Technical Assistance Consultant’s Report · 2015-01-15 · Technical Assistance Consultant’s Report This consultant’s report does not necessarily reflect the views of ADB or

Technical Assistance Consultant’s Report

This consultant’s report does not necessarily reflect the views of ADB or the Government concerned, and ADB and the Government cannot be held liable for its contents. (For project preparatory technical assistance: All the views expressed herein may not be incorporated into the proposed project’s design.

Project Number: 44447 November 2014

India: Preparing the Bond Guarantee Fund for India (Financed by the Japan Fund for Poverty Reduction)

Prepared by CRISIL Risk and Infrastructure Solutions Limited

Mumbai, India

For Department of Financial Services, Ministry of Finance

Asian Development Bank

TA-8279 IND: Preparing the Bond Guarantee Fund for India

– 1 Consulting Firm (44447-012)

Interim Report

November 2014

CRISIL Risk and Infrastructure Solutions Limited


[iii] TA-8279 IND: Preparing the Bond Guarantee Fund for India Draft Interim Report

Abbreviations

ADB Asian Development Bank

AGC Assured Guaranty Corporation

AGL Assured Guaranty Limited

AGM Assured Guaranty Municipal

ASEAN Association of South-East Asian Nations

CBO Collateralised bond obligation

CDO Collateralised debt obligation

CEF Connecting Europe Facility

CGIF Credit Guarantee and Investment Facility

CLO Collateralised loan obligation

CRIS Crisil Risk And Infrastructure Solutions

CRISIL Credit Rating Information Services of India Limited

DGIS Directorate-General for International Cooperation

DIFD Department for International Development

EIB European Investment Bank

FARAC Fideicomiso de Apoyo para el Rescate de Autopistas Concesionadas

FINFRA Fondo de Inversión en Infraestructura

FMFM Frontier Markets Fund Managers

FMO Nederlandse Financierings

FONADIN Fondo Nacional de Infraestructura

FSA Financial Security Assurance, Inc

FSC Financial Services Commission

GBP Great Britain pound

GDP Gross domestic product

ICBC Industrial and Commercial Bank of China Limited

ICF Infrastructure crisis facility

ICT Information and Communications Technology

IDB Islamic Development Bank

IFS Insurer financial strength

IIGF Indonesia Infrastructure Guarantee Fund

INR Indian rupee

JBIC Japan Bank for International Cooperation

KODIT Korea Credit Guarantee Fund

MAC Municipal Assurance Corporation

MARC Malaysian Rating Corporation Berhad

MBIA Municipal Bond Insurance Association


[iv] TA-8279 IND: Preparing the Bond Guarantee Fund for India Interim Report

MFF Multiannual Financial Framework

MIGA Multilateral Investment Guarantee Agency

MoC Meeting of contributors

MoF Ministry of Finance

MoSF Ministry of Strategy and Finance

NBFC Non-banking finance company

OPIC Overseas Private Investment Corporation

PBCE Project bond credit enhancement

PBI Project bond initiative

PIDG Private Infrastructure Development Group

PPP Public private partnership

PRC People's Republic of China

PRG Partial risk guarantee

RAM RAM Rating Services Berhad

SECO State Secretariat for Economic Affairs

SGX Singapore Exchange

SIDA Swedish International Development Cooperation Agency

SMBA Small and Medium Business Administration

SPC Special purpose company

SPV Special purpose vehicle

TBEC Thai Biogas Energy Company

TEN Trans-European Network

THB Thai Baht

USA United States of America

USD United States Dollar

[v]

Contents

1. Executive Summary ........................................................................................................................ 1

2. Introduction ..................................................................................................................................... 4

2.1 Structure of the report ............................................................................................................ 4

3. Defining the optimal structure for BGFI .......................................................................................... 5

3.1 Eligibility criteria ...................................................................................................................... 5

3.1.1 Sectors and entities .................................................................................................... 5

3.1.2 Project stage (applicable only to SPVs) ...................................................................... 5

3.1.3 Minimum source rating ................................................................................................ 5

3.1.4 Target rating ................................................................................................................ 6

3.1.5 Type of guarantee product .......................................................................................... 6

3.1.6 Tenure of guarantee ................................................................................................... 6

3.2 Quantum of guarantee and pricing ......................................................................................... 7

3.2.1 Summary of quantum of guarantee analysis .............................................................. 7

3.2.2 Summary of pricing analysis – cost savings and expected loss to BGFI ................... 7

3.3 Summary of credit guarantee products .................................................................................. 9

3.3.1 Full credit guarantee ................................................................................................... 9

3.3.2 Partial credit guarantee ............................................................................................. 10

4. Business plan and financial analysis ............................................................................................ 11

4.1 Bond portfolio for BGFI ......................................................................................................... 11

4.1.1 Sector split and portfolio build-up.............................................................................. 11

4.1.2 Source credit rating and associated cost of borrowing ............................................. 12

4.1.3 Target credit rating and associated cost of issuance of bond .................................. 13

4.2 Bond repayments and debt obligations ................................................................................ 13

4.3 Default rates, recovery rates and guarantee outflows.......................................................... 13

4.3.1 Default calculations ................................................................................................... 13

4.3.2 Recovery calculations ............................................................................................... 14

4.3.3 Guarantee outflows ................................................................................................... 14

4.4 Equity calculations ................................................................................................................ 15

4.4.1 Preliminary thoughts on legal structure of BGFI ....................................................... 15

4.4.2 Capital adequacy ...................................................................................................... 15

4.5 Income calculations .............................................................................................................. 17

[vi]

4.5.1 Guarantee fee ........................................................................................................... 17

4.5.2 Processing fee income .............................................................................................. 17

4.5.3 Treasury Income ....................................................................................................... 17

4.6 Expenditure calculations ...................................................................................................... 18

4.6.1 Upfront set up cost .................................................................................................... 18

4.6.2 Operating cost ........................................................................................................... 18

4.7 Financial statements, base case .......................................................................................... 18

4.7.1 Profit & loss statement .............................................................................................. 18

4.7.2 Balance sheet ........................................................................................................... 19

4.7.3 Cash flow statement ................................................................................................. 20

4.7.4 Return on equity analysis .......................................................................................... 20

4.7.5 Key takeaways .......................................................................................................... 20

5. Next steps ..................................................................................................................................... 22

5.1 Initial thoughts ...................................................................................................................... 22

6. Annexure 1 – Overview of international guarantee facilities ........................................................ 23

6.1 Credit Guarantee & Investment Facility ............................................................................... 24

6.1.1 Ownership ................................................................................................................. 24

6.1.2 Legal structure .......................................................................................................... 24

6.1.3 Business /operational model ..................................................................................... 24

6.2 European Investment Bank Project Bond Initiative .............................................................. 26

6.2.1 Ownership ................................................................................................................. 26

6.2.2 Legal structure .......................................................................................................... 26


6.3 Korea Credit Guarantee Fund .............................................................................................. 28

6.3.1 Ownership ................................................................................................................. 28

6.3.2 Legal structure .......................................................................................................... 29

6.3.3 Business/operational model ...................................................................................... 29

6.4 GuarantCo ............................................................................................................................ 33

6.4.1 Ownership ................................................................................................................. 33

6.4.2 Legal structure .......................................................................................................... 33


6.5 FONADIN or National Infrastructure Fund, Mexico .............................................................. 38

6.5.1 Ownership ................................................................................................................. 38

6.5.2 Legal structure .......................................................................................................... 38

[vii]


6.6 Danajamin Nasional Berhad ................................................................................................. 39

6.6.1 Ownership ................................................................................................................. 39

6.6.2 Legal structure .......................................................................................................... 39

6.6.3 Business/operational model ...................................................................................... 39

6.7 Indonesia Infrastructure Guarantee Fund ............................................................................ 41

6.7.1 Ownership ................................................................................................................. 41

6.7.2 Legal structure .......................................................................................................... 42


6.8 Monoline insurers ................................................................................................................. 44

6.8.1 Brief snapshot of key monoline insurers in the US ................................................... 44

6.8.2 Regulations governing monoline insurers ................................................................. 48

6.8.3 Past transactions by monoline insurers .................................................................... 48

6.9 Challenges in developing bond/credit guarantee funds ....................................................... 49

7. Annexure 2 – Overview of credit guarantee structures ................................................................ 50

7.1 Types of credit guarantee products in individual bond structures ........................................ 51

7.1.1 Full credit guarantee ................................................................................................. 51

7.1.2 Partial credit guarantee ............................................................................................. 51

7.1.3 Illustration .................................................................................................................. 51

7.1.4 Comparison between full and partial guarantees ..................................................... 53

7.2 Terms of credit guarantee in individual bond structures ...................................................... 54

7.2.1 Terms applicable to both full and partial guarantees ................................................ 54

7.3 Past transactions .................................................................................................................. 58

7.3.1 Full guarantee transactions in India .......................................................................... 58

7.3.2 Partial guarantee transactions in India ..................................................................... 58

7.3.3 Transactions outside India ........................................................................................ 60

8. Annexure 3 – Quantum of guarantee cover and pricing .............................................................. 63

8.1 Quantum of guarantee cover ................................................................................................ 63

8.1.1 Quantum of full credit guarantee cover ..................................................................... 63

8.1.2 Quantum of partial-credit guarantee cover ............................................................... 63

8.1.3 Pricing ....................................................................................................................... 70

9. Annexure 4 – Translating global-scale ratings to CRISIL’s scale ................................................ 75

10. Annexure 5 – Estimation of default rates ..................................................................................... 78

11. Annexure 6 – Legal structure for BGFI ......................................................................................... 64

[viii]

List of tables

Table 1: Features and eligibility criteria for BGFI .................................................................................... 1

Table 2: Indicative credit guarantee (as a percentage of total debt obligations in present value terms),

target rating AA for a 10-year instrument ................................................................................................ 7

Table 3: Comparison between expected loss to BGFI and guarantee as a proportion of cost savings

for a 10-year instrument - percentage of guaranteed amount ................................................................ 7

Table 4: Summary of full credit guarantee product ................................................................................. 9

Table 5: Summary of partial credit guarantee product .......................................................................... 10

Table 6: Specifications of typical projects ............................................................................................. 11

Table 7: Portfolio build-up - number of fresh bond issues across years ............................................... 12

Table 8: Cumulative bond issues and sector split over 10 years.......................................................... 12

Table 9: Source rating by instrument .................................................................................................... 12

Table 10: Source rating by instrument .................................................................................................. 13

Table 11: Debt obligations across 10 years (INR crore) ....................................................................... 13

Table 12: Cumulative default rates used to calculate default values .................................................... 13

Table 13: Recovery calculations (INR crore) ........................................................................................ 14

Table 14: Guarantee outflow (INR crore) .............................................................................................. 14

Table 15: Guarantee portfolio outstanding (INR crore) ......................................................................... 15

Table 16: Capital adequacy of NBFCs .................................................................................................. 15

Table 17: Funded v/s non-funded exposure capital adequacy requirements ....................................... 16

Table 18: Guarantee fee income (INR crore) ........................................................................................ 17

Table 19: Processing fee income (INR crore) ....................................................................................... 17

Table 20: Treasury Income (INR crore) ................................................................................................ 18

Table 21: Operating cost (INR crore) .................................................................................................... 18

Table 22: Profit & loss statement, base case (INR crore) ..................................................................... 18

Table 23: Balance sheet, base case (INR crore) .................................................................................. 19

Table 24: Cash flow statement, base case (INR crore) ........................................................................ 20

Table 25: Return on equity, base case ................................................................................................. 20

Table 26: Return on equity, with 50% callable capital .......................................................................... 20

Table 27: ROEs exhibited by similar institutions in India and abroad ................................................... 21

Table 28: International guarantee facilities ........................................................................................... 23

Table 29: CGIF capital contributions ..................................................................................................... 24

[ix]

Table 30: Financial highlights of CGIF .................................................................................................. 26

Table 31: Some approved projects with PBCE option (in EUR million) ................................................ 28

Table 32: General credit guarantee services of KODIT ........................................................................ 29

Table 33: Performance of P-CBO guarantee over the years ................................................................ 31

Table 34: Outstanding general guarantees by type in KRW billion ...................................................... 31

Table 35: Financial highlights of GuarantCo ......................................................................................... 37

Table 36: Number of instruments guaranteed by Danajamin Nasional Berhad ................................... 41

Table 37: Financial highlights of Danajamin Nasional Berhad ............................................................. 41

Table 38: Financial highlights of IIGF ................................................................................................... 43

Table 39: Ratings of Assured Guarantee Ltd over the years ................................................................ 44

Table 40: Full guarantee transactions of monoline insurers ................................................................. 48

Table 41: Comparison between full and partial credit guarantee ......................................................... 53

Table 42: Fully guaranteed bond transactions in India ......................................................................... 58

Table 43: Partial credit guarantee transactions in India ........................................................................ 59

Table 44: Partial credit guarantee transactions of ADB ........................................................................ 60

Table 45: Partial credit guarantee transactions of IFC ......................................................................... 61

Table 46: Interpolated mapping of S&P ratings to CRISIL ratings based on a CRISIL article ............. 65

Table 47: Average recovery rates in the US ......................................................................................... 65

Table 48: Recovery rate estimates for India ......................................................................................... 66

Table 49: Project specifics for indicative quantum assessment ........................................................... 66

Table 50: Debt repayment schedule for both source and target rating (INR crore).............................. 67

Table 51: Default scenarios over the tenure of the bond ...................................................................... 67

Table 52: MDRs for both source and target rating ................................................................................ 68

Table 53: LGD for both source and target rating (INR crore) ............................................................... 68

Table 54: Indicative credit guarantee (as a percentage of total debt obligations in present value

terms), target rating AA for a 10-year instrument.................................................................................. 69

Table 55: Indicative credit guarantee (as a percentage of total debt obligations in present value

terms), target rating AA+ for a 10-year instrument ............................................................................... 69

Table 56: Annual bank loan rates ......................................................................................................... 71

Table 57: Share of savings accruing to issuer in case of partial/ full credit guarantee ......................... 71

Table 58: Indicative guarantee fee – full guarantee product (Scenario 1) ............................................ 72

Table 59: Indicative guarantee fee as a percentage of principal - partial guarantee product (Scenario

2) ........................................................................................................................................................... 73

Table 60: Approach to calculate loss to BGFI due to expected losses ................................................ 73

Table 61: Expected loss to BGFI – full guarantee ................................................................................ 73

[x]

Table 62: Expected loss to BGFI – partial credit guarantee ................................................................. 74

Table 63: Approach to compare global-scale and national scale-ratings ............................................. 75

Table 64: S&P - Global average cumulative default rates by rating modifier 1981-2013 (%) .............. 61

Table 65: S&P - Marginal default rates by rating modifier (%).............................................................. 62

[xi]

Flow charts and diagrams

Figure 1: CGIF guarantee structure ...................................................................................................... 25

Figure 2: EIB guarantee structure ......................................................................................................... 27

Figure 3: KODIT guarantee structure .................................................................................................... 29

Figure 4: Basic structure of P-CBO guarantee ..................................................................................... 30

Figure 5: Capital funds / leverage ratio of KODIT ................................................................................. 32

Figure 6: GuarantCo structure .............................................................................................................. 33

Figure 7: Structure of GuarantCo’s guarantee for a local-currency bond ............................................. 35

Figure 8: GuarantCo’s commitments by country (USD million) ............................................................ 36

Figure 9: GuarantCo’s commitments by starting year .......................................................................... 37

Figure 10: Danajamin’s guarantee structure ......................................................................................... 40

Figure 11: Guarantee structure for IIGF ................................................................................................ 43

Figure 12: Guarantee portfolio of AGM & MAC Assured Guaranty Ltd (March 31, 2014) ................... 45

Figure 13: Guarantee portfolio of Assured Guaranty Ltd (March 31, 2014) ......................................... 45

Figure 14: Gross issues outstanding of MBIA as on March 31, 2014 .................................................. 47

Figure 15: Outstanding guarantees of Ambac ...................................................................................... 48

Figure 16: Typical guarantee structure ................................................................................................. 50

Chart 17: Illustration for a partial-guarantee product of BGFI (a) ......................................................... 52

Chart 18: Illustration of a partial-guarantee product of BGFI (b) ........................................................... 52

Chart 19: Illustration of a partial guarantee product of BGFI (c) ........................................................... 53

Chart 20: Illustration of guarantee structure for debt instrument with and without acceleration clause

(INR crore)............................................................................................................................................. 54

Chart 21: Illustration of a rolling guarantee (INR crore) ........................................................................ 55

Chart 22: Illustration of a structure without reset (INR crore) ............................................................... 56

Chart 23: Illustration of a structure with a reset feature (INR crore) ..................................................... 57

Figure 24: Methodology for estimating the quantum of credit enhancement ........................................ 64

Figure 25: 10-year bond spreads data for AA, A and BBB category bonds in India............................. 70

Figure 26: CRISIL's approach to translating global-scale ratings ......................................................... 76


[1] TA-8279 IND: Preparing the Bond Guarantee Fund for India Interim Report

1. Executive Summary

A recap – There is tremendous potential and need for BGFI

BGFI is a credit-enhancement mechanism for long-term bonds issued by companies with a credit

rating of less than AA category. Using it, bonds can be upgraded to make them attractive to investors.

CRISIL Infrastructure Advisory (CRIS) has been appointed by the Asian Development Bank (ADB) to

structure BGFI by assessing its business case, preparing its framework and conducting road shows

and seminars. A kick-off meeting with a steering committee1 was held on June 2, 2014, after which an

inception report was submitted to it on June 23, 2014. The business case assessment for BGFI

followed, the report of which was submitted to the steering committee. This revealed a massive

potential for BGFI in India: the long-term financing gap for companies rated below the AA category

was INR 90 lakh crore over the next 10 years. Moreover, an unanimous endorsement of the need of

such a facility was received from the market participants.

This report details the second of a three-stage engagement, which includes a study of the global

guarantee facilities, and, more importantly, the development of a detailed business plan and financial

feasibility of the standalone BGFI

BGFI will deal mainly in non-exotic plain vanilla guarantee business -> full- and partial-

guarantee products, with an emphasis on the former

A full-guarantee product is simple to understand, guaranteeing all obligations of an underlying bond to

the investor. But it would be prudent to have a mix of full- and partial-guarantee products, with greater

focus on the former so as to promote acceptability in the market.

The features and eligibility criteria for such products are in Table 1 below:

Table 1: Features and eligibility criteria for BGFI

Parameters Full guarantee Partial guarantee

Features2 With/without acceleration

With/without acceleration

First loss

With/without reset

Automatic top-up provision

Rolling structure

Acceleration: Bond holders call back instrument upon default, with borrower liable to fulfill all unpaid obligations immediately, so guarantor will have to cover all obligations subject to a maximum quantum

First loss: All initial defaults, subject to a maximum guarantee cover, will be paid by guarantor

Reset: Allows the guarantee to be reset every period, to provide optimal level of guarantee

Top-up: Replenishing utilised guarantee portion with future cash flows

Rolling: Rolling tenure fixed. Guarantee can be utilised anytime during the tenure

Eligibility criteria

1 The steering committee comprises representatives from the Department of Financial Services (DFS) as the chairperson, from

the Department of Economic Affairs (DEA) as observer, and from the Insurance Regulatory and Development Authority (IRDA), the Pension Fund and Regulatory Development Authority (PFRDA), the Reserve Bank of India (RBI) and the Securities and Exchange Board of India (SEBI). 2 Explained in Chapter 4



Parameters Full guarantee Partial guarantee

Sectors and entities Infrastructure & real estate: Limited to SPVs & project companies

Others: All entities

Project stage SPVs: Post commissioning

Others: Not applicable

Minimum source rating Investment-grade

Target rating AAA Start with AA category (AA-, AA, AA+)

Tenure of guarantee 10-15 years

Extent of guarantee cover 100% Maximum 60% of total debt obligations

Source: CRISIL Infrastructure Advisory

Pricing or guarantee fee for credit enhancement is critical for marketability and sustainability

Pricing or guarantee fee will be a percentage of the savings accruing to the borrower from a higher

credit rating achieved through credit enhancement and the consequent better market access. The fee

will cover expected losses on default. For example, if BGFI, upon credit enhancing a bond, is

expected to incur an average loss of 2% on default during the tenure of the bond, it must charge at

least a 2% guarantee fee.

A scenario analysis for bonds with different ratings shows the average losses that BGFI would incur

on bonds with BBB- and BBB ratings are significantly higher. Meaning, while BGFI could demand a

larger share of savings accruing to the borrower, it wouldn’t be enough to cover expected losses.

Therefore, it is recommended that BGFI should transact in instruments rated BBB+ and above – the

market potential is still substantial at INR 15 lakh crores.

In addition to expected losses, BGFI will also incur unexpected losses and administrative costs.

However, Indian banking institutions typically do not set their pricing to cover expected losses,

unexpected losses, and administrative costs, so BGFI will need to follow the market’s normative

pricing to be competitive.

BGFI presents a significant value proposition for all stakeholders

Through this facility borrowers can enjoy cost savings to the tune of 50-100 bps. It is also seen that

the facility will free up existing bank funds of approximately INR 1 lakh crore. Most importantly, by

allowing insurance/pension funds to be released for a larger investment play BGFI could rejuvenate

the bond market in India. However, before insurance/pension funds can really take advantage of

BGFI’s partially guaranteed bonds, insurance regulations would require revisions. Similarly, pension

funds may need to broaden their investment criteria.

The facility is projected to be profitable, PAT margin of ~57%

The facility exhibits around 8% ROE in the base case, with fully funded capital. On assumption of a

50% callable capital the ROE increases to ~10%. The ROEs are in line with what is exhibited by

similar institutions in India – public sector banks 8%, private sector banks 14%, and guarantee

facilities in other countries – Danajamin 8% (Malaysia), IIGF 5% (Indonesia) and Monoline insurers

13% (United States).

The key is to institutionalize this facility now – strong ownership and independent

management critical for its success



The Government of India, should be the key driver in terms of providing support and taking

the vision of this developmental mechanism forward

The model envisages INR 10,000 crore of capital in the first 5 years.

It is suggested that a majority of capital is brought upfront through infusion by public sector

and private sector institutions – banks and other financial institutions.

The remaining portion could be supported by the Government – this could be through

infusion from the budget (Union Budget 2014-15 has earmarked an amount of INR 50,000

crore for development of Pooled Municipal Debt Obligation Facility) or through provision of

long-term deeply subordinated debt. BGFI could tap into this / such other budget provisions

for government’s share.

The afore-mentioned support should be on concessional terms. The capital should be

structured on funded and callable basis

BGFI should ideally be run as a corporate and commercial entity - private sector model, with

a strong independent Board

Keeping these in mind, the next stage of the study would focus on developing an optimal and

viable structure for BGFI

Develop an optimal and viable structure for BGFI

Develop its legal structure

Develop a corporate governance structure and environmental and social safeguards

framework



2. Introduction

The Ministry of Finance (MoF) had requested the Asian Development Bank (ADB) to examine the

modalities for the establishment of the Bond Guarantee Fund for India (BGFI), and assess its viability

so as to deepen India’s rupee-based corporate bond market and meet the financing requirements of

its infrastructure and other sectors.

CRISIL Infrastructure Advisory (CRIS) has been tasked to conceive and structure BGFI, with a

technical assistance grant from ADB. The project is under the aegis of the MoF.

The MoF has constituted a steering committee to oversee the progress of this project, which

comprises representatives from the Department of Financial Services (DFS; as chairperson), the

Department of Economic Affairs (DEA; as observer), the Insurance Regulatory and Development

Authority (IRDA), the Pension Fund Regulatory and Development Authority (PFRDA), the Reserve

Bank of India (RBI), and the Securities and Exchange Board of India (SEBI).

The first meeting of the steering committee was held on June 2, 2014, where CRIS presented the

objectives of the study and the detailed work programme including the approach and methodology,

work plan and a schedule of deliverables. An inception report detailing this was submitted on June 23,

2014.

The second meeting of the steering committee was held on August 11, 2014, where CRIS submitted

a detailed market assessment report. This discussed the long-term debt funding requirements of

India’s infrastructure and other sectors along with the issues and concerns in accessing traditional

sources of finance. It also highlighted alternate sources of financing available such as the corporate

bond market, and the relevance of credit enhancement in a milieu of limited issuances. The report

established the need for BGFI, contained initial thoughts on key issues, and details of discussions on

these with the stakeholders.

This interim report, presents a detailed business plan for BGFI, including an assessment of its

financial viability. It is advised that this report be read after the inception report and the market

assessment report.

2.1 Structure of the report

The report is structured as follows:

Chapter 1 Provides an introduction and puts forth the structure of the report.

Chapter 2 Defines the optimal structure for the products that can be offered by BGFI.

Chapter 3 Summarises the detailed financial analysis undertaken.

Several annexures also form part of this report which captures the following – detailed overview of

similar global facilities, overview of standard credit guarantee products, detailed analysis undertaken

to estimate quantum of guarantee cover/credit enhancement and pricing, translating global ratings

scale to domestic scale, snapshot of default rates and comments on the possible legal structure that

BGFI could assume.



3. Defining the optimal structure for BGFI

3.1 Eligibility criteria

Credit enhancement products of BGFI are envisaged to deepen India’s corporate bond market by

guaranteeing bonds issued by entities in infrastructure and other sectors.

Since bonds are very different from bank loans, laying down appropriate eligibility criteria spelling out

the most-suited entities and sectors, along with size and tenure limits, is vital to ensure successful

guarantee operations. Hence, the following eligibility criteria have been laid down for BGFI credit

guarantee products.

3.1.1 Sectors and entities

Though entities in infrastructure and other sectors can avail of these products, the type of entities

eligible in a certain sector may differ on account of features specific to that sector.

In infrastructure and real estate, credit guarantee schemes will aim to develop specific assets rather

than merely support corporate balance sheets. This will require the eligible assets to be ring-fenced –

wherein the costs and revenues of these assets are segregated from other operations of the

promoters. Hence, only SPVs or discrete project companies will be eligible for guarantee products in

these sectors. This will also engender transparency in utilisation of the guarantee fund and

discourage misuse.

In other sectors, all Indian corporate entities in the form of SPVs, project companies, private

companies, privatised companies, parastatals or public corporations and municipalities shall be

eligible for credit guarantees.

All projects and corporate entities that BGFI guarantees must adhere to local and international

environmental, social and health safeguards as per ADB guidelines.

3.1.2 Project stage (applicable only to SPVs)

Infrastructure projects (including commercial real estate) are typically complex, capital-intensive and

have long gestation periods. Projects at pre-commissioning (COD) stage tend to experience

additional risks compared with projects which have been commissioned. These include risks related

to execution, land acquisition and financial closure, etc, which investors in the bond market are

generally unwilling to take on in the pre-commissioning stage.

Given that the credit guarantee schemes of BGFI will provide guarantees to SPVs and not directly to

promoter companies in infrastructure and real estate sectors, it is recommended that the products be

made available for financing projects that have already been commissioned. Such projects face lesser

risk and are therefore more attractive to investors.

3.1.3 Minimum source rating

Quality of the projects and entities selected for the products is crucial to the success of BGFI. It is

essential for the entity to have a robust and bankable financial structure, reflected by sufficiently high

cash flows in the long run. Further, BGFI as an establishment should have adequate capacity to



assess the economic prospects of diverse infrastructure and non-infrastructure projects to select the

most viable options.

Guaranteeing entities with ratings lower than investment grade (BBB) might make the project

economics unviable/ unattractive to stakeholders since these require greater guarantee cover to

reach the target rating. Hence, entities rated investment grade and above should be selected for the

BGFI products in both infrastructure and non-infrastructure sectors. It might also be prudent for BGFI

to start by guaranteeing higher rated bonds, to promote acceptability.

3.1.4 Target rating

Prospective investors in this scheme are long-term investors such as insurance companies, pension

funds and Employee Provident Fund (mutual funds could also be a target for bond issuances with

tenure less than five years). These investors are mandated by respective regulators, including IRDA

and PFRDA, to invest in papers rated AA and above (they can invest in A+ rated paper subject to

approvals).

Therefore, bond issuances need to be credit enhanced to at least AA to attract investors in case of

the partial guarantee product, though in the medium to long term, credit enhancement of bond

issuances to rating less than AA, i.e A category, could be explored subject to appetite of investors

such as mutual funds.

The full guarantee product, as mentioned earlier, will help the issuer get a rating equivalent to the

rating of the guarantor, i.e. BGFI, which is expected to be AAA, the highest credit rating in the national

scale.

3.1.5 Type of guarantee product

The guarantee concept/ business being nascent in India, a full guarantee product would provide a

higher level of comfort to investors compared with a partial guarantee – an opinion corroborated

during stakeholder interactions held earlier. It might therefore be prudent for BGFI to offer a higher

percentage of full guarantee products, at least initially, for greater acceptability.

3.1.6 Tenure of guarantee

Infrastructure projects are characterised by long gestation periods and large capital investments. The

long maturities of such project loans include the initial construction period and the economic life of the

asset/ underlying concession period (usually 25-30 years). However, the bond market in India

predominantly has issues with tenure greater than 15 years.

Recent regulations by the RBI allow banks to provide longer term financing, for up to 25 years. But

whether bond investors would have an appetite for longer term bonds, with average tenure greater

than the 10-15 years seen today, remains to be seen. Hence, it is recommended that the maximum

tenure for BGFI products be 15 years for all sectors.



3.2 Quantum of guarantee and pricing

3.2.1 Summary of quantum of guarantee analysis

Annexure 3 gives a detailed account of the approach towards estimation of the quantum of guarantee

and the consequent results.

A full credit guarantee product will guarantee all debt obligations, including interest payments of the

bond issued. Hence, its quantum will be 100% of bond value.

In case of a partial credit guarantee, the quantum of guarantee to be provided is dependent on the

target and source rating of the bond issued. An indicative quantum required for enhancing the rating

of instrument to AA for different sectors is given below.

Table 2: Indicative credit guarantee (as a percentage of total debt obligations in present value terms), target rating AA for a 10-year instrument

Transport Power Manufacturing Services

Source rating AA AA AA AA

BBB- 27% 43% 62% 58%

BBB 24% 38% 55% 51%

BBB+ 21% 33% 48% 45%

A- 18% 28% 40% 38%

A 16% 25% 36% 33%

A+ 9% 14% 20% 19%


3.2.2 Summary of pricing analysis – cost savings and expected loss to

BGFI

Annexure 3 also analyses the approach towards pricing of the guarantee or calculation of guarantee

fee.

The tables below give a comparison between guarantee fee (derived from cost savings analysis) and

the average loss due to expected loss. These have been represented as a percentage of guaranteed

amount.

Table 3: Comparison between expected loss to BGFI and guarantee as a proportion of cost savings for a 10-year instrument - percentage of guaranteed amount

Loss Fees Loss Fees Loss Fees Loss Fees


Target Rating

AAA

BBB- 4.12% 2.75% 6.70% 2.75% 9.74% 2.75% 9.13% 2.75%

BBB 2.80% 2.75% 4.39% 2.75% 6.39% 2.75% 5.99% 2.75%

BBB+ 2.00% 2.75% 3.14% 2.75% 4.56% 2.75% 4.28% 2.75%




A- 1.21% 1.34% 1.90% 1.34% 2.77% 1.34% 2.60% 1.34%

A 0.92% 0.99% 1.44% 0.99% 2.10% 0.99% 1.97% 0.99%

A+ 0.47% 0.89% 0.73% 0.89% 1.07% 0.89% 1.00% 0.89%



Target Rating

AA+

BBB- 14.76% 7.75% 14.79% 7.75% 14.77% 7.75% 14.79% 7.75%

BBB 10.57% 8.59% 10.56% 8.59% 10.56% 8.59% 10.57% 8.59%

BBB+ 8.39% 9.77% 8.42% 9.77% 8.43% 9.77% 8.43% 9.77%

A- 5.74% 5.14% 6.42% 5.14% 5.76% 5.14% 5.75% 5.14%

A 4.67% 4.07% 4.66% 4.07% 4.67% 4.07% 4.68% 4.07%

A+ 3.00% 5.80% 2.90% 5.80% 2.94% 5.80% 2.94% 5.80%



Target Rating

AA

BBB- 14.93% 6.92% 14.92% 6.92% 14.92% 6.92% 14.94% 6.92%

BBB 10.79% 7.79% 10.80% 7.79% 10.81% 7.79% 10.80% 7.79%

BBB+ 8.57% 8.90% 8.55% 8.90% 8.57% 8.90% 8.56% 8.90%

A- 5.83% 4.50% 5.96% 4.50% 5.96% 4.50% 5.97% 4.50%

A 4.69% 3.43% 4.82% 3.43% 4.80% 3.43% 4.79% 3.43%

A+ 3.00% 5.00% 3.07% 5.00% 3.04% 5.00% 3.02% 5.00%

Source: CRISIL Infrastructure Advisory. All values in present value terms.

The above table shows the expected losses to BGFI if it guarantees 10-year instruments across rating

categories. As can be seen, the average expected loss to BGFI would be high across the board,

especially for the lower source ratings BBB- and BBB. It must also be noted that the probability of

defaults increases for longer tenure instruments towards the latter half.

The losses are especially pronounced for the manufacturing and services sectors, where we see that

the fees BGFI could potentially charge as a percentage of savings would not be enough to cover the

expected losses. It, therefore, doesn’t make business sense for BGFI to cater to 10-year instruments

in these sectors. BGFI could explore shorter tenure instruments, i.e 3-7 years.

For the infrastructure sector, again, BBB- and BBB ratings would not make business sense, though

BBB+ could be considered. Please note that it is assumed that a much larger share of savings could



be charged as guarantee fee by BGFI. The business portfolio developed for BGFI in the next chapter

largely considered instruments in the A category and some with BBB+ rating.

It should be understood that the economics of these rating combinations, even for BBB- and BBB

source rating, would improve significantly if BGFI is able to realise higher recoveries than estimated.

3.2.2.1 Unexpected losses

Apart from the expected losses mentioned in the earlier section, BGFI could face unexpected losses.

Typically, the capital set aside (capital adequacy) factors in the expected losses. Consider a scenario

where there is a complete run on the capital due to defaults happening as expected; any loss over

and above this would be the unexpected loss, which should ideally be charged into the guarantee fee.

However, considering the already high expected loss percentages seen in the previous analysis, the

unexpected losses have been ignored so that the pricing is consistent with other Indian banking

institutions, which rarely price to cover expected loss, unexpected loss, and administrative costs.

3.2.2.2 Administration costs

Administrative costs such as rent, salaries and utility costs, etc, can also be passed on to the issuer

through guarantee fee. As mentioned in the previous section, to be consistent and competitive with

the pricing practices of other Indian banking institutions, BGFI’s pricing would only cover expected

losses. If the Indian banking sector moves to risk-based pricing, BGFI would have the opportunity to

increase its pricing to include expected losses and administrative costs.

3.3 Summary of credit guarantee products

3.3.1 Full credit guarantee

Table 4: Summary of full credit guarantee product

Parameter Summary

Features With/ without acceleration provision

Eligibility criteria

Sectors & entities Infrastructure & Real Estate – limited to SPVs & project companies

Other Sectors – all entities

Project stage SPVs – post commissioning

Others – not applicable

Minimum source rating Investment grade (greater than BBB+)

Maximum tenure 10-15 years

Target Rating AAA

Quantum & pricing

Quantum 100%



3.3.2 Partial credit guarantee

Table 5: Summary of partial credit guarantee product

Parameter

Features*

First loss

Without reset feature

With top-up provision

With rolling structure

Eligibility Criteria

Sectors & entities Infrastructure & Real Estate – limited to SPVs & project companies

Other sectors – all entities

Project stage Project SPVs – post commissioning

Others – not applicable

Minimum source rating Investment grade (greater than BBB+)

Maximum tenure 10-15 years

Quantum & pricing

Maximum quantum 60% of total debt obligations

* Details of these features can be found in Annexure 2



4. Business plan and financial analysis

The following approach has been adopted for financial analysis of BGFI:


4.1 Bond portfolio for BGFI

4.1.1 Sector split and portfolio build-up

As analysed in the earlier market assessment report, significant investment is expected in

infrastructure and other sectors in the next 10 years. A major portion of this will come from private

players and public sector utilities. Major sub-sectors which would contribute to these investments

include transport (road, port, airport, metro), power, manufacturing and services (including real

estate).

An indicative portfolio has been created for BGFI for the next 10 years, comprising a combination of

these sectors. Specifications/ characteristics of individual projects within these sectors are given

below.

Table 6: Specifications of typical projects

Sector Typical size of project

Unit cost (INR crore)

Project cost (INR crore)

Debt:Equity Debt (INR crore)

Bond that can be issued (INR crore)^

Infrastructure

Power 1000 MW 4.5/MW 4,500 70:30 3,150 1,890

Road 100 km 10/km 1000 80:20 800 800

Port 5 mio* 100/mio 500 80:20 400 400

Airport 12 mn pax** 400/mn pax 4,800 70:30 3,360 2,016

Metro 75 km 150/km 11,250 70:30 7,875 4,725

Non-infrastructure

Manufacturing 250 60:40 150 150

Services 100 60:40 60 60

Source: CRISIL Infrastructure Advisory, *-million tonnes, **-persons, ^-For debt component greater than INR 1,000 crore for

infrastructure it is assumed that bonds amounting to 60% of outstanding debt shall be refinanced

It is assumed that for large infrastructure projects with outstanding debt greater than INR 1,000 crore,

approximately 60% of this debt (or ~45% of project cost) could be refinanced through bond issuances.

Considering the quantum of credit enhancement which could be given by BGFI (~9-43% for



infrastructure sector as calculated in Chapter 3), the exposure of BGFI at a project level would be ~6-

20% of project cost, which is acceptable.

It is assumed that BGFI would need to first establish credibility and acceptability amongst investors.

Moreover, considering the nascent nature of the bond market, a gradual build-up is assumed in

BGFI’s portfolio. Moreover, as is currently common among Indian banking institutions, profitability is

premised on continued growth because the market is yet to adopt risk-based pricing.

Table 7: Portfolio build-up - number of fresh bond issues across years

1 2 3 4 5 6 7 8 9 10 Total

2 3 8 11 17 20 22 24 26 30 163


In terms of sector-wise split of bond issuances, it is assumed that the infrastructure sector would

contribute more than 90% of BGFI’s portfolio by value. The portfolio was designed this way since the

infrastructure sector would provide more comfort to investors due to the following features –

operational projects and therefore greater certainty of cash flows, SPV structure and therefore ring-

fenced operations, and higher recovery rates over non-infrastructure sector.

Table 8: Cumulative bond issues and sector split over 10 years

Sector Cumulative number of issues

Percentage of volume of issues

Percentage of value of issues

Power 24 ~15% 39%

Road/Port 106 ~65% 55%

Airport/Metro 1 ~1% 3%

Manufacturing 19 ~12% 2%

Services 13 ~8% 1%

Total 163 100% 100%


4.1.2 Source credit rating and associated cost of borrowing

The table below indicates the assumed source rating for various instruments in the portfolio.

Table 9: Source rating by instrument

Source rating (as per CRISIL scale)

Source rating (as per S&P scale)

Cost of Borrowing (%)

A- BB+ 11.48%

A BBB- 11.23%

BBB+ BB 12.50%




4.1.3 Target credit rating and associated cost of issuance of bond

The table below indicates the assumed target rating for various instruments in the portfolio.

Table 10: Source rating by instrument

Target rating (as per CRISIL scale)

Target rating (as per S&P scale)

Instrument

All-inclusive Cost of issuance for a 10-year instrument (%)*

AA A- PCG 10.13%

AA+ A PCG 9.87%

AAA A+ FG 9.25%

Source: CRISIL Infrastructure Advisory; *includes transaction cost of bond issues, processing fee for guarantee instrument and

risk premium (only in case of PCG)

As discussed in Chapter 3, the issuance of a bond backed by either partial or full guarantee would

attract an additional 50 basis points in transaction cost (over the tenure of the instrument). Moreover,

the issuance of a PCG-backed bond would attract 50 basis points as risk premium demanded by

investors. The cost of issuance in the table above includes the additional basis points.

4.2 Bond repayments and debt obligations

Repayment of bond principal could take two forms – bullet and amortising. Since the bullet form of

repayment would entail a high negative cost of carry, principal repayment has been assumed to be on

an equally amortising basis. For specific projects, repayment could also have a ballooning profile to

further reduce negative carry. Total debt obligations would include principal as well as interest

repayments. This is shown in the table below.

Table 11: Debt obligations across 10 years (INR crore)

1 2 3 4 5 6 7 8 9 10

274 1,002 2,746 4,800 6,510 9,035 12,953 15,716 18,030 21,324


4.3 Default rates, recovery rates and guarantee outflows

4.3.1 Default calculations

Cumulative default rates as given in the table below were used in the model.

Table 12: Cumulative default rates used to calculate default values

Rating 1 2 3 4 5 6 7 8 9 10

AAA 0.06% 0.11% 0.24% 0.40% 0.53% 0.64% 0.78% 0.93% 1.10% 1.29%

AA+ 0.07% 0.17% 0.27% 0.42% 0.57% 0.78% 0.99% 1.18% 1.42% 1.69%

AA 0.08% 0.20% 0.34% 0.48% 0.69% 0.91% 1.20% 1.42% 1.59% 1.74%



Rating 1 2 3 4 5 6 7 8 9 10

AA- 0.14% 0.38% 0.66% 0.95% 1.27% 1.62% 1.86% 2.12% 2.43% 2.73%

A+ 0.20% 0.51% 0.80% 1.24% 1.69% 2.12% 2.55% 2.98% 3.44% 3.91%

A 0.32% 0.97% 1.73% 2.63% 3.51% 4.30% 5.03% 5.71% 6.27% 6.84%

A- 0.43% 1.25% 2.35% 3.47% 4.56% 5.66% 6.61% 7.31% 8.19% 9.05%

BBB+ 0.68% 2.08% 4.07% 5.92% 7.66% 9.12% 10.45% 11.54% 12.54% 13.39%

BBB 1.13% 3.47% 5.91% 8.26% 10.33% 12.40% 14.10% 15.75% 17.15% 18.33%

BBB- 2.31% 6.26% 10.15% 13.52% 16.05% 18.02% 19.82% 21.43% 22.84% 24.25%

Source: S&P, CRISIL Ratings

4.3.2 Recovery calculations

It is assumed that a portion of the defaulted obligations would be recovered immediately (recovery

percentages as given in Chapter 3). The recovery waterfall is such that only once the investors are

fully paid (to the extent that the guarantee is invoked by the investors and honoured by BGFI) will any

recovery flow to BGFI. In the current model, the default rates assumed are such that the cumulative

default values never exceed the outstanding guarantee cover. Therefore, only a part of the guarantee

is utilised to compensate investors. In such a scenario, recovery directly flows to BGFI.

Table 13: Recovery calculations (INR crore)

1 2 3 4 5 6 7 8 9 10

0 3 11 27 52 89 142 209 281 344


4.3.3 Guarantee outflows

The guarantee potential was calculated by multiplying the percentage of credit enhancement arrived

at and the initial debt obligation for each instrument.

As the PCG will be a “first-loss guarantee”, the defaulted debt obligations will be covered by the

guarantees up to the maximum guarantee cover provided. In case of full guarantee, all the debt

obligations will be covered. Therefore, the guarantee outflows in each year would be equal to the

defaulted debt obligations (provided this does not exceed the opening balance of guarantee cover in

that year). The guarantee outflow calculations are given below.

Table 14: Guarantee outflow (INR crore)

1 2 3 4 5 6 7 8 9 10

1 6 20 49 93 157 253 373 498 605


The guarantee cover at the start of each year is reduced to account for the guarantee outflows for the

previous year (as well as to account for recoveries and write-offs). The guarantee portfolio

outstanding in each year is given in the table below.



Table 15: Guarantee portfolio outstanding (INR crore)

1 2 3 4 5

1,778 6,202 14,549 23,473 29,171

6 7 8 9 10

42,411 61,088 76,987 93,443 119,568


4.4 Equity calculations

4.4.1 Preliminary thoughts on legal structure of BGFI

As suggested in the market assessment report, BGFI can be set up either as an NBFC under the RBI

or as a bond insurance company under the IRDA. A preliminary legal assessment of both these

structures is given in Annexure 6. Based on this assessment, and the fact that the RBI has recently

come out with a circular for constitution of mortgage guarantee companies (which are similar to BGFI

in terms of products offered), it is felt that the NBFC route could be preferred to start with.

4.4.2 Capital adequacy

BGFI needs to be capitalised such that it attains a AAA credit rating. As we are aware, there are no

extant regulations governing the functioning of such a guarantee company. Therefore, we try and

draw some learning from existing entities in the financial sector today. Considering BGFI will be

catering mainly to the infrastructure sector, infrastructure financing companies, or IFCs, would be a

good set of entities to study. IFCs typically maintain a capital adequacy of 20% of funded exposure

(RBI mandates IFCs maintain 15%).

The table below gives the capital adequacy ratio maintained by some IFCs.

Table 16: Capital adequacy of NBFCs

NBFC Capital Adequacy

Power Finance Corporation Ltd. (PFC) 20.10%

Rural Electrification Corporation Ltd. (REC) 19.35%

Infrastructure Development Finance Company Ltd. (IDFC) 23.90%

L&T Infrastructure Finance Company Ltd. 16.97%

Industrial Finance Corporation of India Ltd. (IFCI) 21.30%

SREI Infrastructure Finance Ltd. (SREI) 21.98%

Source: CRISIL Infrastructure Advisory, As per latest estimates available in 2014

Since BGFI will be providing full guarantees and partial credit guarantees, which are non-funded

exposures, it becomes important to assess the capital adequacy requirements in that context.



Table 17: Funded v/s non-funded exposure capital adequacy requirements

Funded exposure First-loss non-funded exposure for PCG

Loan exposure (INR)

Default Rate

Default (INR)

Guaranteed Exposure

Default (INR) Default Exposure as percentage of guaranteed exposure

100 2% 2

50 2 (on principal of INR 100)

4%


6.66%


20%


Let us say the funded exposure of an IFC is INR 100 and the expected default rate is 2%, i.e. INR 2.

IFCs typically maintain a capital adequacy ratio of 20%, which is INR 2 in this case. This would also

be the case if BGFI provides only full guarantee (100% of debt obligations).

However, in case of a PCG, BGFI takes the first loss, i.e. if the total debt obligation outstanding of a

bond is INR 100 and BGFI guarantees 50%, then the non-funded exposure of BGFI will be equivalent

to INR 50, and any loss of up to INR 50 will be absorbed by BGFI first. So, since the default of INR 2

will remain the same, it will be on a lower base of INR 50, i.e. 4% - a multiple of 2 over the 2%

witnessed earlier for a funded exposure of an IFC. Hence, the capital adequacy required in this case

(a non-funded exposure) will also be a multiple of 2 on 20% maintained for a funded exposure.

However, applying a linear multiple is not rational, i.e. the capital adequacy cannot double to 40%.

Suppose BGFI guarantees a first loss of only 10%, i.e. INR 10. Considering a default of INR 2, this will

imply a 20% loss - a multiple of 10 over the initial 2% loss. If the same multiple (10 times) is applied to

the base capital adequacy of 20%, it will yield an absurdly high capital adequacy of 200% of the

guaranteed amount, which is illogical. Hence, ideally, the multiple declines as the non-funded

exposure (proportion of guaranteed amount) decreases. Hence, in the first scenario, where the

guaranteed amount is 50%, the multiple could be around 1.75 times, which leads to a capital

adequacy of around 35% of the guaranteed amount. Let’s assume that this would be the capital

adequacy for BGFI if it is providing only partial credit guarantees.

Since BGFI will be providing a portfolio of full guarantee and partial guarantee products (60:40 as per

the base case scenario), we assume that the capital adequacy requirement will also be in line with

these weights, i.e 60% of 20% plus 40% of 35% = 25%, which has been assumed as the capital

adequacy that has to be maintained by BGFI. The number seems appropriate considering the levels

maintained by IFCs today. Moreover, recent regulations on mortgage guarantee companies (MGC) by

the RBI mandate such entities to maintain a capital adequacy at 10%. The only operational MGC

today is rated AA by ICRA. Even from this aspect, the 25% assumed for BGFI seems appropriate.

Considering the nascence of this guarantee concept, rating agencies in India might require higher

capitalisation in the beginning. Therefore, it is assumed that the capital levels would start at almost

double – a good 75% in the first year, gradually decreasing to 25% in the 7th year of operations.



4.5 Income calculations

Income for BGFI would essentially comprise the guarantee fee charged each year and the upfront

processing fee. Treasury income has also been considered from investment in liquid instruments – in

this case government securities.

4.5.1 Guarantee fee

In section 4.2.3, an analysis on potential savings to the bond issuer was undertaken, and thereby an

estimate of average guarantee fee that could be charged by BGFI was arrived at. A subsequent

analysis, using Monte Carlo simulation3, was then undertaken to arrive at an average loss that BGFI

would incur for guaranteeing various portfolios. The basis for undertaking such an analysis was to

arrive at an optimal guarantee fee that BGFI should charge to tap into the savings accrued to the

issuer as well as cover the average losses that BGFI would incur on guaranteeing the portfolio/

instrument.

The following table gives the total guarantee income accruing to BGFI over 10 years.

Table 18: Guarantee fee income (INR crore)

1 2 3 4 5 6 7 8 9 10

14 53 130 230 318 523 842 1,060 1,293 1,595


4.5.2 Processing fee income

Processing fee is a one-time upfront fee charged at the time of the issue of the bond. For the base

case, the processing fee that could be charged by BGFI is taken as 0.2%. This percentage is applied

on the total guarantee cover provided by BGFI for each of the instrument in its portfolio in the first year

of issue.

Table 19: Processing fee income (INR crore)

1 2 3 4 5 6 7 8 9 10

4 9 17 18 11 27 38 32 33 53


4.5.3 Treasury Income

It is assumed that BGFI will deploy its cash reserves in low-yielding bank deposits/ liquid instruments.

For this purpose, an 8.5% return is assumed on the average cash and bank balances of BGFI in a

given year.

3 Monte Carlo simulation is a problem solving technique used to approximate certain outcomes by running multiple trial runs. In

this particular case for each source-target rating combination and sector, thousands of simulations were undertaken to model the bond obligations, defaults, guarantee outflows and finally the average loss on the portfolio that BGFI would incur.



Table 20: Treasury Income (INR crore)

1 2 3 4 5 6 7 8 9 10

- 56 197 410 660 854 1,072 1,418 1,786 2,130


4.6 Expenditure calculations

4.6.1 Upfront set up cost

A set up cost of INR 5 crore has been assumed, apart from a fixed asset cost of INR 7.5 crore for first

year4, or cost of employees (which has been factored in as part of operating cost).

4.6.2 Operating cost

Operating cost pertaining to administration, employees and other costs shall be incurred by BGFI

every year. A comparison of the costs of comparable entities such as CGIF and monoline insurers

shows that the former has an operating cost of around 3% of the outstanding guarantee portfolio,

while the latter, being established entities, have barely 0.04-0.1%.

A decreasing operating cost has been assumed starting at 0.70% of the outstanding guarantee

portfolio in Year 1 and decreasing to 0.09% of the portfolio in Year 10.

Table 21: Operating cost (INR crore)

1 2 3 4 5 6 7 8 9 10

12 35 65 84 84 97 112 113 110 112


4.7 Financial statements, base case

4.7.1 Profit & loss statement

Table 22: Profit & loss statement, base case (INR crore)

Particulars 1 2 3 4 5 6 7 8 9 10

Guarantee fee

14 53 130 230 318 523 842 1,060 1,293 1,595

Processing fee

4 9 17 18 11 27 38 32 33 53

Treasury income

- 56 197 410 660 854 1,072 1,418 1,786 2,130

4 As of 2013, CGIF had fixed assets of USD 770,000 or around INR 4.6 crore.



Particulars 1 2 3 4 5 6 7 8 9 10

Total income 17 118 345 658 990 1,403 1,952 2,511 3,112 3,777

Upfront set-up cost

5 - - - - - - - - -

Operating cost

12 35 65 84 84 97 112 113 110 112

Loss due to guarantee

0 2 9 22 41 69 110 163 217 262

Total expenses

18 37 74 106 124 166 222 277 327 374

EBITDA -0 81 271 552 865 1,237 1,729 2,234 2,785 3,403

Depreciation 0.5 0.5 0.5 0.4 0.4 0.4 0.3 0.3 0.3 0.3

PBT -1 80 270 551 865 1,237 1,729 2,234 2,785 3,403

Tax 0 26 89 182 285 408 571 737 919 1,123

PAT -0.5 54 181 369 579 829 1,159 1,497 1,866 2,280

PAT margin -3% 46% 53% 56% 59% 59% 59% 60% 60% 60%


4.7.2 Balance sheet

Table 23: Balance sheet, base case (INR crore)

Particulars 1 2 3 4 5 6 7 8 9 10

Liabilities

Equity 1,334 3,271 6,095 8,617 9,699 12,345 15,856 18,334 20,582 24,833

Reserves (0.5) 53 234 603 1,183 2,012 3,170 4,667 6,533 8,813

Total liabilities

1,333 3,324 6,329 9,220 10,882 14,357 19,026 23,001 27,115 33,646

Assets

Gross block - 8 8 8 8 8 8 8 8 8

Capital WIP 8 - - - - - - - - -

Add. depreciation

1 1 1 2 2 3 3 3 4 4

Net block 7 6 6 6 5 5 5 4 4 4

Cash balance

1,326 3,318 6,323 9,215 10,877 14,352 19,021 22,997 27,111 33,642

Total assets 1,333 3,324 6,329 9,220 10,882 14,357 19,026 23,001 27,115 33,646




4.7.3 Cash flow statement

Table 24: Cash flow statement, base case (INR crore)

Particulars 1 2 3 4 5 6 7 8 9 10

Cash from operating activities

PAT (0.5) 54 181 369 579 829 1,159 1,497 1,866 2,280

Add: Depreciation 0.5 0.5 0.5 0.4 0.4 0.4 0.3 0.3 0.3 0.3

Cash from investing activities

Less: Capex (8)

Cash from financing activities

Add: quity Drawdown 1,334 1,937 2,824 2,522 1,082 2,646 3,511 2,478 2,248 4,251

Total cash 1,334 1,937 2,824 2,522 1,082 2,646 3,511 2,478 2,248 4,251


4.7.4 Return on equity analysis

Table 25: Return on equity, base case

Particulars 1 2 3 4 5 6 7 8 9 10

ROE 0% 2.3% 3.7% 4.8% 5.8% 6.6% 6.9% 7.1% 7.4% 7.5%


4.7.5 Key takeaways

BGFI is a profitable proposition exhibiting margins of around 57%. The facility exhibits ROE of around

7.5% in the base case. Currently, the business model assumes that the capital is fully funded. Option

of contingent equity, or callable capital, could be explored. Such an instrument would reduce the

funded equity requirements and thereby increase the returns by a few percentage points. Callable

capital is a common instance amongst multilateral banks.

Table 26: Return on equity, with 50% callable capital

Particulars 1 2 3 4 5 6 7 8 9 10

ROE 0% 3.0% 4.8% 6.0% 7.1% 8.6% 9.6% 9.7% 10.1% 10.3%


The ROEs exhibited are in line with similar institutions in India and abroad.



Table 27: ROEs exhibited by similar institutions in India and abroad

Entity ROE

Public Sector Banks in India 9%

Private Sector Banks in India 14%

Danajamin 8%

IIGF 5%

Monoline Insurers 13%


A facility such as BGFI should be seen as a developmental mechanism – a mechanism which would

be key to reinvigorate the bond markets in India and bring in overall positive impact on the financial

sector in the country

Would allow low-rated entities to access cheaper sources of finance in the bond market, cost

savings of 50-100 bps

Would free up banking capital, which can be used to fund new projects – The BGFI model

envisages that more than ~ INR 1 lakh crore of existing bank finance would be re-financed

through bond issuances

The key would be to institutionalize such a facility as soon as possible



5. Next steps

The next part of the engagement will include the following tasks:

Developing an optimal and viable structure for BGFI

Developing its legal structure

Developing a corporate governance structure and environmental and social safeguards

framework

The output will be part of the Final Report which will be submitted by January 2014. Thereafter, a

presentation on it will be made to the steering committee.

5.1 Initial thoughts

The Government of India, should be the key driver in terms of providing support and taking

the vision of this developmental mechanism forward

The model envisages INR 10,000 crore of capital in the first 5 years.

It is suggested that a majority of capital is brought upfront through infusion by public sector

and private sector institutions – banks and other financial institutions.

The remaining portion could be supported by the Government – this could be through infusion

from the budget (Union Budget 2014-15 has earmarked an amount of INR 50,000 crore for

development of Pooled Municipal Debt Obligation Facility) or through provision of long-term

deeply subordinated debt. BGFI could tap into this / such other budget provisions for

government’s share).

The afore-mentioned support should be on concessional terms. The capital should be

structured on funded and callable basis

BGFI should ideally be run as a corporate and commercial entity - private sector model, with

a strong independent Board

Keeping these in mind, the next stage of the report would focus on developing an optimal and

viable structure for BGFI.



6. Annexure 1 – Overview of international

guarantee facilities

This report begins with an overview of some global guarantee facilities (Table 44). It shows the

ownership, legal structure and operational model of these facilities. The objective is to glean

takeaways that can be incorporated when structuring BGFI.

Table 28: International guarantee facilities

Entity Description

Credit Guarantee and Investment Facility (CGIF)

Owned by ASEAN+3 countries and ADB (Capital = USD 700 million), provides various types of credit guarantees to entities in the ASEAN+3 region to access domestic capital markets.

European Investment Bank (EIB) Project Bond initiative

Under this initiative, the EIB provides eligible infrastructure projects (transport, energy and telecom in Europe) with credit enhancement in the form of a subordinated instrument to support senior project bonds issued by a project company, which, in turn, would lead to credit enhancement of the senior bonds.

Korea Credit Guarantee Fund (KODIT)

Korea Credit Guarantee Fund (KODIT) was founded in June 1976 by the Korea Credit Guarantee Fund Act in order to channel funds to small and medium-sized enterprises (SMEs) for financial or business transactions. Its main sources of capital are contributions from the government, financial institutions and enterprises.

GuarantCo

Sponsored by donors – DFID, SECO, DGIS, SIDA, World Bank, Irish Aid, AusAID, ADA and KfW. Provides risk mitigation instruments (credit guarantees as well as risk guarantees) for local debt issuance – loans and bonds for projects in Africa, Asia, Latin America Central America and Caribbean.

Fondo Nacional de Infraestructura or National Infrastructure Fund, Mexico

Administered by Mexico’s state-owned development bank (Banobras), it is an infrastructure fund that supports private-sector investments, and also provides guarantees.

Danajamin Nasional Berhad, Malaysia

Fully government-owned entity [Minister of Finance Incorporated (50%) and Credit Guarantee Corporation Malaysia Berhad (50%)] and AAA rated in the domestic scale provides full guarantees to Malaysian companies to access domestic capital markets.

Indonesia Infrastructure Guarantee Fund (IIGF)

Fully government-owned entity (Ministry of Finance). Provides risk guarantees for infrastructure projects in Indonesia.

Monoline insurers Monoline insurers, primarily in the US, provide guarantees to bonds in the form of credit wraps. After beginning life providing wraps for municipal bond



Entity Description

issues, they branched out to providing wraps for mortgage-backed securities and collaterised debt obligations.

6.1 Credit Guarantee & Investment Facility

6.1.1 Ownership

Credit Guarantee and Investment Facility (CGIF) is a multilateral facility that was established in

November 2010 by the ten members of the Association of Southeast Asian Nations (ASEAN) together

with the People's Republic of China (PRC), Japan and the Republic of Korea (ASEAN+3), and the

Asian Development Bank (ADB) to promote economic development, stability and resilience of

financial markets in the region.

CGIF has received total capital contributions of USD 700 million from the shareholders. The largest

shareholders of CGIF are PRC and Japan Bank for International Cooperation (JBIC) with 28.6% of

subscribed capital each, followed by ADB with 18.6% and Korea with 14.3 percent.

The authorised capital of USD 700 million is divided into 7,000 shares with a nominal value of USD

100,000 each.

Table 29: CGIF capital contributions

Contributors Contributions (USD million)

People’s Republic of China 200

Japan Bank for International Cooperation 200

Republic of Korea 100

ADB 130

Others 70

Total 700

Source: http://www.cgif-abmi.org/

Malaysian Rating operation Berhad (MARC) affirmed its credit rating of AAA/MARC-1 for CGIF with a

stable outlook in February 2014.

6.1.2 Legal structure

CGIF is structured as a trust fund of the ADB. It is ADB’s responsibility to hold in trust and manage all

CGIF funds and other properties in accordance with the provisions of CGIF’s Articles of Agreement,

which sets out establishment and operations guidelines.

CGIF’s governance and operational structure are independent of ADB, and Meeting of Contributors

(MoC) is its highest decision-making body. Under MoC, CGIF has its own board of directors,

internationally recruited management, and staff.

6.1.3 Business /operational model

CGIF offers both partial and full guarantee on bonds. These are irrevocable, unconditional

http://www.cgif-abmi.org/



commitments to pay the bondholders upon default by issuers through tenures. CGIF’s portfolio

consists of regional companies issuing bonds in their local currencies, with guaranteed principal and

interest repayments.

Figure 1: CGIF guarantee structure

Source: http://www.cgif-abmi.org/

6.1.3.1 Eligibility criteria

Companies and principal shareholders must be from ASEAN+3 countries

They should have a minimum local rating of BBB- (investment grade)

All projects must meet CGIF’s environment and social safeguards

Each bond issue can be of a maximum USD 140 million equivalent size

Bond tenures up to 10 years allowed

Some recent transactions:

Noble Group’s baht-denominated bond (April 2013): USD 96.34 million offering issued by SGX-

listed Noble Group has a tenure of 3 years and pays a coupon of 3.55%. It is guaranteed by the CGIF

and has a AAA rating from Fitch.

Medium-term note for PT BCA Finance (BCAF) (March 2013): CGIF fully guaranteed a three-year,

medium-term note priced at 8.20%. It was a USD 25 million issuance in the Indonesian local currency

bond market.

Senior unsecured guaranteed bonds for Kolao Holdings (August 2014): CGIF fully guaranteed a

60 million Singapore dollar, three-year bond in the Singapore local currency bond market. This has

been rated AAA by Fitch.

6.1.3.2 Overview of operations

CGIF completed its second year of guarantee operations in May 2014. As of end-2013, the facility

had closed two guarantee transactions with a total guarantee value of USD 125 million.

CGIF recorded its first year of guarantee fees in 2013, receiving USD 421,000 from two transactions.

It also recognised guarantee fee receivables of USD 1.18 million (present value of future receivables).



Revenue for 2013 was USD 8.13 million of which interest income amounted to USD 7.65 million, or

tantamount to 95% of total income. Administrative costs were 81% of total costs, depreciation 4% and

other provisions 13%.

Table 30: Financial highlights of CGIF

2013 2012 2011

Operating revenue (USD ’000) 8,132 8,009 7,538

Net profit (USD ’000) 2,718 4,109 5,851

Return on assets (%) 0.89 0.59 0.61

Return on equity (%) 0.38 0.59 0.89

Cost to income ratio (%) 64.3 48.7 17.1

Total assets (USD ’000) 714,673 714,696 687,567

Liquid assets/Total assets (%) 0.99 0.99 1.00

*Annualised

Source: CGIF and MARC

6.2 European Investment Bank Project Bond Initiative

6.2.1 Ownership

The Project Bond Initiative (PBI) is a risk-sharing instrument/guarantee mechanism created by the

European Commission (EC) and the European Investment Bank (EIB) to enable companies to issue

project bonds. The sectors are limited to trans-European transport and energy grids, and

telecommunication and broadband networks.

To assess long-term viability, a PBI pilot was set up with a budget of EUR 230 million (USD 300

million) to allow stakeholders to acquaint themselves with the instrument on the basis of successful

transactions. The EC is expected to provide EIB with adequate capital to credit-enhance project

bonds.


The pilot phase of the PBI was established by regulation 670/2012, published in L 204/1, the official

journal of the EC, on July 31, 2012. This regulation lays down guidelines under which the pilot phase

shall unfold. As per this, the EC is responsible for defining the project eligibility framework, while the

EIB is responsible for managing and implementing the initiative.

A mechanism also exists to share the credit-enhancement risks between the EIB and EC. Once a

project is deemed eligible, the EIB appraises it through due diligence and financial analysis in the

structuring phase, prices the subordinated loan or guarantee, and keeps monitoring. The EIB can also

act as the controlling creditor, subject to inter-creditor principles established.


EIB provides credit enhancement in the form of a subordinated instrument (either a loan or contingent

facility) to support senior debt issued by a project company (which is a public-private partnership



established to build, finance and operate an infrastructure project). The Project Bond Credit

Enhancement (PBCE) facility is available through the project lifecycle, including the construction

phase.

Figure 2: EIB guarantee structure

Source: European Commission website

http://ec.europa.eu/economy_finance/financial_operations/investment/europe_2020/index_en.htm

An improvement in credit rating depends on how the debt of the project company is separated into

senior and subordinated tranches. EIB provides a subordinated tranche, or a facility to enhance the

credit quality of senior bonds. PBCE provides credit-enhancing subordinated tranche in two ways:

1. Through funded PBCE, where a loan is given to the project company at the outset.

2. Through unfunded PBCE, in the form of a contingent credit line that can be drawn by the

special purpose entity if the cash flows generated by the project are not sufficient to ensure

debt service to the senior bonds, or to cover construction cost overruns.

The proposed mechanism of the initiative will:

Have a maximum size of individual transactions of up to the lower of EUR 200 million or 20%

of credit enhanced senior debt;

Be based on EIB’s capacity to deliver subordinated loans, not necessarily its rating;

Only target EIB’s core business, i.e. infrastructure financing – transport and energy, as well as

broadband and ICT projects;

Only support robust projects which benefit from the EIB’s proven due diligence, valuation and

pricing methodologies.

PBCE targets bonds of A- investment-grade quality to enable purchases by institutional investors.

Moreover, in the pilot phase, which started on November 7, 2012, only projects which are expected to

reach financial close before December 31, 2016, are eligible to avail of this facility.

6.2.3.1 Products & transactions

Castor Energy Storage Plant in Spain: EIB supported the issue of a EUR 1.4 billion (USD 1.8

billion) bond due in December 2034. With a coupon of 5.76% at a spread of 100 basis points over

Spanish government securities, the bonds financed the construction and operation of underground

gas storage and associated facilities off the Mediterranean coast in northern Spain. There were 30

investors with insurers and pension funds taking over 60% of the issue, and the remainder by

agencies, fund managers and banks (around 4%). The bond was issued by Watercraft Capital, an

SPV based in Luxembourg, which on-lent the proceeds to the project company to refinance its

outstanding shorter-dated loans for the construction of the gas storage facility.

Greater Gabbard Offshore Transmission Link: A GBP 305 million (USD 506 million) public bond,

which pays a fixed coupon of 4.14% and matures on November 29, 2032, was issued for the project,




which attained financial closure in November 2013. Moody’s assigned a provisional A3 rating to the

bond with a stable outlook, reflecting the credit enhancement provided by PBI.

Belgian Highway A11 – EIB provided EUR 115 million (USD 150 million) guarantee. The credit

enhancement received a three-notch lift to A3 (Moody’s). The A11 project is the first greenfield project

under PBI.


An interim report released in December 2013 showed nine energy and transport projects eligible for

PBCE have been approved by the EIB board.

Table 31: Some approved projects with PBCE option (in EUR million)

Sector (Energy/transport)

Sub-sector Country Expected size of credit enhancement facility (EUR million)

Transport Motorway Germany 120

Transport Motorway UK 200

Transport Motorway Slovakia 200

Energy Grid connection to several offshore wind farms

UK 150

Energy Gas storage Italy 200

Energy Grid connections to several offshore wind farms

Germany 170

Source: European Commission Website -


Based on a positive interim evaluation in 2013 and subject to final evaluation of the pilot phase in

2015, PBI is expected to be fully rolled out within the Connecting Europe Facility of the European

Union, forming part of the 2014-2020 Multiannual Financial Framework.

6.3 Korea Credit Guarantee Fund

6.3.1 Ownership

Korea Credit Guarantee Fund (KODIT) was founded in June 1976 by the Korea Credit Guarantee

Fund Act in order to channel funds to small and medium enterprises (SMEs) for financial or business

transactions.

The main sources of capital for KODIT are contributions from government, financial institutions and

enterprises. The contribution from the government is subject to change every year based on its credit

guarantee policy. Contributions from all banks in Korea equal to a value of 0.3% of total loans, is

mandated by The Korea Credit Guarantee Fund Act.





KODIT is incorporated as a public finance institution under the Korea Credit Guarantee Fund Act and

supervised by the Financial Services Commission (FSC), the apex regulator. It is inspected by the

National Assembly, and audited by the Board of Audit and Inspection. It operates as a non-profit

special legal entity backed by the government.

The internal operations of KODIT are controlled by a Board of Policy, which consists of

representatives from the FSC, the Ministry of Strategy and Finance, the Small and Medium Business

Administration, Bank of Korea, Industrial Bank of Korea and other financial institutions, apart from The

Federation of Enterprises in Korea.

6.3.3 Business/operational model

KODIT’s services largely focus on partial credit guarantees.

Figure 3: KODIT guarantee structure

Source: KODIT website - http://www.kodit.co.kr

Full guarantees are only for corporate bonds, commercial bills, execution of contracts and tax

payments since financial institutions abstain from such investments. In each case, the portion of the

risk shared by KODIT depends on the credit standing of the guaranteed company.

Similarly, KODIT’s guarantee fee also varies according to the credit rating of the issuer company, but

is within the 0.5-3.0% range of outstanding guarantees. Large enterprises are charged 0.5% more

than SMEs with a similar rating.

6.3.3.1 Products and transactions

6.3.3.1.1 General credit guarantee service

Table 32: General credit guarantee services of KODIT

Product Type of guarantee Creditors

Guarantee for Indirect Financing

Bank loans, payment guarantees, NBFC loans, leases, acceptance of trade bills

Banks, NBFCs, leasing companies

http://www.kodit.co.kr/



Product Type of guarantee Creditors

Guarantee for direct financing* Bond issuance (corporate bonds)

Bond holders

Guarantee for credit transaction between enterprises

Guarantee for commercial bills, guarantee for execution of contract, guarantee for transaction liabilities

Government and public institutions, note holders, enterprises

Guarantee for tax payment Guarantee for tax and duty Tax office

* In Korea, SME funding from capital markets does not happen currently. KODIT doesn’t have outstanding guarantees in direct

financing since 2008. However, SMEs are able to access the primary market with the help of KODIT’s P-CBO Guarantee,

explained subsequently.

Source: KODIT website http://www.kodit.co.kr

6.3.3.1.2 Primary collateralised bond obligation (P-CBO) / Collateralised loan obligation

(CLO) guarantees

P-CBO enables SMEs to get better access to the primary bond market. Its features are similar to an

asset-backed security where the obligation is backed by a variety of corporate bonds with differing

risks and coupon rates. Repayment is thus guaranteed indirectly and leads to more efficient financing.

This was introduced by KODIT in July 2000 in the aftermath of the currency crisis. The P-CBO

guarantee helped restore the confidence of the Korean bond market by allowing companies to access

finance from it at a lower cost and enabling institutional investors to purchase low-risk bonds.

Here’s how a P-CBO guarantee is given:

A securities company (originator) first pools corporate bonds or loans working with KODIT.

Then a special purpose company (SPC) is set up to purchase these pooled assets. The SPC

securitises them by issuing CBOs in two tranches: senior and subordinated.

To upgrade the rating of the senior CBOs to AAA, KODIT provides a guarantee. The senior

CBOs are sold to investors, while the subordinated CBOs are repurchased by the issuing

companies at a price based on their credit ratings.

Figure 4: Basic structure of P-CBO guarantee

Source: KODIT website - http://www.kodit.co.kr

The P-CBO guarantees became one of the main businesses of KODIT through amendments to the

Credit Guarantee Fund Act. Consequently, SMEs were able to directly access the capital market with





corporate bonds worth USD 1,486 million in 2013. Table 49 below shows the performance of the P-

CBO guarantee in the last 6 years.

Table 33: Performance of P-CBO guarantee over the years

2008 2009 2010 2011 2012 2013

New P-CBO guarantee supplies (USD million)

962 1,622 951 696 1,056 1,486

Source: KODIT annual reports

6.3.3.1.3 Electronic credit guarantee service

The electronic credit guarantee service has been developed by KODIT to promote safer e-commerce

transactions. The e-commerce guarantee system is based on an online network linking KODIT,

financial institutions, enterprises and e-commerce marketplaces. This is provided in two forms:

1. E-commerce loan guarantee: This is a service to guarantee loans that the buyers would get

from financial institutions in order to facilitate the purchasing process under e-commerce

contracts.

2. E-commerce liabilities guarantee: This is a service to guarantee the liabilities, which SMEs

have to perform on the credit transaction.

Total outstanding guarantees by KODIT amounted to KRW 40,581 billion (USD 40 billion) in 2013, out

of which, outstanding guarantee for bank loans constituted over 80%.

Table 34: Outstanding general guarantees by type in KRW billion

Type 2008 2009 2010 2011 2012 2013

Guarantee for bank loans 25,584 32,311 32,881 32,653 33,397 34,635

Guarantee for payment warrant of banks

285 276 294 291 284 276

Guarantee for corporate bonds

0 0 0 0 0 0

Guarantee for tax and duty

0.3 2.4 4 4 4 2

Guarantee for commercial bills

1,572 1,627 1,445 1,357 1,320 1,251

Guarantee for loans from non-banking financial institutions

1,521 1,900 1,963 1,961 2,057 2,159

Guarantee for leases 0 0 0 0 0 0

Guarantee for execution of contract

327 799 552 383 351 294

Guarantee for transaction liabilities

1,097 1,349 1,633 1,782 1,868 1,965

Guarantee for acceptance of trade bills

0 0 0 0 0 0



Type 2008 2009 2010 2011 2012 2013

Guarantee for secured loans

0.4 983 9 0 0 0

Total amount 30,387 39,249 38,781 38,431 39,281 40,581



Since inception, KODIT has played a significant role in helping SMEs secure funds in Korea, backed

by its collateral obligations and credit guarantees. The fund is said to have contributed immensely to

reviving the country’s economy after financial crises and instability.

Capital with KODIT totalled KRW 5,961 billion (USD 5.9 billion) in 2013, with KRW 50 billion (USD 49

million) for general guarantees and KRW 20 billion for market-stabilising guarantees from the

government, and KRW 888.3 billion (USD 875 billion) from financial institutions and corporations. Its

capital adequacy ratio stood at 12.56% in 2013.

However, KODIT mostly guarantees bank loans to SMEs and does not engender issuances in the

corporate bond market.

Figure 5: Capital funds / leverage ratio of KODIT

(Unit: KRW billion)


47,333

45,487 45,449

47,436

6,508

6,627 6,329

5,961

7.3

6.9

7.2

8

6.2

6.4

6.6

6.8

7

7.2

7.4

7.6

7.8

8

8.2

40,000

42,000

44,000

46,000

48,000

50,000

52,000

54,000

56,000

2010 2011 2012 2013

Outstanding Guarantees Capital Funds Leverage Ratio (%)



6.4 GuarantCo

6.4.1 Ownership

GuarantCo is a specialty insurance company established in 2006 and incorporated in Mauritius. It is

indirectly owned by development agencies of four nations:

1. Department for International Development (DIFD; 65.6% of total equity), UK (AA1 stable)

2. Directorate-General for International Cooperation (DGIS; 16.6%), Netherlands (AAA stable)

3. State Secretariat for Economic Affairs (SECO), Switzerland (AAA stable)

4. Swedish International Development Cooperation Agency (SIDA), Sweden (AAA stable)

They act through Private Infrastructure Development Group (PIDG) and Nederlandse Financierings

(FMO), which are private sector financing companies.

GuarantCo’s equity is provided by the four development agencies, which increased GuarantCo’s

equity to USD 205 million in 2013, and committed more so as to increase the capital to USD 300

million by the end of 2014.

GuarantCo encourages private-sector involvement in financing of infrastructure projects, and helps

develop local-currency capital markets in low-income countries. It also provides credit enhancements

to lenders and investors in developing countries, and guarantees issuances in Africa, Asia, Latin

America, Central America and Caribbean.

Moody's Investors Service assigned a local currency issuer rating of A1 to GuarantCo in June 2014

while Fitch rated the entity AA- in May 2014.


The entity is owned by PIDG members through the PIDG trust and, in the case of DGIS, through

FMO. The management of GuarantCo is outsourced to Frontier Markets Fund Managers Limited

(FMFML), a private fund manager. FMFML is responsible for advising GuarantCo on transactions,

including origination, structuring and negotiating documentation, due diligence and monitoring of

GuarantCo’s portfolio.

GuarantCo had also signed an agreement for counter-guarantees in 2009, which was extended in

2012, whereby all its guarantees are backed by the German developmental bank KfW (rated AAA),

Dutch development bank FMO (rated AAA) and Barclays (rated Aa3-/ A-/ A).

The structure of GuarantCo is depicted in the figure below.

Figure 6: GuarantCo structure

Source: http://www.guarantco.com/about-us/guarantcos-structure.aspx

http://www.guarantco.com/about-us/guarantcos-structure.aspx




GuarantCo is permitted to provide full guarantee cover, but typically the financing covered is up to

three times the guarantee. The cover for a transaction is limited to a minimum USD 5 million and a

maximum USD 30 million in local currency equivalent. GuarantCo can cover debt and subordinated or

mezzanine financing, but not equity, and the maximum tenure is 15 years.


6.4.3.1.1 Guarantee products

Partial credit guarantees: A partial credit guarantee will cover non-payment of a “part” of the debt

service regardless of the reason for default. GuarantCo can provide partial credit guarantees and can

cover, on exceptional occasions, up to 100% of principal repayment (if it is a regulatory requirement).

Partial risk guarantees: A partial risk guarantee can cover specific risks such as of completion and

liquidity. GuarantCo can provide partial risk guarantees with the exception of political risk guarantees.

Political risk guarantees: Political risk guarantee covers certain political risk events such as

currency inconvertibility, currency transfer restrictions, war and civil disturbance and

expropriation. GuarantCo does not provide a specific political risk guarantee but political risk events

can be included in the more general cover provided by a partial credit guarantee.

Tenure extension guarantees: Tenure is one of the key limitations for project developers seeking

local currency financing. But guaranteeing certain risks can help extend the tenure match the

financing requirements. The fees and margin payable to the local bank and GuarantCo would be

structured in order to provide an incentive for the local bank to continue with the financing till the full

tenure of the project.

On-demand guarantees: The beneficiary may call a demand -- or on-demand -- guarantee from the

guarantor even if there is no proof of default. In contrast, a conditional guarantee requires milestones

to be met before payment is made by the guarantor, which would include obtaining full and final

judgment of default, acceleration or realisation of the security. GuarantCo can provide either but it is

recognised that in a majority of cases, an on-demand guarantee will be required. For an on-demand

guarantee, GuarantCo will need a waiting period before payment and should be able to inform the

borrower that a claim has been made under the guarantee.

6.4.3.1.2 Guarantee structure examples

Local currency loan: Such a structure will involve a partial credit guarantee provided by GuarantCo

to the beneficiary or the debt issuer. This will cover default on the loan or facility agreement between

the beneficiary and the borrower up to the limit of the guarantee. Typically, a recourse agreement is

made between the borrower and GuarantCo to cover the latter’s fees, as well as the rights and

obligations of the borrower, GuarantCo, and the beneficiary following a call under the guarantee.

Local currency bond: This will be similar to a guarantee to a local currency loan except that the

beneficiary here will be the trustee acting on behalf of note holders.

http://www.guarantco.com/case-studies/types-of-guarantee/political-risk-guarantees.aspx



Figure 7: Structure of GuarantCo’s guarantee for a local-currency bond

Source: http://www.guarantco.com/about-us/guarantcos-structure.aspx


1. INR 940 million partial credit guarantee for lending to several slum redevelopment projects

in Mumbai, India.

Date: November 2009

Country: India

GuarantCo guaranteed amount: INR 940 million (out of initial financing of INR 3.9 bn)

Total project cost: INR 55 billion

Benefit of guarantee: This 5-year project financing facility provides Ackruti City Limited (since

renamed to Hubtown Ltd) with early-stage funding that was not available from other sources.

Typical slums illegally exist on municipal land and banks approached by slum dwellers and

developers find it difficult to accept it as a security pledge. The process to acquire ownership

rights of land is lengthy and fraught with risk. And ambiguity in local land regulations adds to the

discomfort of banks. Frontier Markets Fund Managers Limited played an active role in structuring

the financing, while GuarantCo’s partial credit guarantee enabled the loan to be increased by over

40%.

2. USD 20 million equivalent partial credit guarantee for long-term senior debt raised by Au

Financiers

Date: March 2013

Country: India

GuarantCo guaranteed amount: Up to the INR equivalent of USD 20 million

Total transaction size: Up to the INR equivalent of USD 60 million

Benefit of guarantee: Au Financiers (AuF), besides rapidly growing its core business of

transportation services financing, is diversifying into financing housing and small businesses

(linked to the transportation sector). Its debt requirements have grown with its portfolio, and a

good track record and portfolio quality have meant it has been able to raise financing from Indian

banks and financial institutions when required. To ensure that funding keep pace with growth,

AuF needed to diversify its sources and the facility provided by GuarantCo, FMO and the CDC

Group do just that -- offer stable long-term funds to help it continue offering affordable loans to

small entrepreneurs.

3. THB 425m credit guarantee of long term senior loan provided by ICBC Thailand

http://www.guarantco.com/about-us/guarantcos-structure.aspx



Date: April 2014

Country: Thailand

GuarantCo guarantee amount: THB 425m (USD 13.5 million)

Benefit of guarantee: Thai Biogas Energy Company won contracts to build and operate two

biogas plants in south Thailand. However, its debt requirements were too small for the project

finance departments of local banks, and too complex for their corporate banking departments.

GuarantCo’s assistance was crucial, and enabled Thai Biogas to raise long-term, affordable

financing for the plants, and even expand into poorer neighbouring countries. This expansion got

another boost through a viability gap funding grant from the PIDG Technical Assistance Facility.


GuarantCo has committed over USD 290 Million since inception in 2006, and has the largest footprint

in south Asia and Africa. In 2013, it issued five guarantees totalling USD 60.4 million for projects in

energy, transport and telecommunications, making it the maximum number of transactions signed in a

year by GuarantCo.

Figure 8: GuarantCo’s commitments by country (USD million)

Source: PIDG annual report, 2013



Figure 9: GuarantCo’s commitments by starting year

Source: PIDG annual report, 2013

In terms of capitalisation, GuarantCo is strong with a capital adequacy ratio of 30% as on March 31,

2013. However, its profitability has been weak in recent years because of a low interest-rate

environment and fairly high fixed costs.

The main components of GuarantCo’s revenues in 2013 were guarantee fee revenue (85%) and

finance income (15%), while the costs predominantly were professional and administrative expenses

(64%) and provision in respect of guarantees and doubtful debts (34%).

Table 35: Financial highlights of GuarantCo

2013 2012

Operating profit (USD ’000) (3,747) (1,240)

Return on assets (%) (0.036) (0.011)

Return on equity (%) (0.034) (0.010)

Total assets (USD ’000) 193,741 139,819

Total equity (USD ’000) 180,612 130,144

Total liabilities (USD ’000) 13,129 9,674

Source: GuarantCo website and public disclosures

12 28

54.3

109.3

169.3

201.3

230.3

290.7

60.4

0

50

100

150

200

250

300

350

400

2006 2007 2008 2009 2010 2011 2012 2013

Cumulative Investment in 2013



6.5 FONADIN or National Infrastructure Fund, Mexico

6.5.1 Ownership

FONADIN was created in 2008 as a coordination tool of the Mexican government for the development

of infrastructure. Administered by Banobras, Mexico’s state-owned development bank, it supports

private sector investments in infrastructure including through guarantees.

The National Infrastructure Fund was established with money from the trust to Support Rescue

Highway Concession (FARAC) and Infrastructure Investment Fund (FINFRA).

The sectors it supports are communications, transport, water, environment and tourism. It also

participates in planning, financing, designing, construction and transfer of infrastructure projects

where there is private sector participation, where there is social impact, and where profitable.


FONADIN is under the jurisdiction of the Ministry of Finance of Mexico, whose investment unit

approves projects, but it does not have a team of specialists to offer financial guarantees. It works

mainly in toll roads, waste and water projects, and sector specialists handle support offered by

FONADIN, including financial guarantees.



FONADIN offers two facilities to support PPPs:

1. Non-recoverable instruments, where contributions are targeted to study viability and

subsidies for investment projects

2. Recoverable instruments, where risk capital contributions, subordinated debt and

guarantees are housed and meant for investment projects

The financial guarantees offered by FONADIN are:

a. First loss: Assuming first loss and carrying out first expenditure from the guarantee to

cover debt service payment, before spending on any other guarantee.

b. Pari passu: Providing guarantee proportionate to the insufficiency of funds and as

agreed with lenders or guarantors.

c. Final payment: Be the last party to disburse from this guarantee, upon insufficiency of

project funds, after honouring other guarantees.

d. Mixture: Be a combination of First loss and Pari passu.

However, it does not offer full-wrap guarantees, only partial ones and that too limited to 50% of the

guaranteed obligation.

FONADIN also offers performance (covering management) and political risk guarantees. The

management-risk guarantee covers part of a project’s construction risk, up to 15% of the budget.

Some guarantees also cover the initial project operations, till inflows reach 40% of projected income.




FONADIN does not have any placed guarantees. On the other hand, the products of BANOBRAS

(such as timely payment guarantees, guarantees for service rendering projects) are more favourably

placed. While BANOBRAS guarantees investments that are rated investment-grade, FONADIN

focuses on projects rated lower.

The reason why FONADIN does not have placed guarantees may be because it doesn’t have the

specialists, product knowledge and organisational procedures for them. Also, the projects FONADIN

guarantees bear higher risk, being rated below investment grade.

6.6 Danajamin Nasional Berhad

6.6.1 Ownership

Danajamin Nasional Berhad is Malaysia’s first and only provider of financial guarantee. It was

established in May 2009 to catalyse the Malaysian bond -- or sukuk -- market, and guarantees

issuances. Danajamin is equally owned by the Ministry of Finance and the Credit Guarantee

Corporation Malaysia Berhad, which, in turn, is majority owned by Bank Negara Malaysia. Danajamin

had total assets of RM1.9 billion and shareholder equity of RM1.2 billion as on December 31, 2013. It

is rated AAA by both RAM Rating Services Bhd and Malaysia Rating Corporation.


Danajamin is licensed as an insurance company pursuant to the Insurance Act, 1996, and subject to

the regulatory purview of Bank Negara Malaysia as per the country’s Financial Services Act, 2013.

There are strict corporate governance and prudential norms to ensure its long-term commercial

sustainability. The management of Danajamin reports to an independent board of directors

comprising private sector professionals with extensive experience in the financial sector.

6.6.3 Business/operational model

Danajamin provides credit enhancement through financial guarantees to bonds rated higher than

investment grade, which means they get automatically upgraded to the highest AAA (fg) rating. This

makes it very attractive to investors, who are assured of repayment of principal and up to one coupon

on behalf of the issuer if there is a default. The premium is based on the standalone credit rating and

risk of each issue. The higher the standalone rating, the lower is the premium -- and vice versa.



Figure 10: Danajamin’s guarantee structure

Source: Danajamin Nasional Berhad website - http://www.danajamin.com/

Full guarantees comprise a major portion of Danajamin’s portfolio. It also collaborates with banks to

provide credit enhancement s through co-guarantees and by fronting bank-guaranteed bonds.


Great Realty Sdn Bhd (May 2014): Danajamin, in collaboration with CIMB Bank Berhad, offered a

guarantee of USD 9.5 million (out of a total guarantee facility of USD 54 million) for Great Realty Sdn

Bhd for up to 15 years.

KMCOB Capital Berhad (December 2013): Danajamin, along with OCBC Bank (Malaysia) Berhad,

Standard Chartered Bank Malaysia Berhad and Hong Leong Investment Bank Berhad guaranteed

KMCOB’s serial bonds of up to USD 100 million with a tenure of five years . KMCOB is an SPV set up

for issuing debt securities for Scomi’s oilfield services business. Of this, bonds worth USD 95 million

have been issued till date.

Premier Merchandise Sdn Bhd (June 2013): Danajamin provided a 50% guarantee to USD 100

million debt notes of this investment holding company. The notes were rated AAA (fg) by Malaysia

Rating Corporation.

NUR Power Sdn Bhd (June 2012): Danajamin, along with Maybank Islamic Berhad, fully guaranteed

USD 158 million, 15-year bonds of this investment holding company which has subsidiaries

generating, distributing and selling electricity. The full amount of guarantee facility has been issued.

Ranhill Powertron II Sdn Bhd: Danjamin partially guaranteed USD 216 million of 18-year Islamic

medium-term notes used by Ranhill and rated AAAIS (fg) by the Malaysian Rating Corporation


As of August 2014, Danajamin had a total guarantee facility of USD 2.2 billion, amount issued at USD

2.1 billion and total outstanding guarantees at USD 1.8 billion. Around USD 150 million in

guarantee/insurance premium fees were recognised as receivables, equating to 8.4% of the

guarantee portfolio.

Till date, Danajamin has fully guaranteed over 120 instruments, most of it in 2011. Its portfolio is

dominated by the retail, manufacturing and real estate sectors, which constitute over 40% of the

guaranteed amount.

http://www.danajamin.com/



Table 36: Number of instruments guaranteed by Danajamin Nasional Berhad

2010 2011 2012 2013 2014 (Till September)

10 51 31 26 5

Source: http://www.danajamin.com/

In 2013, Danajamin co-guaranteed 11 issues and assumed on average 37% of the risk of the total

financing amount. Its largest exposure was to the real estate sector at 22% of its insured portfolio,

followed by power and property development at 14% each.

Nearly two-thirds of revenues were from guarantee premiums earned and just over a third from

investment income. Costs were entirely about management expenses.

Table 53 offers the financial highlights of the last two years.

Table 37: Financial highlights of Danajamin Nasional Berhad

2013 2012

Net profit (USD million) 33 24

Return on assets (%) 5.4% 4.6%

Return on equity (%) 8.02% 6.7%

Total assets (USD million) 612 525

Total equity (USD million) 395 365

Total liabilities, excluding equity (USD million) 215 160

*Average conversion rate of Malaysian ringitt at 0.32 USD

Source: Danajamin Nasional Berhad annual report

6.7 Indonesia Infrastructure Guarantee Fund

6.7.1 Ownership

The Indonesia Infrastructure Guarantee Fund (IIGF) was established in 2009 as a state-owned

enterprise providing guarantees to infrastructure projects against project risks. These include

obligations of government contracting agencies such as ministries or regional governments in PPP

projects through a single-window mechanism. It has an authorised capital of USD 1 billion and paid-

up capital of USD 500 million.

IIGF’s capital consists of equity in the form of government equity participation funds allocated from the

state budget. In May 2013, it signed a loan agreement with the World Bank for USD 30 million as a

guarantee liquidity and technical assistance facility, but is yet to utilise the money. IIGF is also

expected to attract other multilateral development agencies for capital support and capacity building.

The objectives of IIGF are:

Encourage participation of the private sector in infrastructure projects in Indonesia

Improve the credit worthiness of infrastructure projects, and

Minimise exposure from contingent liabilities and shock to state budgets (ring fencing)



Fitch Ratings has assigned IIGF long-term foreign and local currency ratings of 'BBB-' and short-term

foreign currency rating of 'F3' with a stable outlook.


Being a 100% state-owned enterprise, IIGF is governed by five regulations:

1. Presidential Regulation 67/2005 and its amendments, Presidential Regulation 13/2010 and

Presidential Regulation 56/2011, which govern public private partnerships in Indonesia.

2. Presidential Regulation 78/2010, which govern regulation on infrastructure guarantees that

sets out the legal framework for government guarantees in PPP projects in Indonesia.

3. MOF Regulation 260/2010, which guides the implementation of infrastructure guarantees for

PPP. This supplements Presidential Regulation 78/2010.

4. Government Regulation 35/2009, on state capital injection for the establishment of a state-

owned enterprise which operates the infrastructure guarantee provisions.

5. Government Regulation 55/2011, on additional state capital injection into IIGF.

IIGF is also subject to company law under which it must produce periodical financial reports. In the

event its capital falls below a threshold, it can seek additional capital from the government.


IIGF provides guarantee to the private sector for infrastructure risks emanating from government

actions or inactions, which may lead to losses in PPP projects. These include:

Delays in processing permits and licences

Changes in rules and regulations, and

Breach of contract (revenue, pricing, other)


In line with its mandate, IIGF is a ‘single-window’ operation -- the only mechanism through which

guarantee proposals from contracting agencies can be assessed and structured. Once this is done,

IIGF will either issue the guarantee itself or if its capital is insufficient, request the government to cover

the risks that it can’t.

This helps IIGF and investors sign guarantee agreements where IIGF will provide payment to

investors in case the contracting agency defaults on its obligation under PPP covenants.

Simultaneously, IIGF and the contracting agency also enter into a recourse agreement where IIGF will

be reimbursed by the contracting agency for payments made to settle investor claims.



Figure 11: Guarantee structure for IIGF

Source: IIGFwebsite – http://www.iigf.co.id

Guarantees are also provided jointly with the Ministry of Finance in case of the following – when IIGF

falls short on capital, when there are differences with multilateral financial institutions, when there is

cooperation but limited facility or guarantee, or when recapitalisation of IIGF is pending. The

government of Indonesia provides this joint infrastructure guarantee with IIGF. A direct government

guarantee through the Ministry of Finance is also an alternative.

Private companies that benefit from the guarantee pay a one-time guarantee fee (based on project

value) and recurring fees (based on maximum exposure guarantee). The final fee also depends on

project risk profile, guarantee coverage and guarantee period. For indicative purposes, the current

one-time fee is 100 basis points, while recurring fee is around 50 to 100 basis points of the

guaranteed amount.

The Central Java Power Plant in Batang regency is the only project covered by IIGF with a guarantee

amount of ~ USD 26 million. Some projects in its pipeline include the Clean Water Supply (SPAM)

Bandar Lampung project, the Sumatra Selatan 9 & 10 Mine mouth Power Plant projects, and the

Umbulan SPAM project in East Java.


IIGF has also tied up with various international institutions such as the Multilateral Investment

Guarantee Agency, China Exim, Islamic Development Bank, and the Overseas Private Investment

Corporation to enhance its guarantee capacity.

IIGF recorded operating revenues of USD 33 million in 2013, which was entirely from investment-

related income and not guarantee fee.

Table 38: Financial highlights of IIGF

2013 2012

Operating revenue (USD million) 26 22

Net profit (USD million) 21 18

Net profit margin (%) 63.5 68.3

Return on equity (%) 4.96 5.47

http://www.iigf.co.id/



2013 2012

Total assets (USD million) 447 427

Total equity (USD million) 443 423

*Average conversion rate: 1 Indonesian rupiah = 0.000086 US Dollar

Source: IIGF annual report

6.8 Monoline insurers

Monoline insurance companies, also known as financial guarantors, provide guarantees to

bondholders or issuers through credit-enhancement wraps. They repay both principal and interest

repayments of a debt obligation if an issuer defaults.

Prior to the 2008 US monoline crisis, it was a successful business model, with nearly 50% of

municipal bonds being backed by a monoline in 2007. So much so, seven AAA-rated monoline

insurers accounted for nearly the entire municipal bond insurance business in the US. These bonds

were considered AAA quality with no need to even measure the underlying credit profiles because all

monolines were AAA-rated and none had ever defaulted.

However, post the crisis, in October 2008, only two of the seven managed to maintain their AAA rating

-- Financial Security Assurance, Inc (FSA) and Assured Guaranty Ltd (AGL), which is now AA rated.

In July 2009, AGL acquired FSA, thereby consolidating the two financial guarantors that successfully

navigated the global credit crisis.

6.8.1 Brief snapshot of key monoline insurers in the US

6.8.1.1 Assured Guaranty Ltd

Assured Guaranty Ltd is a Bermuda-based holding company incorporated in 2003 that provides credit

protection in the US and international markets through its subsidiaries.

The company applies its credit underwriting judgment, risk management skills and capital markets

experience to offer financial guaranty insurance that protects holders of debt, and other monetary

obligations, from defaults. Obligations insured by Assured Guaranty Ltd include bonds issued by state

or municipal governmental authorities in the US, notes issued to finance international infrastructure

projects and asset-backed securities issued by special purpose vehicles.

A monoline insurer markets its financial guaranty directly to issuers and underwriters of public finance

and structured finance securities as well as to investors. Assured Guaranty is present largely in the

US and the United Kingdom, but also guarantees obligations in Australia and western Europe.

Table 39: Ratings of Assured Guarantee Ltd over the years

Current (2013) 2009 2008 2007

IFS Rating A3/AA Aa3/AAA Aa2/AAA Aaa/AAA

Assured Guaranty Ltd operates through three group companies:

1. Assured Guaranty Municipal (AGM): Located and domiciled in New York, AGM was formed

in 1984 and commenced operations in 1985. AGM is the largest company in the Assured

Guaranty family based on net par outstanding and statutory claims-paying resources. But



AGM today insures only municipal bonds and infrastructure transactions. Prior to August

2008, it also covered structured finance transactions.

2. Municipal Assurance Corporation (MAC): MAC is located and domiciled in New York and

was formed in 2008. In 2013, it was capitalised using a USD 800 million contribution AGM

and AGC, which jointly own it. At inception, MAC assumed a USD 111 billion book of insured

US municipal businesses from AGM and AGC.

Figure 12: Guarantee portfolio of AGM & MAC Assured Guaranty Ltd (March 31, 2014)

Source: Assured Guaranty investor presentation, March 2014

3 Assured Guaranty Corporation (AGC) – AGC, which is located in New York and domiciled

in Maryland, was formed in 1985 and commenced operations in 1988. Like AGM, AGC

underwrites guarantees on both primary and secondary-market municipal bonds and

infrastructure transactions in the US. It also underwrites guarantees for structured finance

products, including asset-backed securities, in the US and some international markets.

Figure 13: Guarantee portfolio of Assured Guaranty Ltd (March 31, 2014)

Source: Assured Guaranty investor presentation, March 2014

5%

8%

54%

33%

Net par outstanding - USD 55.2 billion

Non-US Public Finance$2.8b

Non-US StructuredFinance $4.2b

US Public Finance $30.1b

US Structured Finance $18b



Municipal credit-enhancement products

Municipal bond insurance policies, which cover principal and interest for both new issues and

those trading in the secondary market

Surety policies, which replace cash-funded reserves in municipal bond transactions

Specialised financial guaranty policies such as swap sureties, which guarantee a municipal

issuer’s obligation under a swap agreement with a broker-dealer

Types of municipal bonds insured

General obligation bonds are full-faith, credit bonds issued by states, their political subdivisions and

municipalities, and are supported by the general obligation of the issuer to repay from available funds

and through a pledge to levy ad valorem taxes sufficient to provide full repayment.

Tax-backed bonds are obligations supported by an issuer from specific and discrete sources of

taxation. They include tax-backed revenue bonds, general fund obligations and lease revenue bonds.

Municipal utility bonds are obligations of all forms of municipal utilities, including electric, water and

sewer utilities and resource recovery revenue bonds. These may be organised in various forms,

including municipal enterprise systems, authorities or joint action agencies.

Transportation bonds include a wide variety of revenue-supported bonds such as those for airports,

ports, tunnels, municipal parking facilities, toll roads and toll bridges.

Healthcare bonds are obligations of healthcare facilities, including community-based hospitals and

systems, as well as of health maintenance organisations and long-term care facilities.

Higher education bonds are obligations secured by revenue collected by either public or private

secondary schools, colleges and universities. Such revenue can encompass all of an institution's

revenue, including tuition and fees, or in other cases, can be specifically restricted to certain auxiliary

sources of revenue.

Housing revenue bonds are obligations relating to both single and multi-family housing, issued by

states and localities, supported by cash flow and, in some cases, insurance from entities such as the

Federal Housing Administration.

Infrastructure bonds include obligations issued by a variety of entities engaged in the financing of

infrastructure projects such as roads, airports, ports, social infrastructure and other physical assets,

delivering essential services supported by long-term concession arrangements with a public sector

entity

Investor-owned utility bonds are obligations primarily backed by investor-owned utilities, first

mortgage bond obligations of for-profit electric or water utilities providing retail, industrial and

commercial service, and also include sale and leaseback obligation bonds supported by such entities.

Other public finance bonds include other debt issued, guaranteed or otherwise supported by

national or local governmental authorities in the US, as well as student loans, revenue bonds, and

obligations of some not-for-profit organisations.

6.8.1.2 Municipal Bond Insurance Association

A consortium of insurance companies (Aetna, Fireman's Fund, Travelers, Cigna, and Continental)

formed the Municipal Bond Insurance Association (MBIA) in 1973 to diversify their holdings in

municipal bonds. The company went public in 1987.

MBIA provides financial guarantees to the public finance market in the US through a wholly owned

subsidiary called National Public Finance Guarantee. It was independently capitalised and had USD

5.2 billion in claims-paying resources as on March 31, 2014. Standard & Poor’s had a Corp ‘AA-

/Stable/-- rating on the National Public Finance Guarantee in July 2014.



National Public Finance Guarantee’s portfolio consists of municipal bonds, including tax-exempt and

taxable indebtedness of US political subdivisions, as well as utility districts, airports, healthcare

institutions, higher educational facilities, student loan issuers, housing authorities and other similar

agencies and obligations issued by private entities that finance projects that serve a substantial public

purpose. Its total outstanding issues stood at USD 268 billion as on March 31, 2014.

Figure 14: Gross issues outstanding of MBIA as on March 31, 2014

Source: MBIA investor presentation, March 2014

6.8.1.3 Ambac

Ambac Financial Group, headquartered in New York, is a financial services holding company

incorporated in the state of Delaware on April 29, 1991. It operates in the financial guarantee and

financial services verticals.

Ambac was hit hard by the monoline insurer crisis in 2008 and filed for bankruptcy in 2010. However,

on May 1, 2013, it emerged from Chapter 11 protection issuing 45 million new common shares and

approximately 5 million new warrants to holders of allowed claims.

Ambac’s financial guarantee business is conducted through its primary operating subsidiary, Ambac

Assurance Corporation, and the wholly owned Ambac Assurance UK Limited. Ambac Assurance

derives financial guarantee revenues from premiums earned from insurance contracts, net investment

income, revenue from credit derivative transactions, net realised gains and losses from sale of

investment securities, and amendment and consent fees.

As on March 2014, it had USD 112.7 billion outstanding guarantees in the public finance segment.

General Obligations

36%

Municipal Utilities

18%

Tax Backed 14%

Others 32%

Total outstanding - USD 68 billion



Figure 15: Outstanding guarantees of Ambac

Source: Investor presentation, June 2014

6.8.2 Regulations governing monoline insurers

The requirements of insurance holding company statutes vary from jurisdiction to jurisdiction in the US

although monoline insurers are regulated in much the same way as multiline ones -- that is, by the

insurance authorities of the states in which they operate.

6.8.3 Past transactions by monoline insurers

Table 56 provides a sample of past transactions.

Table 40: Full guarantee transactions of monoline insurers

Monoline insurer

Municipal agency Insured amount

Change in rating Sale date

Assured Guaranty

City of Lancaster, Pennsylvania, general

USD 54 million Underlying rating - A+/A2 (S&P/Moody’s)

June 2014

General Municipal

82%

Health Care 3%

Housing 7%

Non Profits 8%

Public Finance - USD 108 billion

General Fund 22%

Tax 18%

State 15%

UTY 11%

TSP 9%

School Dist 7%

Public Higher Ed 6%

Tabs 6%

Other 6%

General Municipal - USD 89 billion



Monoline insurer

Municipal agency Insured amount

Change in rating Sale date

obligation bonds Enhanced rating – AA (S&P)

Assured Guaranty

City of Commerce City, Colorado - sales and use tax revenue bonds

USD 73 million

Underlying rating - A- (S&P)

Enhanced rating – AA (S&P)

May 2014

Assured Guaranty

Lake Charles Harbor and Terminal District, Los Angeles - revenue bonds

USD 39 million

Underlying rating - A-/A3 (S&P/Moody’s)

Enhanced rating – AA (S&P)

November 2013

National Public Finance Guarantee Corporation – MBIA

North Texas Tollway Authority

USD 20 million

Underlying rating – A2/A- (S&P)

Enhanced rating – AA- (S&P)

July 2014

AMBAC Alameda Corridor Transportation Authority

USD 539 million

Underlying rating – BBB- (S&P)

Enhanced rating – AA- (S&P)

June 2014

Source: Company investor presentations

6.9 Challenges in developing bond/credit guarantee funds

International guarantee mechanisms, barring monoline insurers, are in the nascent stages of

development, with business models and areas of operations being constantly modified to better serve

their mandated objectives. The major constraints behind their slow development and low activity of

bond guarantee funds may be due to issues of operational capacity, scale, costs, and risk exposure.

After-effects of the 2008 financial crisis: One reason for the torpor in bond guarantee funds could

be the overhang of the financial crisis of 2008 delaying execution of credit enhancement products

amid uncertainty in the capital markets.

Lack of product knowledge: A bond guarantee fund’s institutional ability to analyse the viability, of

projects, potential risks and expected outcomes of operation completion, revenues and costs can

slow down development as is the case of Fondo Nacional de Infraestructura, or FONADIN, the

Mexican government’s infrastructure fund. FONADIN does not have an internal team of specialists but

relies on outside ones for sectors such as roads, waste and water.

Inadequacy of resources: Many a time, the resources available – which is mostly contributions from

government – are insufficient to cover operational breadth and competition, which creates risk-

aversion and consequently slows down product delivery.

Unattractive projects: From the demand side, projects which do not offer investors a fair return for

the risk taken can lead to undersubscribed issuances or ‘failed auction’. In an economy with multiple

infrastructure projects, the rate of return to the investor will be a crucial factor.



7. Annexure 2 – Overview of credit guarantee

structures

A credit guarantee is a de facto credit enhancement where the borrowers’ debt obligations are

partially or completely guaranteed by a third party. This third party, or guarantor, is liable to repay on

default. In the case of individual structures, bonds are typically issued by SPVs, parent companies of

SPVs, and public sector undertakings. The credit guarantee can be of two kinds – full or partial, and a

typical structure is given in Figure 18.

Figure 16: Typical guarantee structure

All guarantee structures, whether full or partial, are unconditional, irrevocable and timely in nature.

These characteristics are explained below:

Unconditional: The guarantee is honoured by the guarantor under all circumstances,

including failure by the issuer to pay the financial guarantee premium. The guarantor will

wave in advance any or all rights it may have, by law, contract or otherwise, to avoid a

payment, or excuse itself from making a payment, under the guarantee.

Irrevocable: The bond is backed by a financial guarantee throughout the tenure of the

guarantee obligation and the guarantor waives any or all rights to cancel the guarantee

before maturity of the obligation, including bankruptcy of the issuer, dissolution or any other

circumstance that may affect the issuer.

Timely: The guarantee obligation has to ensure timely fulfilment of obligation since a credit

rating agency, when assessing a security, will not only look at the ability of an issuer to repay

the obligation in full, but also its ability to pay each coupon on time.

Such characteristics enable credit enhancements and lower the financing cost of debt issuances. The

features of full and partial credit guarantee structures are explained later.

Borrower

Lender

Loan

Repa

ym

ents

Guarantor

Seeks guarantee cover

Provides guarantee



7.1 Types of credit guarantee products in individual bond

structures

7.1.1 Full credit guarantee

A full credit guarantee is where all debt obligations of a borrower are guaranteed by the guarantor.

This transfers all credit risk from the borrower to the guarantor by covering all interest and principal

payments accruing to the borrower.

So the credit risk profile of the guarantor has to necessarily be stronger than that of the borrower. As

mentioned earlier, given the nascence of the corporate bond market in India, credit enhancement

products will have greater acceptability if the guaranteeing entity -- BGFI in this case – has the

highest – or AAA -- credit rating.

In the case of full guarantee, the rating of the guaranteeing entity will be reflected in the rating of the

bond being issued. Thus, a product guaranteed fully by BGFI, will be automatically credit-enhanced

and get the prized AAA rating.

7.1.2 Partial credit guarantee

In partial credit guarantee only a part of the borrower’s debt obligation is supported by a guarantee.

Such a guarantee will enhance the credit rating of the bond to a target rating of maximum AA+. So a

higher credit rating of the issue will mean lesser guarantee is required to attain the targeted rating,

and vice-versa. Partial credit support could be extended in many ways such as making good shortfalls

till a pre-determined amount is reached, or up to a pre-determined portion of every repayment, or a

combination of both.

7.1.3 Illustration

A partial credit guarantee covers only a portion of the interest and principal repayment, and this part

could be anything, such as a fraction of the debt obligations in every repayment or the entire debt

obligation during a part of the tenure of the bond, or a combination of both. For example, it could

cover:

a) The last six principal and interest payments (a guarantee on the trailing part of debt obligations is

referred to as a back-ended guarantee, while a guarantee on the initial part of debt obligations is

referred to as front-ended guarantee)

b) 40% of the principal and interest payments in each instalment over the five years, and

c) Only-principal payments

Each of these structures is depicted in Charts 19 to 21, assuming a scenario where the borrower has

an obligation to repay a loan of INR 10 million. The principal shall be paid in 10 equal semi-annual

instalments over a period of five years. The interest shall be paid semi-annually at a rate of 12% per

annum.



Chart 17: Illustration for a partial-guarantee product of BGFI (a)


Chart 18: Illustration of a partial-guarantee product of BGFI (b)




Chart 19: Illustration of a partial guarantee product of BGFI (c)


7.1.4 Comparison between full and partial guarantees

Table 57 shows the differences between a full-wrap guarantee and a partial credit guarantee for a

bond transaction.

Table 41: Comparison between full and partial credit guarantee

Characteristic Full guarantee Partial guarantee

Guarantee of principal and interest on a timely manner

Yes Yes

Irrevocable Yes Yes

Unconditional Yes Yes, subject to the maximum limit of the amount guaranteed

Limit to the coverage of the guarantee

No limit. Covers 100% of every coupon of principal and interest

Limit determined according to the amount of credit enhancement required

Credit enhancement Increases the rating of the guaranteed obligation to the credit rating assigned to the guarantor

Increases the rating of the guaranteed obligation by specific notches according to the size of the limit amount of the guarantee

Complexity

Standardised, simple to understand. Investors need to understand the underlying risk but derive comfort from the 100% guarantee

More complex. Investors need to understand the characteristics of each partial guarantee, the underlying risk, the credit enhancement provided and its sufficiency




7.2 Terms of credit guarantee in individual bond structures

Terms of a credit guarantee, either full or partial, can vary to suit operational requirements. While

various adjustments to the structure are possible in partial guarantee, that’s not the case with a full

guarantee. Here, we detail the suitable operational structure for guarantee schemes.

7.2.1 Terms applicable to both full and partial guarantees

7.2.1.1 Synchronisation with acceleration provisions in the supported facility

The debt instrument supported by guarantee (full or partial) may or may not have an acceleration

clause. In case it does, holders can recall the bond, which means the borrower is liable to pay all

unpaid obligations immediately upon default. Hence, the guarantee in such instruments will have to

cover entire repayments (up to a maximum of the guaranteed amount) on default. Where there is no

acceleration clause, the guarantee shall cover only the amount due in that particular period (up to a

maximum of the guaranteed amount).

Illustration

In the transaction illustrated in Chart 19 above, let us say the borrower could not generate any cash

flow in period 5 and the repayment due for the period was INR 1.36 crore. In the case of an

instrument without accelerating clause, only INR 1.36 crore of the guaranteed amount will be utilised.

But in the case of an instrument with acceleration clause, total future repayments of INR 7.26 crore

have to be covered by the guarantee if the bond holder chooses to invoke the acceleration clause.

Since the outstanding guarantee amount is INR 5.32 crore, it is utilised only to that extent.

Chart 20: Illustration of guarantee structure for debt instrument with and without acceleration clause (INR crore)

Both full and partial-credit guarantee products could guarantee bonds with or without acceleration

clause. A call on this can be taken by the guarantor on a case-to-case basis.

Terms applicable to partial credit guarantees

There are three other terms in the guarantee structure, in addition to the one explained above, that

are suitable to the operations of a partial credit guarantee. These embedded covenants can alter the

7.26

1.36

5.32 5.32

1.36

0

1

2

3

4

5

6

7

8

Future repayments at thetime of default

Amount due during periodof default

Outstanding Guaranteeamount

Guarantee Utilized in aninstrument with

acceleration clause

Guarantee Utilized in aninstrument withoutacceleration clause



credit risk of a transaction. Proper structuring would minimise the credit risk with lesser support from

the guarantor. The terms of a guarantee can be as follows:

1. Rolling or non-rolling

2. First loss

3. With or without a reset feature

4. With or without an automatic top-up feature

7.2.1.1 Rolling or non-rolling

The tenure of a partial credit guarantee can be rolling or non-rolling (i.e, fixed). Fixed tenures are

preferable in case of certainty of cash flows, where the guarantee covers repayments during the fixed

part of tenure of the debt. Rolling tenures, on the other hand, are more suited to projects with higher

volatility in cash flows, where the guarantee can be utilised anytime during the rolling tenure up to a

maximum of the guaranteed amount. Such a feature can mitigate the risks related to uncertainties in

cash flow any time during the rolling tenure.

Illustration of a rolling guarantee

In the transaction illustrated in Figure 19, say two of the first six semi-annual principal and interest

payments are guaranteed. Here, the first six periods (spanning three years) is referred to as the rolling

tenure and a maximum of two semi-annual payments are guaranteed. The borrower cannot draw

more if the guarantee has already been utilised for payments in the two periods. This is depicted in

Chart 21. While the highlighted portions of periods 4 and 5 are guaranteed, the guarantee can cover

only any two of the periods 1 to 6. The rolling guarantee may also cover a fixed amount during the

rolling period. For example, INR 5 crore may be guaranteed out of total repayments of INR 8.7 crore

during the rolling period. In this case, the guarantee of INR 5 crore can be utilised any time during the

rolling period, but not outside it.

Chart 21: Illustration of a rolling guarantee (INR crore)

A rolling tenure structure is recommended for partial guarantee products since all losses up to a

maximum of the guarantee amount would be covered by the guarantor.

1.6 1.54

1.48 1.42

1.36 1.3

1.24 1.18

1.12 1.06

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

1 2 3 4 5 6 7 8 9 10

Maximum of 2 payments guaranteed



7.2.1.2 First loss

The guarantee should be a first-loss guarantee up to the guarantee quantum and only shortfalls in

cash flows beyond the guarantee amount should pass on to bond investors. The first-loss feature

provides comfort to investors, adding to the attractiveness of the bond. Alternatively, where there is no

first-loss guarantee (the bond only guarantees a fixed part of each payment), investors will have

protection only for some portion of each instalment due. It’s pertinent to note here that credit rating

agencies in India consider an instrument to be under default if it is not paid in full on or before the due

date. Hence, a first-loss feature is essential for credit enhancement.

Further, partial credit guarantee shall cover both interest and principal to enable the first-loss feature.

If either is not guaranteed, any shortfall in cash flows (to cover the interest or principal) will result in a

default even though the guarantee remains unutilised.

7.2.1.3 With or without a reset feature

A reset feature allows the guarantee amount to be periodically reset, thereby providing optimal cover

to a transaction. It also implies the minimum guarantee required to achieve a target rating.

In the absence of a reset, the guaranteed amount remains fixed during the tenure of the debt. So if

the guarantee remains underutilised, the guarantee cover as a percentage of debt outstanding will

increase with debt repayment.

In a guarantee with a reset, the guarantee structure covers only repayments (a fixed percentage) as

the debt gets amortised. The guarantee amount can be reset periodically or every year based on

requirements and the rating targeted. This will lower the guarantee fees because the guarantee

amount can be reduced if unutilised. In theory, the guarantee can also be reset to increase the

guarantee cover, but in practice, it is difficult to get a guarantor to countenance such terms.

Illustration without reset

Let us say, in a transaction, INR 5 crore is the total amount guaranteed. INR 1 crore, INR 0.5 crore,

INR 0.8 crore and INR 0.2 crore are utilised in periods 3, 4, 7 and 8, respectively. The outstanding

guarantee amount is the total guaranteed amount minus the utilised amount. As seen in Chart 22

below, the outstanding amount is more than future repayments, which may not be necessary.

Chart 22: Illustration of a structure without reset (INR crore)

13.3

11.7

10.16

8.68

7.26

5.9

4.6

3.36

2.18

1.06

5 5 5

4 3.5 3.5 3.5

2.7 2.5 2.5

0 0

1 0.5

0 0 0.8

0.2 0 0 0

2

4

6

8

10

12

14

1 2 3 4 5 6 7 8 9 10

Total Future Repayments Outstanding Guarantee Guarantee Utilized



Illustration with a reset

Let us say, in a transaction, INR 6 crore (45% of future repayments) is the total guaranteed amount at

the time of disbursement of debt, as shown in Chart 23. The guarantee is reset periodically so that the

guaranteed amount is a minimum 45% of future repayments or the outstanding guarantee in the

previous period minus the utilised amount in that period. In this case, the outstanding guarantee will

not be more than future repayments at any point in time. On the other hand, if the utilisation is higher,

the guarantee is not reset.

Chart 23: Illustration of a structure with a reset feature (INR crore)

Such a feature could be explored for BGFI as it develops the ability to handle complex structures. It

would be pertinent to note that a reset feature could make the guarantee structure complicated as any

change in the terms of guarantee can alter the amount guaranteed for the debt obligation. A case in

point is guaranteeing a fixed percentage of the total debt obligation in every period, where the amount

guaranteed in every period is modified depending on the outstanding debt obligation. This alters the

guarantee structure and the associated premium, which will have to be re-evaluated by the guarantor.

Further, in case of a reset, if the guarantee structure of the instrument undergoes alteration, fresh

credit ratings will have to be assigned. This could impose additional overheads related to the rating of

the bond issue. However, the issuer could possibly negotiate a lower annual guarantee fee over the

tenure of the bond with the guarantor in order to get some pricing benefit.

7.2.1.4 With or without an automatic top-up feature

The top-up feature allows topping up of the utilised amount of guarantee with future cash flows of the

borrower. The utilised guarantee amount can be replaced within a pre-determined timeline. In this

case, interest may be charged for the interim period by the guarantor on the amount outstanding.

Such an automatic top-up is recommended for partial guarantee schemes as it addresses short-term

liquidity issues and subsequent recovery can be used to pay the utilised guarantee amount. The

borrower benefits by continuing to have recourse to the full guarantee amount in contingencies during

the tenure of the bond and by economising on interest payouts to the guarantor (which may be higher

than the interest rate applicable on the supported facility). The guarantor benefits by minimising the

period of funded exposure to the borrower.

13.3

11.7

10.16

8.68

7.26

5.9

4.6

3.36

2.18

1.06

6.0 5.3

4.6 3.9

3.3 2.7

2.1 1.5

1.0 0.5

0 0

1 0.5

0 0 0.8

0.2 0 0 0

2

4

6

8

10

12

14

1 2 3 4 5 6 7 8 9 10

Total Future Repayments Outstanding Guarantee Guarantee Utilized



This feature also provides more comfort to the investors as any future loss, once the guarantee is

reinstated, will continue to be ring-fenced to the extent of the outstanding guarantee. However, a

proper waterfall mechanism is needed for cash flows from recovery. Further, the guarantor will charge

an interest on the utilised amount so as to persuade the borrower to give high priority for reinstating

the utilised guarantee over other expenses.

7.3 Past transactions

7.3.1 Full guarantee transactions in India

Though transactions with full guarantee by a third party on a commercial basis have not been

executed in India, they are being provided by state and central governments for bonds issued by their

entities, especially in the power and road sectors. Table 58 is a sample of such transactions:

Table 42: Fully guaranteed bond transactions in India

Issuer Guarantor Instruments guaranteed Date Rating (CRISIL)

Tamil Nadu Electricity Board (TNEB) and Tamil Nadu Generation and Distribution Corporation Ltd (TANGEDCO)

Government of Tamil Nadu

INR 12 billion bond programme of TNEB

INR 14 billion bond Programme of TANGEDCO

November 2013

A-(SO)

Krishna Bhagya Jala Nigam Limited

Government of Karnataka

INR 7.5 billion bond programme

July 2014 AA-(SO)

Karnataka State Financial Corporation

Government of Karnataka

INR 2.5 billion non-convertible bond programme

July 2014 AA-(SO)

Food Corporation of India

Government of India

INR 80 billion bond programme

February 2014.

AAA(SO)

India Infrastructure Finance Company Limited

Government of India

INR 5 billion bonds July 2014 AAA(SO)

Konkan Railway Corporation Limited

Government of India

INR 16.67 billion bonds May 2014 AAA(SO)

Source: CRISIL Ratings

7.3.2 Partial guarantee transactions in India

7.3.2.1 Partial Credit Guarantee Scheme (PCG) by IIFCL

Under the partial credit guarantee scheme, India Infrastructure Finance Company Limited (IIFCL),

which is supported by ADB, provides partial credit guarantee to enhance the ratings of project bonds

and channel long-term funds to the infrastructure sector. By virtue of the AAA rating that IIFCL enjoys,

the rating of project bonds can be enhanced to a maximum AA+ (as it is a partial credit guarantee).

This is a refinancing mechanism and only commissioned projects operating for at least six months



after their commercial operations date (COD) are eligible to float bonds to refinance debt. The

features of this partial credit guarantee include:

First-loss guarantee

Irrevocable and unconditional guarantee

Rolling cover with the guarantee quantum usable at any time during the tenure of the bond

Automatic reset

Automatic repayment of utilised guarantee from subsequent guarantee

The scheme was launched in 2012. A pilot transaction with an SPV of GMR Jadcherla Expressway

was initiated in 2012 to refinance a debt of around INR 320 crore. The transaction reached the final

stages after signing of an agreement with IIFCL, attaining a credit rating for the issuance, but fell

through because of high interest rate on the bond and cheaper financing available elsewhere. GMR

ultimately sold off its stake in the SPV to a private equity player. A similar transaction initiated by a

group company of Larsen & Toubro also came a cropper for the same reasons.

7.3.2.2 Other partial credit-guarantee transactions

Five debt papers with partial credit guarantee have been placed in India as per information available

in the public domain (the market assessment report carried their snapshot). These transactions have

enabled innovative funding of various projects. In the absence of market appetite for papers rated

lower than AA category (referred to in the market assessment report), partial credit guarantee from

multilateral/bilateral development agencies had ensured credit enhancement at relatively lower costs.

Table 59 lists some of these transactions:

Table 43: Partial credit guarantee transactions in India

Issuer Guarantor Tenure (years)

Guarantee structure Outcome

Ballarpur Industries Ltd

IFC 10

Rolling guarantee for 2 semi-annual installments and back-ended guarantee for 11 semi-annual installments

5 notches upgrade to AA+(so)

Ballarpur Industries Ltd

FMO, Netherlands

7

Rolling guarantee for 1 semi-annual installment and back ended guarantee for 7 semi-annual installments

5 notches upgrade to AA+(so)

Bharti Mobile Ltd IFC 10

Rolling guarantee for 1 semi-annual installment and back ended guarantee for 14 semi-annual installments

Rating enhanced to AA+(so)

Water and Sanitation Pooled Fund of Tamil Nadu

USAID / Tamil Nadu govt

15

Tamil Nadu had to maintain a reserve of 1.5 times the annual debt repayments. USAID provided 50% backstop guarantee for the reserve

Rating enhanced to AA(so)

Tata Engineering & Locomotive Company Limited

IFC NA

Partial credit guarantee of up to USD 65 million for a USD 103 million local currency bond issue to part-finance the project

NA

Source: Various



7.3.3 Transactions outside India

Globally, transactions with credit guarantee structures have been infrequent. International facilities

such as GuarantCo and CGIF, along with multilateral development agencies such as ADB,

International Finance Corporation and World Bank, have such schemes and have provided credit

enhancements, improving access to finance. Monoline insurers in the US provide credit guarantees

to municipal bonds of all types. There are also funds providing credit guarantees that promote lending

to the SME sector such as the Korea Credit Guarantee Fund.

7.3.3.1 CGIF

CGIF provides full and partial guarantees to local currency-denominated bonds issued by companies

that help them gain access to the local bond markets and issue local currency bonds with longer

maturities. Currently, the CGIF portfolio consists of regional corporates issuing in their local currencies

and receiving full CGIF guarantee on the principal and interest. Such full-wrap transactions of CGIF

are listed in section 2.1.3.1.

7.3.3.2 Monoline insurers

Monoline insurers provide guarantees to bondholders or issuers, often in the form of credit wraps that

enhance the credit of the issuer. They guarantee the principal and interest payments of a debt

obligation. If the issuer defaults, the monoline insurer steps into make the obligated payments to

investors. Some recent transactions in the US are shown in section 2.8.3

7.3.3.3 ADB

ADB also has a partial credit-guarantee product for debt instruments. Some of its transactions have

been first-of-their-kind such as helping restructure the power sector in the Philippines, acting as a

catalyst for commercial lending in Thailand, and setting a milestone in long-tenure financing in Sri

Lanka. Table 60 lists such transactions:

Table 44: Partial credit guarantee transactions of ADB

Issuer Issue amount (USD million)

Structure/guarantee cover Outcome

Export Import Bank of Thailand

950

The issue had a term of 5 years. ADB provided partial credit guarantee for the principal and interest due in the first 3 years, with an extension to the fourth year if Thailand got rated below BBB/Baa2

This was the first term financing arranged for Thailand after the start of the Asian financial crisis in July 1997. It acted as a catalyst for subsequent post-crisis commercial lending to Thailand.

DFCC Bank (Sri Lanka)

65

The issue had tenure of 10 years. ADB guaranteed the principal at maturity. The government of Sri Lanka guaranteed interest payment

This issue set a milestone as the longest financing tenure achieved by Sri Lanka in the capital markets

Power Sector Assets and Liabilities Management Corporation,

500

The issue had two tranches of 18- and 20-year tenures. ADB provided 10-year back-ended guarantee for interest and guarantee for principal at maturity. Philippines

With a partial credit guarantee of ADB, Power Sector Assets was able to borrow at significantly more favourable terms to extend the tenure by 11-13 years




Structure/guarantee cover Outcome

Philippines guaranteed 100% of the repayment and principal

over an ROP standalone bond issue

Source: ADB

7.3.3.4 IFC

IFC has provided partial credit guarantees to many transactions across the world spanning social and

infrastructure sectors, helping finance projects under difficult circumstances. Most of these

transactions had a fixed structure guaranteeing up to 70% of the principal. There were up to a three-

notch upgrades in ratings because of this. In some cases, the partial credit guarantee facilitated

lending by financial institutions that were otherwise risk-averse. Table 61 lists such transactions:

Table 45: Partial credit guarantee transactions of IFC


Maximum guarantee amount (USD / % of principal)

Issue tenure (years)

Outcome

Banco BBA-Creditanstalt (Brazilian wholesale bank)

50 13.63% 10

Four-notch upgrade to Baa3 from B1. Substantially lower yield than bonds issued by the government of Brazil

Banco Davivienda (Columbian Mortgage Originator)

50 30% of principal 10

One-notch upgrade to AA+. The bond was placed within the first day of the offering

Chuvash Republic (Russian Federation)

34.7 23% of principal 5 One-notch upgrade to AA2.ru on Moody's local rating scale

City of Johannesburg

153 40% of principal 12 Three-notch upgrade to AA-.Zaf from A-.Zaf by Fitch

Financiera Comparatamos (microfinance company in Mexico)

43.4 34% of principal 5 Two-notch upgrade to AA from A-

Municipality of Guatemala City Project

9.5 70% of principal 10

Introduced a new source of commercial financing for local governments without relying on sovereign guarantees

Russian Standard Bank

16.7 60% of principal 3

The guarantee enabled the bank to achieve a longer tenure for the bond issue than that which other borrowers in




Maximum guarantee amount (USD / % of principal)

Issue tenure (years)

Outcome

the domestic market were able to achieve post Russia’s 1998 economic crisis

Sociedad Acueducto, Alcantarilladoy Aseo de Barranquilla (Colombian water, sewerage, and waste services provider)

63 25% of principal 10

Three-notch upgrade to AAA by Duff & Phelps de Colombia and BRC Investor Services

Telecom Asia 425 50% 8

Telecom Asia achieved a national scale A rating, three notches above its stand-alone rating

Source: IFC

7.3.3.5 World Bank

The World Bank (International Bank for Reconstruction and Development) also has a partial credit

guarantee product, which provides cover to private lenders against risk of default by governments or

public-sector borrowers. It guarantees only debt taken for projects by government and public-sector

agencies.

The bank did a transaction in Argentina in 1999, providing partial credit guarantee (of USD 250

million) for USD 1.5 billion, zero-coupon notes. A series of six separate zero-coupon notes (Series A

through F), each with a face value of USD 250 million, were issued to be repaid in five years.

While Series A was fully guaranteed, subsequent series could avail of the guarantee facility by paying

the utilised amount within 60 days (in case it is utilised by the previous series). Obligations of

Argentina to the World Bank carry a preferred-creditor status, meaning Argentina had to prioritise

repayment to the World Bank. The rolling reinstatable partial credit guarantee cover over the term of

all the series helped the issue to be rated at AAA (so) for Series A notes and BBB (so) for Series B

through F by Standard & Poor’s, Duff & Phelps and Fitch IBCA. S&P’s foreign currency issuer credit

rating Argentina was BB, three notches below the BBB assigned for Series B through F.

The notes were launched at a time when Argentina was facing difficulty in tapping the US market and

its ability to raise money from the capital market was restricted. The use of World Bank’s partial credit

guarantee allowed the country to place a large issue at a time when investors were not disposed to

buying debt from emerging markets, more so a large issuance.



8. Annexure 3 – Quantum of guarantee cover and

pricing

8.1 Quantum of guarantee cover

8.1.1 Quantum of full credit guarantee cover

The full credit guarantee product will guarantee all debt obligations, including interest payments of the

bond issued. Hence, its quantum will be 100% of bond value.

8.1.2 Quantum of partial-credit guarantee cover

The quantum of guarantee to be provided is dependent on the target and source rating of the bond

issued. Hence, the quantum of guarantee cover required will be assessed keeping in mind the target

rating of AA or above.

The quantum of guarantee required for a guarantee product can be evaluated using three variables:

Credit rating of the borrower,

Credit rating of the guarantor and

The target credit rating

Nature of guarantee (pari passu / first loss) will also be a consideration.

The first step to assessing quantum, for a single transaction, is to construct scenarios over the tenure

of issue. This would range from a scenario where the bond will never default to a scenario where the

bond will default from the first year.

Each scenario will have a probability of default associated with it. The default, as usually defined by

rating agencies, refers to the first occurrence of delayed or missed payment of debt obligations. A

higher credit rating implies a lower probability of default and vice versa. For example, if the cumulative

probability of default for AA+ rating over three years is 0.1%, then out of 1,000 AA+ rated instruments

in a year, one instrument is expected to default within the next three years.

The next step will be to assess the cumulative loss (which will be equal to the debt obligations due

each year). Defaults are also typically accompanied by some amount of recoveries that are used to

pay the arrears in debt repayments and top up the utilised guarantee amount. Hence, the extent of

recovery from the defaulted entries/ instruments is also a key variable in determining the quantum of

guarantee cover. The higher the recovery, the lower is the guarantee cover required. Recovery rates

applied to the loss give the loss given default (LGD).

The default rates would be then applied to the loss given default to arrive at the expected losses (EL).

Credit enhancement would be determined as the extent to cover the expected losses.

The calculation is summarised in the following formula, while the approach has been depicted in the

diagram below.

PDSource Rating * (LGDSource Rating - CE) = PDTarget Rating * LGDTarget Rating



Figure 24: Methodology for estimating the quantum of credit enhancement


In subsequent sections, appropriate default and recovery rates are estimated for the purpose of

modelling the quantum of credit enhancement.

8.1.2.1 Default rates

While it may be theoretically possible to arrive at specific default rates for a particular sector, such

estimation will not be meaningful as the proposed post-PCG enhanced bond has to be rated by a

domestic rating agency since the debt instrument has to be placed in the capital market. The rating

agency will use its own estimate of default rates to assign the credit rating for the instrument. Hence,

an independent estimation of default rates may not serve the purpose since the rating agencies will in

any case adopt their own default rates.

Credit rating agencies publish default rates for each rating category. These rates are sector agnostic,

implying a default rating such as AA does not vary from sector to sector.

Therefore, it is advisable to adopt default rates published by rating agencies while estimating the

quantum of credit enhancement. However, cumulative default rates available from leading domestic

rating agencies in India are for only up to five years (CRISIL, ICRA and CARE – 3 years; Fitch India –

5 years).This data may not be suited for analysis since the typical tenure of debt in the infrastructure

sector is 10-15 years. Further, rating agencies in India have limited history in lower rated instruments

and hence, the published default rates may not have statistical relevance for default rates in lower

categories.

International credit rating agencies such as S&P, Moody’s and Fitch Ratings publish average

cumulative default rates for a longer period of time (typically 10-20 years). Hence, these rates become

the reference rate after adjusting for rating difference between the global scale and national scale (i.e.

a rating of BBB by an international credit rating agency is not equivalent to BBB of a domestic rating

agency) by using the first principles approach.

8.1.2.1.1 S&P Ratings mapped to CRISIL Ratings

As mentioned in the article (refer Annexure 4) ‘Translating Global Scale Ratings onto CRISIL’s Scale,

2012’, three types of approach could be used for mapping global scale ratings to national scale –

sovereign ratings linkage approach (based on the mapping of sovereign rating in the global scale),

independent rating approach (rating independently again using local benchmarks) and first principles

approach.



CRISIL generally uses the first principles approach for mapping of rating. In this approach, the key

performance indicators such as default rates, transition rates and expected loss of the two rating

scales are compared. Interpolating from the article, the following table provides the indicative mapping

of S&P ratings to those of CRISIL.

Table 46: Interpolated mapping of S&P ratings to CRISIL ratings based on a CRISIL article

Firm Mapping of ratings

CRISIL Rating

AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- BB- B C D

Equivalent S&P Rating

AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- BB+ BB BB- B+ B B- CCC/C D

Source: CRISIL Ratings

Annexure 5 contains the 15-year average cumulative default rate table of S&P for the period 1981-

2013.

While estimating the quantum of credit enhancement, CRISIL’s mapped default rates have been

considered since these cover the majority of rated structured debt instruments in India and thus

provide a representative data set for our purpose.

8.1.2.2 Recovery rates

Recovery rate is the ratio of the total amount recovered from the defaulted debt obligations to the total

outstanding debt obligations at the time of default.

In India, there is limited information on recovery rates in the public domain due to lack of stringent

bankruptcy control norms. Further, unlike default rates, rating agencies don’t publish recovery rates

because when the entities emerge from default, their credit risks are evaluated anew, independent of

their previous rating.

However, detailed studies5 conducted by global rating agencies such as S&P and Moody’s have

revealed that the recovery rates for entities and projects in the infrastructure sector – namely power &

transportation, are higher than those in non-infrastructure.

Table 47: Average recovery rates in the US

Sector Average recovery rate (S&P) Average recovery rate (Moody’s)

Transport 79.8% 80-100%

Power 88.2% 80-100%

Manufacturing 74.4% 60-80%

Services 74.4% 60-80%

Source: S&P, Moody’s

Infrastructure projects boast of higher recovery rates due to certain features specific to them. These

projects face limited competition in most scenarios, operating as monopolies or oligopolies, thus

5 Recovery Study (U.S.): Are Second Liens and Senior Unsecured Bonds Losing Ground As Recoveries Climb? – S&P,

December 2013; Default and Recovery Rates for Project Finance Bank Loans, 1983–2011 – Moody’s, September 2013



enjoying a larger share of the market. Also, infrastructure services are essential in nature, requiring

substantially less managerial intervention, thus ensuring cash flows even under stressed scenarios.

In contrast, recoveries in the non-infrastructure sector are back-ended since revenues are dependent

on defaults. In case a manufacturing company defaults, its working capital limits will be frozen,

resulting in ceased operations and stalled production. In such scenarios, lenders tend to be reluctant

to extend funding, hampering recovery.

Recovery rates for secured transactions in infrastructure and non-infrastructure sectors in India, as

shown in Table 4, have been estimated based on global recovery rates and primary interactions with

in-house experts. These estimates are conservative in nature, keeping in mind the higher risk profile

of projects in India - specifically, weak bankruptcy protection laws and weak enforceability of

contracts. The corporate sector in India faces several challenges in recovery of assets. As per World

Bank, India ranks as one of the worst countries in the world for the ability to enforce a contract, taking

an average 1,420 days. In 2014, the World Bank group rated India 134 out of 189 economies in terms

of ease of doing business.

Table 48: Recovery rate estimates for India

Sector Average recovery rate

Transport 65%

Power 45%

Manufacturing 20%

Services 25%

8.1.2.3 Extent of credit enhancement

Having established the desired source rating and target rating, along with the associated default rates

and recovery rates, this section explains and calculates the extent of credit enhancement that BGFI

would be required to give to enhance the credit rating of the borrower/ issuer of the bond from BBB- to

AA or above.

A sample project in infrastructure is considered to establish the extent of credit enhancement required

from BBB to AA.

The specifications of a transport sector project are given below.

Table 49: Project specifics for indicative quantum assessment

Parameters

Project specifics

Project cost INR 1,000 crore

Start of construction April 1, 2014

Number of years for construction 3

Commercial operations date April 1, 2017

Current financing assumptions

Total senior debt (bank loan) INR 2,000 crore

Loan disbursement date April 1, 2014



Parameters

Interest rate 12.50% percent

Start of repayment of senior debt April 1, 2019

Tenure of loan 14 years (till 2027)

Quantum of senior debt financed 50% of INR 2,000 crore (INR 1,000 crore bond principal)

Year of issue of bond April 1, 2018 (one year after COD)

Source credit rating BBB

Security Secured

Guarantee assumptions

Target rating of bond AA

Coupon rate 9.56%


It is assumed that the project will refinance 50% of its bank loan, i.e. INR 1,000 crore, through issue of

a bond one year after achieving COD. The cost of alternative finance available to the borrower, i.e. a

bank loan, is 12.50%. However, after acquiring credit enhancement, the rating of the bond would

move to AA with an associated coupon rate assumed at 9.56%.6 The final cost of issuing this bond,

however, will also factor in the transaction cost for issuance of bond (typically paid by the issuer to the

investment banker), estimated at 0.50% (over the tenure of the instrument), and the risk premium that

investors associate with partial guarantee structures, estimated at 0.50%. Also, the guarantor would

charge an upfront processing fee (for issuance of guarantee), which would be payable by the issuer,

assumed at 0.20%. The tenure of the bond is assumed as 10 years. Hence, the final pricing of the

enhanced AA rated, 10-year instrument equals 10.13%.

We start this assessment by ascertaining the debt (principal plus interest) repayment schedule for

both source rating and target rating.

Table 50: Debt repayment schedule for both source and target rating (INR crore)

Rating 1 2 3 4 5 6 7 8 9 10

Source 219 206 194 181 169 156 144 131 119 106

Target 191 181 172 162 153 143 133 124 114 105


The next step will be to model the default scenarios. For a 10-year bond, as considered, there can be

only 11 default scenarios from No Default at one end to Default in every year at the other end. The

assumption is that in practice, if a bond defaults in one year, it will default in every year post that for

the remaining tenure of the bond.

Table 51: Default scenarios over the tenure of the bond

Scenario 1 2 3 4 5 6 7 8 9 10

6 As of Sep, 2014, 10-year AA spread is 1.04 percentage points over risk-free rate. Risk-free rate is taken at 8.52 percent.



Scenario 1 2 3 4 5 6 7 8 9 10

1 D D D D D D D D D D

2 D D D D D D D D D

3 D D D D D D D D

4 D D D D D D D

5 D D D D D D

6 D D D D D

7 D D D D

8 D D D

9 D D

10 D

11 ND

Source: CRISIL Infrastructure Advisory, D-Default, ND-No Default

The likelihood of these scenarios playing out is given by the marginal default rates, or MDR (derived

from published cumulative default rates as given in annexure).

Table 52: MDRs for both source and target rating

Rating 1 2 3 4 5 6 7 8 9 10

Source 1.13% 2.34% 2.44% 2.35% 2.07% 2.07% 1.70% 1.65% 1.40% 1.18%

Target 0.08% 0.12% 0.14% 0.14% 0.21% 0.22% 0.29% 0.22% 0.17% 0.15%


It can be surmised from the table above that in case of source rating of BBB, there is 18.33% chance

the instrument will default one way or the other, meaning 81.67% of the time it will not default. The

corresponding figures for a AA (target rating) rated instrument are 1.74% and 98.26%.

The quantum of defaulted obligations was arrived at based on the default scenarios. For instance, for

Scenario 1, in case of source rating, the entire amount of INR 1,625 crore would default. Assuming

the recovery rate of 65% as considered, the LGD would be INR 569 crore.

Table 53: LGD for both source and target rating (INR crore)

Rating 1 2 3 4 5 6 7 8 9 10

Source 569 492 420 352 289 230 175 125 79 37

Target 517 451 387 327 270 217 167 120 77 37




Drawing reference to the formula mentioned in Section 4.2.2 (PDSource Rating * (LGDSource Rating - CE) =

PDTarget Rating * LGDTarget Rating); the loss remaining after credit enhancement multiplied by the

probability of default gives the expected losses after credit enhancement at the source rating. The

appropriate quantum of credit enhancement would equate these expected losses to the expected

losses seen after credit enhancement or at the target rating.

The percentage of credit enhancement (as a percentage of total debt obligations) to enhance the

credit rating of the sample project considered in the transport sector from BBB to AA is 25% in

nominal value terms of 21% in present value terms.

Similar analysis has also been undertaken for projects in other sectors, such as power, manufacturing

and services. The result is shown in the table below.

Table 54: Indicative credit guarantee (as a percentage of total debt obligations in present value terms), target rating AA for a 10-year instrument


Source rating AA AA AA AA

BBB- 27% 43% 62% 58%

BBB 24% 38% 55% 51%

BBB+ 21% 33% 48% 45%

A- 18% 28% 40% 38%

A 16% 25% 36% 33%

A+ 9% 14% 20% 19%


Table 55: Indicative credit guarantee (as a percentage of total debt obligations in present value terms), target rating AA+ for a 10-year instrument


Source rating AA+ AA+ AA+ AA+

BBB- 28% 43% 63% 59%

BBB 25% 39% 57% 53%

BBB+ 22% 34% 50% 47%

A- 19% 27% 43% 40%

A 17% 26% 38% 36%

A+ 10% 16% 24% 22%


While an approximation of possible credit enhancement has been arrived at, the actual quantum of

credit enhancement to be given would need to be assessed on a case-to-case basis. However, BGFI

could specify the maximum quantum of guarantee cover for any project at 60% for its PCG product.

Also, it can be gleaned from the table above that the quantum of guarantee required in case of non-

infrastructure projects is a high 22-63%, mainly due to lower recovery rates. For instance, if a

manufacturing company defaults, its working capital limits will be frozen, resulting in ceased

operations and stalled production. In such a scenario, the lender will be reluctant to extend funding.



Hence, the quantum required to partially guarantee projects in this sector is considerably high. Based

on this analysis, it can be said that the partial guarantee product may prove infeasible for non-

infrastructure projects and entities, compared with a full guarantee.

8.1.3 Pricing

Pricing is an important aspect of credit guarantee products. The guarantee fee impacts not only the

marketability of the products to prospective bond issuers, but is also a key factor determining the

financial sustainability of the facility. While fees would be typically negotiated as a percentage of

savings accruing to the borrower/ issuer because of credit enhancement, the guarantor should also

ensure that the guarantee fee covers all expected losses (losses due to default), unexpected losses

(over and above default and therefore an impact run on the capital).

8.1.3.1 Cost savings analysis

The analysis will need to take into account several factors. These factors are as listed below –

Credit spreads: The quantum of guarantee fee will be a function of the credit spread between the

rating of issuer of the guaranteed bond and the rating of the guaranteed bond at the time of issuance.

The credit spreads are depicted in the figure below:

Figure 25: 10-year bond spreads7 data for AA, A and BBB category bonds in India

Cost of alternative sources of finance: The primary alternative financing option available for both

infrastructure and non-infrastructure sectors is bank loan. Hence, the pricing of guarantee schemes

will need to take into account the prevailing cost of bank loans for each project. Currently, the base

rate for lending mandated by RBI is in the range of 10.00-10.25%.

It has to be noted that there is no correlation between the external rating and the risk premium in most

of the commercial banks in India, as per primary research. This poses a challenge in determining the

exact interest rate offered for existing facilities. However, for our analysis, we have assumed a risk

premium of 0-300 basis points for the borrower, as a result of which, the interest rate for a loan is in

the range of 10.13-12.50% at an average, as listed in the table below.

7 Spread measures the difference between the yield of a bond and the yield to maturity of a similar maturity treasury bond.



Table 56: Annual bank loan rates

Rating Spread Average Interest rate

AAA 0.00% 0.00% 10.13%

AA 0.10% 0.20% 10.28%

A+ 0.80% 1.00% 11.03%

A 1.00% 1.20% 11.23%

A- 1.20% 1.50% 11.48%

BBB+ 1.75% 3.00% 12.50%

BBB 1.75% 3.00% 12.50%

BBB- 1.75% 3.00% 12.50%

Source: RBI, CRISIL Infrastructure Advisory

Structure risk premium associated with investment in guaranteed bonds: Guarantee products

and schemes are in a nascent stage in India. Such schemes attract lesser interest from investors due

to perceived complexities and higher risk associated with guaranteed structures, especially in case of

a partial credit guarantee. The pricing of partial credit guarantee products will thus need to incorporate

the higher risk premium associated with guarantee structures. Based on primary interactions, this risk

premium is likely to be 0.50%8 for partial credit guarantee. In case of full credit guarantee, investors

may have a higher comfort (given the number of such instances in bonds issued by state-owned

entities) and hence may not have any risk premium.

The first level pricing of the guarantee can be determined based on the savings in financing cost

accruing to the borrower on account of the guarantee. The optimum guarantee fee can be estimated

such that by issuing the guaranteed bond, the issuer is able to retain a certain portion of the

difference between the total issuance cost of the bond and the cost of funding alternatives available at

that point in time. This share has been assumed as listed in the table below, on the basis of the

source rating of the bond issued.

Table 57: Share of savings accruing to issuer in case of partial/ full credit guarantee

Source rating Share of gross savings assumed to accrue to issuer

A+ 50%

A 50%

A- 40%

BBB+ 50 bps

BBB 50 bps

BBB- 50 bps

Source: CRISIL Infrastructure Advisory; it is assumed that a facility such as BGFI would be able to charge a higher percentage

of savings as guarantee fee for lower rated instruments, especially in the BBB category

8 Interactions with several investor/investment bankers revealed a desired risk premium of 20-75 basis points.



Estimation of an indicative guarantee fee for the credit guarantee products has been conducted for

the following scenarios in the transport sector.

Scenario 1 – Full credit guarantee; Source rating – BBB, Target rating – AAA.

Scenario 2 – A - Partial credit guarantee; Source rating – BBB, Target rating – AA+

Scenario 1 – Full credit guarantee, source rating BBB, target rating – AAA

In such a scenario, two primary alternatives available to the borrower to raise funds for tenure of 10

years are: a loan from any commercial bank and issue of a full credit guarantee bond.

As calculated above, the bank loan is available to the borrower (with a BBB rating) at an interest rate

of 12.50%.

In case the borrower opts for a full credit guarantee that results in an upgrade to AAA rating, the

associated pricing range is 9.18% currently. Factoring in a transaction cost of 0.25% (for the entire

tenure or an annual fee of 0.025% every year) for the issue of bonds and an upfront processing fee of

0.20% (for the entire tenure or an annual fee of 0.020% every year) charged by the guarantor, the

total cost for issuing the AAA rated bond will be around 9.28%.

Hence, by issuing the fully guaranteed bond and not opting for the bank loan, the total savings

accruing to the borrower due to the higher credit rating will be around 3.22%. In context of the current

scenario, it is assumed that 0.50% from the savings will flow to the borrower and the remaining could

be potentially charged by BGFI

Table 58: Indicative guarantee fee – full guarantee product (Scenario 1)

Particulars Value

Gross saving (A) 3.22%

Guarantee fees (% of total bond principal) 2.72%

Guarantee fees (% of guaranteed amount) 2.72%


Scenario 2 – Partial Credit Guarantee; Source rating – BBB, Target rating – AA+

If, instead of a full guarantee, a partial cover is provided by BGFI, the credit enhancement results in a

seven-notch upgrade to AA+ rating and the instrument will be priced at 9.30% as per current rates,

compared with the 12.50% interest charged on the bank loan. Factoring in the transaction cost of

0.25% for the entire tenure (or an annual fee of 0.025% for 10 years) for the issue of bonds and an

upfront processing fee of 0.20% for the entire tenure (or an annual fee of 0.020%) charged by the

guarantor and a risk premium of 0.50% (that an investor would typically demand) associated with a

partial guarantee structure, the total cost for AA+ rated bond will be around 9.87%, as depicted in the

table below.

In this case, the total savings accruing to the issuer will be 2.63%. It is assumed that the guarantor

can charge 2.53% on the bond value.

Assuming the quantum of credit enhancement given is 25% of the bond value, the guarantee fee that

could be charged by the guarantor can be represented as 8.20% of the guaranteed amount



Table 59: Indicative guarantee fee as a percentage of principal - partial guarantee product (Scenario 2)

Particulars Value

Gross saving (A) 2.63%

Guarantee fees (% of total bond principal) 2.13%

Guarantee fees (% of guaranteed amount) 10.60%


8.1.3.2 Expected losses to BGFI

The expected losses on any guaranteed instrument will be equal to the loss given default or LGD

(after recovery) multiplied by the probability of that default happening. The calculation for loss to BGFI

due to these expected losses will be an extension of the analysis undertaken in section 3.2.2.3.

The starting point to this assessment is the LGD arrived at. The quantum of credit enhancement that

BGFI would provide to cover this LGD would give the absolute loss to BGFI. Multiplying this quantum

by the probability would result in the expected loss to BGFI for each scenario. Average loss

percentage would then be calculated as the sum of losses to total debt obligations.

Table 60: Approach to calculate loss to BGFI due to expected losses


Considering the examples/scenarios in 3.2.3.1, the associated losses to BGFI would be

Scenario 1 – Full credit guarantee; Source rating – BBB, Target rating – AAA

Table 61: Expected loss to BGFI – full guarantee

Particulars Value

Loss as a percentage of bond principal* 2.75%

Loss as a %age of guarantee amount 2.75%

Source: CRISIL Infrastructure Advisory; *-Since bond principal is the present value, the loss has been calculated on the present

value of all debt obligations

Scenario 2 – Partial credit guarantee; Source rating – BBB, Target rating – AA+



Table 62: Expected loss to BGFI – partial credit guarantee

Particulars Value

Loss as a percentage of bond principal* 2.62%

Loss as a percentage of guarantee amount (26% guarantee)

10.57%

Source: CRISIL Infrastructure Advisory; *-Since bond principal is the present value, the loss has been calculated on the present

value of all debt obligations



9. Annexure 4 – Translating global-scale ratings to

CRISIL’s scale

In an increasingly globalised investment environment, an issue Indian investors frequently face is the

lack of clarity on the relation between rating symbols of domestic and global raters. CRISIL faces this

issue when assessing the credit quality of instruments that carry an element of foreign credit risk. In

such instances, CRISIL's assessment involves 'translation', whereby the foreign company’s' ratings on

a global rating scale are 'mapped' to CRISIL's own rating scale. CRISIL's methodology for such

translation is based on the first principles of correlating the default and transition rates of both scales.

This is backed by CRISIL's extensive in-house research and a rating history of more than 20 years,

spanning about 5,000 issuer years and 121 defaults.

According to empirical data, a rating in the 'AA' category and above on S&P's global foreign currency

scale tends to map to a 'AAA' rating on the CRISIL scale, while an 'A' category rating on the global

scale foreign currency tends to map to a 'AA' category rating on the CRISIL scale. Such translation

would mean global rating changes by international rating agencies may, at times, result in changes in

the ratings on the debt instruments of domestic companies that carry the element of foreign credit risk.

The need for such translation has also gained importance as multinationals have increased their

presence in India. CRISIL's ratings of such companies are influenced, to varying degree, by the credit

quality of their parents, as indicated by their outstanding credit ratings from S&P. CRISIL uses these

global-scale ratings in its analytical framework while rating debt issued by the related Indian entities,

irrespective of whether explicit guarantees are provided by the multinational parent.

In cases where the parent company provides an explicit guarantee for the rated debt, CRISIL's rating

depends solely on its assessment of the credit quality of the guarantor, as reflected in the translated

rating. In instances where there is no explicit guarantee, CRISIL takes a view on the standalone rating

of the Indian entity and the translated rating of the foreign parent, and assesses the relationship

between the two from a credit perspective. These factors determine the extent to which the Indian

entity's standalone rating will be notched up to factor in the credit strength of its parent. In both

instances, the foreign company's credit quality is assessed after translating its rating on the global

scale onto CRISIL's scale.

Different approaches used to translate ratings

A comparison between global-scale and national-scale ratings can be done in three ways: sovereign

ceiling, direct credit assessment and the first principles approach as shown in the table below.

Table 63: Approach to compare global-scale and national scale-ratings

Sovereign rating linkage Independent credit assessment First principles approach

S&P and other major international rating agencies typically have three rating scales— global scale foreign currency ratings, global scale local currency ratings, and national scale ratings—to address the various investor segments.

In such an approach, the foreign company is assessed in the same way a domestic company is, and assigned a rating on the domestic scale.

Such an exercise involves an analysis of the industry and business risks of the foreign company. These are placed in the

The first principles approach compares the key rating performance indicators, namely, default rates, transition rates and financial ratios of the two rating scales for translation.

The ratings are expected to convey a measure of the



Sovereign rating linkage Independent credit assessment First principles approach

The global scale local currency and foreign currency ratings cater to the needs of transnational investors.

Rating agencies may choose to adopt the concept of sovereign rating linkage while translating global scale ratings onto the national scale, where all the global scale ratings that are higher than the rating of the sovereign are assigned ‘AAA’ (or the equivalent) on the national scale.

With this benchmark, the global scale ratings that are lower than the rating of the sovereign may be translated to correspondingly lower levels on the national scale.

context of the local companies in a similar business; the past and expected financial performance of the foreign company, and its comparison with domestic players, with appropriate scaling for size and foreign currency exchange rates; peer group comparison of market position of foreign company and its domestic contemporaries and the like.

While such an exercise may be meaningful in a fully globalised economy (such as Japan or the Western European economies) the sheer difference in size and other structural differences limit the usefulness in the Indian context.

credit risk (expressed either as default rates or as expected loss).

Comparing such a uniform measure between the global and national scales provides the most meaningful translation between the two rating scales.

CRISIL’s approach to translating global-scale ratings

CRISIL’s approach to translation is based on the first principles of comparison of default rates,

transition rates and financial ratios of CRISIL and S&P in order to ensure an appropriate mapping of

the two rating scales. CRISIL’s default and transition rates are based on ratings assigned by it over 25

years or so, covering multiple credit cycles, and is the most comprehensive database on corporate

defaults and rating transitions in India.

Figure 26: CRISIL's approach to translating global-scale ratings

The translation is based on comparisons of:

Historical default rates: Ratings convey credit risk expressed either as default rates or expected

loss. Comparing using a uniform measure for global and national scales provides the most meaningful

translation Ratings by CRISIL & S&P express credit risk in terms of the likelihood of default, measured

by default rates. CRISIL’s method, therefore, uses default rates as a key input in translation.



Historical stability rates: In conjunction with default rates, stability rates form an important yardstick

of a rating agency’s performance. While default rates are of interest to all types of investors, some

investors, whose investment horizon is less than the maturity of the instrument, are affected by rating

transitions as well. Any mapping between two rating scales should also incorporate transition rates/

stability rates to capture this element.

Financial ratios: Rating across different rating agencies may also be directly compared on the basis

of the financial ratios of the rated entities. Debt protection ratios like net cash accruals to total debt are

not influenced by the size or state of the economy, and hence, are comparable across countries.

According to CRISIL’s translation method, a rating on S&P’s global scale tends to map to a rating on

the CRISIL scale which is roughly 4 to 5 notches higher than the S&P rating. For example, a rating of

‘A’ on S&P’s scale would map to either a ‘CRISIL AAA’ or ‘CRISIL AA+’. A rating of BBB-(India’s

sovereign rating currently) would map to either a ‘CRISIL A+’ or ‘CRISIL A’. In order to arrive at the

exact mapping level, CRISIL also factors in the outlook of the parent’s rating from S&P, the industry/

economic scenario, the rating history of S&P’s rating actions on the parent, etc.

Changes in the ratings of parent companies inevitably impact the guaranteed and notched-up ratings

of their Indian subsidiaries. Volatility in global ratings may, therefore, affect the credit quality of Indian

companies rated by CRISIL - this is an inevitable fallout of translation between the global and national

rating scales.



10. Annexure 5 – Estimation of default rates

The cumulative default rate for a specified period is the number of defaults among rated entities

expressed as a percentage of the total number of rated entities whose ratings were outstanding

throughout the period. Cumulative default rate can be calculated at each rating level, and can be

calculated over multiple periods.

For instance, a five-year cumulative default rate for 2006-2010 can be calculated as the ratio of total

defaults at the end of 2010 to the total number of instruments rated during the period. Only those

instruments whose ratings are outstanding during the entire period are included in the calculation

(referred to as static pool). Let us say an instrument had an outstanding rating on January 1, 2006,

but it was withdrawn in 2008. This instrument will not be included in the calculation. In the case of ‘AA’

category default rate for 2006-2010, the static pool is chosen considering the rating of AA at the

beginning of the period (January 1, 2006). The number of defaulted instruments in the static pool

during the period determines the default rating for the AA category.

The average cumulative default rates are published for the whole universe of rated instruments and

also for each specific rating category. The average cumulative default rate for a period is the simple

mean of the default rates calculated over a period of time – for example, in the case of a five-year

default rate, an average of default rates over 2000-2005, 2001-2006, 2003-2007 and so on is

calculated.

The average cumulative default rate overrides any aberration due to economic conditions, i.e., the

annual default rates during 2008 and 2009 are higher than that of other years.

The tables below give the average cumulative rate of S&P for the period 1981-2013 and the

calculated marginal default rates.


[61] TA-8279 IND: Preparing the Bond Guarantee Fund for India Interim Report Module 3 Draft

Table 64: S&P - Global average cumulative default rates by rating modifier 1981-2013 (%)

S&P rating CRISIL rating

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

AAA

0.00% 0.03% 0.13% 0.24% 0.35% 0.47% 0.53% 0.62% 0.68% 0.74% 0.77% 0.81% 0.84% 0.91% 0.99%

AA+

0.00% 0.06% 0.06% 0.11% 0.17% 0.24% 0.30% 0.36% 0.43% 0.50% 0.57% 0.64% 0.72% 0.80% 0.89%

AA

0.02% 0.03% 0.09% 0.23% 0.38% 0.51% 0.65% 0.78% 0.88% 0.99% 1.09% 1.16% 1.28% 1.36% 1.45%

AA-

0.03% 0.10% 0.20% 0.29% 0.39% 0.50% 0.59% 0.65% 0.72% 0.79% 0.87% 0.95% 0.98% 1.05% 1.12%

A+ AAA 0.06% 0.11% 0.24% 0.40% 0.53% 0.64% 0.78% 0.93% 1.10% 1.29% 1.46% 1.65% 1.88% 2.14% 2.36%

A AA+ 0.07% 0.17% 0.27% 0.42% 0.57% 0.78% 0.99% 1.18% 1.42% 1.69% 1.91% 2.07% 2.21% 2.31% 2.52%

A- AA 0.08% 0.20% 0.34% 0.48% 0.69% 0.91% 1.20% 1.42% 1.59% 1.74% 1.88% 2.04% 2.19% 2.29% 2.38%

BBB+ AA- 0.14% 0.38% 0.66% 0.95% 1.27% 1.62% 1.86% 2.12% 2.43% 2.73% 3.02% 3.19% 3.41% 3.75% 4.17%

BBB A+ 0.20% 0.51% 0.80% 1.24% 1.69% 2.12% 2.55% 2.98% 3.44% 3.91% 4.42% 4.86% 5.24% 5.37% 5.60%

BBB- A 0.32% 0.97% 1.73% 2.63% 3.51% 4.30% 5.03% 5.71% 6.27% 6.84% 7.48% 8.00% 8.50% 9.24% 9.75%

BB+ A- 0.43% 1.25% 2.35% 3.47% 4.56% 5.66% 6.61% 7.31% 8.19% 9.05% 9.64% 10.29% 10.85% 11.28% 12.05%

BB BBB+ 0.68% 2.08% 4.07% 5.92% 7.66% 9.12% 10.45% 11.54% 12.54% 13.39% 14.23% 14.98% 15.35% 15.59% 15.90%

BB- BBB 1.13% 3.47% 5.91% 8.26% 10.33% 12.40% 14.10% 15.75% 17.15% 18.33% 19.26% 19.97% 20.78% 21.58% 22.28%

B+ BBB- 2.31% 6.26% 10.15% 13.52% 16.05% 18.02% 19.82% 21.43% 22.84% 24.25% 25.36% 26.23% 27.05% 27.79% 28.45%

B BB- 4.73% 10.55% 15.19% 18.51% 21.02% 23.29% 24.79% 25.84% 26.79% 27.67% 28.50% 29.28% 29.99% 30.61% 31.37%

B- B 7.92% 15.37% 20.55% 24.12% 26.93% 28.98% 30.64% 31.65% 32.32% 32.94% 33.66% 34.29% 34.64% 35.04% 35.49%

CCC/C C 26.87% 36.05% 41.23% 44.27% 46.75% 47.77% 48.85% 49.67% 50.64% 51.35% 51.99% 52.76% 53.67% 54.40% 54.40%

Investment grade

0.11% 0.30% 0.52% 0.79% 1.07% 1.35% 1.61% 1.86% 2.10% 2.35% 2.59% 2.79% 2.98% 3.17% 3.37%

Speculative grade

4.02% 7.86% 11.19% 13.86% 16.03% 17.82% 19.33% 20.60% 21.74% 22.78% 23.66% 24.42% 25.09% 25.69% 26.28%

All rated

1.53% 3.02% 4.33% 5.43% 6.35% 7.14% 7.82% 8.39% 8.92% 9.42% 9.85% 10.21% 10.54% 10.84% 11.14%

Ministry of Urban Development

TA-8279 IND: Preparing the Bond Guarantee Fund for India Interim Report Module 3 Draft [62]

Marginal default rates

To estimate the extent of credit enhancement required to enhance the rating of a bond from the source rating to the target rating, default rates will be

applied to the annual bond obligations to arrive at the annual defaults for both the source rating and target rating. The default rates to be applied will be

the marginal default rates and not the cumulative default rates. The method for calculation of marginal default rates is shown below

where It+1 = Marginal default rate for t+1 year

Ct+1 = Cumulative default rate for t+1 year

Ct = Cumulative default rate for t year

The above formula calculates the percentage of bonds which hadn’t defaulted till year t, and which are expected to default in year t+1.

Table 65: S&P - Marginal default rates by rating modifier (%)

S&P rating CRISIL rating 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

AAA

0.00% 0.03% 0.10% 0.11% 0.11% 0.12% 0.06% 0.09% 0.06% 0.06% 0.03% 0.04% 0.03% 0.07% 0.08%

AA+

0.00% 0.06% 0.00% 0.05% 0.06% 0.07% 0.06% 0.06% 0.07% 0.07% 0.07% 0.07% 0.08% 0.08% 0.09%

AA

0.02% 0.01% 0.06% 0.14% 0.15% 0.13% 0.14% 0.13% 0.10% 0.11% 0.10% 0.07% 0.12% 0.08% 0.09%

AA-

0.03% 0.07% 0.10% 0.09% 0.10% 0.11% 0.09% 0.06% 0.07% 0.07% 0.08% 0.08% 0.03% 0.07% 0.07%

A+ AAA 0.06% 0.05% 0.13% 0.16% 0.13% 0.11% 0.14% 0.15% 0.17% 0.19% 0.17% 0.19% 0.23% 0.26% 0.22%

A AA+ 0.07% 0.10% 0.10% 0.15% 0.15% 0.21% 0.21% 0.19% 0.24% 0.27% 0.22% 0.16% 0.14% 0.10% 0.21%

A- AA 0.08% 0.12% 0.14% 0.14% 0.21% 0.22% 0.29% 0.22% 0.17% 0.15% 0.14% 0.16% 0.15% 0.10% 0.09%

BBB+ AA- 0.14% 0.24% 0.28% 0.29% 0.32% 0.35% 0.24% 0.26% 0.32% 0.31% 0.30% 0.18% 0.23% 0.35% 0.44%

BBB A+ 0.20% 0.31% 0.29% 0.44% 0.46% 0.44% 0.44% 0.44% 0.47% 0.49% 0.53% 0.46% 0.40% 0.14% 0.24%

BBB- A 0.14% 0.24% 0.77% 0.92% 0.90% 0.82% 0.76% 0.72% 0.59% 0.61% 0.69% 0.56% 0.54% 0.81% 0.56%

BB+ A- 0.20% 0.31% 0.29% 0.44% 0.46% 0.44% 0.44% 0.44% 0.47% 0.49% 0.53% 0.46% 0.40% 0.14% 0.24%

BB BBB+ 0.32% 0.65% 0.77% 0.92% 0.90% 0.82% 0.76% 0.72% 0.59% 0.61% 0.69% 0.56% 0.54% 0.81% 0.56%


[63] TA-8279 IND: Preparing the Bond Guarantee Fund for India Interim Report Module 3 Draft

S&P rating CRISIL rating 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

BB- BBB 0.43% 0.82% 1.11% 1.15% 1.13% 1.15% 1.01% 0.75% 0.95% 0.94% 0.65% 0.72% 0.62% 0.48% 0.87%

B+ BBB- 0.68% 1.41% 2.03% 1.93% 1.85% 1.58% 1.46% 1.22% 1.13% 0.97% 0.97% 0.87% 0.44% 0.28% 0.37%

B BB- 1.13% 2.37% 2.53% 2.50% 2.26% 2.31% 1.94% 1.92% 1.66% 1.42% 1.14% 0.88% 1.01% 1.01% 0.89%

B- B 2.31% 4.04% 4.15% 3.75% 2.93% 2.35% 2.20% 2.01% 1.79% 1.83% 1.47% 1.17% 1.11% 1.01% 0.91%

CCC/C C 4.73% 6.11% 5.19% 3.91% 3.08% 2.87% 1.96% 1.40% 1.28% 1.20% 1.15% 1.09% 1.00% 0.89% 1.10%

Investment grade

7.92% 8.09% 6.12% 4.49% 3.70% 2.81% 2.34% 1.46% 0.98% 0.92% 1.07% 0.95% 0.53% 0.61% 0.69%

Speculative grade

26.87% 12.55% 8.10% 5.17% 4.45% 1.92% 2.07% 1.60% 1.93% 1.44% 1.32% 1.60% 1.93% 1.58% 0.00%

All rated

0.11% 0.19% 0.22% 0.27% 0.28% 0.28% 0.26% 0.25% 0.24% 0.26% 0.25% 0.21% 0.20% 0.20% 0.21%


[64] TA-8279 IND: Preparing the Bond Guarantee Fund for India Market Assessment Report

]

11. Annexure 6 – Legal structure for BGFI

It is important to note that under Indian law, there is a distinction between a contract of guarantee and

a contract of insurance. A contract of guarantee has been defined in Section 126 of the Indian

Contract Act, 1872 (Contract Act) to mean:

“A contract to perform the promise, or discharge the liability, of a third person in case of his default.

The person who gives the guarantee is called the surety; the person in respect of whose default the

guarantee is given is called the principal-debtor, and the person to whom the guarantee is given is

called the creditor”.

Based on a reading of the definition, other provisions of the Act and judicial decisions in relation to a

contract of guarantee, the following may be stated to be the main attributes of a contract of guarantee

under Indian law: (a) it is a tri-partite contract between the surety, the creditor and the principal debtor;

(b) the surety assumes the obligation upon a request (whether express or implied) made by the

principal debtor; (c) the liability of the surety is collateral to the main contract and he is not primarily

liable for the repayment of a loan; (d) the obligation of the surety arises on default; (e) subject to a

contract to the contrary, the surety has a right of subrogation and a right to the security.

As opposed to a contract of guarantee, a contract for insurance under Indian law is a contract in the

nature of an indemnity as defined under Section 124 of the Contract Act (although excluding certain

insurance contracts such as life insurance contracts which are not contracts of indemnity). A ‘contract

of insurance’, while not defined under the Insurance Act, 1938, or any other statute, has been

interpreted by courts in India to indicate that, “a contract of insurance is one whereby one party (the

‘insurer’) promises in return for a money consideration (the ‘premium’) to pay to the other party (the

‘assured’) a sum of money or provide him with some corresponding benefit, upon the occurrence of

one or more specified events”. As a contract of indemnity, an insurance contract is essentially a

bilateral contract between the insurer and the insured and provides no statutory right of subrogation

and recovery.

Given the distinction between a contract of guarantee and a contract of insurance, while it would be

feasible for BGFI to provide ‘credit insurance’ products, BGFI’s rights of recovery or subrogation in

case of a claim by the insured would be limited in nature on account of absence of statutory

recognition of right of subrogation for contracts of indemnity. In case of an insurance product, BGFI

would be required to enter into a contract with the bond subscriber/ investor and not the bond issuer.

Therefore, from a legal risk perspective, a ‘credit guarantee’ product may be a more appropriate

structure than a ‘credit insurance’ product. Further, in addition to the statutory rights of subrogation

and recovery available to BGFI as a guarantor, several contractual safeguards (such as, provision of

security in favour of BGFI) can be built in the guarantee document to mitigate the risks associated

with invocation of the guarantee.

Setting up BGFI as an NBFC: An NBFC is defined to include (i) a financial institution which is a

company (which in turn is defined to mean any non-banking institution which inter alia carries on as its

business or a part of its business financing (whether by way of making loans or advances or

otherwise) of any activity other than its own, and (ii) such other non banking institution or class of such

institutions as the RBI may, with the previous approval of the central government and by notification in

the official gazette, specify.

RBI has notified certain categories of NBFCs, which are (i) asset finance companies; (ii) investment

companies; (iii) loan companies; (iv) infrastructure finance companies; (v) core investment companies;


[65] TA-8279 IND: Preparing the Bond Guarantee Fund for India Draft Interim Report

(vi) Infrastructure debt fund – NBFC; (vii) NBFC- factors; (viii) NBFC – micro finance institution; and

(ix) Non-operative financial holding company.

The RBI Act (as well as the various rules and directions framed by the RBI) do not expressly prohibit

the issuance of a ‘guarantee’ by an NBFC. RBI has recently come out with regulations pertaining to

mortgage guarantee company, whose operations would be similar to that of BGFI.

[b]

Disclaimer

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Development Bank. This Report is based on the information / documents provided by the Company and/or information

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About CRISIL Infrastructure Advisory

CRISIL Infrastructure Advisory is a division of CRISIL Risk and Infrastructure Solutions Limited, a 100% subsidiary of CRISIL Limited – India’s leading

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agencies and private-sector clients. We have extended our operations beyond India and are present in other emerging markets in Africa, Middle East

and South Asia.

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Documents

Technical Assistance Consultant’s Report · 2015-01-15 · Technical Assistance Consultant’s Report This consultant’s report does not necessarily reflect the views of ADB or