The Regional Credit Guarantee Facilities: Cases and Business Models

1
The Regional Credit Guarantee Facilities Cases
and Business Models

• Noriyuki Suzuki
• Daiwa Institute of Research Ltd.
• September 25, 2007
• Asia-Pacific Finance and Development Center
  Seminar

2
Outline of the Presentation

• What is a credit guarantee?
• Need for a credit guarantee facility
• Advantages in utilizing guarantees
• Cases and business models of credit guarantee
  institutions
• Credit guarantee business demand in Asia

3
What is a Credit Guarantee?

• Credit guarantees or insurance assure
  bondholders of payment of principal and accrued
  interest in the event bond issuers fall into
  default, or any mutually agreed credit event.
• Definition found in Asian Bond Markets The Role
  of Securitization and Credit Guarantee, the
  second annual conference of PECC finance forum,
  July 2003, Hua Hin, Thailand

4
Why a Credit Guarantee Facility?

• Information asymmetries / lack of transparency
  prevent private corporations from issuing bonds
• ?
• Information gap between issuers credit quality
  and investors minimum credit requirement
• ?
• Significant impediments to the development of the
  efficient and liquid bond markets in the region
• ?
• A regional credit guarantee facility could help
  the bond market development by enhancing issuer
  credit quality

5
Advantages in Utilizing Credit Guarantees

• From Issuers Perspective
• Reduction of financing cost
• Longer term financing
• Wider investor base
• Reduction of uncertainty in interest cost
• From Investors Perspective
• Improved level of security in investment
• Enhanced liquidity and stabilized prices
• Outsourcing of assessment / monitoring to
  monoline insurance companies ? sense of
  reassurance and easier internal decision of
  investment

6
Advantages in Utilizing Credit Guarantees

• From Investment Banks Perspective
• Reduction of underwriting risks
• Transfer of risks of complex issuance to monoline
  insurance companies
• Acceleration of issuance process due to credit
  rating agencys recognition of monoline insurance
  companies

7
Cases and Business Models of Credit Guarantee
Institutions

• Credit Guarantee Providers
• Private companies (monoline)
• Government agencies (export credit agencies)
• Multilateral development banks

8
Private Companies and Recent Industry Trend

• Worldwide growth of insurance written
  (2002-2006)
• International public sector par insured
  exponential growth
• Asset-backed par insured growing worldwide
• US municipal par insured mature market

Source Association of Financial Guaranty Insurers
9
Business Models Private Companies

• Monoline insurers emerged in the early 1970s in
  the U.S.
• Started insurance operations for municipal bonds
• Now their insurance coverage includes
  asset-backed securities
• Monoline insurers advocate a zero loss or
  remote loss underwriting standard
• Unconditional guarantees of scheduled principal
  and interest payments are provided

10
Business Models Government Agencies (Export
Credit Agencies)

• Definition (by OECD)      An agency in a
  creditor country that provides insurance,
  guarantees, or loans for the export of goods and
  services.
• Most of ECAs are not active in credit guarantees
  in relation to bond market development.
• Potential business model
• Issuance of local currency denominated bond to
  promote regional FDI
• Guarantee on infrastructure bond
• Guarantee on trade facilitation related bond

11
Japan Bank for International Cooperation (JBIC)
Source JBIC
12
JBICs Operations / Guarantees

• Provide cover for risks involved in loans made by
  private financial institutions, bonds issued by
  developing country governments and corporate
  bonds issued by overseas Japanese affiliates.
• JBIC's guarantee cover for loans made by private
  financial institutions and bonds issued by
  developing country governments helps facilitate
  private capital flows to developing nations and
  expand international finance operations of
  private-sector companies.
• JBIC also offers performance bond guarantees for
  the export of plants from Japan, the import of
  aircraft and other manufactured goods to Japan
  and overseas investment projects.

Source JBIC
13
Business Models Multilateral Development Banks

• Private sector development focus
• MDBs specialize in sovereign lending, but
  operations for private sector developments are
  growing among various MDBs.
• Assistance for private sector developments takes
  a form of loans, equity investments, or
  guarantees.
• Guarantees provided are still much smaller
  compared to other forms of assistance, but the
  use of guarantees is increasingly expanding.

Source Fitch
14
Business Models Multilateral Development Banks

• Assistance to SME sector development
• Various MDBs focus or concentrate their efforts
  on developing private sectors, especially, in
  regional SME development
• Promotion of securitization
• Securitization for SME and other assets
• High credibility with group strategy
• Many MDBs possess AAA credit ratings
• PCS (Preferred Creditor Status) of parent
  institutions bring favorable treatments of
  products of subsidiaries / affiliates / funds
• Callable capital can be called when necessary
• Callable capital is owned by highly rated
  shareholders

15
EIF/EIB European Investment Bank Group

• Supports creation, growth, development of SMEs
• Concentrates on investment in SMEs through
  venture capital funds on SME guarantee
  operations

• EU specialized vehicle providing venture capital
  guarantee instruments for SMEs
• Areas of cooperation with EIB
• Support of SMEs and share expertise in supporting
  them
• EIFs authorized capital is 3 billion

16
IFC/MIGA/IBRD World Bank Group

• IFC (International Finance Corporation)
• Supports private sector development by investing
  providing TA, focusing on SMEs, access to
  finance, etc.
• Common types of financing 1) project finance, 2)
  corporate finance, 3) trade finance.
• Products include loans, equity finance, partial
  credit guarantees, securitizations, and so on.

17
IFC/MIGA/IBRD World Bank Group

• MIGA (Multilateral Investment Guarantee Agency)
• Promotes foreign direct investment (FDI) into
  developing countries to help support economic
  growth and reduce poverty
• Has no AAA rating
• De facto Preferred Guarantor Status
• Provides political risk insurance
  (non-commercial)
• Currency transfer restrictions
• Expropriation
• War and civil disturbance
• Breach of contract

18
IIC/MIF/IDBInter-American Development Bank Group

• IIC (Inter-American Investment Corporation
• Encourages the establishment, expansion,
  modernization of SMEs
• Products include loans, equity investments, and
  credit guarantees
• All direct clients are private enterprises
  (mostly SMEs)
• IICs Credit Committee acts as the investment
  committee for MIF

19
IIC/MIF/IDBInter-American Development Bank Group

• MIF (Multilateral Investment Fund)
• Promotes broad-based economic growth through
  private sector development, particularly
  microenterprises and small businesses
• Not legally separate from IDB
• MIF benefits indirectly from the IDBs AAA rating
  and PCS since IDB signs MIF project agreements
• MIFs Donors Committee approves all MIF projects
• IDB acts as Administrator of the MIF
• MIF and IIC work closely together to provide TA
  and financing to SMEs
• Products include loans, equity investments, and
  grants

20
Cases

• Case studies
• Ambac / Korean MBS securitization
• Japan Bank for International Cooperation (JBIC) /
  Cross border CLO
• European Investment Fund (EIF) / SME
  securitization
• Asian Development Bank (ADB) / Remittance
  securitization

21
Ambac Bichumi Global 1 Limited
Source Ambac
22
JBIC Guarantee for Korean CBOs

• CBOs secured on corporate bonds (totaling 7.7
  billion yen) issued by 46 Korean SMEs were
  divided into senior and junior bonds
• Industrial Bank of Korea provided a credit
  facility for the senior bonds
• JBIC guaranteed and issued the bonds in the
  Singaporean Securities Exchange

Japan/Overseas
Korea
Small Business Corporation
Junior Bond
Proceeds ()
Proceeds ()
Proceeds ()
Korean SMEs
Korean SPV
Investors
Singapore SPV
Senior Note
Senior Bond
Corporate Bond
Guarantee
Credit Facility
Japan Bank for International Cooperation
Industrial Bank of Korea
Source Japan Bank for International Cooperation
23
EIF SME Securitization
Source European Investment Fund
24
ADB Kazkommertsbank (Kazakhstan)

• Kazkommertsbank (KKB) Originator of the
  diversified payment rights and servicer
• USD 150,000,000 Series 2007A Notes due 2017
• USD 250,000,000 Series 2007B Notes due 2017
• USD 100,000,000 Series 2007C Notes due 2017
• Joint lead arrangers bookrunners Merrill Lunch
  WestLB
• Financial guaranty insurance policy providers
  Financial Guaranty Insurance Company (2007A),
  MBIA Insurance Corporation (2007B), Asian
  Development Bank (2007C)
• New features 1) Regulation 144A Program second
  deal of KKB 2) Largest DPR securitization at
  that time in Kazakhstan 3) First time ever
  reached maturity for 10 years 4) Several times
  over subscribed.

Source Asian Development Bank
25
Credit Guarantee Business Demand in Asia
ADBs Technical Assistance on Credit Guarantee
Investment Mechanism Phase 1 (2003-2005)

• Objectives of Phase 1 TA 1) Determine whether
  there is sufficient business demand for the
  Mechanism 2) project required capital for the
  Mechanism based on the estimated demand
• Business focus Provision of facilities to the
  private sector to develop local currency bond
  markets in the ASEAN3 region
• Credit rating of the Mechanism International AAA

26
ADBs Technical Assistance on Credit Guarantee
Investment Mechanism Phase 2 (2006-2007)

• Objectives of Phase 2 TA 1) Revise update
  Phase 1 business demand estimates for the
  Mechanism 2) project required capital for the
  Mechanism based on the estimated demand
• Business Focus Added remittance securitization
  as a new asset class

27
Potential Products to be Guaranteed

• Public Sector Bonds
• Asset-backed Securities
• Mortgage-backed Securities
• Collateralized Loan or Debt Obligations
• Bonds backed by publicly or privately funded
  public-purpose projects
• Sovereign and sub-sovereign bonds
• Future cash flow securitization products e.g.
  overseas remittance

28
Demand Estimates and Background Large Local
Currency Bond Growth Potentials in Focus
Countries

• Consistently high GDP growth and saving rates
• Continuing institutional reforms and capital
  investment favor bond market development
• Establishment of institutionalized guarantee
  mechanism can lead to additional growth potentials

29
Demand Estimates Hypothetical Approach and Logic
Employed

• The hypothetical approach incorporated the
  following three premises in estimating business
  demand for the credit guarantee mechanism
• 1. Definition of Demand
• 2. Pricing
• 3. Circumstances where Demands Exist

30
Premises Used

• Definition of Demand Usually, the quantity of
  demand is very likely to be determined by price.
  
• We hypothesized the quantity of demand for a
  guarantee or loan product is determined at a
  given price (guarantee fee or loan rate)
• Pricing The price (determined by the Mechanism)
  will greatly affect the demand quantity. Demand
  can be either nil or infinitely large depending
  on the level of fee/rate.
• We assumed that prices of fee or rate are set
  according to default probabilities exclusively by
  the Mechanism
• Circumstances where Demands Exist
• We hypothesized that demand will exist only when
  
• Financing costs applied through the Mechanism
  become smaller than existing financing costs
• Companies without access to financing can obtain
  financing through the use of the Mechanism

31
List of Products Demand Estimates

• Bond Guarantees
• SME Warehouse Loans
• SME Securitization Guarantees
• Infrastructure Bond Guarantees
• Infrastructure Loans

32
Demand Estimates by Country (USD mn)
Demand Estimate
Indonesia 1,988
Malaysia 4,452
Philippines 1,555
PRC 7,390
Thailand 2,787
TOTAL 18,171
33
Demand Estimates by Product (USD mn)
Demand Estimate
1 Equity Investments in Financial Sector Infrastructure 75
2 Bond Guarantees 9,169
3 Governance Equity Investments 150
4 SME Warehouse Loans 1,885
5 SME Securitization Guarantees 1,377
6 RMBS Securitization Guarantees and Other ABS Guarantees 5,189
7 Infrastructure Bond Guarantees 1,409
8 Infrastructure Loans 1,623
9 Infrastructure Equity Investments 80
TOTAL 18,171
Item 5 and 7 are excluded to avoid
double-counting of loans and guarantees.
34

• Our research indicates that there is a huge
  demand for credit guarantees and a credit
  guarantee mechanism in the ASEAN3 region
• Establishing the credit guarantee mechanism can
  significantly enhance the development of the
  local bond markets in the region
• Thank you very much