The ADB PowerPoint Presentation Political Risk by MikeJenny


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									The ADB’s role in encouraging
and facilitating Asset
Reconstruction Companies

Dr. William Willms
Principal Investment Officer, Asian Development Bank
6 November 2004

 ADB: Participating at early stage
   Public Sector: Advising policy and framework dialogue,
   coordination and relationship management with Governments
   Private Sector: Debt and Equity funding at early, riskier, stage

 ADB and India
   Public Sector: TA on the SAFREASI Act and Secured Transactions
   Private Sector: Equity funding for ARCs, potentially Security
   Receipt investor
NPL market drivers and the ADB

 INVESTMENT BANKS: Principal business needs risk
   Require leverage to lower equity cost, WACC
   Seek diverse partners to better share risks

 ASIAN NPL MARKETS: Early-stage Development
   Early stage: Fewer players, higher costs
   Later stage: More standardization like other markets

 ADB: Valuable Early-stage Participant
   Public Sector: Provide political value as multilateral
   Private Sector: Offer Debt and Equity funding at riskier early stage
Section 1: ADB’s Role in NPL
Resolution Projects outside

 MAIN: Senior, limited-recourse debt

 Partial Credit & Political Risk Guarantees

 Equity Participation at Early Stage

 General “Comfort” as Multilateral Partner
ADB Loan for NPL Portfolio Purchase

 Portfolio Acquisition Loan
   Senior, limited recourse
   Maximum of 25% of total transaction cost (funding) or US$ 75
   million (whichever is less)
   Full credit, market asset and legal due diligence
   Market-based spread
   Underwriting Fee of 1% - 1.5%
   US$, Euro or, depending on the country, local currency
Example: Outright Sale


                                        100%   Debt

                    Portfolio                    Fee
                                    SPV                    Servicer

                  Purchase Price               Servicing
ADB and Securitization

 ADB Partial Credit Guarantee (PCG)
   timely payment of interest and ultimate payment of principal
   up to 100% of one tranche
   2 shadow ratings by acceptable rating agency

 Liquidity Facility

Political Risk Guarantee
Example: Conventional CLOs

                                                                    • Guarantee
                                                                    • Loss bearing
                                                                      Liquidity Facility

                            Trust        Senior Tranche
                                         • rated bonds
                                100%     • 1st priority security over Portfolio
                                equity   • 5 years (callable after 3)                      Investors
                                         • Coupon Bearing
                                         • Liquidity Facility from OECD Bank
               sale of                   Mezzanine Tranche
              Portfolio                  • unrated bonds
                            SPV          • 2nd priority security over Portfolio            Investors
                                         • 7 years
                Market                   • Coupon Bearing

                                         Junior Tranche
                                         • bond/loan/preference shares
                                         • subordinated                                    Originating
                                         • 10 years                                          Bank
                                         • zero coupon (cash sweep)
Critical Issues: The Servicer

 More than for any other asset class, the Servicer is critical for an NPL
 deal. There will not be any cash flow from the assets without a Servicer.

 Two kinds of Servicer:
    Special Servicer
    Seller (Bank)

 Recovery Strategies:
    Legal Proceedings
    DPOs (Discount Pay-Offs) or out-of-court settlements
    REO company, a third party that will go to auction if prices become too low
    with the purpose of selling the property on the open market afterwards
    Marketing & Sale Programmes
    Funding Programmes, to provide funding to potential buyers of real estate
    properties (at auction or outside)

 Other Critical Issues: Underlying asset pool (secured vs. unsecured),
 legal environment, structural enhancements
Section 2: ADB’s Role in NPL
Resolution in India
ADB and Indian ARCs


                     Sale of NPL
   Originating                         Trust

           Security Receipts (SRs)   Cash
              In consideration
                                        Local          Investor
    Appendix 1:
Asia’s NPL Resolution
New strategies in investment banking

 Moving away from “client focus” to principal business

 Ramping up proprietary business
   shrinking investment banking fees
   growing proprietary trading
   expanding distressed debt investment business
   example: Goldman Sachs’s business model in Japan

 Growing advisory business in area of distressed
   continuous conflicts of interest to be managed
Equity Solution for Asian NPLs?

 NO. Equity is not sufficient.
    Magnitude of NPL problem in Asia
    Country limits and single deal exposures for investors
    Increasing sophistication from sellers (e.g. PRC AMCs): more
    complex bid/offer spread
                    Total Asia ex-Japan Distressed Debt                                          Distressed Debt to Stock Markets

                           Thailand                          Kong Kong/China                                     Distressed Debt   Stock Market
                             $50                                  $480
                    Indonesia                                                                  250                                        215
                       $60                                                                     200

                                                                               $ in billions
    $ in billions

                                                                                               150                                  105
                     South Korea                                                               100   60
                        $105                                                                                     50    45
                                                                                                           28                                      15    14
                                   Taiw an                                                     50
                                    $65                                                         0
                                                                                                     Indonesia   Thailand          South Korea    Philippines

   Source: Ernst & Young; Bloomberg
                                                                               Source: Ernst & Young; Bloomberg
   - Approximately US$815 billion of Asia                                             - Value of distressed debt is greater than
      ex-Japan NPLs                                                                   some local stock markets
 ADB’s Involvement: EARLY STAGE

                                                 EARLY STAGE: CATALYTIC
               NPL Resolution Market

                                                 –    “Common Funder”
                                                 –    Strong benchmarks and
                                                      transparent NPL market
                             Number of Players
                 Fees                            –    “Best market practices”
      Market                                     –    Catalyzing debt funding
Development                                           from international and
                                                      domestic banks

                 (a)                t
ADB’s Market

                                       Outside ADB Scope:
                                       • South Korea
                                       • Japan
                                       • Taipei,China

    Tiny       Starting      Growing

    Thailand   Philippines   PRC
Appendix 2: ADB Due Diligence

    NPLs can be classified into two categories:
       Secured NPLs have a security – a mortgage security or personal guarantee
       – of good quality. In most cases, mortgage loans with a first-rank lien or
       loans with a corporate guarantee fall under this category. The recovery
       process will largely depend on legal proceedings, while the extent of the
       recovery will depend on the real estate market.
       Unsecured NPLs do not benefit from a good security. In most cases,
       mortgage loans with a second- or third-rank lien, unsecured corporate loans,
       consumer loans or overdrawn bank accounts fall under this category. The
       recovery process will largely depend on the efficiency of the servicer.

   The presence and the quality of a security for NPLs will obviously affect
    the expected level of recoveries for the creditor.

    NPL debtors are either private individuals or corporate legal entities
    (corporations in most cases). The debtors’ legal characteristics will affect
    the legal proceedings and their durations.
General Principles

 The Asset Side:
   the characteristics of the NPL portfolio (secured vs. unsecured
   the efficiency and the recovery strategies of the Servicer
   the eventual support mechanisms (Liquidity Facility/Guarantee in
   the case of payment shortfall on the NPLs)

 The Liabilities Side:
   The waterfall of payments on the different classes of notes
   (subordination capital and/or interest)
   The eventual support mechanisms (collateral in the case of
   payment shortfalls on the notes)
Modeling Process

   INPUTS on:
      - assets                                                      OUTPUTS:
(recovery, timing)    Modeling of Cash Flows                         Expected
                                                  Cash Flow Model   Repayment
     - support       Generated by NPL Portfolio
   mechanisms                                                        Profile of
                                                                    ADB Debt
Modeling Assets’ Cash Flows
 Assets’ Cash Flows: Secured or Unsecured

 Secured NPLs – Loan-by-Loan analysis
       Type of legal proceedings (insolvency/bankruptcy or foreclosure)
       Phase of the legal proceedings and number of auctions according to the
       underlying real estate property.
       Court timing recovery according to the legal phase.
       Servicer’s strategy (legal proceedings or out-of-court settlements, or other
       strategies ….)
       Mortgage security amount
       Loan/claim Outstanding Amount (Gross Book Value) at the expected recovery
       date (legal interest or late payment interest)
       Forced Sale Value (minus legal fees) at the expected recovery date. The
       Forced Sale Value of the property is derived from the last Market Value and
       projections for the real estate market (according to the kind of property –
       residential, commercial, industrial – and the geographic situation)

 Several scenarios regarding timing (courts, Servicer’s
 efficiency/strategy) and real estate markets (cycles, volatility)
       Appendix 3:
Other Potential NPL Structures
(1) Joint Venture Management
                                                             ADB Loans
                     Outright                                • secured by Portfolio
                      sale of                                • 5/7 to 10 years
 Originating         Portfolio
   Bank                                 SPV            Debt Funding
                  Market Value                         Equity Funding

                                                           50% In-Kind                     50% Cash

                                      Portfolio                    Originating          JV
                                                                     Bank             Partner

                                                              JV Agreement
      Compared to Holding the Portfolio, this solution provides:
      •   Leverages the expertise & resources of two JV Partners
      •   Lower upfront proceeds
      •   Medium up-front write-down
      •   Financing risk
      •   Maximum work-out upside / downside
      •   No deconsolidation
(2) Joint Venture with Pooling

         Outright sale                                                     25%
         of Portfolio A                 Senior Loan                      Funding
                                        • 1st priority security
Bank A
                                          over Portfolios A & B
         Market Value                   • 5 to 7 years

                            SPV          Junior Loan A     Junior Loan B 25%
         Outright sale                   • subordinated    • subordinated Funding
         of Portfolio B                  security over     security over
                                         Portfolio A       Portfolio B              Bank B
Bank B                                   • 7 to 10 years   • 7 to 10 years
         Market Value
                                        25%                          25%
                                      Funding                      Funding

                                            Bank A            Bank B

(3) Synthetic Sale

                   1/3 : Financial close          Senior Debt
                      1/3 : 1st year
       Bank                1/3 : 2nd year   SPV
                       Market Value

                    - Base Fee
                    - Incentive Fee
 (4) Synthetic CLO with CDS


                                      equity   Senior Tranche
                                               • rated bonds
                                               • 1st priority security over Collateral           Investors
              Premium only                     • 5 years (callable after 3)            Funding
                                               • Coupon Bearing
              No Credit Event:
                   Zero                        Mezzanine Tranche
Originating                        SPV
               Credit Event:                   • unrated bonds
  Bank                                         • 2nd priority security over Collateral           Investors
               Deliver Asset
                                               • 7 years                               Funding
               reference price                 • Coupon Bearing

   (5) Hybrid CLO with Equity

                           7.5% of                  100% of
                          equity of                 equity of   Senior Tranche
                            SPV 1                    SPV 2      • rated bonds
             45% of                                             • 1st priority security over Loan Receivables
            equity of                  47.5% of                                                                 Investors
                                                                • 5 years (callable after 3)
                                       equity of
Originating  SPV 1                                              • Coupon bearing
                                        SPV 1                   • Liquidity Facility from OECD Bank

                                                                Mezzanine Tranche
                                                                • rated bonds
                            SPV 1                   SPV 2       • 1st priority over 0% RW Assets                Investors
                                                                • 2nd priority security over Loan Receivables
                                       Secured                  • 7 year
Originating   Portfolio                 Loan
  Bank                                                          • Coupon bearing

                                                                Junior Tranche
                                                                •bond/loan/preference shares                    Originating
                                                                •10 years
                                                                •zero coupon (cash sweep)

William Willms
Asian Development Bank
+63 2 632 5469

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