How To Successfully Lend Overseas
Updated: Sep 15, 2020
Private lending to an overseas firm can be a daunting task, especially when confronted with the current market environment and the moving target that is currency market. Some finance or investment teams may even scoff at the idea due to the perceived complexity of the transactions and thus may push their sales and management teams to favor domestic opportunities.
However, increased pressure on bank balance sheets and governments being forced to pull back on their guaranteed loan programs. There is expected to be a dramatic rise in alternative lending which will open up a swathe of global opportunities. Choosing to focus on domestic sources - leaders may be limiting their firm's ability to find the best deals. As private credit and lending continue to gather steam, we look at the key points that managers and their teams should consider when lending funds overseas.
Have it clear in your mind what currency you will be lending in and receiving back in.
When lending overseas it is important for CFOs to ascertain which currency they will be lending and receiving in and on which side of the transaction the responsibility to change the currency sits. Swings in the currency, if not hedged, could put them in a position where returns diminish to the point of losing money. A CFO with a good understanding their currencies exposure can take advantage of a number of strategies that are available to them, thus guaranteeing returns against currency swings.
The best way to distribute funds.
Understanding the interest rate differential of the currency pair in these situations is key. It might be worth CFOs considering a waterfall structure and only sending funds when they are needed. When lending USD to EUR, drip feeding the euro loan cycle whilst hedging the remainder, will actually generate a positive carry and could offset the cost of the repayment hedging costs. On the reverse CFOs may be leaving alpha on the table if they aren't fully invested.
Can they afford to pay back?
Of course they can, the banking team has completed their diligence and through many clever financial models, the team has ascertained that the client has the ability to pay back the (X) million in currency lent them, plus interest. But... a sharp unforeseen currency movement that was not accounted for turned that (X) million into considerably less. CFOs shouldn't pass the buck when it comes to the FX risk. SWe advise our clients to stress test their loans against currency swings and know the risk tolerance, especially if the conversion is on the lender.
Do you trust them to manage their FX?
It's important to remember that managing FX may be the difference between getting paid back or not.
The question I ask you is, how much did you think about FX before reading this article?
If the answer is not a whole lot, then put yourself in the shoes of non-financial services firm to whom you are lending. It's difficult to trust someone to do something when they may not even know the problem/solution exists.
Talk to an FX specialist. I'm not saying talk to a broker or banker as they often just sell you what you want to hear. Talk to someone to a peer that understands the process you are going through and that can provide a more bespoke plan that takes in all the different variables of YOUR transaction.
Make sure your borrower takes advice from an FX Specialist. It's great being set up for success yourself, but ultimately if your borrower isn't on board or at least aware of the FX risks you could be putting both you and your clients money at unnecessary risk.
If you are considering lending overseas or would like to discuss your firms specific situation with an expert then get in touch with us at Deaglo Partners.