Title: InterAmerican Development Bank Private Sector Department Capital Markets Unit
1Inter-American Development BankPrivate Sector
DepartmentCapital Markets Unit
Capital Markets Development Financial Guarantee
Program Credit Risk Mitigation, local currency
instruments IDB Capital Market for Development,
June 03, 2003
2Contents
- Private Sector Department
- Overview Bond Markets
- Capital Markets
- Objectives
- Strategy
- Eligibility Criteria
- Conditions
- Financial Guarantees
- Definition
- Program Coverage (issuers,assets and placement)
- Options under Consideration
- Pricing Approach
- Transactions in the Region
- Infrastructure Bond (Rutas del Pacifico, Chile)
- Mortgage Backed Security (Colpatria, Colombia)
- Business securitization bond (Developer, Peru)
3Private Sector Department (PRI)
- Responsible for IDBs support of private sector
operations in LATAM and Caribbean - First Mandate (1995) Support Private Investment
in Infrastructure - Eligible infrastructure sectors
- water / sanitation
- transportation (roads, railroads, pipelines,
ports, airports) - energy (power generation, transmission,
distribution) - telecommunications
- Second Mandate (2000) Support development of
Capital Markets in the Region - Eligible capital market transactions
- project bonds
- corporate bonds
- asset backed securities (including mortgage
backed securities) - future flow s securitization
- Third Mandate (2003) Support reactivation of
Trade Finance in the Region -
4IDB (PRI) Financial Instruments Overview
1. Cross - Border Financing Products
- A-Loans (for IDBs own account) B-Loans (for
market participants) - Up to US75 million or 25 of total project costs
(in small countries can go as high as 40) - Up to 20 years (typically in 10-15 year range)
- Market-based pricing
- Private Placement (similar structure as the A/B
but placement among 144A institutional investors) - Political Risk Guarantees
- sovereign (transfer convertibility) and
selected non-commercial risks (contract
frustration) for infrastructure development in
the Region (up to 50 of project costs or US150
million). Streamlined approval process (3
months). - Could include selected non-commercial risk
regulatory risks such as breach of contract by
the grantor of the concession (e.g., San Pedro de
Macoris, IPP, Republica Dominicana)
5IDB (PRI) Financial Instruments Overview
2. Local currency Financing Products
- IDB Financial Guarantees (partial credit
guarantees) - credit enhancements to improve credit risk
profiles of local issuers to enable them to
access market financing under better conditions
(tenor and pricing). Same limitations as the A/B
loans. - Instruments mechanism that cover or protect
debt service payments to institutional investors
(bondholders). - Products can be structured to guarantee an
specific layer of credit risk,in order to elevate
the risk profile of the overall transaction and
thereby attract investors. By guaranteeing an
intermediate part of the debt (I.e., guaranteeing
to pay a portion of the obligation after the
internal cash reserves or sponsor support has
been exhausted) the local investor maybe more
willing to put its capital at risk for the
remaining exposure. - The IDB is willing to adapt its financial
guarantee products to whatever forms make sense
commercially and developmentally. The risk not
guaranteed by IDB can be covered by co-insurers
or taken by the investors.
6Size Structure of the Bond Markets
7Size Structure of the Bond Markets (LATAM)
- Capital Markets still represent a very small
of GDP (except Chile) average 11 (est. 2001). - Average holdings of sovereign risk by investors
is relatively high (70 to 85)
8Local Capital Market Development
- Objectives
- Financial des-intermediation is a key component
of a sustainable economic development strategy. - Support of good quality credit rating private
sector instruments as a way to diversify
investors portfolio (e.g., pension fund
development in LATAM increased sovereign risk
cases of Argentina, Uruguay, Brazil, Colombia) - Develop local currency funding instruments that
could mitigate cross-border risk (FX risk).
Projects that are typically local currency
generators Water sanitation, toll roads,
irrigation, etc. will have a tough time getting
finance in the US markets (even with the best
build-in contracting clauses for US tariff based
there is a tolerance to FX adjustments in a
particular economy)
9Capital Markets Development Strategy
- In February, 1999, the IDB Board of Governors
approved the Banks Private Sector Departments
participation in the development of domestic
financial markets to complement other Bank
activities as part of a coherent strategy to
promote domestic capital market development in
the Region. - Developmental Impact
- Increase Participants Private Issuers that
today have no access to capital markets financing
(e.g., second tier corporate issuers). Support
new private participants in the capital markets. - Improve Conditions Private Issuers that have
regular access to capital markets financing but
under limited conditions. Support private issuers
in obtaining better terms for their funding via
capital markets (tenor, placement, pricing). - Liquidity Provide liquidity to the instrument
(bond) to be issued with the support of our
financial guarantee (enhance probabilities of
secondary trading of the instrument).
10Capital Markets Activities Areas of Interest
Utilities Bonds
Priority
- Credit Enhancement of Corporate and Project Bond
Issues. In developed markets, financial
guarantee insurance for bond issues is a
well-established credit enhancement mechanism for
providing third-party support or security for the
payment of principal and interest. While the
product is common in developed markets, major US
and European insurance companies only recently
have begun to consider opportunities in emerging
markets. - Future Flows Receivables / Loan Securitization.
In a future flows securitization, a company
creates a bankruptcy-remote special purpose
vehicle that issues a debt instrument whose
repayment of principal and interest to investors
is secured by future receivables the company
expects to generate through its normal course of
operation. Such a transaction could be
implemented based on, for example, public or
private utility receivables in any number of
sectors, including telecommunications, water and
power. In a loan securitization, existing
portfolios of mortgage, education, commercial and
other types of loans may be securitized to help
provide term funding to originating entities,
such as commercial banks and mortgage companies.
The IDB can support such transactions by
providing financial guaranty insurance or through
the guarantee of a specific tranche of the
capital structure.
11Capital Markets Activities Areas of Interest
After positioning period (2003 --)
- Support of Credit Intermediaries (establishment
of local or regional financial guarantee entities
to enhance local debt issuance) - A country or regional financial guarantee
intermediary could provide credit enhancement to
local issuers to enable access to debt markets
achieving better credit ratings. The types of
credit enhancement products offered by the
intermediary might be similar to those currently
offered by market. The IDB could support such
transactions through credit enhancement of the
intermediarys capitalization, or through the
provision of reinsurance. - On-lending Facilities for Highly Developmental
Activities. Local currency on-lending facilities
to selected activities or sectors (such as health
and education) could be funded utilizing an IDB
credit-enhanced debt issue. Strategic partners
such as local banks or specialized financial
institutions (with expertise in targeted sector
lending) would issue the instrument to fund the
facilities as well as operate them.
12Financial Guarantees IDB Exposure Placement
- IDB Exposure Limits
- Up to US75 million per project (local currency
equiv.) or 25 of project size (in small
countries can go as high as 40), whichever is
lower. - IDB can provide certain types of guarantees alone
or participate alongside co-insurance from
private guarantors, acting as guarantor of
record. - Market Placement of Debt
- Debt will be guaranteed in local currency and
will be targeted primarily for placement in the
local domestic market - Local/foreign mixed currency debt issues placed
in both domestic and foreign markets will also be
eligible - Subject to market circumstances for
infrastructure and ABS projects, foreign currency
bonds placed in the international markets could
also be considered.
13Financial Guarantee Options
Application of Partial Credit Risk Enhancements
Design the optimal partial credit enhancement
for a given project in order to improve its
credit risk profile enough to capture private
capital on adequate terms conditions
- Mezzanine Guarantee
- Pool Guarantee
- Rolling Guarantee
- Maturity Guarantee
- Co-Wrap Guarantee with Co-insurance
14Financial Guarantees Options
- Mezzanine Guarantee
- A credit loss protection enhancement with IDB
providing a guarantee for a specified mezzanine
layer of credit risk, thereby elevating the
overall transaction to investment grade on the
local currency scale. It is anticipated that
subsequent to the provision of the mezzanine
guarantee by the IDB, the issuer could seek, if
warranted, a full wrap guarantee on the
transaction from a private financial guarantor. - Illustration For a project bond, the IDB could
provide a partial guarantee for an external
liquidity reserve, which would pay out after the
transactions internal credit enhancement (such
as cash reserves or sponsor recourse) has been
exhausted, but prior to the local investors
capital being at risk for the remaining exposure.
15Mezzanine Guarantee (energy distribution co.)
Transaction (Receivables Securitization )
Mitigation of the lower credit risk quality and
improving the transaction rating attracts
participation of Monoline Insurers to provide a
wrap on the whole transaction, improving
further the transaction credit rating.
Project Revenues (High Credit Risk Quality
Layers)
- Transaction Reserves
- Over-collateralization
- Project Debt Service Reserve Acount
- Liquidity Reserve (sponsors recourse)
Partial Guarantee (a portion of the credit loss
on the transaction, -- debt service)
Layer of Lower Credit Risk Quality
16Financial Guarantees Options
- Pool Guarantee for Asset-Backed or
Mortgage-Backed Bonds - A partial credit enhancement product with IDB
providing a guarantee for a portion of principal
and interest sufficient to offset potential
losses resulting from non-performing assets
within the underlying collateral pool. The Pool
Guarantees amount will be calibrated for each
transaction to improve the projects credit
rating in a manner sufficient to attract targeted
local investors. - Illustration A bank with a mortgage portfolio
may pledge mortgage receivables as collateral to
repay a bond issue. Although the mortgage
collateral enhances the bonds credit quality,
the information on the collateral in emerging
markets may not be adequate (e.g. incomplete
records of past performance) and as such, the
collateral may not be sufficient to attract local
investors to purchase the bond. The IDB could
further enhance the bond with a partial credit
guarantee in order for the bond to achieve a
credit quality sufficient to interest targeted
local investors.
17Pool Guarantee CBO, for Illustrative purposes
Source Rating Agencies Methodology (Case Example)
18Financial Guarantees Options
- Rolling Guarantee
- A partial credit enhancement product with IDB
providing a guarantee of a specified number of
interest and/or principal payments, on a rolling
forward basis i.e. the guarantee rolls forward
to the next installment date upon payment by the
issuer of the current installment -- so that the
IDB guarantee covers a rising share of remaining
debt service. - Illustration For a project or corporate bond
issue where investors perceive a potential risk
associated with a variation in the debt service
coverage at some point within the overall bond
tenor, or are uneasy about a period of heavy
corporate expenditures, the IDB could provide a
rolling guarantee to smooth out the repayment
profile and allay investor concerns about
potential timing/cash flow issues.
19Rolling Guarantee (transmission and
distribution companies)
Outstanding Principal
Debt / Service Coverage Ratio
DSCR
1.5
1.0
Rolling Guarantee
Years
N
N I
20Rolling Guarantee (transmission and
distribution companies)
Outstanding Principal
Debt / Service Coverage Ratio
DSCR
1.5
1.0
Guarantee Liquidity Facility
Years
N
N I
21Financial Guarantees Options
- Maturity Guarantee
- A partial credit enhancement product with IDB
offering a put option to investors to refinance
an issue at maturity with the IDB -for the
purpose of persuading investors to accept longer
maturities. - Illustration In certain emerging markets the
interest rate environments are such that even for
private issuers with very strong credit quality,
tenors longer than three years, for example, are
just not available. In these markets, the IDB
could offer issuers a maturity guarantee, to
attract local investors with an appetite for
3-year paper into longer maturities, by providing
them an exit if desired.
22Maturity Guarantee (generation projects)
Outstanding Principal
Capital Repayment
Bullet
Maturity Guarantee
Bullet
Years
N
N I
23Financial Guarantee Options
- Co-Wrap Guarantee with Co-insurance
- A wrap credit enhancement product with IDB
providing a guarantee for a portion of principal
and interest and the remaining portion guaranteed
by one or more private financial guarantors on a
pari passu basis under a co-guarantee
arrangement. IDB acts as guarantor of record for
the transaction.
IDB Guarantor
Co-guarantor
Bond-holders
24Financial Guarantee Pricing Approach
- Pricing F expected losses capital allocation
cost market factors no-loss underwriting
strategy - Expected losses F default rates, recovery
rates, ratings - Capital allocation cost F capital accounting
methodology structuring (i.e., how partial is
the partial) - Market factors valued added (improvement in
credit rating) and market benchmarks (pricing of
monoline and other private insurers)
Pricing Benchmarks Rating
BP
Credit Rating b/ guarantee
Guarantee Structure (capital allocation)
X1 BP
Market Pricing
Credit Rating a/ guarantee
X2 BP
25Capital Markets in the Region
26Capital Markets Activities Organization
(PRI/CMU)
- Ellis J Juan
- Unit Head, Capital Markets Unit (PRI)
- phone (202) 623-3063
- email ellisj_at_iadb.org
- Juan Mario Laserna
- Investment Officer, Capital Markets Unit (PRI)
- phone (202) 623-3791
- Daniela Carrera
- Investment Officer, Capital Markets Unit (PRI)
- phone (202) 623-1088
- Kelle Bevine
- Investment Officer, Capital Markets Unit (PRI)
- phone (202) 623-3626
- email kelleb_at_iadb.org
- Juan Jose Garcia
- Investment Officer, Capital Markets Unit (PRI)
- phone (202) 623-2141
Contact List of Key Staff for Capital Markets
Activities