Government Guarantee Risk Measurement Sovereign Debt Management - PowerPoint PPT Presentation

Government Guarantee – Risk Measurement Sovereign Debt Management Forum – World Bank Washington DC, 3-4 December 2014 Lalu Taruna Anugerah Head of Contingent Liabilities Unit Ministry of Finance of The Republic of Indonesia Directorate General of Debt Management Phone : +6221 351 0714 Fax : +6221 351 0715 Website : www.djpu.depkeu.go.id Email : lalu.taruna.anugerah@gmail.com

Outline 1. Key Characteristic  Background  Guarantee Scheme  Guarantee Programs 2. Fundamental Risk Analysis  Internal Credit Rating (ICR), Why ?  ICR Functions  Example : ICR for Regulated Electricity 3. Risk Quantifications  Expected Losses 4. Application of Risk Measurement  Probability of Default  Guarantee Fee  Budget Allocation  Reserve Account DGDM M – Mini nistr try y of Finance nance RI 2

Key Characteristic Background :  Encourage private sector involment in infrastructure development programs  Attracting investors/creditor (credit worthiness)  Sharing risks between government and investor/creditor  Decreasing cost  Decreasing tariff DGDM M – Mini nistr try y of Finance nance RI 3

Key Characteristic Guarantee Schemes: Recourse Agreement Govt Guarantee Letter Credit SOE / Creditors Local SOE Guarantee Loan Agreement Scope of Guarantee Letter: - Default risk Project Sponsor Sponsor Govt Sponsor Equity Equity Recourse Investment Agreement Guarantee Agreement Guarantee Line Ministry/ Project SPV Municipality/SOE/ Local SOE Cooperation Agreement / PPA Creditors Scope of Guarantee Agreement: Loan Agreement a. Default risk b. Termination risk caused by political risk DGDM M – Mini nistr try y of Finance nance RI 4

Key Characteristic Current Government Guarantee Programs: Sector Type Fast Track Program Phase 1 (FTP 1) • Full credit guarantee – Government will directly Power pay to creditor(s) of PLN* when PLN fails to service its financial obligation Credit Guarantee Clean Water Availability Program • Guarantees 70% of repayment of PDAM* Water obligations to creditor(s) Fast Track Program Phase 2 (FTP 2) • Business Viability Guarantee – Guarantees the viability of PLN* to fulfill its obligations under Power Power Purchase Agreement with Private Power Producers and also guarantees against political risk Investment Guarantee Public and Private Partnership (PPP) Power, Water, Toll Roads, Railways, • Guarantees obligations of Ministry/Agency, Local Bridges, Ports, and Government, SOEs/Local SOEs to an entity under a PPP Agreement Others * PLN is an SOE in electricity sector, and PDAMs are Local SOEs in water sector DGDM M – Mini nistr try y of Finance nance RI 5

Fundamental Risk Analysis Internal Credit Rating (ICR) methodology, Why ?  Previous methodology : based on credit rating agency  Not all guaranteed parties have been rated by credit rating agency  Difficulty in risk measurement  Setting threshold for acceptable risk level in providing guarantees  Strong capability of credit analysis is necessary for ongoing credit monitoring and credit risk mitigation  Different sectors have different characteristics  Regulated electricity  Regulated water  Project financing  The next projects (?)  Different kinds of guaranteed parties :  Line Ministry  Municipality  SOEs  Local SOEs DGDM M – Mini nistr try y of Finance nance RI 6

Fundamental Risk Analysis Functions ICR :  Assessing level of credit risk the government would be exposed  Analyzing credit risks factors: regulatory risks, business risks, operational risks, financial risks.  Setting up risk mitigation plan  Used to determine:  Probability of default  Expected loss  Guarantee fee  State budget allocation DGDM M – Mini nistr try y of Finance nance RI 7

Fundamental Risk Analysis (example : Score card for regulated electricity) Internal Credit Rating SPU for Company XYZ Sub Score Final Score Weight Regulatory Framework 20.0% 0.70 a. Legislative and Judicial Underpinnings of the 10.0% 4 b. Consistency and Predictability of Regulation 10.0% 3 Ability to Recover Cost and Earn Return Ability to Recover Cost and Earn Return 20.0% 2.60 2.60 a. Timeliness of Recovery of Operating and Capital 10.0% 12 b. Sufficiency of Rates and Return 10.0% 14 Diversification 10.0% 1.30 a. Market Position 5.0% 12 12 b. Generation and Fuel Diversity 5.0% 14 Management 10.0% 1.40 a. Strategic Positioning 3.3% 15 b. Operational Effectiveness 3.3% 12 c. Governance (BoD) 3.3% 15 Key Credit Metrics 40.0% 5.10 a. (CFO pre WC + Interest)/(Interest+Principal) 15.0% 12 b. CFO pre WC/Debt 15.0% 12 c. Debt/Total Asset 5.0% 18 d. Foreign Currency Debt/Domestic Currency Debt 5.0% 12 Ba1 Base Rating 11.10 Base Modifiers Factors Notch Adjusted Score Base Rating 11.10 Liquidity 3 0 11.10 Financial Policy 2 0 11.10 Final Rating Non Investment Grade Ba1 11.10 DGDM M – Mini nistr try y of Finance nance RI 8

Risk Quantification Example : Expected Losses at COD period ICR = Ba1 (Moody’s)  The Expected Losses are calculated with the following formula: EL = PD x EAD X LGD  PD = Refers to Probability of Default from default study of rating agency  EAD = Exposure at Default is the annual credit exposure depending on disbursements and amortizations for credit guarantee OR realization of equity + debt for investment guarantee = USD 3.200.000.000  LGD = Loss Given Default = 1 - recovery rate = 50% EL = 0,674% x 3.200.000.000 x 50% EL = USD10.784.000 DGDM M – Mini nistr try y of Finance nance RI 9

Application of Risk Measurement Guarantee Fee:  One time fee : arranging fee, front end fee, processing fee  Recurring fee : guarantee fee Fee calculated based on the yield spread between unguaranteed bonds of the guaranteed party with the yield of government bonds (market value approach) Fee = 50%* x [ government bond yields – XYZ ** bond yields ] Fee = 50% x [ 80 bps ] Fee = 40 bps Example: Fee at COD period Fee = 40 bps x exposure Fee = 40 bps x USD 3.200.000.000 = USD 12.800.000 * Additional discount could be applied to the fee : • Government is not profit entity • Acceleration in infrastructure programs, and • Depending on impact to the tariff. ** XYZ is a State Owned Enterprise in electricity sector DGDM M – Mini nistr try y of Finance nance RI 10

Application of Risk Measurement Budget Allocation and Reserve Account:  Budget allocation = expected losses (with 100% LGD*) = PD x EAD X LGD = 0,674% x 3.200.000.000 x 100% = USD 21.568.000  Guarantee Fund Reserve account  Only for guarantee payments (restricted cash)  Unused budget allocation will be accumulated in the Reserve Account, until its balance reaches a certain amount  Purposes :  To make sure Government has sufficient amount to pay guarantee claims in a timely manner  To avoid the need for allocating a huge amount of fund in the state budget *) - The guarantee has been issued by government mostly only for one party (undiversified) - Needed huge amount of fund if termination risk occur - MoF is developing guarantee fund reserve account DGDM M – Mini nistr try y of Finance nance RI 11

Thank You Ministry of Finance of The Republic of Indonesia Directorate General of Debt Management Frans Seda Building Wahidin Raya 1 Street, Jakarta Phone: +6221 351 0714 Fax: +6221 351 0715 Website: www.djpu.depkeu.go.id DGDM M – Mini nistr try y of Finance nance RI 12

Fundamental Risk Analysis (example : Score card for regulated water) Internal Credit Rating SPU for Company ABC Weight Score Final Score Regulatory Environment & Asset Ownership Model 30.0% 2.76 a. Stability & Predictability of Regulatory Environment 12.0% 9 b. Cost and Investment Recovery (Ability & Timeliness) 8.0% 6 c. Asset Ownership Model 10.0% 12 Operational Characteristics & Asset Risk 14.0% 2.1 a. Operational Efficiency 7.0% 15 b. Scale & Complexity of Capital Programme & Asset Condition 7.0% 15 Stability of Business Model & Financial Structure 10.0% 0.45 a. Ability & Willingness to Pursue Opportunistic Corporate Activity 5.0% 3 b. Ability & Willingness to Increase Leverage 5.0% 6 Management 6.0% 0.84 a. Strategic Positioning 2.0% 15 b. Operational Effectiveness 2.0% 12 c. Governance (BoD) 2.0% 15 Key Credit Metrics 40.0% 4.05 a. Adjusted Interest Coverage OR FFO Interest Coverage 15.0% 1 b. Net Debt to Regulated Asset Base OR Debt/Capitalisation 15.0% 18 c. FFO / Net Debt 5.0% 6 d. RCF* / Capex 5.0% 18 Baa3 Base Rating 10.2 Base Adjusted Modifiers Factors Notch Score Score Rating Base 10.20 Liquidity 3 0 10.20 Financial Policy 3 -1 11.20 *) Retained Cash Flow (RCF) (FFO – Dividend) / Capex Final Rating Non Investment Grade Ba1 11.20 DGDM M – Mini nistr try y of Finance nance RI 13

Rating agencies’ databases can be used to estimate PDs based on credit rating DGDM M – Mini nistr try y of Finance nance RI 14