Practices Publication -UCP 600

Overview of Global Trade and Trends in Finance Receivables Lower borrowing costs, shorten Dales Sales Outstanding (DSO) Improve quality of A/R earnings Reduce payment and FX risk Broaden sales market (revenue growth) Global Trade Cycle Payables Extend Days Payables Outstanding (DPO) Lower Cost of Goods Sold (COGS), access supplier s discounts Links with payment technology & card solutions Inventory Improve asset turnover and ROA Maintain/expand supplier base Risk management Working Capital Optimization Supply chain strategy

Structure Favorable & Acceptable Payment Terms with Vendors As the global recession continues to impact most markets, exporters and sellers are aggressively competing for sales and market share placing buyers or importers in a stronger negotiating position over trade and payment terms. Dual quotes in USD vs. Foreign Currency Advance Payment vs. Open Account Down payment & progress payment Commercial Letter of Credit vs. Standby Letter of Credit Sight Draft vs. Time Draft Delay the payment to minimize your risk and maximize your working capital.

Expedite Export Payments While Mitigating Risks Letters of credit (LC) can discipline buyers and sellers to make a payment and ship goods in a timely fashion Confirming export letters of credit to shift a foreign bank risk to a US bank risk Discounting drafts under letters of credit to expedite payments and liquidity while reducing risk Use of guarantees and standby letters of credit to save cash and protect against default Purchasing export credit insurance to cover foreign AR under open account Depending on the size of the transaction and numbers of POs, one should apply different payment methods. Trade financing cost is relatively higher in emergent markets. US exporters can take advantage of low cost trade finance market here to help foreign buyers and promote sales

Trade Case Summary Client: Import Co is a mid-size company that is planning to source its inventory from China Situation: Payments are made to Chinese suppliers 50% down and 50% upon BL Orders are placed regularly Trade cycle requires significant working capital Access / Move Capital Manage Risk Improve Efficiency How do I make payments to my suppliers? How can I manage my working capital needs? How do I manage my currency risk? Goals: Key Considerations How do I manage trade disruption? Keep cost of goods as low as possible Minimize risks Streamline payments How do I streamline the payment process? How can I better track my currency positions? 14

Trade Case Summary Challenge Client: Import Co imports from multiple suppliers in China Challenges: With the rising cost of labor and material, suppliers constantly change the prices and the 50% down payment absorb too much working capital Concerns: Reliability of the new vendors. Receipt of damaged merchandise Non receipt of required documents Benefits Extend payment term Better negotiated price Help vendor obtain low cost financing Solution 1) Ask for a quotation in both USD or CNY 2) Issue a commercial LC for a large transaction or for a new customer to mitigate risk 3) Extend payment term from sight to time draft 4) The bank will finance the time draft U.S. Import Co GOODS 2. LC or CNY Trade Payment 1. USD Funding or LC request under the line of credit China Beneficiary Bank 3. Advising LC or crediting CNY Credit to Bene Acct Beneficiary Account. 15

. Trade Case Summary Client: Export Co is a mid-size company that is planning to sell machines to India Situation: Goals: First time to sell to India Secure the sales Progress payments per milestones Minimize risks India buyer wants a 270 day payment term Streamline payments Trade cycle requires significant working capital Key Considerations Access / Move Capital Manage Risk Improve Efficiency How do I receive payments from my buyer? How can I manage my working capital needs? How do I manage the foreign risk? How do I manage trade disruption? How do I streamline the payment process? How can I shorten DSO? How can I accelerate payments? 16

Trade Finance Case Study Summary Solutions & Benefits The Export Co obtained working capital from its bank under Ex-Im Bank Working Capital Program The Export Co negotiated payment terms allowing a performance & warranty bond instead of cash holdback by the buyer (releasing the working capital constrains) The India buyer agrees to issue a commercial LC in favor of the seller allowing multiple drawings and shipments (LC allows flexibility and disciplines all the parties for the obligation) The Export Co's bank confirms the LC and discount the time draft (mitigating the risk and accelerated the payments) The Export Co is able to sell to its Indian customer without worrying about their credit worthiness, receive payments per schedule without delays, increase visibility of their cash flow and accelerate the payments while shortening DSO

Mitigate Currency Risk by Developing a Workable Foreign Exchange Policy Consider for a moment the following statements: International sales are down 10% and it s not because of the abilities of our A-Sales Team, or the demand and quality of our product Foreign currency receivables have deteriorated by 12% and it s not because of bad debt expense Our baseline US dollar payables to foreign vendors have increased by 2.63% Year-Over-Year!

Mitigate Currency Risk by Developing a Workable Foreign Exchange Policy 1 Identify and Quantify Exposure 2 Identify Strategies to Manage Risks 3 Define Corporate Philosophy 4 Define Policies and Procedures 5 Monitor Exposures and Execute Hedges 6 Review and Measure Performance -19-

Mitigate Currency Risk by Developing a Workable Foreign Exchange Policy Time Horizon Shorter Longer Risk Type Transaction Risk - Exposure arising from conversion of known and expected foreign currency cash flows from international transactions (e.g., receivables, payables, loans, etc.) - Does your company produce revenue in one currency and expense in another currency, and will it do so in the future? Translation Risk - Exposure arising from periodic revaluation of a subsidiary s net foreign revenues and expenses or assets and liabilities into USD to create consolidated financial statements - Although sales from a self-sustaining foreign operation are steady, the parent company may be exposed to the translation of net income back to USD Strategic/Economic Risk - Changes in a company s competitive position arising from movements in exchange rates - Can your company absorb a substantial move in exchange rates over the long run such as those that take place when bidding on a foreign project or acquisition? Ease of Risk Management Easier Difficult 20

Mitigate Currency Risk by Developing a Workable Foreign Exchange Policy The goal of a hedge program should not be to try to beat the market, but to provide a known outcome Establish benchmark rates to guide you in applying a reasonable and manageable hedge program There is no right way to manage FX risk; However, it should coincide with corporate philosophy Un-hedged - Spot Forward Vanilla Options Option Structures Speculative Full flexibility to change notional amounts 100% participation in favorable moves 100% risk of unfavorable moves Zero cost Provides certainty but at the expense of opportunity Full commitment to settle original notional 0% participation in favorable moves 0% risk of unfavorable moves Maximum risk is premium paid upfront No commitment to settle at all 100% participation in favorable moves 0% risk of unfavorable moves Cash outlay is required Potentially locked into forward contract Potential commitment to deliver Restricted participation in favorable moves 0% risk of unfavorable moves Zero or little cash premium required 21

Mitigate Currency Risk by Developing a Workable Foreign Exchange Policy Corporate Philosophy Hedge Strategy Execution Our goal is to know exactly the USD value of our foreign currency receivables. We are less concerned about sacrificing upside potential if we can determine the future USD equivalent today "There may be some uncertainty regarding the amount and timing of our currency cash flow. We also would like to retain upside potential and don't mind paying for it "We can tolerate some variance due to FX movements, but we definitely want to protect against large adverse movements. In addition, we would like to participate in market upside, but are not willing to pay any premium for hedge protection Lock in future rate with Forward Contract Purchase the right to lock in a future rate with an Option Contract Combine a Forward with an Option Contract 22

Address the Hidden Risk of Transacting International Payables and Receivables in US Dollars Our baseline US dollar payables to foreign vendors have increased by 2.63% Year-Over-Year! We don t have any foreign exchange risk because we deal exclusively in US dollars If you transact business outside the boundaries of the U.S. and deal in U.S. dollars only, you are participating in the foreign exchange market In any international transaction, foreign exchange risk exists What business opportunities are lost by dealing exclusively in US dollars? 23

Address the Hidden Risk of Transacting International Payables and Receivables in US Dollars Situation Analysis: US golf club manufacturer imports components from China for final product assembly in Texas. A Chinese vendor provides a price list in US dollars good for 90 days; terms are net 45 days Prices have increased 2.63% Year-Over-Year directly impacting profit margins Tough competition in the US market makes it difficult to pass along price increase to consumers With a newly minted Foreign Exchange Policy in place, the US company can inquire about obtaining component prices in both US dollars and Chinese Renminbi 24

Address the Hidden Risk of Transacting International Payables and Receivables in US Dollars Chinese Vendor- 2013 Sales Budget 13-Jan 28,000,000.00 6.2800 $ 4,458,598.73 Price Increase Progression Quarter Receivables FX Rate USD Equivalent Actual FX Rate Short Fall in USD New USD Pricing 13-Mar 7,000,000.00 6.2800 $ 1,114,649.68 6.20680 $ (13,145.64) $ 1,127,795.32 13-Jun 7,000,000.00 6.2068 $ 1,127,795.32 6.13560 $ (13,087.40) $ 1,140,882.72 13-Sep 7,000,000.00 6.1356 $ 1,140,882.72 6.08650 $ (9,203.54) $ 1,150,086.26 13-Dec 7,000,000.00 6.0865 $ 1,150,086.26 6.05000 $ (6,938.54) $ 1,157,024.79 Total $ 28,000,000.00 $ 4,533,413.98 6.17636 $ (42,375.11) $ 4,575,789.09 2.63% US Importer- 2013 Inventory Budget 13-Jan 28,000,000.00 6.2800 $ 4,458,598.73 Quarter Payables Forward USD Equivalent Actual FX Rate Savings from Hedging US dollar Pricing 13-Mar 7,000,000.00 6.2755 $ 1,115,448.97 6.20680 $ (12,346.35) $ 1,127,795.32 13-Jun 7,000,000.00 6.2805 $ 1,114,560.94 6.13560 $ (26,321.77) $ 1,140,882.72 13-Sep 7,000,000.00 6.2860 $ 1,113,585.75 6.08650 $ (36,500.51) $ 1,150,086.26 13-Dec 7,000,000.00 6.2900 $ 1,112,877.58 6.05000 $ (44,147.21) $ 1,157,024.79 Total $ 28,000,000.00 $ 4,456,473.24 $ (119,315.85) $ 4,575,789.09 2.63% 25

International Team Guy Lamb SVP - Manager, International Services Tulsa, OK Oscar Arriaza SVP Foreign Exchange Specialist Dallas 214-346-3993 oarriaza@bokf.com Mark Way SVP Foreign Exchange Specialist Dallas 214-346-3999 mway@bokf.com Kathy Jiang SVP International Trade & Treasury Specialist Dallas 214-346-3938 kjiang@bankoftexas.com 26

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