Introduction

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

2. Introduction • ADB: Participating at early stage • Public Sector: Advising policy and framework dialogue, coordination and relationship management with Governments • Private Sector: Debt and Equity funding at early, riskier, stage • ADB and India • Public Sector: TA on the SAFREASI Act and Secured Transactions • Private Sector: Equity funding for ARCs, potentially Security Receipt investor

3. NPL market drivers and the ADB • INVESTMENT BANKS: Principal business needs risk sharing • Require leverage to lower equity cost, WACC • Seek diverse partners to better share risks • ASIAN NPL MARKETS: Early-stage Development • Early stage: Fewer players, higher costs • Later stage: More standardization like other markets • ADB: Valuable Early-stage Participant • Public Sector: Provide political value as multilateral • Private Sector: Offer Debt and Equity funding at riskier early stage

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

5. Overview • MAIN: Senior, limited-recourse debt • Partial Credit & Political Risk Guarantees • Equity Participation at Early Stage • General “Comfort” as Multilateral Partner

6. ADB Loan for NPL Portfolio Purchase • Portfolio Acquisition Loan • Senior, limited recourse • Maximum of 25% of total transaction cost (funding) or US$ 75 • million (whichever is less) • Full credit, market asset and legal due diligence • Market-based spread • Underwriting Fee of 1% - 1.5% • US$, Euro or, depending on the country, local currency

7. Example: Outright Sale Investor 100% Debt Portfolio Originating Bank SPV Servicer Fee Purchase Price Servicing

8. ADB and Securitization • ADB Partial Credit Guarantee (PCG) • timely payment of interest and ultimate payment of principal • up to 100% of one tranche • 2 shadow ratings by acceptable rating agency Liquidity Facility Political Risk Guarantee

9. Example: Conventional CLOs • Guarantee • Loss bearing Liquidity Facility Charitable Trust • Senior Tranche • rated bonds • 1st priority security over Portfolio • 5 years (callable after 3) • Coupon Bearing • Liquidity Facility from OECD Bank Investors 100% equity SPV Outright sale of Portfolio • Mezzanine Tranche • unrated bonds • 2nd priority security over Portfolio • 7 years • Coupon Bearing Originating Bank Investors MarketValue • Junior Tranche • bond/loan/preference shares • subordinated • 10 years • zero coupon (cash sweep) Originating Bank Portfolio

10. Critical Issues: The Servicer • More than for any other asset class, the Servicer is critical for an NPL deal. There will not be any cash flow from the assets without a Servicer. • Two kinds of Servicer: • Special Servicer • Seller (Bank) • Recovery Strategies: • Legal Proceedings • DPOs (Discount Pay-Offs) or out-of-court settlements • REO company, a third party that will go to auction if prices become too low with the purpose of selling the property on the open market afterwards • Marketing & Sale Programmes • Funding Programmes, to provide funding to potential buyers of real estate properties (at auction or outside) • Other Critical Issues: Underlying asset pool (secured vs. unsecured), legal environment, structural enhancements

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

12. ADB and Indian ARCs ARC 100% Sale of NPL Trust Originating Bank SRs SRs Security Receipts (SRs) In consideration Cash Foreign Investor Local Investor

13. THANK YOU

14. Appendix 1: Asia’s NPL Resolution Problem

15. New strategies in investment banking • Moving away from “client focus” to principal business • Ramping up proprietary business • shrinking investment banking fees • growing proprietary trading • expanding distressed debt investment business • example: Goldman Sachs’s business model in Japan • Growing advisory business in area of distressed assets • continuous conflicts of interest to be managed

16. Equity Solution for Asian NPLs? • NO. Equity is not sufficient. • Magnitude of NPL problem in Asia • Country limits and single deal exposures for investors • Increasing sophistication from sellers (e.g. PRC AMCs): more complex bid/offer spread Total Asia ex-Japan Distressed Debt Distressed Debt to Stock Markets $ in billions Source: Ernst & Young; Bloomberg Source: Ernst & Young; Bloomberg • Approximately US$815 billion of Asia • ex-Japan NPLs • Value of distressed debt is greater than some local stock markets

17. ADB’s Involvement: EARLY STAGE EARLY STAGE: CATALYTIC • “Common Funder” • Strong benchmarks and transparent NPL market • “Best market practices” • Catalyzing debt funding from international and domestic banks NPL Resolution Market Number of Players Fees Market Development t (a) ADB (b)

18. Outside ADB Scope: • South Korea • Japan • Taipei,China ADB’s Market Tiny Starting Growing Thailand Philippines PRC India

19. Appendix 2: ADB Due Diligence

20. Introduction • NPLs can be classified into two categories: • Secured NPLs have a security – a mortgage security or personal guarantee – of good quality. In most cases, mortgage loans with a first-rank lien or loans with a corporate guarantee fall under this category. The recovery process will largely depend on legal proceedings, while the extent of the recovery will depend on the real estate market. • Unsecured NPLs do not benefit from a good security. In most cases, mortgage loans with a second- or third-rank lien, unsecured corporate loans, consumer loans or overdrawn bank accounts fall under this category. The recovery process will largely depend on the efficiency of the servicer. • The presence and the quality of a security for NPLs will obviously affect the expected level of recoveries for the creditor. • NPL debtors are either private individuals or corporate legal entities (corporations in most cases). The debtors’ legal characteristics will affect the legal proceedings and their durations.

21. General Principles • The Asset Side: • the characteristics of the NPL portfolio (secured vs. unsecured NPLs…) • the efficiency and the recovery strategies of the Servicer • the eventual support mechanisms (Liquidity Facility/Guarantee in the case of payment shortfall on the NPLs) • The Liabilities Side: • The waterfall of payments on the different classes of notes (subordination capital and/or interest) • The eventual support mechanisms (collateral in the case of payment shortfalls on the notes)

22. Modeling Process INPUTS on: - assets (recovery, timing) - support mechanisms OUTPUTS: Expected Repayment Profile of ADB Debt Modeling of Cash Flows Generated by NPL Portfolio Cash Flow Model

23. Modeling Assets’ Cash Flows • Assets’ Cash Flows: Secured or Unsecured • Secured NPLs – Loan-by-Loan analysis • Timing • Type of legal proceedings (insolvency/bankruptcy or foreclosure) • Phase of the legal proceedings and number of auctions according to the underlying real estate property. • Court timing recovery according to the legal phase. • Servicer’s strategy (legal proceedings or out-of-court settlements, or other strategies ….) • Amount • Mortgage security amount • Loan/claim Outstanding Amount (Gross Book Value) at the expected recovery date (legal interest or late payment interest) • Forced Sale Value (minus legal fees) at the expected recovery date. The Forced Sale Value of the property is derived from the last Market Value and projections for the real estate market (according to the kind of property – residential, commercial, industrial – and the geographic situation) • Several scenarios regarding timing (courts, Servicer’s efficiency/strategy) and real estate markets (cycles, volatility)

24. Appendix 3: Other Potential NPL Structures

25. (1) Joint Venture Management • ADB Loans • secured by Portfolio • 5/7 to 10 years Outright sale of Portfolio Originating Bank SPV Debt Funding Market Value Equity Funding 50% Cash 50% In-Kind Originating Bank JV Partner Portfolio JV Agreement • Compared to Holding the Portfolio, this solution provides: • Leverages the expertise & resources of two JV Partners • Lower upfront proceeds • Medium up-front write-down • Financing risk • Maximum work-out upside / downside • No deconsolidation

26. (2) Joint Venture with Pooling 25% Funding Outright sale of Portfolio A SPV Bank A • Senior Loan • 1st priority security • over Portfolios A & B • 5 to 7 years Market Value • Junior Loan A • subordinated • security over • Portfolio A • 7 to 10 years • Junior Loan B • subordinated • security over • Portfolio B • 7 to 10 years 25% Funding Bank B Outright sale of Portfolio B Bank B Market Value 25% Funding 25% Funding Bank A Bank B Portfolio Joint Management Agreement

27. (3) Synthetic Sale Senior Debt 1/3 : Financial close Originating Bank SPV 1/3 : 1st year 1/3 : 2nd year Equity Investor Market Value Servicing Contract - Base Fee - Incentive Fee

28. (4) Synthetic CLO with CDS Charitable Trust Guarantee 100% equity • Senior Tranche • rated bonds • 1st priority security over Collateral • 5 years (callable after 3) • Coupon Bearing Investors CREDIT DEFAULT SWAP: SPV Premium only Funding Originating Bank No Credit Event: Zero Credit Event: Deliver Asset reference price • Mezzanine Tranche • unrated bonds • 2nd priority security over Collateral • 7 years • Coupon Bearing Investors Funding Portfolio

29. (5) Hybrid CLO with Equity Charitable Trust Guarantee 7.5% of equity of SPV 1 100% of equity of SPV 2 • Senior Tranche • rated bonds • 1st priority security over Loan Receivables • 5 years (callable after 3) • Coupon bearing • Liquidity Facility from OECD Bank Investors 45% of equity of SPV 1 47.5% of equity of SPV 1 Originating Bank SPV 2 SPV 1 • Mezzanine Tranche • rated bonds • 1st priority over 0% RW Assets • 2nd priority security over Loan Receivables • 7 year • Coupon bearing Investors Originating Bank Secured Portfolio Loan • Junior Tranche • bond/loan/preference shares • subordinated • 10 years • zero coupon (cash sweep) Originating Bank Portfolio

30. William Willms Asian Development Bank +63 2 632 5469 wwillms@adb.org