# Presentation: 472896

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

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

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- www.delphosinternational.com

## 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

## 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.

## 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 world’s FX reserves and consume 47% of world’s oil.

## 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 S&P ratings actions as of August 2005)
- In Latin America, Chile, El Salvador and Mexico have reached investment grade (S&P: BBB- or higher)
- Turkey and Kazakhstan likely upgrades in 2006

## EM Equities – Higher Returns (and Risk)

## Sovereign Risk Premiums

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

- Decreasing yields over US Treasuries

- Source: *The Economist*. December 14, 2005

## 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

## 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

## 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.

## 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

## 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)

## 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

## 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

## 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”)

## 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

## 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)

## 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

## 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)

## 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

## 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%.

## 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.

## 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

## 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.

## Equity/Quasi-Equity

- Equity
- Provides between 5-15% of project’s 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

## 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

## 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

## 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)

## 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

## 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 			Peru’s capital markets lack experience with corp 		borrowers