Banks unwind aluminium financing deals, others keen to enter

Tue Feb 12, 2013 12:33pm EST

* Regulations, capital requirements weigh on banks

* No shortage of takers as some unwind financing deals

* Warehouse rents offer good return in lean times

By Susan Thomas and Maytaal Angel

LONDON, Feb 12 (Reuters) - Several big banks are unwinding the lucrative financing deals that tie up millions of tonnes of aluminium as collateral in warehouses, but the activity is flourishing as eager rivals enter it or expand.

For years a handful of banks have been buying up aluminium and simultaneously selling it forward for instant profit to futures market speculators, then taking advantage of cheap funding to store it at low cost in warehouses.

Deutsche Bank and Standard Chartered Bank have been the two biggest participants with millions of tonnes of the metal under financing, metals and banking sources said. Credit Suisse had a sizeable holding too.

Aluminium financing deals can earn an investor an assured yield of at least 5 percent, not bad with interest rates around historic lows and with returns on equities and debt uncertain.

But banks across the world are cutting costs and selling off, or writing down, assets in a bid to meet tougher regulations aimed at preventing a repeat of the 2008 crisis.

Balance sheets across the sector have come under scrutiny after warnings from regulators that capital may need bolstering.

While Credit Suisse, which had 3 million tonnes of aluminium in financing deals, and Deutsche Bank, with around 4 million tonnes two years ago, are unwinding or have unwound their positions, Standard Chartered has been expanding, bank and industry sources said.

Credit Suisse is no longer involved in the deals, the sources said. The bank itself declined to comment. Deutsche Bank did not immediately respond to a request for comment.

British bank Barclays, which on Tuesday announced a major overhaul partly to burnish its reputation, said its business in commodities including metals would continue.

Some French banks, including Societe Generale and Credit Agricole, pulled out of such deals in the past two years when they scaled back their commodities presence, sources in the sector said.

These banks' withdrawal is not going to bring relief to industrial users of metal, frustrated that so much is tied up this way, as there is no shortage of willing candidates to continue the financing business.

"Instead of three or four big banks, it'll be 10 or so smaller players," said a source at a bank that has had millions of tonnes in financing deals. "We had no problem off-loading it, there's still big interest in financing deals."

Standard Chartered had been one of the takers.

A spokesman for the London-listed bank said commodities trading "is a decent part of our business and aluminium financing is something that is part of that. It's something we're very much committed to".

He declined to say how big the bank's position was, but acknowledged that Standard Chartered was a "sizeable player".

Newer entrants include Royal Bank of Canada, and possibly Chinese banks, the sources said. One or two French banks are now returning.

MILLIONS OF TONNES LOCKED DOWN

Financing deals are believed by industry sources to have locked down around 90 percent of the roughly 5 million tonnes of aluminium stored in London Metal Exchange (LME)-registered warehouses - worth more than $9 billion at current prices. There is believed to be another 5 million tonnes held off exchange.

But there will be a limit to the size of any single bank's holdings. A second banking source said banks had to calibrate their financing holdings, mindful of reputational risk and appearing too dominant in one market.

"We want to make sure we are not accused of manipulating the market in any way, so we're quite careful about that," the source said. "We monitor quite carefully how we stand in the market relative to the whole industry size, we don't want to get accused of maniupulation."

In any event, banks have had to limit physical holdings under regulations introduced after the 2008 crisis.

"Under new regulations, you can only have a certain percentage of physical (metal) on your books, and I would think most of those banks are just about there," said a third source at a major bank, who asked not to be identified.

Another restraint on the size of the deals is the amount of working capital tied up in them. When the price of aluminium rises, the banks' internal credit limits for a particular investment kick in at a lower tonnage of metal.

The price of LME benchmark three-month aluminium futures rose around 10 percent in January.

"Even if the ownership structure of the financing deals changes, the overall business case remains sound as long as U.S. interest rates remain low," the third source at a big bank said.

The deals rest on banks or traders buying metal from producers, using money borrowed at a low interest rate, and selling it forward, making use of a 'contango' market structure in which futures prices are higher than for immediate delivery.

They then negotiate a discounted rent deal to store it in a warehouse.

"There's bags of appetite for it," Standard Chartered Bank analyst Dan Smith said. "As long as you get a decent contango then there's lots of appetite for this."

Smith did not comment on the status of Standard Chartered's financing deals.

But the best way to profit from the trade, and get the cheapest storage deals, is to own a warehouse registered by the LME, the world's biggest marketplace for industrial metals.

"If you can't earn rent and you're also having to pay rent then the differential in the interest rate is not beneficial," the second source said.

Banks Goldman Sachs and JPMorgan and trading houses Trafigura, Glencore and Noble have bought LME-registered warehouse firms in the last three years.

Barclays bought a stake in one in 2011, and a source said the bank is committed to developing the investment.

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