Forfaiting: a Worked Example

A maker of capital equipment often wins an order by offering credit: the buyer pays part on signing and the rest in instalments over several years. Carrying those instalments ties up the exporter's capital and leaves it holding the risk of a foreign buyer, a foreign bank and a foreign country, none of which it is well placed to price. Forfaiting converts the instalments into cash when the goods ship and moves those risks to a buyer of paper whose business is pricing them.

For the exporter's own lender the difference is the recourse. A receivable sold with recourse is still, in substance, a debt the exporter may have to make good. One sold without recourse is not, and what the exporter keeps is narrow: answerability for the claim it sold, not for whether the buyer pays.

The paper is usually a set of promissory notes issued by the buyer or bills of exchange it has accepted, each guaranteed by its bank through an aval or a separate guarantee, or a bank's deferred payment undertaking under a letter of credit. Each instalment is its own instrument with its own due date, so each can be sold on. URF 800, the ICC's forfaiting rules, governs transactions whose parties adopt it, in the primary sale from the exporter and in later resales between forfaiters.

The price has three parts: a discount for the time to each maturity, at a rate reflecting the guaranteeing bank, its country and the forfaiter's funding; often a few days of grace added to each tenor for delays in payments across borders; and, where the price is fixed before the paper exists, a commitment fee for holding it. The discount is quoted in one of two ways:

The first takes interest off the face value; the second treats the rate as the return earned on the money paid out, and gives the exporter more. On notes that run beyond a year the yield method is often compounded by period, and the gap between the two widens, so a quotation that does not say which it uses is not yet a price.

A maker of grain-drying plant, constructed for this page like every figure in it, sells a US$3.6m installation to an overseas buyer. The buyer pays 20% on signing and the rest in six half-yearly instalments of US$480,000, evidenced by promissory notes that it issues and its bank avalises. A forfaiter quotes a straight discount of 7% a year, counting a 360-day year, with the notes treated as falling due every 180 days. The rate and terms are the example's.

The exporter receives US$720,000 on signing and US$2,527,200 at shipment, against a contract price of US$3.6m. The US$352,800 is the cost of being paid now and of passing on the risk, and an exporter that has the forfaiter's quote before it signs can build it into the price. The last line shows what the method of quotation is worth on the longest note: about US$17,500 at the same headline rate.

What the exporter keeps is narrow. If the buyer later complains that the plant is defective and stops payment, the forfaiter is still owed by the avalising bank, and as a holder in good faith it is generally not exposed to defences arising from the sale. If instead the claim was not what the exporter sold, because the exporter did not own it outright, knew or ought to have known of a fact undermining it and did not disclose it, or a fraud touching the claim or the sale means the claim does not exist, URF 800 makes the exporter answerable to the forfaiter, whether or not it took part in the fraud.

Invoice discounting advances part of the value of short-dated trade invoices, usually with recourse to the business that sold the goods, and the lender's security is a book of debts owed by many buyers. Forfaiting buys each instrument outright, at a discount to its full face value, and the paper is negotiable and usually backed by a bank. The first is working capital for a business with a debtor book; the second is the sale of a few large, long-dated claims on a single buyer and its bank.

It also differs from an export credit agency's buyer credit, where a bank lends to the overseas buyer under a government guarantee and the exporter is paid from the loan. In forfaiting no one lends to the buyer. The buyer's promise already exists, and it is the promise that is sold.

DEFINED IN ONE PARAGRAPH → · THE AVAL → · PRODUCT FILE: LC DISCOUNTING →

For the forfaiter, the credit decision is on the guaranteeing bank and its country, and the limit used is a bank and country limit. The file's questions are about the paper: whether the aval or guarantee is valid under the law that governs it, whether the people who signed it could bind the bank, whether the notes can be transferred freely, and whether the country's rules on payments abroad could stop the money even when the bank is willing to pay.

For the exporter's lender, a forfaiting commitment can be the repayment source for pre-shipment finance on a capital-goods contract: the loan that builds the plant is repaid from the proceeds at shipment. It works only if the commitment is firm and its conditions, notes in the agreed form, avalised by the named bank, delivered by a set date, are within the exporter's power to meet. A lender reads those conditions as it would read a credit's documentary requirements.

RECOURSE, DEFINED → · POST-SHIPMENT FINANCE → · HOW BANKS READ EXPORTERS →