InterAmerican Development Bank Private Sector Department Capital Markets Unit

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Inter-American Development BankPrivate Sector
DepartmentCapital Markets Unit
Using Local Capital Markets Financing
Infrastructure Projects Credit Risk Mitigation,
local currency instruments (September 2003)
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Contents

• Private Sector Department
• Overview of Infrastructure Needs in the Region
• Development of Local Currency Debt Instruments
• Financial Guarantees
• Definition (partial credit guarantees)
• Options under Consideration
• Liquidity Facility Guarantee
• Pricing Approach
• Transactions in the Region
• Infrastructure Bond (Rutas del Pacifico, Chile)
• Mortgage Backed Security (Colpatria, Colombia)
• Business securitization bond (Developer, Peru)

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Private 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

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IDB (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)

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IDB (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.

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Local 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 degree of tolerance to FX adjustments
  in a particular economy)

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Infrastructure Needs LATAM (2005-2010) /1
Source World Bank, Working Paper 3102,
Fay-Yepes, 2003
Note /1 Does not include rehabilitation,
deferred past maintenance and upgrades
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Infrastructure Needs LATAM (2005-2010) /1

• LATAM infrastructure needs are estimated at US
  71 billion per year (it was close to US 60 back
  in 1995). Of this close to 45 is represented by
  maintenance.
• The most demanding sector in the Region will
  appear to be the Telecom Sector (US 32.5 billion
  per year or 46 of the total), with the mobile
  sub-sector alone demanding US 25 billion
  annually. Following Telecom will be Electricity
  (mainly generation) with US 25 billion per year,
  and toll roads with US 7 billion per year.
• In the golden years of infrastructure finance in
  the Region (1996), total amount of financing
  raised was closed to US 30 billion. This figure
  is probably now in the US 8 to US 10 billion at
  best. These demand figures do not include a stock
  of deferred investments and maintenance. If we
  add the weak foreign capital flows into LATAM
  infrastructure during the last years (and
  immediate future), the outcome is a pressing need
  for new financing options
• Redesign of the government role (from regulator
  to partner, PPPs)
• Development of risk mitigation products that can
  addressed the FX risk
• Development of local currency debt instruments

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Development of local currency debt instruments

• Matching of revenue generation (productive
  assets) and liabilities for private corporations.
  
• Mitigation of economic regulation framework under
  volatility scenarios (I.e., US based tariffs in
  utilities public services)
• Development of local savings capacities (I.e.,
  diversification from investments in government
  related securities).
• Incorporation of local debt holders as stake
  holders in infrastructure projects (mitigate
  regulatory risk)
• Introduce market performance benchmarks to
  improve risk return remuneration for local
  savings (domestic investment)

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Financial 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

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Financial 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.

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Mezzanine 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
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Financial 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.

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Pool Guarantee CBO, for Illustrative purposes
Source Rating Agencies Methodology (Case Example)
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Financial 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.

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Rolling Guarantee Utilities
Outstanding Principal
Debt / Service Coverage Ratio
DSCR
1.5
1.0
Rolling Guarantee
Years
N
N I
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Rolling Guarantee Utilities
Outstanding Principal
Debt / Service Coverage Ratio
DSCR
1.5
1.0
Liquidity Facility Guarantee
Years
N
N I
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Liquidity Facility Guarantee FX mitigation
Projected Cash-Flows
Real Cash-Flows (after FX adjustment)
Local currency Project Cash-flows expressed in
real US (going exchange rate)
US cash shortfall
US cash shortfall
Years
N
N1
N2
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Liquidity Facility Guarantee FX mitigation
Projected Cash-Flows
Real Cash-Flows (after FX adjustment)
Local currency Project Cash-flows expressed in
real US (going exchange rate)
DSCR
US cash shortfall to cover DSCRl
US cash shortfall to cover DSCRl
Years
N
N1
N2
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Liquidity Facility Guarantee FX mitigation
Projected Cash-Flows
Real Cash-Flows (after FX adjustment)
Local currency Project Cash-flows expressed in
real US (going exchange rate)
DSCR
Liquidity Facility covers short fall up to debt
service payment
Liquidity Facility covers short fall up to debt
service payment
Years
N
N1
N2
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Financial 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.

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Maturity Guarantee (e.g, power projects)
Outstanding Principal
Capital Repayment
Bullet
Maturity Guarantee
Bullet
Years
N
N I
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Financial 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
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Financial 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
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Case Santiago-Valparaíso, Financial Guarantee

• Concession awarded to a consortium led by ACS and
  SACYR Group (Spain) in 1998 in Santiago de Chile,
  Chile.
• The toll-road concession consists in the
  expansion and refurbishing of 110 km linking
  Santiago-Valparaíso and Viña del Mar
• Investment program of US 450 million to be
  partly financed through a local currency bond
  issue for the equivalent of US 300 million.
• IDB provided a credit guarantee to enhance the
  bonds rating to a level acceptable to local
  institutional investors. The IDB is Guarantor of
  Record for up to US75 million with the remaining
  amount provided by private insurers. FSA (USA
  based private insurer) acted as co-guarantor of
  the transaction.
• The issue before the IDB/FSA credit enhancement
  has been rated Baa2 by Moodys, which is the
  highest investment grade rating ever given to a
  toll road project in Chile. This is also the
  largest infrastructure bond sold primarily to
  Chilean pension funds and insurance companies,
  paying a coupon of 6.02 percent (Unidad de
  Fomento), with a maturity of 23 years.
• The issue was rated AAA by local rating agencies
  after the IDB/FSA enhancement. It was
  successfully placed in April 9, 2002

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Case Grana Montero, Secured Corporate Bond

• IDeveloper Group is the largest engineering
  services group in Peru with around US200 million
  of total assets and US180 million in revenues.
• It is mainly dedicated to the business of
  engineering and construction services.
• It also provides petroleum services (fuel
  terminals, drilling, extraction), information
  systems, engineering and real estate developing
  services.
• Strategic investments in concessions and public
  service companies. It is the operator of the
  first toll road concession in Peru (Arequipa).
• 70 years of history and excellent work completion
  track record.
• BBB (triple B) national scale rating as a
  corporate by Fitch and Equilibraim, local rating
  agencies

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Case Grana Montero, Partial Credit Guarantee

• Bond Profile
• Amount US50,000,000
• Term 8 years
• Grace period 6 months
• Amortization Semi-annual principal and interest
  payment
• Type of payment Equal coupons (principal
  interest),
• mortgage style
• Coupon amount US4.3 million (with 8.5
  interest rate)
• Final payment October 2011
• Shadow rating -AA/AA
• Guarantee Structure
• Amount Up to US20 million by IDB and FMO
• Coverage Callable for the full amount as a
  back-stop facility
• for reduction of principal under consecutive
  events of default

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Case Grana Montero, Bond Structure, Trust

• Assigned Cashflows
• Level 1 Segregated assets from
  non-construction subsidiaries
• IMI S.A. - Information technology, platform
  service
• IMD S.A. Engineering service
• IMT. Toll road concession
• IMP S.A. Petroleum and fuel terminal operation
• Level 2 Sales from GyM S.A.
• Pre-funded Debt Service Reserve Account
• Equal to 2 coupons (one year debt service)

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Capital Markets Activities Organization
(PRI/CMU)

• Ellis J Juan
• Unit Head, Capital Markets Unit (PRI)
• phone [phone]
• email ellisj_at_iadb.org
• Juan Mario Laserna
• Investment Officer, Capital Markets Unit (PRI)
• phone [phone]
• Daniela Carrera
• Investment Officer, Capital Markets Unit (PRI)
• phone [phone]
• Kelle Bevine
• Investment Officer, Capital Markets Unit (PRI)
• phone [phone]
• email kelleb_at_iadb.org
• Juan Jose Garcia
• Investment Officer, Capital Markets Unit (PRI)
• phone [phone]

Contact List of Key Staff for Capital Markets
Activities