The African Development Bank faces a number of particular
challenges in its funding programme.
With an annual financing requirement which rarely surpasses $1bn,
its opportunities to market its credit to institutional investors
with benchmark issues are limited.
At the same time it is trying to adopt a more cost-oriented,
opportunistic approach to the capital markets.
Is it succeeding in attempting to find the right balance in its
Despite raising over $3bn in the international capital markets
in the last four years, the African Development Bank (AfDB) remains
one of the least understood supranational borrowers.
Few investors are familiar with the bank's operations, even fewer are regular buyers of its paper. Remembering past allegations of mismanagement and rating agency Standard & Poor's decision to downgrade the bank in 1995, many institutions continue to regard AfDB bonds as a riskier investment than other supranationals, even though Moody's awards AfDB a triple A rating.
The AfDB's image among investment banks is not good either. Ever since an embarrassing debacle in the late 1980s, when the bank lost money on some mispriced options, investment bankers have tended to dismiss the AfDB as "unsophisticated" or "a bit behind the learning curve". This is despite the bank having a 45 strong treasury department.
Ask a bond trader in London or New York to quote a price on AfDB debt, and the reply will often be "African who?". One AfDB official complains that such image problems have led many investment banks to ignore the bank when touting new capital-raising ideas.
Such views are beginning to look outdated. Over the past 12 months, a quiet revolution has been underway at the bank's headquarters in Abidjan, Côte d'Ivoire.
Lending to deeply indebted countries has been cut back, with loan approvals down from $1.35bn in 1992 to an estimated $665m in 1997. The bank now lends directly to only 13 of its 53 members.
As a result, the bank's finances are in a much healthier position. Net income has risen from $80.6m in 1993 to an estimated $163.6bn in 1997. At the same time, reserves have risen from $685.3bn in 1993 to over $1.06bn in 1997.
The approach of its treasury has changed as well. The lending product range has expanded with the introduction in October of three new single currency loan products. A new asset and liability management committee has been set up and is currently testing an in-house value at risk system based on JP Morgan's RiskMetrics.
Since January, assets and liabilities have been measured against the same six-month Libor-based benchmark. To streamline the treasury function, a special operations team has also been established to improve internal controls and risk analysis.
The AfDB has begun to take a much more flexible approach to capital raising. Since the end of 1996, it has abandoned its reliance on large, fixed rate plain vanilla deals in favour of more opportunistic, structured and arbitrage-driven transactions.
"We have been much more inclined to consider cost effectiveness as our main objective. And to do that we have had to increase our involvement in opportunistic and more structured deals," explains Thierry de Longuemar, a former bond trader at the private banking arm of Crédit Agricole who became AfDB's director of treasury operations in July 1996.
As part of the change, de Longuemar has established floating rate Libor-based funding cost targets.
This shift can be seen in the bank's debt issuance so far this year. In February, it launched its first emerging market currency issue - a R100m two year deal via Hambros.
The following month, it issued a Ffr500m 10 year deal linked to the Tec-10 floating rate benchmark index. Then in April came two deals aimed at Japanese investors. The first was a ¥15bn 10 year dual currency transaction paying interest in Australian dollars (its first ever using this structure).
The second comprised a ¥10bn capped FRN five year, nine month deal via Norinchukin International, which offered investors six month Libor plus 40bp, with a maximum coupon that rose from 1.5% to 2.4% over the life of the bond. In July, the AfDB was back in the market again with a ¥10bn reverse dual currency deal via Yamaichi.
The AfDB's need to balance opportunistic financing, and to maintain a presence with institutional investors, was evident in two financings it launched in early October.
First came a return to the Euro rand market, in a R100m seven year deal again led by Hambros. It was an important deal for the AfDB - South Africa is its 53rd and latest member and the proceeds of the transaction were swapped into floating rate rand, rather into floating dollars, as the previous rand deal had been.
AfDB officials expect the bank to increase its lending to southern African countries in the coming years, and its ability to access the rand market in this way is likely to form an important part of its treasury operations as a result.
One week later the bank also launched a $300m five year benchmark issue, which followed an extensive series of meetings with institutional investors in Europe.
It was priced at 23bp over Treasuries, reflecting the improved perception of the AfDB's credit among investors. Its 6.75% of October 2004 bonds had traded in from 40bp over to 25bp over in the previous 18 months.
Thanks to the success of this year's deals - which achieved a cost of funds of Libor minus 20bp - de Longuemar plans to expand the bank's range of issuance in the coming years.
He says: "We would like to do more emerging market currency deals. We are looking at the Egyptian pound, Moroccan dirham, Tunisian dinar and CFA franc markets."
Of these, a CFA franc deal seems the most likely, with de Longuemar reporting local investor interest in a five year transaction.
More structured issuance is also possible, which would likely be issued off the bank's $1bn Euro-MTN programme.
"We will continue to examine new funding opportunities as part of our programme to reduce borrowing costs," he says. "We have the staff in place to evaluate new structures quickly."
The only proviso seems to be that the structure must not involve the AfDB being a net seller of any options. De Longuemar says: "We are not allowed any foreign exchange exposure or any negative gamma."
If structured deals offer the best opportunities for sub-Libor funding, de Longuemar is also acutely aware that such deals do little to improve the bank's image among international investors - hence the decision to launch the benchmark dollar issue.
"The bank needs to be better known around the world," de Longuemar says. "The new environment in Africa has helped a lot of people to get to know the bank. But there is a difference between knowing it and understanding it. I am not convinced structured deals help you to improve this situation."
He continues: "It is a question of balancing short term and long term goals. A Eurodollar deal helped our long term relationships with investors."
The roadshow also allowed the bank to highlight its improving creditworthiness. De Longuemar says he hopes the AfDB will benefit in pricing on several fronts: the rarity value of its product (for example, it has a DM200m maturing in January that will be repaid through existing liquidity); the way in which the AfDB can provide investors exposure to the improving economic situation in many African economies; and the bank's strict credit policy, which has resulted in a reduction in loans to member countries.
De Longuemar hopes that these positive factors will increase the possibility of Standard & Poor's upgrading the supranational from AA+ to AAA.
According to de Longuemar, the AfDB's rate of issuance is likely to slow in the coming months. After the October deals, it had raised almost $1bn of its $1.2bn borrowing requirement for 1997. Next year is likely to be quiet compared with 1997, with a funding requirement estimated at $700m.
In the longer term, the picture is one of steadily increasing issuance. The AfDB has stated that it wishes to increase its lending to the private sector in Africa. At present, this sector only accounts for 1% of the bank's total lending.
However, there are plans to raise this to between 10% and 20%. Such a move would inevitably lead to higher borrowing requirements in future years. "We could be borrowing more in three to four years time," says de Longuemar. EW