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. 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. 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. 4 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

5. 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. 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 agency ’ s recognition of monoline insurance companies

7. 7 Cases and Business Models of Credit Guarantee Institutions Credit Guarantee Providers:  Private companies (monoline)  Government agencies (export credit agencies)  Multilateral development banks

8. 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. 9 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 securities  Monoline insurers advocate a “ zero loss ” or “ remote loss ” underwriting standard  Unconditional guarantees of scheduled principal and interest payments are provided

10. 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. 11 Japan Bank for International Cooperation (JBIC) Source: JBIC

12. 12 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.

13. 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. 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. 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 EIF’s authorized capital is €3 billion

16. 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. 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. 18 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

19. 19 IIC/MIF/IDB: Inter-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 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 financing to SMEs  Products include loans, equity investments, and grants

20. 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. 21 Ambac: Bichumi Global 1 Limited Source: Ambac

22. 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 Korean SMEs Small Business Corporation Korean SPVInvestors Industrial Bank of Korea [Japan/Overseas] [Korea] Japan Bank for International Cooperation Singapore SPV Proceeds (¥) Credit Facility Corporate Bond Senior Note Guarantee Senior Bond Junior Bond Source: Japan Bank for International Cooperation

23. 23 EIF: SME Securitization Source: European Investment Fund

24. 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. 25 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

26. 26 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

27. 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. 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. 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. 30 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

31. 31 List of Products: Demand Estimates  Bond Guarantees  SME Warehouse Loans  SME Securitization Guarantees  Infrastructure Bond Guarantees  Infrastructure Loans

32. 32 Demand Estimates by Country (USD mn) Demand Estimate Indonesia1,988 Malaysia4,452 Philippines1,555 PRC7,390 Thailand2,787 TOTAL18,171

33. 33 Demand Estimates by Product (USD mn) Demand Estimate 1 Equity Investments in Financial Sector Infrastructure75 2 Bond Guarantees9,169 3 Governance Equity Investments150 4 SME Warehouse Loans1,885 5 SME Securitization Guarantees1,377 6 RMBS Securitization Guarantees and Other ABS Guarantees 5,189 7 Infrastructure Bond Guarantees1,409 8 Infrastructure Loans1,623 9 Infrastructure Equity Investments80 TOTAL*18,171 *Item 5 and 7 are excluded to avoid double-counting of loans and guarantees.

34. 34  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