The ADB’s role in encouraging and facilitating Asset Reconstruction Companies
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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. Introduction. ADB: Participating at early stage

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Introduction 3375527

The ADB’s role in encouraging and facilitating Asset Reconstruction CompaniesDr. William WillmsPrincipal Investment Officer, Asian Development Bank6 November 2004


Introduction

Introduction

  • 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

NPL market drivers and the ADB

  • INVESTMENT BANKS: Principal business needs risk sharing

    • 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 india

Section 1:ADB’s Role in NPL Resolution Projects outside India


Overview

Overview

  • 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

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


Introduction 3375527

Example: Outright Sale

Investor

100%

Debt

Portfolio

Originating

Bank

SPV

Servicer

Fee

Purchase Price

Servicing


Adb and securitization

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

Example: Conventional CLOs

  • Guarantee

  • Loss bearing Liquidity Facility

Charitable

Trust

  • Senior Tranche

  • rated bonds

  • 1st priority security over Portfolio

  • 5 years (callable after 3)

  • Coupon Bearing

  • Liquidity Facility from OECD Bank

Investors

100% equity

SPV

Outright sale of Portfolio

  • Mezzanine Tranche

  • unrated bonds

  • 2nd priority security over Portfolio

  • 7 years

  • Coupon Bearing

Originating

Bank

Investors

MarketValue

  • Junior Tranche

  • bond/loan/preference shares

  • subordinated

  • 10 years

  • zero coupon (cash sweep)

Originating

Bank

Portfolio


Critical issues the servicer

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

Section 2:ADB’s Role in NPL Resolution in India


Introduction 3375527

ADB and Indian ARCs

ARC

100%

Sale of NPL

Trust

Originating

Bank

SRs

SRs

Security Receipts (SRs)

In consideration

Cash

Foreign

Investor

Local

Investor


Thank you

THANK YOU


Appendix 1 asia s npl resolution problem

Appendix 1:Asia’s NPL Resolution Problem


New strategies in investment banking

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 assets

    • continuous conflicts of interest to be managed


Equity solution for asian npls

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

$ in billions

Source: Ernst & Young; Bloomberg

Source: Ernst & Young; Bloomberg

  • Approximately US$815 billion of Asia

  • ex-Japan NPLs

  • Value of distressed debt is greater than some local stock markets


Introduction 3375527

ADB’s Involvement: EARLY STAGE

EARLY STAGE: CATALYTIC

  • “Common Funder”

  • Strong benchmarks and transparent NPL market

  • “Best market practices”

  • Catalyzing debt funding from international and domestic banks

NPL Resolution Market

Number of Players

Fees

Market Development

t

(a)

ADB

(b)


Adb s market

  • Outside ADB Scope:

  • South Korea

  • Japan

  • Taipei,China

ADB’s Market

Tiny Starting Growing

Thailand Philippines PRC

India


Appendix 2 adb due diligence

Appendix 2: ADB Due Diligence


Introduction1

Introduction

  • 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

General Principles

  • The Asset Side:

    • the characteristics of the NPL portfolio (secured vs. unsecured NPLs…)

    • 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

Modeling Process

INPUTS on: - assets (recovery, timing) - support mechanisms

OUTPUTS:

Expected

Repayment Profile of ADB Debt

Modeling of Cash Flows

Generated by NPL Portfolio

Cash Flow Model


Modeling assets cash flows

Modeling Assets’ Cash Flows

  • Assets’ Cash Flows: Secured or Unsecured

  • Secured NPLs – Loan-by-Loan analysis

    • Timing

      • 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 ….)

    • Amount

      • 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)


Introduction 3375527

Appendix 3:Other Potential NPL Structures


1 joint venture management

(1) Joint Venture Management

  • ADB Loans

  • secured by Portfolio

  • 5/7 to 10 years

Outright sale of Portfolio

Originating

Bank

SPV

Debt Funding

Market Value

Equity Funding

50% Cash

50% In-Kind

Originating

Bank

JV

Partner

Portfolio

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

(2) Joint Venture with Pooling

25%

Funding

Outright sale of Portfolio A

SPV

Bank A

  • Senior Loan

  • 1st priority security

  • over Portfolios A & B

  • 5 to 7 years

Market Value

  • Junior Loan A

  • subordinated

  • security over

  • Portfolio A

  • 7 to 10 years

  • Junior Loan B

  • subordinated

  • security over

  • Portfolio B

  • 7 to 10 years

25%

Funding

Bank B

Outright sale of Portfolio B

Bank B

Market Value

25% Funding

25% Funding

Bank A

Bank B

Portfolio

Joint Management Agreement


Introduction 3375527

(3) Synthetic Sale

Senior Debt

1/3 : Financial close

Originating

Bank

SPV

1/3 : 1st year

1/3 : 2nd year

Equity

Investor

Market Value

Servicing Contract

- Base Fee

- Incentive Fee


4 synthetic clo with cds

(4) Synthetic CLO with CDS

Charitable

Trust

Guarantee

100% equity

  • Senior Tranche

  • rated bonds

  • 1st priority security over Collateral

  • 5 years (callable after 3)

  • Coupon Bearing

Investors

CREDIT DEFAULT SWAP:

SPV

Premium only

Funding

Originating

Bank

No Credit Event:

Zero

Credit Event:

Deliver Asset

reference price

  • Mezzanine Tranche

  • unrated bonds

  • 2nd priority security over Collateral

  • 7 years

  • Coupon Bearing

Investors

Funding

Portfolio


5 hybrid clo with equity

(5) Hybrid CLO with Equity

Charitable

Trust

Guarantee

7.5% of

equity of

SPV 1

100% of

equity of

SPV 2

  • Senior Tranche

  • rated bonds

  • 1st priority security over Loan Receivables

  • 5 years (callable after 3)

  • Coupon bearing

  • Liquidity Facility from OECD Bank

Investors

45% of

equity of

SPV 1

47.5% of

equity of

SPV 1

Originating

Bank

SPV 2

SPV 1

  • Mezzanine Tranche

  • rated bonds

  • 1st priority over 0% RW Assets

  • 2nd priority security over Loan Receivables

  • 7 year

  • Coupon bearing

Investors

Originating

Bank

Secured

Portfolio

Loan

  • Junior Tranche

  • bond/loan/preference shares

  • subordinated

  • 10 years

  • zero coupon (cash sweep)

Originating

Bank

Portfolio


Introduction 3375527

William Willms

Asian Development Bank

+63 2 632 5469

[email protected]


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