Argentina introduces novel offerings - World Bank issues first Policy Based Guarantee

3URMHFW )LQDQFH 35895 DQG *XDUDQWHHV January2000 ProjectFinanceandGuaranteesDepartment PrivateSector&InfrastructureVice-Presidency Argentina Introduces Novel Offerings World Bank Issues First Policy Based Guarantee World Bank Leverages Argentina's Fund for only 17% of total public debt. Due to the Raising limitations of the domestic capital markets, the government has sought a large share of its financing needs from foreign sources. This has been part of On October 15, 1999, the World Bank provided its an effort to limit crowding out of private firms from first Policy Based Guarantee (PBG) for US$1.5 domestic credit, given that private companies have billion notes issued by the Republic of Argentina. limited access to international markets. By late A series of six separate zero-coupon notes (Series 1999, Argentina's ability to tap foreign financial A through F), each with a face value of US$250 markets had been affected by a number of external million were issued to be repaid within a five-year shocks, the impending change in government in period. Series A, C-F mature at the end of year IFR Awards 1999 October and the perceived risks of the Y2K one through five, except series B, which matures at problem. Hence, Argentina's access to foreign the end of 18 months. The overall yield for the markets for large issuance became difficult. This Best Sovereign Bond issuance was 9.73% (on a semi-annual basis), and was augmented by the general lack of liquidity in Best Latin American Bond the gross proceeds were about US$1.165 billion. the US capital markets for emerging market paper. The notes were launched at a time when Argentina Argentina, therefore, pursued a strategy in the was facing difficulties in tapping US institutional international markets limited to niches. Since May markets and its ability to raise financing from 1999, when it last issued a global US dollar bond, capital markets was constrained to small size Argentina could only tap the market for smaller issuance. After the East Asian crisis and its global amounts limited to US$100-300 million equivalent impact, international financial markets remained primarily from the Euro and Yen markets with largely constrained for emerging market credits. progressively increasing spreads. Argentina, which was pursuing sound economic It is in the context of these financing needs and reform, was severely affected especially after the Argentina's prudent strategy of pre-financing its Brazilian crisis in January 1999. The use of the needs by a quarter, that the Argentine authorities World Bank's PBG allowed Argentina to do a requested the Bank to explore the feasibility of large issue at a time when investors generally were deploying the Policy Based Guarantee instrument. not disposed to buy emerging market debt, especially for larger size issuance. The Bank's objective in offering such a guarantee was to help Role of the World Bank Investment Dealers' Argentina mobilize capital market financing through a targeted and limited support. The Bank Given the special funding needs and Argentina's Digest guarantee would help Argentina improve its future compliance with the reform conditions under the access to private foreign capital in terms of Special Structural Adjustment Loan (SSAL), the Deal of the year in broadening the group of investors for Argentine World Bank decided to structure its first Policy paper. Based Guarantee (see Box) for Argentina. It was Emerging Markets envisaged that the use of the PBG with a corresponding cancellation of the equivalent Argentina's Financing Needs amount from the second tranche of the SSAL would not increase the Bank's exposure to Argentina and Argentina's reliance on external financing is allow Argentina to leverage Bank's support and tap historic and results from decades of high inflation, the capital markets for much larger amounts. fiscal deficits, currency devaluations and bouts of hyperinflation. The financing needs of the The market had become aware in late July 1999 that Republic for 1999 were estimated to be about $17 Argentina was considering requesting the Bank to billion with US$8-9 billion to be raised from provide a PBG. Two investment houses competed international markets. The domestic market in aggressively to develop innovative structures that Argentina has remained shallow and has accounted maximized the benefits of the Bank guarantee. The banks held extensive negotiations with the  3URMHFW)LQDQFH Argentine government, which thoroughly of notes only if Argentina reimburses the World DQG*XDUDQWHHV evaluated trade-offs between pricing and leverage. Bank within the 60 days of such payment by the By late August, Argentina decided to award the World Bank. In such an event, the guarantee will January 2000 mandate jointly to both the banks for its public roll forward at the time of reimbursement. In the offering that would result in above US$1 billion event that the maturity of the notes of any series net funding for Argentina. which is not then currently guaranteed is accelerated pursuant to an event of default, the guarantee will not be rolled forward to such series, The Republic of The Issuance but will roll forward to the next series of notes, if Argentina Launched through the Argentine US Shelf on any, that has not been accelerated. Neither the October 7, 1999, the public issuance comprised six series of notes that is at any time guaranteed by the series of zero-coupon notes, each with a face value World Bank nor the World Bank guarantee itself Gross Proceeds: US$ 1,165 million of US$250 million. The Bank's maximum may be accelerated and paid prior to the scheduled Guaranteed Amount: US$250 million maturity of such series under any circumstances. Guarantor: World Bank exposure for the transaction is US$250 million Issue Date: October 15, 1999 (21.55% of the gross proceeds). Gross proceeds of Maturity: 1, 1.5, 2, 3, 4 and 5 yrs. the notes would equal US$1.165 billion resulting Coupon: Zeros Benefits of the Policy Based Guarantee Issue Price: 94.202, 88.485, 83.450, in a leverage of about 4.6:1 over the Bank's This Policy Based Guarantee operation, structured 74.897, 66.421, 58.701 respectively. maximum exposure. Ratings for the notes were Spreads: -15 (over Libor), +250, +335, under the umbrella of the Special Structural sought from three rating agencies -- S&P, Duff & +385, +435, +470 over UST strip yields. Adjustment Loan had the objective of allowing the Underwriting Fees: 12.5, 37.5, 60, 65, Phelps and Fitch IBCA. All three agencies have government to remain focused on longer term 70 & 75 bps respectively. given investment grade ratings for series B Guarantee Fees: 75 bp development issues, not only by preventing through F and a AAA rating for series A (the first Listing: Luxembourg; Buenos Aires backtracking on previous reforms, but also of the series being fully covered by the World Governing Law: New York advancing on fiscal reform, financial sector Lead Managers: Goldman Sachs & Bank guarantee). The notes were successfully J.P. Morgan strengthening, regulatory reform, and protecting launched and placed despite a rating downgrade of critical social programs in a period of recession. Argentina by Moody's on the day prior to launch, negative interest rate outlook by the Fed and a Towards that goal, the Policy Based Guarantee very tight market for emerging market credits. The helped Argentina mobilize the funds to meet its particular structure, where different series were financing needs at reasonable spreads. Benefiting marketed to different investors also allowed from the 30-year yield curve established prior to the Argentina to broaden its investor base beyond the crisis, the guarantee transaction was structured and typical dedicated emerging market funds. About priced with reference to the secondary market Argentina moves into 75% of the issue was placed with new investors pricing. The rolling structure was critical for both mainly with major investment funds from the the leverage and the investment grade ratings investment-grade territory United States. The notes were launched at an required for effective market access to the with its World Bank backed overall yield of 9.73% p.a. The demand and institutional investors. The structure also achieved bond. subscription levels varied for different series with low Bank exposure that did not increase over the a maximum subscription level of 2.5 times for life of the guarantee. At the same time, the series F. transaction widened the Argentine investor base-- the higher-rated issue seems to have appealed to crossover investors who are more likely to buy and Structure of the Notes and Guarantee hold than dedicated funds. The notes will be direct, unconditional and This transaction demonstrated that effective use of unsecured obligation of Argentina, backed by the World Bank enhancement with careful structuring full faith and credit of Argentina. The World Bank and marketing could help client countries such as will guarantee the payment of the aggregate Argentina tap the capital markets in a difficult, but The World Bank guarantee principal amount due on a scheduled maturity date clearly transitory, financial environment. for a single series of notes at any time, up to a allows Argentina to vary maximum of $250,000,000. Initially, only the its investor base, so that it Series A notes will be guaranteed. If Argentina can distribute to a higher pays the principal amount of the Series A notes on For more information on the Argentina Notes, echelon of investors. the scheduled maturity date, the guarantee of the please contact: World Bank will automatically roll forward to the principal amount of the series then guaranteed at Nina Shapiro or Suman Babbar its stated maturity. Project Finance and Guarantees Department If Argentina fails to pay the principal amount of Tel: (202) 473-1650 / 2029 the series then guaranteed by the World Bank, and Fax: (202) 477-0218 the World Bank has made a payment under its Email:Nshapiro@worldbank.org; guarantee will be rolled forward to the next series Sbabbar@worldbank.org  3URMHFW)LQDQFH DQG*XDUDQWHHV January 2000 The Republic of Argentina US$ 250 million Guaranteed Notes Issue Exposure to the World Bank Structure of the Argentine Guarantee $250 $240 $230 $220 0.0 1.0 1.5 2.0 3.0 4.0 5.0 Tenor (yrs) Market Distribution Credit Ratings M id M arket S&P Duff Fitch NAIC Pension 2% Funds 10% Series A Note: AAA AAA AAA NAIC 1 Investm ent Retail4% Advisor/ M utual Funds Hedge Series B Note: BBB A BBB+ NAIC 3 56% Funds US 8% 85% EU Series C Note: BBB A- BBB+ NAIC 3 15% Bank 7% Series D-F BBB BBB+ BBB+ NAIC 3 Insurance Notes: 13% To obtain a copy of the Brochure, The World Bank Guarantee: Catalyst for Private Capital Flows, please contact Andres Londono at (202) 473-2326 or alondono1@worldbank.org  3URMHFW)LQDQFH DQG*XDUDQWHHV January 2000 An Introduction to Policy Based Guarantees In April 1999, the Bank approved the use of "Policy Based Guarantees" (PBGs) an extension of partial credit guarantees in support of adjustment use of borrowings beyond investment projects. These guarantees are expected to play a catalytic role in helping Bank borrowers, with strong economic and social programs, improve their access to private foreign financing. These guarantees would serve two important purposes for the borrower-- enhanced financial leverage and enhanced policy leverage-- that together would add up to enhanced development impact. They would help eligible client countries improve their access to private foreign credits in terms of increased volumes and longer maturities, and reduced spreads; the overall result would be more development finance within a favorable policy and institutional environment. Policy Based Guarantees (PBGs) could also enhance the Bank's policy leverage: by exposing clients to market discipline that would encourage greater progress on structural and social reforms. However, PBGs are not for all countries, and not for all economic times. They are more suitable for countries, which have a strong track record of economic performance or whose external financing needs have important structural, institutional, and social dimensions. More importantly, PBGs are more effective, where the Bank can act as a catalyst for countries seeking to (re)gain access to international financial markets and hence, expecting to (re)establish themselves as borrowers in their own name, without guarantees, in the medium term. As stand-alone guarantees, they cannot improve country performance or market assessments of country performance. Nevertheless, they make a difference for strong performers whose access to markets is temporarily limited or blocked. The guarantee could help reinforce and enhance positive performance and market assessment. In this context, the target clients for this product are strongly performing countries, for which the guarantee and the reform program with which it is associated would positively attract market access. Such guarantees would usually cover a portion of debt service on a borrowing by an eligible member country from private foreign creditors in support of agreed structural, institutional, and social policies. The guaranteed borrowing could take the form of a loan or a bond and the guaranteed portion of debt service could consist of a combination of interest and principal payments; the actual structure would be determined on a case-by-case basis. The guarantee could be self-standing or part of a larger package of IBRD financial support, including possible adjustment loans. For the most part, the Bank would offer PBGs on the same terms as project-based partial credit guarantees. However, the Bank would offer only nonaccelerable PBGs. If the PBG were made in situations comparable to SAL, then the maturity, level of fees, and possible waivers would be standard, and if the PBG were made in association with an SSAL program, then the maturity, level of fees, and possible waivers would be at SSAL-equivalent levels. To provide a PBG, the Bank must be satisfied with the country's macroeconomic, structural, and social policies, institutions, and public expenditures, since this type of guarantee would signal to markets the Bank's endorsement of the borrower's performance and program. Overall, the appraisal framework is designed to ensure that a PBG would be used only if it provided additionality and is financially efficient. Appraisal would entail assessing complementarities between policy conditionality and financial value- added and tradeoffs among additional private exposure (increased access), guarantee coverage (leverage), and yield (reduced borrowing costs). It would take account of Bank (CAS) strategy, country domestic and external circumstances, and market conditions. As in single-tranche adjustment operations, the government's undertakings to adopt and implement the agreed policies and reforms must be reflected in conditions for specific difficult-to-reverse up-front actions in key areas. Such up-front commitments would be consistent with the time sensitive nature of the Bank-guaranteed borrowings, especially in volatile markets.