The Regional Credit Guarantee Facilities: Cases and Business Models

Noriyuki SuzukiDaiwa Institute of Research Ltd.

September 25, 2007Asia-Pacific Finance and Development Center Seminar

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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

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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]

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Why a Credit Guarantee Facility?

Information asymmetries / lack of transparency prevent private corporations from issuing bonds

Information gap between issuer’s 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

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Advantages in Utilizing Credit Guarantees

From Issuers’ Perspective Reduction of financing cost Longer term financing Wider investor base Reduction of uncertainty in interest costFrom Investors’ Perspective Improved level of security in investment Enhanced liquidity and stabilized prices Outsourcing of assessment / monitoring to monoline insu

rance companies sense of reassurance and easier internal decision of investment

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Advantages in Utilizing Credit Guarantees

From Investment Banks’ Perspective Reduction of underwriting risks Transfer of risks of complex issuance to monoline insuran

ce companies Acceleration of issuance process due to credit rating agen

cy’s recognition of monoline insurance companies

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Cases and Business Models of Credit Guarantee Institutions

Credit Guarantee Providers:

Private companies (monoline)

Government agencies (export credit agencies)

Multilateral development banks

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Private Companies and Recent Industry Trend

Worldwide growth of insurance written (2002-2006):International public sector par insured = exponential

growthAsset-backed par insured = growing worldwideUS municipal par insured = mature market

0

100,000

200,000

300,000

400,000

500,000

600,000

700,000

2002 2003 2004 2005 2006

(In

Mill

ion

$)

US municipal par insured US asset-backed par insured

International public sector par insured International asset-backed par insured

$574,116

$431,176

Source: Association of Financial Guaranty Insurers

-40.0%

-20.0%

0.0%

20.0%

40.0%

60.0%

80.0%

100.0%

120.0%

140.0%

2003 2004 2005 2006

YoY

Gro

wth

US asset-backed par insured

US municipal par insured

Total par insured

International asset-backed par insured

International public sector par insured

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Business Models: Private Companies

Monoline insurers emerged in the early 1970’s in the U.S. Started insurance operations for municipal bonds Now their insurance coverage includes asset-backed securiti

es Monoline insurers advocate a “zero loss” or “remote loss” un

derwriting standard Unconditional guarantees of scheduled principal and interest

payments are provided

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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 promo

te regional FDI Guarantee on infrastructure bond Guarantee on trade facilitation related bond

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Japan Bank for International Cooperation (JBIC)

Source: JBIC

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JBIC’s Operations / Guarantees

Source: JBIC

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.

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Business Models: Multilateral Development Banks

Private sector development focus: MDBs specialize in sovereign lending, but operations for private sector devel

opments are growing among various MDBs. Assistance for private sector developments takes a form of loans, equity inv

estments, or guarantees. Guarantees provided are still much smaller compared to other forms of assi

stance, but the use of guarantees is increasingly expanding.

MDB Private Sector FinancingPrivate Sector Exposure / Total Exposure* (%)

African Development Bank 5.2%Asian Development Bank 2.8%European Bank for Reconstruction and Development 79.5%European Investment Bank 43.4%Inter-American Development Bank 3.0%International Bank for Reconstruction and Development 1.2%

* Exposure = Outstanding gross loans + equity investments

+ outstanding guaranteesSource: Fitch

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Business Models: Multilateral Development Banks

Assistance to SME sector development: Various MDBs focus or concentrate their efforts on developing private s

ectors, 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 tre

atments of products of subsidiaries / affiliates / funds Callable capital can be called when necessary Callable capital is owned by highly rated shareholders

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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

Owns 66%

of EIF

25% owned

by EC

9% by others

EuropeanInvestment

Bank

EuropeanInvestment

Fund

EIB Group

• EU specialized vehicle providing venture capital & guarantee instruments for SMEs

• Areas of cooperation with EIB:

Support of SMEs and share expertise in supporting them

• EIF’s authorized capital is €3 billion

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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.

* MIGA is a member of theWB group* Political risk insurance /TA / dispute mediation

* IFC coordinates activities withthe WB, but legally andfinancially independent* Private sector developmentfocus

World Bank Group

IFCIBRDMIGA

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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

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IIC/MIF/IDB:Inter-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)

IIC’s Credit Committee acts as the investment committee for MIF

* IIC is a legallyautonomous affiliateof IDB.*Involved in privatesector / SMEsdevelopment tocomplement IDBoperations.* IIC's CreditCommittee acts as theinvestment comitteefor the MIF'soperations.

* MIF is not aseparate legal entity.* Donors Comitteeapproves all MIFprojects.*MIF and IIC workclosely to provide TAand financing toSMEs.* IDB acts asadministrator of theMIF.

IIC MIF

IDB Group

IDB

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IIC/MIF/IDB:Inter-American Development Bank Group

MIF (Multilateral Investment Fund): Promotes broad-based economic growth through private s

ector development, particularly microenterprises and small businesses

Not legally separate from IDB MIF benefits indirectly from the IDB’s AAA rating and PCS

since IDB signs MIF project agreements MIF’s Donors Committee approves all MIF projects IDB acts as Administrator of the MIF MIF and IIC work closely together to provide TA and financi

ng to SMEs Products include loans, equity investments, and grants

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Cases

Case studies

Ambac / Korean MBS securitization Japan Bank for International Cooperation (JBIC) / Cross bord

er CLO European Investment Fund (EIF) / SME securitization Asian Development Bank (ADB) / Remittance securitization

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Ambac: Bichumi Global 1 Limited

Originator SPVInvestor

USAEurope

AsiaAMBACCredit

Enhancement

Senior

Reserve

Sub

Originator SPVInvestor

USAEurope

AsiaAMBACCredit

Enhancement

Senior

Reserve

Sub

• Samsung Life issued the first cross-border Securitization of Residential Mortgage

• $299.6 million US denominated note, the 144A private placement market

• The transaction carries a AAA-rated surety policy from, AMBAC, a specialty bond insurance company

• Part of strategy to raise the company’s profile internationally

Source: Ambac

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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

Korean SMEs

Small Business Corporation

Korean SPV Investors

Industrial Bank

of Korea

[Japan/Overseas][Korea]

Japan Bank for International Cooperation

Singapore SPV

Proceeds (¥) Proceeds (¥)Proceeds (¥)

Credit Facility

Corporate Bond Senior Note

Guarantee

Senior Bond

Junior Bond

Source: Japan Bank for International Cooperation

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EIF: SME Securitization

BW Bank KfW

PromiseSPV

InvestorsAAA to

BBB

OECDBank

EIFSwap

counterparty

ReferencePortfolio

EUR 1 bn

ReferencePortfolio

EUR 1 bn

KfWCDS

SwapPremium

Super Senior CDS

Swap PremiumCredit-Linkedcertificates of indebtedness

ProceedJunior & Mezzanine CDS

Swap Premium

Interest Sub Participation

CLN

Proceed

BW Bank KfW

PromiseSPV

InvestorsAAA to

BBB

OECDBank

EIFSwap

counterparty

ReferencePortfolio

EUR 1 bn

ReferencePortfolio

EUR 1 bn

KfWCDS

SwapPremium

Super Senior CDS

Swap PremiumCredit-Linkedcertificates of indebtedness

ProceedJunior & Mezzanine CDS

Swap Premium

Interest Sub Participation

CLN

Proceed

• Transaction: Promise-G 2001-1

• Issuer: BW Bank

• Portfolio: 4,644 loans to SME totaling EUR 1,000m

• Expected maturity: 7 years

• EIF acts as junior credit default swap counterparty for an amount of EUR 31.2 m as well as sub-mezzanine credit default swap counterparty for EUR 10.1 m

Source: European Investment Fund

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ADB: Kazkommertsbank (Kazakhstan)

Kazkommertsbank (KKB): Originator of the diversified payment rights and servicer

USD 150,000,000 Series 2007A Notes due 2017USD 250,000,000 Series 2007B Notes due 2017USD 100,000,000 Series 2007C Notes due 2017

Joint lead arrangers & bookrunners: Merrill Lunch & WestLB Financial guaranty insurance policy providers: Financial Guaranty In

surance 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

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Credit Guarantee: Business Demand in Asia – ADB’s 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 ASEAN+3 region

Credit rating of the Mechanism: International AAA

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ADB’s 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

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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

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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

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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 Demand2. Pricing3. Circumstances where Demands Exist

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Premises Used

1. 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)

2. 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

3. Circumstances where Demands Exist We hypothesized that demand will exist only when: a. Financing costs applied through the Mechanism become

smaller than existing financing costs;b. Companies without access to financing can obtain financing

through the use of the Mechanism

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List of Products: Demand Estimates

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

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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

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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.

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Our research indicates that there is a huge demand for credit guarantees and a credit guarantee mechanism in the ASEAN+3 region

Establishing the credit guarantee mechanism can significantly enhance the development of the local bond markets in the region

Thank you very much