Exports to China are particularly vulnerable


The credit crunch is starting to hit U.S. exporters, especially smaller ones. Already squeezed by their bankers’ reluctance to provide trade finance for shipments overseas, they’re being hurt by the inability of their foreign buyers to open letters of credit with their own banks. The crunch is particularly acute in developing markets such as China and India, where buyers lack access to more sophisticated forms of trade finance.

Chinese banks, whose doors have been open for trade financing in past years, have tightened standards for issuing letters of credit in the last few months. On top of this, there have been a few cases where some banks are refusing to honor existing letters of credit issued by other banks. All of this is having a severe impact on global exporters whose business is already suffering from a slowdown in Chinese demand.

The letter-of-credit squeeze erupted suddenly. “We were getting ready to ship the regular monthly shipment of 40 containers of lumber we’ve been selling to one big firm in China when all of a sudden they sent us an e-mail saying they were going to have to hold up on that month’s shipment because they couldn’t get a letter of credit opened by their bank,” said Richard Burnett, president of Cross Creek Sales, an Augusta, Ga., sawmill that sells kiln-dried lumber worldwide. “Then they came back a month later and said they were sorry, but it was now going to take six months to get their letters of credit. Well, obviously, that was the end of the business.”

That wasn’t the first time one of Cross Creek’s Chinese customers couldn’t get their bank to open a letter of credit. “Another one of our customers told us they couldn’t get a letter of credit because banking is difficult over there,” Burnett said. “They tried to get us to do a wire transfer, so it has impacted us quite a bit.”

The credit problems of the company’s Chinese customers have come as sales are slowing as a result of the global economic turndown.

China is the only country where the company’s customers have been unable to get trade finance for their purchases, but this has been particularly troublesome because it is one of Cross Creek’s bigger markets. The inability of its Chinese customers to get letters of credit, coupled with the slowing of exports to its other major markets, has cost Cross Creek as much as $4 million this year, one-third of its projected revenue, forcing it to lay off 15 of its 35 employees, Burnett said.

Difficulty in obtaining letters of credit for exports to China is spreading globally. Philip Damas, division director of Drewry Supply Chain Advisors, said a Danish forwarder told him that its export business from Denmark to China had dried up because its Chinese importers could not secure trade financing.

An unusual number of smaller exporters are having trouble getting trade finance in the U.S., said James Morrison, president of the Small Business Exporters Association in Washington, which recently surveyed 1,000 of its members to determine the impact of the credit crisis on their ability to finance exports.

“We are noticing that members in some parts of the country are really screaming and others are saying we don’t really have a problem,” Morrison said. Although smaller U.S. exporters may qualify for 90 percent underwriting for their foreign sales by the Export-Import Bank of the United States and the Small Business Administration, many are still having trouble getting trade finance for the balance from U.S. banks that are skittish about financing trade in tight credit markets.

“All bankers hate foreign risk,” Morrison said. “They’re all thinking, ‘How am I going to repossess that damned tractor in Peru?’ ”

That’s why smaller exporters depend on their buyers to open letters of credit, one of the oldest forms of trade finance. Letters of credit account for a hefty portion of trade finance globally, especially in trade with developing markets such as China and India, where other forms of trade finance are not as well developed.

A letter of credit is a formal document guaranteeing payment by an issuing bank on behalf of a buyer (an importer) to the exporter for a specific amount of money, provided certain conditions are met.

With the acceleration of the credit crunch around the globe, some banks are refusing to honor letters of credit issued by other banks, which could have severe repercussions for international trade if the trend continues. Not only that, but HSBC, a leading trade finance bank, has said that the cost of guaranteeing a letter of credit, a routine instrument used for payment of goods, has doubled.

The credit crunch has already hit the dry bulk trade with China, driving freight rates to record lows and forcing some dry bulk carriers to lay up their ships. Rates are so low that Zodiac Maritime Agencies Ltd., the line managed by Israel’s Ofer family, which also controls Zim Integrated Shipping Services, announced that it may idle 20 of its largest ships.

“Global shipping has been hit as exporters and importers struggle to secure letters of credit,” said Matt Robinson, an economist in the Sydney office of Moody’s Economy.com. “A letter of credit is an IOU between an importer and exporter and the lifeblood of international trade flows. Some cargo ships have been stranded at ports as stocks pile up, because exporters have been unable to arrange shipping without being afforded bank finance,” Robinson said in an article posted on the Economy.com Web site.

“If this problem persists, it will be a double whammy for Asia’s export-oriented economies, already reeling from falling consumer demand in key export markets,” Robinson said. With sellers’ banks deciding they don’t trust the financial institutions named in buyers’ letters of credit, there have been alarming reports of cargo ships being stuck in home ports, he said. “With ships not moving, stocks have been piling up and exporters have grown desperate for income from idle inventory. Importers of raw materials for production are also feeling the pinch as supplies dwindle.”

Late last month, Pascal Lamy, the World Trade Organization’s director general, invited leaders of banking giants such as HSBC, Royal Bank of Scotland, JPMorgan Chase and Commerzbank, along with top officials from the International Monetary Fund and World Bank, to an emergency meeting in Geneva on Nov. 12. Lamy said the goal of the emergency meeting was to find new ways to finance global trade, which faces a slowdown because of the tight credit constraints caused by the financial crisis. In a letter to invitees, Lamy said the meeting of about 15 leaders would review how the international market for trade finance is faring, and look at ways to improve the availability of funds at affordable rates for developing countries.

The WTO said key international players need to figure out how to ensure a sufficient supply of capital for traders looking to cover risks such as the bankruptcy of commercial partners, damaged or delayed deliveries, transportation problems or sudden shifts in exchange rates. Banks and other trade finance institutions have tightened lending conditions considerably by imposing more onerous requirements on importers and exporters before issuing letters of credit or other forms of trade finance.

“Letters of credit are always drawn against the bank account of the buyer, and with this credit crisis, there’s less and less liquidity, so it’s tougher to open up L/Cs,” said Arjan van de Wall, senior vice president and director of international operations for Euler Hermes ACI, the world’s largest credit insurer. “When a seller and a buyer start working together and a seller says, ‘I’m happy to sell to you but you need to open up a credit,’ he’s already saying to the buyer, ‘First, show me the money and then we’ll do business with you.’ ”

But with the spreading credit crisis, buyers increasingly are looking to their suppliers to come up with vendor credit, because that’s one of the few ways that they can still tap into a credit line when they can’t get letters of credit from their banks. But van de Wall said even vendor credit lines are getting more difficult to secure as credit standards tighten.

Euler Hermes, which is owned by Germany’s Allianz Group, is examining the risks of trade finance more carefully. “We are more cautious to make sure that we cover credits that are creditworthy,” van de Wall said. “Many companies are in distress, so we are more aware of things that can go wrong.”

From a seller’s perspective, credit insurance is easier than waiting for a buyer to open a letter of credit because a policy covers a whole year of trade transactions, van de Wall said. “It’s something you do once and then you’re done with it for the whole year, and it’s less sensitive to mistakes in the paperwork,” he said.

Van de Wall said letters of credit can be cumbersome to use because a new one must be opened for every trade transaction, and any error in the paperwork can result in delays or even failure of banks to honor paperwork. “Sometimes it’s a way for the bank to delay shipment because it can always find a little hiccup in the paperwork,” he said. 

More information is available at www.drewrysupplychains.com, www.economy.com, www.eulerhermes.com/en, www.sbea.org and www.wto.org.