Freeport LNG Marketing LLC Financing: Did US Eximbank and PEFCO Flub Due Diligence on Greensill?

There was an article in the FT today calling into question US Eximbank's and PEFCO's due diligence in connection with an approval of a supplier credit transaction for Freeport LNG involving Greensill as lender.

The timing raises questions about the due diligence that the Exim Bank and Pefco, its funding partner on the deal, conducted on Greensill, whose German banking subsidiary was under investigation by regulators last year.

I think the questions raised can be answered: no.

Summary:

Eximbank and PEFCO have no financial exposure (credit risk) to Greensill in this transaction. As such, their due diligence was appropriate at the time it was conducted.

Eximbank’s primary focus in this transaction and others is (a) the promotion of US exports and (b) creation of US jobs.

Or in other words, Eximbank's customer here is Freeport.  Greensill is a service provider.

At this point, the ability of Greensill to fulfill its obligations under the transaction are in question. Eximbank is no doubt looking for a replacement.

That raises two issues: (a) finding an FI able to handle the supply chain invoice processing and (b) one willing to take risk (10%) on Freeport.

Detailed Argument

Now to the details that support those contentions.

At its 29 September 2020 Board of Directors Meeting ,US Eximbank approved a 90% guarantee under its Supply Chain Finance Program for transactions involving Freeport LNG Marketing LLC as the obligor. (Eximbank reference AP089370XX).

Note that date. Eximbank issued its commitment in September 2020.

At this point concrete news about Greensill’s situation was much different than in January 2021. So if there is an issue with Eximbank’s due diligence, it has to be focused on the period before 29 September 2020.

Eximbank lending is highly rules based. Procedures for approval are more complex and thus more time consuming than in a typical financial institution.

The board approval package would have been prepared, reviewed, and finalized well before the board meeting. 

You can well expect that as well preparation and approval of transaction documentation is similar. That explains the time taken to finalization.

Some key points about this transaction.

1. Freeport is the obligor on the loan. Eximbank's credit risk lies squarely here.

2. US Eximbank guarantees to pay the lender 90% of principal if Freeport doesn’t pay.

3. The lender bears the risk of the unguaranteed 10%.

4. US Eximbank is providing a guarantee not funding.

5. If the lender does not or can not lend, then Eximbank has no exposure to either the obligor (in this case Freeport) or any obligation to the lender (Greensill).

6. Eximbank reviews the documentation for each transaction under an approval for compliance with (a) the terms and conditions of its approval and (b) US content requirements. Then and only then it issues a “guarantee” for that transaction.

Clearly, then the primary focus of Eximbank’s due diligence would be on Freeport.

Due diligence on the lender would focus on its ability to handle a supply chain transaction both in terms of systems and experience as well as no "blocking" issues.  

Those would include legal prohibitions, e.g., US sanctions, etc.

Greensill passed those tests at the time of due diligence.

If the bar were set to exclude those FIs that engaged in reckless banking practices (imprudent lending, over concentration of risks, market manipulation) or illegal behaviour, then the set of "acceptable" banks for US Eximbank would appear to be fairly limited.  And exclude a large number of the G-SIBs.  

PEFCO is a specialist private sector owned lender that provides primary and secondary funding for loans guaranteed by US Eximbank. It also does a very minuscule business in other sovereign guaranteed loans. Roughly 1.4% of total loans.

Eximbank exercises “oversight” on PEFCO’s operations beyond that it does with other financial institutions to which it may give a guarantee.

Given the nature of its business, PEFCO is able to access both fixed and floating rate funding at very attractive rates.

In the Freeport transaction, PEFCO reportedly acquired a 100% “participation interest” in the Eximbank guaranteed portion of the Freeport loan.

That would mean that Greensill remained at risk of non payment on the unguaranteed 10%.

For the same reasons as above, PEFCO has no credit risk exposure to Greensill.

Given the Eximbank guarantee, it has none to Freeport.

Its decision to enter the transaction was almost certainly based on the US Eximbank guarantee.

PEFCO’s s role in the transaction would be to provide competitively priced funding in the form of a lower discount rate than Greensill could obtain in the market

That is, when Greensill presented PEFCO an Eximbank approved (guaranteed) supplier invoice, it would buy the invoice from Greensill at an agreed discount rate.

To reiterate: Eximbank's guarantee is evidenced by its issuance of a document after it examines the invoice and any supporting documents to ensure that (a) US content and other requirements have been met and (b) the transaction complies with the conditions of that approval.

PEFCO would make sure to confirm the guarantee.

Greenill’s compensation would be potentially a mixture of (a) the difference between its discount rate and PEFCO’s (b) any upfront fee it charged Freeport, and (c) any fees it charges Freeport for the processing of the supplier invoices.

What is to be done now?

Now there is a question as to what Eximbank “should” do now that Greensill has crashed or when the probability of its crash became apparent.

As noted above, Eximbank’s mission is to promote US exports and US jobs. 

So it would be rather reluctant to throw the Freeport "baby" (its customer) out with the Greensill "bathwater" (a service provider).  

As a general rule, Eximbank tends to very "high church" in honoring commitments/approvals it has given.  

Part of this is institutionally motivated to maintain market confidence in its "word".  

Part is concern that its customer may have made financial commitments and would therefore incur a loss, if Eximbank were to walk away. 

Eximbank and Freeport are no doubt looking for a replacement institution with the capacity to process supply chain finance.

And the willingness to hold 10% of the risk of any outstandings within the US$ 50 million.  

Two other key considerations for Eximbank.

The SCF program has been in existence for a few years. Frankly, usage has been disappointing. 

Eximbank has also domestic political considerations given its recent close encounter with the grim reaper.

Market Commentary: Marketing Madness in the Central Lowlands -- abrdn

Spot the Link to Scotland

 

A relatively large amount of ink – both real and electronic-- has been spilled of late over Standard Life Aberdeen’s adoption of a “new” trendy identity.

Just the step you’d probably expect “futurists” would take.

I have my own opinion on this sad affair.

When I think of the Scots, I picture thrifty, hard working, sensible people, who can have a bit of fun. “Laugh with the devil” and be as “gentle and prickly as our own downy thistle”.

“arbdn” doesn’t “fit” that impression.

Contrary minds might cite “Irn-Bru” to counter my ill-tempered judgement..

But that (the name not my judgement) arose for copyright and brand identity concerns. Sensible marketing..

Rather than piling on abrdn, I want to focus on the apparent pernicious effect of marketing in this matter. Because the name doesn’t seem to be accompanied by typical consultancy advice on strategy or structure.

But rather merely placing the old wine in new skins.

To set the stage a quote from a recent FT article on the topic.

But Manfred Abraham, joint chief executive of Yonder Consulting, said Abrdn was the first branding change in wealth management “befitting of the fintech revolution”.

He added: “Asset management brands are all very homogenous and traditional.

“Abrdn has the feel of a Monzo or Starling — and that opens the door to the inner workings of the company modernising too.”

And my reaction.

I’m not sure what abrdn or its new logo have to do with fintech.

It could just as well be a competitor to Airbnb. Or a new fast food restaurant. Perhaps the result of a corporate “coupling”.  

Or perhaps signage in an airport or tube station.  This way to the "abrdn".

There is a reason why why asset management firms have traditional names. To convey the impression that they are sensible careful people who you can trust with your money.

That being said, there is clearly a market for investments for those who like to take a punt on delusion. Hopefully, abrdn is not targeting this group.

As to other names …

When I hear the name “Monzo”, I think of “gonzo”. Or perhaps the nickname of a loan shark. Not a proper bank.

In the former North American colonies, starlings are about as well respected as their “cousins” pigeons -- “rats with wings”.

Whatever one’s view of this species, it’s hard to connect either bird with “fintech” or finance. Perhaps with bicycles?

That leads to the name of the company commenting on the change: “Yonder”.

A firm with this archaic name would not appear to be on the “bleeding edge” of the marketing “space”. One not inhabited by “tiger teams”.

It’s not a legacy name.

There is no eponymous founder, Anthony Charles Brakewell Yonder, OBE, the English David Ogilvy.

Yonder is of more recent vintage.

Formed in October 2020 out of four companies to “create a new consultancy proposition”. Whose truth value perhaps remains undetermined to this day. At least it’s not a conjecture.

After the apparent application of their unique skills and insights, they actually chose this name. It may come then as no surprise that “abrdn” also is melodious to their ears.

It is not a unique name. Not an Exxon or Exelon.

Rather you will find a variety of other “Yonder” companies across the globe. Or as we might say surveying the field “yonder lea, yonder lea”.

So much for brand identity.

Physician, heal thyself.

“YNDR”? Redyon? Ekeipera?

I don’t know how to react to the last comment about these names “opening the door to the inner workings of the company modernising too”.

Many of the great advances in business babble have come to us from the “science” of marketing and consultancy. As well I will admit valid insights, but perhaps less often.

GFG's "Tiny" Auditor = Rather "Large" Credit Red Flags

Even He Probably Couldn't Perform
Audits on 60 Companies

An introductory note to what follows.

Credit “red flags” in themselves do not conclusively prove there is a problem with an entity. Rather they identify areas for enhanced due diligence to determine if there is a problem.

According to research by the FT, one apparently very small English Chartered Accountancy firm, King & King, audited over 60 companies in Mr. Gupta’s Group. Companies with a combined Sterling 2.5 billion in revenues!

It is one of the long standing—but often ignored—rules of due diligence to scrutinize not only audited financial reports but also the auditor.

1. Is it a known firm? What is its reputation and track record?

2. Does it have the skills and resources to conduct an audit of the particular company? Horses for courses.

3. Is there an imbalance in the relationship between the company and the auditor that might make the auditor subject to undue influence on its work?

For example, if the auditor is dependent on the company for the bulk of its revenues, it might well find it hard to say “no” to the company.

I’d hasten to add that this is not a conclusive test.

There are more than a few cases where the “biggest” auditing firms appear to have failed in conducting sufficiently probing audits.

After reading the FT’s excellent article, I decided to do a bit of digging myself.

What better place to start than an electronic visit to the UK’s Companies House?

There I searched for the name King & King and the address 273-287 Regent St, London W1B 2HA, United Kingdom. This search returned three entities that appear directly related:

1. KING & KING LTD Company number 04871854. Listed as dormant. Last Financial Statements 20 August 2019. Net assets GBP 1.

2. KING & KING (ACCOUNTING & ADVISORY) LTD Company number 07597296. Listed as dormant. Last Financial Statements 30 April 2019. Net assets GBP 1.

3. KING & KING WILLS LTD Company number 07533423 Last Financial Statements 28 February 2020. Net assets GBP 685.

There is no doubt a reasonable explanation for what would appear at face value to be a discrepancy here. How could a dormant firm with so modest financials audit 60 companies.

However, what that explanation is eludes me.

I suppose it may be that the firm that does the audits is registered under another name. 

I did take the obvious step of using Companies House to search on the names of officers and directors at the above companies on the assumption that one or more of these might be at the firm with "with another name".  

However, I came up with a blank.

To make sure I covered as many bases as possible,  I then searched Companies House for the address alone.

To my surprise there were 20 pages of entities.

Companies House told me to refine my search as there were many many more.

So it may be that I missed that new name.

No results for K&K’s Middlesex Office at Companies House using both its name and the address.

But using Google, I quickly turned up at least 51 companies at the Middlesex address.

I did however find a related company at that address which shares a director with King & King.

RELANS LIMITED Company number 07317670. Latest Financial Statements 30 April 2020. GBP 127,284 in total equity.

While the income statement was not included, comparative figures would suggest it was a good year indeed for Relans as its retained earnings increased approximately GBP 120,000 year on year. Quite a remarkable change from previous years!

As to the numerous parties at both of K&K’s listed addresses, at first glance it would appear that both buildings are “rather large”.

Or perhaps more likely the address is that of virtual office or a corporate registration service.

Perhaps, K&K are “working from home” as part of a Covid inspired remote work initiative.

Turning back to the FT article, the FT asked chartered accountants at other firms what K&K’s reputation was. The answer they received seems to be “who?”.

According to the FT, K&K is registered at the ICAEW as having one CA and one professional staff.

On its face, that might make some question the “depth of its bench” in terms of ability to perform audits of large firms.

It would also suggest that GFG was the “father of the feast” at K&K. Loss of this relationship would be likely to dramatically reduce revenues.

Typically, scrutiny is focused on the auditor of the obligor or the counterparty to a transaction.

And that absent guarantees or other support from related parties, focus on those parties’ auditors would be minimal at best.

However, even with a limited one company focus, there are enough red flags to suggest weakness. That would include the questions posed by my Companies House search.

And those threads when pulled might well have revealed other issues. Or resulted in a clean bill of health for K&K.

For those with exposure to GFGroup, a wider focus would be appropriate.

Discovering that one very small CA firm was auditing a large number of GFG companies should have been a gigantic red flag, prompting further investigation..

It’s not just the three questions above, but the fact that K&K was auditing 60 companies but it had a staff of one CA and one other professional. Companies with Sterling 2.5 billion in revenues.

If we assume that one-quarter of these firms had their fiscal year at each quarter’s end as opposed to all at 31 December, it boggles the mind to think that K&K would be able to do the intensive work required for an audit even on “just” 15 firms.

The ability to repeat this intensive process quarter on quarter would have required probably more than a singe Stakhanovite.

More importantly one might reasonably struggle to understand how a firm this size could perform a proper audit on even one company each quarter.

If, as is more likely, 31 December was the FYE for all or the majority of the 60 companies,, then the improbable becomes the impossible.

One caveat K&K notes on their website they are affiliated with IRGlobal a network of accountancy, advisory, and tax firms and so would appear to have access to additional knowledge resources.

Somehow the extent of K&K’s audit work (and prowess) was missed.

The FT was able to discover this interesting issue apparently without undue or time-consuming exertion.

Admittedly, they benefited from hindsight: GFG’s woes were public knowledge

Also admittedly, the FT has a cadre of very savvy financial reporters who have been responsible for uncovering financial frauds. By their own skill, not just via whistleblower tips.

Bondhack and Cynthia O’Murchu made a significant pre-crash discovery regarding the weak state of NMC’s finances by the clever use of credit bureau information.

One-at least this one-would expect that financial institutions with money at stake would have at least as competent staff.

And perhaps because they were doing this for a living, or were supposed to be doing this, would have additional resources and experience.

Sadly, hope is not necessarily accompanied by change. 

Or so I have been told.