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Emerging Markets

AfDB to innovate again with hybrid capital, risk transfer

Lom Pangar Dam, Lom River, Deng Deng National Park, East Cameroon

First deal relieves risk on $1bn of loans, second will create synthetic equity

The African Development Bank is working on two first-of-a-kind transactions that will put it back at the forefront of multilateral development banks in financial innovation.

If successful, the deals could stimulate wider efforts among MDBs to make their capital go further by using techniques employed in the private sector.

“The challenges African countries have — the infrastructure gap, poverty, inequality, climate change and then you add a layer of Covid, which we are not out of yet, then add the Russia-Ukraine war and food insecurity — it’s a lot,” said Hassatou N’Sele, chief financial officer at the African Development Bank. “We view ourselves as a financier, but also as a catalyst for bringing additional capital to Africa. Our capital is small compared to our mandate. Optimising our balance sheet is another way to provide more resources to the continent.”

In 2018 the AfDB won widespread attention with a synthetic securitization of $1bn of project finance, corporate and financial institution loans and a $500m guarantee of financial institution loans by insurance companies. Together, they freed up capital for $1.1bn of new loans. The deals were expected to be widely emulated, but other MDBs have been less active than enthusiasts had hoped.

Now after a long gestation, the AfDB has completed a new risk transfer on government loans — harder because they carry less yield. Insurance companies, supported by the UK government, will absorb much of the risk on $1bn of loans to African governments, generating substantial capital relief.

Next year should come a deal that causes a big stir in capital markets. “We have been working for a year and a half to have hybrid capital approved by the Bank and to design a structure which would work for MDBs,” said N’Sele.

Any equity credit AfDB can obtain with the hybrid can be leveraged with senior bonds to produce three to four times its volume in development lending.

Some MDBs have subordinated debt, but there has never been a full scale public hybrid capital issue. It could open the way to a new asset class.

After much back and forth with the rating agencies and some criteria revisions, the AfDB has designed an instrument that earns 100% equity credit from at least S&P and Fitch. It will be perpetual and any coupon deferral will be irrevocable. BNP Paribas and Goldman Sachs have helped with the structuring.

The next stage is to place the hybrid with investors. One option is a private placement to supportive investors such as the AfDB’s shareholders, but the Bank is leaning towards a market transaction.

This will require extensive roadshows, probably next year, “to explain the strategy of the bank, and also to explain the credit.”

The Bank receives a general capital increase every 10 years and has an overarching risk appetite statement which requires it to remain triple-A. The Bank has many levers to adjust its lending if any ratios appear threatened.

The AfDB has defined what triggers would cause the hybrid to take losses. These have to be “plausible and remote,” said N’Sele. “But just because of the way we are structured as an institution, and based on our solid risk management framework, the instrument is not expected to get to that level. Because internally we have all the buffers and as a multilateral development bank, we have benefited from extraordinary shareholder support. In my view when investors understand the MDB model they will be able to price it.”