Approach Paper. A Review of IDB Group s Non-Sovereign Guaranteed Problem Projects

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1 Apprach Paper A Review f IDB Grup s Nn-Svereign Guaranteed Prblem Prjects

2 This wrk is distributed under a Creative Cmmns license (CC BY-NC-ND 3.0 US). Yu are free t share, cpy and redistribute the material in any medium r frmat, Under the fllwing terms: Attributin - Yu must give apprpriate credit, prvide a link t the license, and indicate if changes were made. Yu may d s in any reasnable manner, but nt in any way that suggests the licensr endrses yu r yur use. Nn-Cmmercial - Yu may nt use the material fr cmmercial purpses. N Derivatives - If yu remix, transfrm, r build upn the material, yu may nt distribute the mdified material. N additinal restrictins - Yu may nt apply legal terms r technlgical measures that legally restrict thers frm ding anything the license permits. The link prvided abve includes additinal terms and cnditins f the license. Inter-American Develpment Bank, 2017 Office f Evaluatin and Oversight 1350 New Yrk Avenue, N.W. Washingtn, D.C CII/RE-32

3 TABLE OF CONTENTS I. CONTEXT... 1 II. EVALUATION DESIGN... 2

4 I. CONTEXT 1.1 Managing credit risk is a key functin f multilateral develpment banks (MDBs) that lend directly t the private sectr withut a svereign guarantee. Unlike svereign guaranteed (SG) peratins, fr which the wrstcase scenari is generally delayed repayment, nn-svereign guaranteed (NSG) peratins with private cunterparts can bring abut lsses f bth principal and interest. An MDB s debt cllectin recrd als has indirect effects. First, repayment serves as a key criterin fr rating agencies, thus ptentially affecting future funding csts. Organizatins like the Develpment Bank f Latin America (CAF), whse sharehlders are nt AAA rated, have been building up rating imprvements n the basis f stellar repayment recrds. Secnd, an institutin s recrd f enfrcing cntractual bligatins has reputatinal effects and sends a key message t existing and ptential private sectr cunterparts. Finally, cfinanciers such as B-lenders rely n the lead arranger s reputatin t structure sund peratins. 1.2 The Inter-American Bank (IDB) Grup s histrical NSG 1 write-ffs have been relatively lw at 0.2% and in line with cmparatr rganizatins: 0.3% at the Internatinal Finance Crpratin (IFC) and 0.2% at the Eurpean Bank fr Recnstructin and Develpment (EBRD). 2 In part because impaired lans tend t be kept n the bks fr an extended perid until they are finally reslved r written ff, the level f impairment in IDB s and cmparatrs NSG peratins shws an upward trend. 3 In cntrast, the Inter-American Investment Crpratin s (IIC) share f impaired lans rse during the financial crisis but fell again in 2011 and has remained flat since then, likely due bth t recvery effrts and t the decreasing risk in its prtfli (with a high cncentratin f financial intermediary peratins) IDBG s NSG 2016 prtfli includes the NSG peratins bked in IIC and in IDB via crss-bking. Average NSG write-ffs frm 2007 t 2016 (until 2015 fr EBRD, fiscal year ending in June fr IFC). Figure 1.1 measures the stck f impaired lans as a share f the ttal stck f utstanding lans. If impaired lans are kept n the rganizatin s bks rather than being written ff r reslved, this rati will rise as nn-impaired lans are paid ff and exit the prtfli. 1

5 Figure 1.1. Evlutin f NSG impaired lans: IDBG and cmparatrs Impaired lans as % utstanding lan prtfli 9.0% 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% IDB-NSG IIC IFC EBRD Surce: IDB, IIC, IFC and EBRD Financial Statements 1.3 IDBG has apprached NSG prblem prjects with a fcus n minimizing lsses n a prject by prject basis. Bth the IDB windws dealing with NSG prjects and IIC and nw the new IIC, where the NSG peratins f IDBG have been cnslidated had prject mnitring criteria seeking t identify prblem prjects. In general, this cnsisted f flagging prjects fr increasing degrees f attentin (e.g. radar r watchlist) as they presented signs f prblems, and ensuring the cllabratin f their respective Special Assets Units (SAUs), either as advisrs r as recipients f prjects requiring their specialized mitigatin and recvery activities. Althugh lss preventin was a clear bjective, as develpment institutins bth IDB and IIC als tried t the extent pssible t preserve the viability f prjects. The SAUs at bth IDB and IIC have invlved their Bards in key decisins during the negtiatin prcesses related t impaired assets. II. EVALUATION DESIGN 2.1 As part f OVE s 2017 wrk prgram, the Bard asked OVE t review IDBG s recent histry f impaired prjects, with an eye tward identifying lessns frm past experience. These include the experiences and prcesses f the frmer Structured and Crprate Finance Department (SCF) and the Opprtunities fr the Majrity Initiative (OMJ) in IDB and prcesses in the ld IIC, as well as the nes nw being adpted by the new IIC. 2.2 The bjective f the evaluatin is t shed light n factrs that might have affected the extent f NSG lsses in IDB and IIC in the past, with an eye t gathering lessns that might be useful ging frward. The evaluatin is intended t be frward-lking, as past prblems can be viewed as pprtunities fr future learning, recgnizing that develpment wrk is inherently risky and sme risks will inevitably materialize. The evaluatin will (i) analyze the reasns leading prjects t becme impaired t see if any patterns emerge; (ii) review rganizatinal structures and prcesses in the IDBG, bth past and present, t see hw these have functined ver time; and (iii) lk at practices at selected multilateral and institutins and private financial institutins t see if lessns emerge. Amng multilaterals, IFC and EBRD have a strng reputatin fr 2

6 handling prblem prjects, including thse caused by systemic cuntry crises such as the ne invlving Russia at EBRD. Amng private sectr cmparatrs, cmmercial banks can gather lessns n SME cllectin issues and investment banks n cllectin issues related t mre cmplex, larger prjects. OVE will nt cnduct a cmprehensive review f external practices but rather will seek t gather ptentially applicable lessns frm these few cmparatr rganizatins. 2.3 OVE s review will fcus n 66 IDBG NSG prjects 4 that were financially impaired 5 at sme pint ver the last 10 years. The review s cmmn denminatr will be prjects deemed by IDBG management as psing a risk f financial lss, als called impaired, dubtful, written-ff r lss prjects. Mst f the 66 impaired prjects were small (usually with SME clients f the ld IIC and OMJ), while a few large prjects (mainly in infrastructure f the ld SCF) accunted fr mst f the vlume. Sme f these prjects later recvered full value, while thers spiraled dwnwards. The 10 year perid will allw enugh time fr prjects t have been reslved and fr varied ecnmic cnditins t ccur. 2.4 The evaluatin will address the fllwing questins: What were the main causes f prblems in NSG prjects? What were the characteristics f prjects that defaulted? Are there cmmn reasns why they went int default? T what extent were the risks in these prjects identified at apprval and, if identified, justified in the lan prpsal by a strng develpment ratinale? What prject traits and/r IDBG prcesses appear t be assciated with mre psitive pst-default utcmes? Were any particular prject traits assciated with relatively psitive pstdefault results? Is it pssible t identify pst-default prcedures that appear t have helped the IDBG achieve relatively psitive pst-default results? D the experiences f cmparatr financial institutins ffer any lessns fr IDBG n hw t handle prject prjects? 2.5 T address these questins OVE will cnduct (i) a desk review f IDBG Impairment Reprts (and ther relevant dcumentatin if needed) fr the 66 prblem prjects in the evaluatin prtfli, (ii) a dcument review and structured interviews with current and frmer IDB and IIC staff regarding the plicies, practices, and rganizatinal setups t deal with prblem prjects at IDBG; and (iii) structured interviews with relevant staff f selected cmparatr rganizatins, mst likely including IFC, EBRD, and at least tw private sectr banks. 4 5 Apart frm these 66 prjects, 24 ther impaired prjects were excluded frm the review. Seven were apprved befre 1996 (thugh still under SAU during the perid) and were cnsidered t ld t yield useful lessns n current practices. Fifteen were equity prjects and tw were guarantees that were excluded due t equity s and guarantees different natures. This includes prjects that were written-ff during the perid, regardless f whether they had been declared financially impaired befre. Hwever, it excludes runding dwn write-ffs f less than $1,000, usually resulting frm minr adjustments, such as fees waivers in therwise financially sund prjects. 3

7 2.6 The evaluatin team includes Alejandr Srian and Rland Michelitsch (team leaders), Rni Szwedzki, Patricia Oliveira, and Melanie Putic. T facilitate management review in light f the busy year-end bunching seasn, a draft f the evaluatin is expected t be delivered t management in December 2017, and the final evaluatin is expected t be delivered t the IIC Bard f Executive Directrs in January