Banking on the Private Sector : How to obtain MDB money for your project in emerging markets

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• Banking on the Private Sector How to obtain MDB
  money for your project in emerging markets

1101 30th Street NW, Suite 200 Washington, DC
20007 Tel. [phone] Fax. (202)
333-1158 www.delphosinternational.com
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Agenda

• Session I
• Introduction
• Latest trends in emerging markets
• History and role of MDBs in private sector
  development
• Main financing instruments
• Session II
• Overview of financing process
• Minimizing delays and avoiding pitfalls
• MDBs and small businesses
• Delphos International

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Recent Developments in EMs

• Following the Mexican and East Asian currency
  crises of the 1990s, emerging market countries
  enacted structural reforms.
• Implemented stricter fiscal and monetary
  policies.
• Most have shifted to more flexible exchange rate
  regimes.
• Opened markets and strengthened financial
  systems, thereby creating investing efficiencies.

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EM Come of Age

• From 2002-2005, emerging market economies
  averaged economic growth of 6, outpacing the
  2.4 average growth of developed economies.
• Combined GDP in 2005 increased by 1.6 trillion,
  compared to 1.2 trillion in developed economies.
• In 2005, their combined output accounted for more
  than 50 of the world total conceivable that in
  20 years they could account for two-thirds of
  global output.
• Hold two-thirds of worlds FX reserves and
  consume 47 of worlds oil.

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Reforms Pay Off

• Return of FDI
• Today a larger percentage of capital comes from
  private vs. public investment
• In 2005, net private capital flows to emerging
  markets hit a record-high of 358 billion,
  compared to (15) billion net repayment to
  official creditors
• Sovereign rating upgrades
• More upgrades than downgrades in 2005 (19 vs. 10
  SP ratings actions as of August 2005)
• In Latin America, Chile, El Salvador and Mexico
  have reached investment grade (SP BBB- or
  higher)
• Turkey and Kazakhstan likely upgrades in 2006

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EM Equities Higher Returns (and Risk)
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Sovereign Risk Premiums
Decreasing yields over US Treasuries

• In 2002, emerging market bonds traded at yields
  of 900 bps.
• Today, spreads are at a record low of under 200
  bps.

Source The Economist. December 14, 2005
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Ability to Access Private Capital

• Leading EMs have easier access to capital markets
• BRIC economies experiencing strong economic
  growth
• Central Eastern European countries are
  benefiting from EU accession
• Large-scale infrastructure spending by the EU
• Mexico and Chile
• Benefits from regional trading blocs

Brazil, Russia, India, and China
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Ability to Access the Capital

• Frontier countries encounter more difficulties
• Peru, Ecuador, Bolivia, Guatemala, Honduras
• Even the strongest companies in these markets
  cannot access private capital
• Within the star pupil countries, non-blue chip
  companies face challenges finding private
  financing
• Not everyone is a Telmex or an Embraer

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History of MDBs

• Prior to 1944, no multilateral organization
  focused on economic development in developing
  countries.
• Concept of the multilateral development bank
  (MDB) was spawned from the efforts to rebuild
  Europe after World War II.
• The International Bank for Reconstruction and
  Development, the original institution of The
  World Bank Group, was created in 1944
  specifically for post-war reconstruction first
  loan was 250 million to France in 1947.

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History of MDBs

• Within The World Bank Group
• International Finance Corporation (IFC)- Launched
  in 1956 to foster the private sector competition
  that would be rewarded for skill and efficiencies
• Also formed MIGA in 1988 to provide PRI,
  technical assistance, and dispute resolutions
• Inter-American Development Bank (IDB)
• Created its private sector dept in 1994 to
  mobilize financing for private infrastructure
  deals. PSD represents 10 of total IDB
  commitments.
• Multilateral Investment Fund (MIF) and
  InterAmerican Investment Corporation (IIC) focus
  on smaller deals

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History of MDBs

• Others MDBs
• European Bank for Reconstruction and Development
  (EBRD)
• Asian Development Bank (ADB)
• African Development Bank (AfDB)
• Regional Development Banks
• Central American Bank for Economic Integration
  (CABEI)
• Andean Investment Corporation (CAF)
• National Development Banks (e.g. BNDES)
• Bilateral Development Banks (e.g., OPIC)

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Commonalities of MDBs

• Capitalized with government capital, collectively
  owned by its member countries
• Fundamental objective poverty reduction in
  emerging markets
• Catalytic role in increasing capital flows and
  encouraging private sector development
• Have special/privileged relationship with host
  governments
• Have appetite for higher risk projects
• Have clear commercial perspective on risk/return,
  typically do not provide concessionary financing
• Are not supposed to compete w. private sector
  (additionality)
• Most have AAA ratings

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Eligibility for MDB Projects

• Project located in a member country
• Investor must be from member country
• US is a member of all major MDBs and single
  largest shareholder in IFC, IDB, and EBRD
• Greenfield or expansion projects
• New focus on corporate finance
• Foster local economic and social growth
• Environmental and social considerations
• Sinful businesses excluded

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The Pros

• Will consider countries/projects that private
  players regard as too risky
• Often provide more attractive cost of funding
  than private sector
• Typically offer longer tenors than commercial
  banks
• Implicit political risk mitigation advantages to
  project participation (halo effect)

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The Cons

• Slower approval process
• Introspective rather than client oriented
• Stricter/more onerous debt covenants
• Public disclosure of projects inviting comments
  from stakeholders
• Limited (though expanding) portfolio of financing
  products

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Programs and Products

• Flagship product project financing senior debt
• Corporate finance debt
• Equity and quasi-equity products
• Syndications
• Partial credit guarantees
• Political risk insurance
• Technical assistance (government and business
  consulting)

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Project Financing

• Ideal for large-scale greenfield or expansion
  projects in infrastructure (electricity,
  telecoms, roads)
• Limited or non-recourse to project sponsors
• Corporate balance sheet protected
• Create separate legal entity, where project cash
  flows provide primary source of repayment
• Sponsors pledge project assets to secure loan
• Debt or Equity Participation Options
• Senior Debt
• Subordinated Debentures
• Common and Preferred Equity

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Risk-sharing with MDBs

• Since the projects have no operating history,
  lender will evaluate specific risks and mitigants
  to determine overall project viability.
• Risks include
• Completion risk (cost overrun, timing)
• Operating risk (technology, management)
• Supply risk (terms of supply contract)
• Market risk (demand fluctuations)
• Currency risk
• Interest rate risk
• Political risk
• Force majeure (natural and political)

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Senior Debt

• Agencies can finance up to 25 of total
  project/company for their own account
• IFC 35 for smaller projects
• IDB 40 for tougher countries
• Grace periods track the cash flow of the project
• Usually 12-36 months
• Payment terms vary typically 10-15 years
  door-to-door but can be longer depending on type
  of project
• Lend at commercial rates (LIBOR spread)
• Will often require LT supply or purchase
  agreements for duration of project
• Power Purchase Agreement
• Fuel Supply Agreement

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A-B Loan Structure

• A Loan MDB own cash (25 limit, 100 MM)
• B Loan syndicated loan (no limit)
• Designed to mobilize funds from international
  banks
• Limits to exposure
• IDB can lend up to 25 of total project costs in
  A loans, up to 75M. For some frontier
  countries participation can increase to 40.

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A-B Loan Structure

• Private banks provide syndicated loan (B Loan)
• Have implicit PRI coverage
• MDB remains lender of record
• Share security
• Other advantages. For example, banks are granted
  immunity from withholding taxes due to MDBs
  special relationship with borrowing countries.

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Typical Fees

• Front-end fee one time (1.5-2.5)
• Commitment fee periodic fee (0.5), charged on
  undisbursed portion of loan
• Underwriting fee independent analysis for
  lender due diligence (e.g. engineering,
  environmental)
• Legal fees both sponsor and lender fees
• Post-closing monitoring fees

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Case Study Bulgarian Power

• Project AES Maritza East 1
• Description To undertake the rehabilitation
  and upgrade of a 600MW lignite- fired coal
  plant near Galabovo, Bulgaria. Project cost
  of 1.1 bn
• Instruments 114 million EBRD A-loan
• 711 million covered facilities (EBRD B,
  Coface, Hermes, MIGA)
• Highlights 16 year tenor, 4-year grace period
• Pricing around 200bps over Euro LIBOR.

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Equity/Quasi-Equity

• Equity
• Provides between 5-15 of projects equity never
  largest shareholder (no more than 35 stake)
  non-voting stake
• Does not have active role in company management
• Can directly invest in equity instruments (IFC
  C-loan) or in PE funds or mezz facilities that
  on-invest in emerging markets
• Quasi-Equity (acts like debt and equity)
• Subordinated loans, convertible debt, preferred
  shares
• Higher risk, higher yield
• Profit participation

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Case Study Russian Tech Firm

• Company IBS (Russia)
• Project One of the largest IT company in Russia,
  IBS is a distributor of hardware, and also
  provides IT consulting and services to many
  multinationals and local blue chips in Russia.
  Also has a software development group.
  Controlled by CEO, two Western funds present
  that want to avoid dilution.
• Instruments 12 million IFC convertible loan
  with warrants
• Highlights Flexible customized instrument for a
  high growth company

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Partial Credit Guarantees (PCG)

• MDBs take the risks that the private sector
  refuses to assume on reasonable terms
• MDBs let the private sector fund the guaranteed
  and uncovered portion. Greater bang for the buck
• Guarantees cover creditor losses up to a point in
  the event of a specific or general default
• Structured to reduce probability of default
  and/or increase recovery given default
• Can support bank loans or domestic/ international
  bond placements

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Partial Credit Guarantees

• Partial credit guarantee cover principal and/or
  interest up to a pre-determined amount.
• General features
• Medium- to long-term coverage
• Foreign or local currencies
• Typically up to 30 risk participation
• Guarantee fee for MDBs
• Can be for specific risks or periods (e.g., last
  3 years of principal and interest to extend tenor)

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Benefits of PCGs

• Allows sponsors to diversify availability of
  funding sources, both locally and internationally
  
• Better able to finance in currency of choice
  (e.g., when revenue is in local currency but
  local currency financing terms are typically
  restrictive)
• Creditors are more comfortable extend credit for
  longer tenors
• Liquidity backstop allows borrowers to draw on
  guarantee to prevent a default on creditors
• Can elevate project rating

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Case Study PRG for Peruvian Pharmaceutical

• Sponsor Corporación Drokasa S.A.
• Project Drokasa mainly engages in the
  manufacture, marketing and sales of
  pharmaceutical products also produces and
  exports asparagus and table grapes. Required
  a PCG to enhance a 25M securitized bond
  issue in Peru.
• Instruments 7.5 million IFC partial credit
  guarantee
• Highlights Credit enhancement raised the rating
  of the bond issuance to local AAA, a benefit
  where Perus capital markets lack experience
  with corp borrowers