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Wednesday, 13 December 2017

CAF gets it right

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  • CAF gets it right

The development bank is held in near-universal respect by those in Latin America who use its services and those in the region and the wider world who lend it money.

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Everything about Corporacion Andina de Fomento is contrary. It’s a Latin American institution that both lends to private interests and boasts a zero-level impairment rate on its loan book. It hoards, borrows, lends, and hedges in US dollars despite having been based, since its inception in 1970, in the anti-American stronghold of Venezuela. And it’s beloved of yield-hungry global investors drawn to its high credit rating and its regular, aggressive and diversified pricing of debt issued in Australian dollars and Norwegian kroner, Chinese renminbi and Swiss francs. Like an Escher drawing, none of it makes any visible sense, yet it works in perfect symmetry. What went right for CAF?

A good start can be found in the respect felt across Latin America for the institution. Borrowers rarely if ever fail to meet their obligations to the institution. In the 44 years since CAF’s creation, every major Latin American economy bar Colombia has either defaulted on its sovereign obligations or been forced to restructure its debt – think here of Brazil in the mid-1980s; Argentina two decades on; Peru on four occasions between 1976 and 1984. Yet even when placed in this invidious position, none has dared skip a payment to CAF.

“The bank always received the funds it was owed by every sovereign,” said Franklin Santarelli, head of Latin American banking at Fitch. “Even when Peru defaulted on payments in the 1980s to other multilaterals and development banks, they never defaulted to CAF.”

Sarah Glendon, an assistant vice-president in the sovereign risk group at Moody’s, agreed. “CAF serves as a lender of last resort for countries that have lost access to other sources of financing. For example, when Ecuador defaulted on its 2012 and 2030 bonds and lost access to international capital markets, it kept paying CAF,” she said.

There are three good reasons for the bank’s pristine accounts, and its almost Mafia-like ability to ensure that it always gets paid. The first lies in its lack of preachiness. Unlike many of its peers – the International Monetary Fund springs immediately to mind – it “doesn’t lecture”, said Santarelli, who covered CAF as an analyst for 14 years from the mid-1990s. “They don’t lend money with strings attached, telling you what you need to do in order to secure loans.”

Reason two is its stature in the region. Latin America can be justly proud of CAF’s success story. Originally envisaged as an Andean development bank, the list of five founding members (Colombia, Peru, Ecuador, Venezuela, and Chile) has since grown to 18, ranging from the might of Brazil to island states such as Jamaica and the Dominican Republic.

During that period, it quietly and with minimum fuss transformed and upgraded its image among global investors and ratings agencies.

“For some time now, we have viewed CAF as a regional supranational financial institution, on par with the IDB [the Inter-American Development Bank], [rather than] as a sub-regional bank,” said Kelli Bissett-Tom, a sovereign ratings analyst at Standard & Poor’s.

It lends regularly, widely and diversely. At the end of September 2013, the bank’s outstanding stock of lending was US$17.5bn, according to its latest set of financial data, up US$2bn over the previous year. Total assets rose by 10% over that period, to US$26.8bn, with net income up a third to US$178m.

“It has very solid credit, and it lends cheaply to shareholders who really need the capital,” said a Latin America-focused SSA syndicate banker. “Member states know that if one person violates repayments, it will mess with CAF’s books and rating, and make borrowing and lending more expensive. CAF helps you when you are in trouble, without conditions. God help you if you mess with this institution.”

Ties that bind

And if anyone was in any doubt about the intimate nature of the ties that bind CAF with its sovereign shareholders, they should look no farther than the bank’s board, which includes the foreign ministers of every member state.

“These guys can sit down with the bank and talk about their problems,” said the syndicate banker. “Their relationship with CAF is far stronger than it is with the IMF or the IDB.”

Nor is the bank just a good listener. It has built up its credit rating, solidly and systematically, over a period of decades. Standard & Poor’s raised its rating from A+ to AA– in December 2012, with Fitch following suit three months later. Moody’s Glendon underscores the esteem with which the institution is held, pointing to four core strengths, including a “strong willingness” to provide financial support, “prudent financial management” reflected in diversified funding sources, and a record of “strong asset performance”.

CAF also has long and strong links with non-state interests: fully one-fifth of its outstanding stock of loans is held by privately run corporates. Even here, the bank currently has zero impairments, unlike other supranationals. Fitch’s Santarelli said the reason was CAF’s “deep involvement with its loan book. They embrace a very consistent and detailed credit risk policy. They have impeccable local connections, and they know when an investment will work or not.”

Investors have considerable respect for the bank’s chief executive officer, Enrique García Rodríguez, as well as chief financial officer Hugo Sarmiento. Both, notes the head of an emerging-market fund that has on several occasions bought CAF bonds, “are transparent and competent and a pleasure to do business with”.

Turnover, or the lack thereof, also helps. CEO Garcia has been in his position since 1991, and is scheduled to remain there until December 2016. Luis Enrique Berrizbeitia has served as the bank’s executive vice-president for 18 years.

“You have a very cohesive management team, at least when it comes to the top 10 or 15 positions,” said Santarelli. “This projects an impression of strength and stability.”

To an extent, CAF can consider itself fortunate. It is blessed in many ways, not least because it is almost deified by its shareholders. Its total lack of non-performing or distressed loans is also a curious anomaly.

“For any institution to have zero impairments over such a long period of time, there has to be a bit of luck involved,” said the SSA syndicate banker. “They only do business with blue chips, and their research is impeccable. Still, it’s not sustainable to keep [levels of soured loans] at zero forever.”

Small but perfectly formed

Since the start of 2012, the bank has approached the global bond markets on no fewer than 22 occasions, raising a total of US$4.8bn spread over seven currencies. It never issues in bulk – the largest print was in June 2012, when it raised US$600m. This, however, tends to boost yield on its bonds, a key selling point for a Double A rated institution. CAF’s October 2013 US$212m 10-year Kangaroo bond issue was a case in point, priced at 99.469 for a yield of 6.3225%.

Moody’s Glendon said that going forward, CAF had indicated that it “plans to issue more frequently in the Aussie market”, noting that a higher rating, and a concomitant lower cost of funding, led to a “shift in investor appetite. CAF hopes to expand its investor base to central banks and other institutional investors in Europe and Asia.”

S&P’s Bissett-Tom said the regional supranational’s funding programme had become “very diversified by both geographic market and type of investor”. By end-September 2013, 74% of its outstanding funding was sourced from international capital markets.

It is this blend of rating and yield, stability and strength, regionalism and globalisation, that makes CAF such a compelling investment.

“They offer a good rating and a bit of yield, and that’s what people want in this world,” said Philip Brown, head of sovereign capital at Citigroup. “It’s also a relatively highly rated institution with slightly higher funding targets than its larger, well-known peers. It’s got everything, on the face of it, that an investor wants.”

Next challenge

CAF still has further to go. The main challenge, analysts say, will be to continue to diversify its loan portfolio while expanding its capital base at a faster clip than its loan base. A Triple A rating is likely to remain beyond its reach for some time to come, in large part due to the nature of both its location and its client base.

“CAF’s non-borrowing membership base is still limited, which is a governance constraint relative to the IDB, which has greater diversity of shareholders,” said Bissett-Tom. “The bank’s risk-adjusted capital adequacy and average balance sheet liquidity is also lower than some higher-rated peers.”

Yet this just being picky. Everything about Corporacion Andina de Fomento may be contrary, but that doesn’t make its story any less extraordinary. The IDB may boast broader institutional support in Western capital cities, and several regional development banks may be larger. But there is a reason why increasingly deep pools of global investors love the CAF story, one dominated by stability, yield and, above all, the deep and enduring respect of its shareholders.  

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