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October 27, 2004, São Paulo Mahesh Kotecha, President Structured Credit International Corp. (SCIC) INCREASING MDB LEVERAGE FOR GUARANTEES.

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Presentation on theme: "October 27, 2004, São Paulo Mahesh Kotecha, President Structured Credit International Corp. (SCIC) INCREASING MDB LEVERAGE FOR GUARANTEES."— Presentation transcript:

1 October 27, 2004, São Paulo Mahesh Kotecha, President Structured Credit International Corp. (SCIC) INCREASING MDB LEVERAGE FOR GUARANTEES

2 2 What is the Problem?  While the core competence of multilateral financial institutions is to mitigate risks their risk mitigation products are largely ineffective  Such products as partial credit guarantees and partial risk guarantees are more than a decade old but their use is paltry for a number of reasons  One critical reason is that multilaterals have chosen to emphasize a commodity product -- money – which is not scare and de-emphasize a competitive product -- risk mitigation -- which is scarce  Guarantees account for ~1% of loans for IBRD and ~5% for ADB  Higher leverage for guarantees would level the playing field, making guarantees more attractive for multilaterals than loans  Increased leverage would represent a fundamental change in the financial architecture of financial architecture of international financial institutions unlike other reforms which have largely tinkered with the plumbing instead

3 3 Role of Official Guarantors  Official guarantors have been active as triple-A credit enhancers for nearly a decade but volume of activity is relatively modest  World Bank Group and regional development banks  OPIC / EXIM  Rating agencies rely on the “halo effect” provided by the multilateral lender’s “preferred creditor” status to pierce the sovereign ceiling  The “halo effect” concept becomes less convincing with increasing volume of issues benefiting from the multilateral’s preferred creditor status  Also, credibility is tested when stresses occur, e.g,, B loans in Argentina  Utilizing products to support securitization  A/B loan structures – the preferred creditor “halo” effect of B loans seems to be fading, post Argentina  Full wrap or partial credit guarantees for issues placed locally  Combination of partial credit guarantees from Official Guarantors and private market guarantees to achieve higher ratings (constrained by costs of two guarantees)

4 4 Role of Private Sector Guarantors  Instruments  Full guarantees of principal and interest are most common  Partial guarantees have been provided, especially for such ABS as those backed by home equity (second mortgage loans)  Maturity guarantees (to provide certainty on final maturity)  Counterparty guarantees  “Supply guarantee” to cover export performance risk  Requirements vary  Monolines require a investment grade rating before the guarantee (Foreign currency rating for FX transactions; LC for domestic transactions)  Multilines can go to lower rated transactions and prefer high non- investment grade transactions before the guarantee

5 5 Potential of Public - Private Partnerships Private Financial Guarantee Recourse to sponsor Government, ECA or Multilateral PRI / PCG Bank LOCs, puts, etc. Private PRI Cash Reserves Second Loss Protection First Loss Protection

6 6 Why are Partial Credit Guarantees and Partial Risk Guarantees Not Used More?  Coverage not available for refinancings / restructurings  Unwillingness or inability or both to partner effectively with private sector monoline and multiline financial guarantors to provide additional capacity  Complex, inefficient, expensive, time consuming to negotiate  Insensitive to private sector’s timing constraints and decision process on financing decisions  Low leverage makes guarantees a secondary product for most multilaterals

7 7 Public Sector Guarantors Are Too Complex MIGAIBRDADBNEXI Leverage4:11:1 NA Requires government counter-guarantee?NoYesNo Applicable for loans?Yes Applicable for equity (or quasi- equity)?YesNo Yes Covers contractual obligations of governments? Yes Applicable for govt. controlled projects?NoYes How many months of wait before payment is made on AAD? 6 mo12 moNA Types of coverages  Transfer restriction/inconvertibility  Expropriation  War and civil disturbance  Breach of contract Yes

8 8 MDB Leverage  MDBs (multilateral development banks) have been around a long time – since Bretton Woods (1945)  The leverage of such institutions is typically one to one  One dollar capital and unimpaired reserves to one dollar of loans and guarantees combined  Has ensured triple A ratings which provide cheap market access and low cost of funds at the expense of shareholder capital  But there are triple A rated multilaterals with higher leverage  EIB and NIB at 2.5 to 1  IFC and MIGA at 4 to 1  Some others are even higher  Multilateral leverage should be higher to save shareholder costs of capital and to increase developmental impact

9 9 Benefits of Higher Leverage  Lower need for shareholder capital  Both callable and paid in  Reduced fiscal burden on shareholders  Greater discipline on risk assumption by multilaterals with greater emphasis on risk assessment and risk management to meet test for the market for top credit ratings rather than political tests imposed by political bosses  Better asset quality and greater developmental impact on financings of viable projects  Triple – A ratings could be maintained by leverage as high as 4 to 1  Low cost of funds

10 10 Costs of Higher Leverage  Unwillingness to offer competitive products that the market demands, such as guarantees, and greater focus on offering money, which is available in the market if risks can be mitigated  Unfair playing field where guarantees often suffer from higher effective cost of capital relative to loans  One or more interest payments are counted against capital  Guarantees are not a mainstream product for any multilateral except for MIGA  MIGA is itself limited as it requires an equity interest on the part of the guaranteed entity before any debt can be guaranteed  By scores guarantees on an equal footing as loans against country allocations, IDA makes guaranteed unattractive relative to loans

11 11 Next Steps: Commission a Study  Review the track record of multilaterals as guarantors  Develop a vision of how higher leverage could be achieved  Within the current statutory limits via present valuing, not counting interest payments against capital, etc.  Beyond the current statutory limits via higher statutory leverage  Determine impact on ratings of higher leverage  Quantify costs and benefits  Suggest an implementation strategy to increase leverage  Focus on the most likely first mover

12 12 Mahesh K. Kotecha, C.F.A. Mr. Kotecha is President and founder of Structured Credit International Corp. (SCIC), a New York- based financial advisory firm providing advice on ratings, credit enhancement and structured finance. Prior to forming SCIC, he was Managing Director of MBIA Insurance Corp., of CapMAC Asia and CapMAC and an Alternate Director for ASIA Ltd. His previous responsibilities at MBIA included deal origination and execution of structured financings. He came to CapMAC in 1989 from Kidder, Peabody, where he was Director of the Market Analysis and Product Development Group in the Asset Finance Department. Mr. Kotecha led Kidder into the UK mortgage backed securities markets, structured the first public Collateralized Bond Obligation (CBO), and advised International Finance Corporation (IFC) and Turkey on capital markets issues. Previously, Mr. Kotecha worked for eight years at Standard & Poor's, where he was responsible for all international public sector ratings and ratings based on non-US collateral: mortgage and non- mortgage. Earlier, Mr. Kotecha worked for four years at the Federal Reserve Bank of New York and for three years at the United Nations Fund for Population Activities (UNFPA). Mr. Kotecha holds a Master's degree in management from the Sloan School of Management at MIT, and a Bachelor's degree in physics and engineering from Harvey Mudd College in Claremont, California. He is listed in Who's Who in America (1992 -). He is a member of and was an Adjunct Senior Fellow at the Council on Foreign Relations from 1999 to He is also member of East African Development Bank's International Advisory Panel and the Board of Directors of BRC Investors Service, a Colombian rating agency.


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