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AfricanAfrican DevelopmentDevelopment BankBank
AfricanAfrican DevelopmentDevelopment BankBank

NonNon--SovereignSovereign PortfolioPortfolio CreditCredit RiskRisk ReviewReview 20042004 -- 20062006

PreparedPrepared byby FFMAFFMA OctoberOctober 20072007

Risk Risk Review Review 2004 2004 - - 2006 2006 Prepared Prepared by by FFMA FFMA

Overall Institutional Risk Management Framework

The Board of Directors oversees compliance through four annual risk management presentations

Financial Non-Sov Sovereign Market Performance Portfolio Portfolio Risk Review Outlook Review Review
Financial
Non-Sov
Sovereign
Market
Performance
Portfolio
Portfolio
Risk Review
Outlook
Review
Review
 

Consolidate risks assumed with risk bearing capacity

Interest rate,

currency,

liquidity risks

Risk capital

Objectives,

utilization

practices and

Sensitivity

strategies,

effectiveness

Income allocation

 

2

 

decisions

Project rating changes

Impact on portfolio

risk profile

Impact on provisioning, capital adequacy, pricing, etc.

Country rating

changes

Impact on

portfolio risk

profile

Impact on

provisioning,

capital adequacy,

concentration

Risk Management Framework – Period Reporting

o

The financial performance outlook consolidates all risks assumed by the Bank with its risk bearing capacity, determines the risk capital utilization, discusses the factors affecting the Bank’s outlook and provides guidance on income allocation decisions.

o

The Market Risk Review provides information on the monitoring of the interest rate, currency and liquidity risks.

o

The Non-Sovereign Portfolio Review focuses on project rating changes, and their impact on the portfolio risk profile, provisioning, capital adequacy and loan pricing.

o

The Sovereign Portfolio Review assesses country rating changes, and their impact on the portfolio risk profile, provisioning, capital adequacy and portfolio concentration.

Introduction

The Bank’s medium-term strategy calls for increasing investments without sovereign guarantees.

Private sector

Enclave projects

Commercially-oriented public sector entities

A number of measures have been taken to maintain the desired portfolio risk profile.

Private sector development strategy

Exposure limits and risk profile benchmarks

Portfolio management division for effective monitoring

This presentation examines the evolution of the credit risk profile of the non-sovereign portfolio over the past 3 years.

3

Purpose of the Report

Over the past two years the non-sovereign operations of the Bank has recorded significant growth. Further expansion is expected with the heightened emphasis on the private sector and other non-sovereign operations as one of the key priorities of the Bank's Medium Term Strategic Framework.

Recognizing the inherent risks of development lending without a full sovereign guarantee, the Bank has taken several measures to ensure that adequate safeguards are put in place to sustain the growth of the desired portfolio and foster the enabling environment to support project lending. These measures also include a risk management framework that will strengthen the transaction origination and portfolio management functions within the Bank.

As part of its compliance monitoring role, the Financial Management Department (FFMA) is actively involved in all facets of the Bank’s internal process for non-sovereign operations. It is entrusted with the preparation of several risk review report to assist the Boards in their oversight function of the financial integrity of the institution

This presentation is one of the reports prepared by FFMA to provide the Board with an independent assessment of credit risk profile of the non-sovereign portfolio. The report covers essentially the three-year period 2004-2006 1 and high recent developments in 2007.

1 - The Financial Management Department prepares four annual reports on various aspects of the Bank’s risk profile: 1) market risk review; 2) non-sovereign portfolio credit risk review; 3) Sovereign portfolio credit risk review, and 4) medium-term financial performance outlook;

This presentation is organized into three principal parts

Rating Trends

Portfolio Risk Profile

Risk Management Implications

4

Structure of the Report

The report is organized into three principal sections.

o

The first section presents the project rating trends within the active non-sovereign portfolios.

o

The second section summarizes the combined impact of new projects, disbursements and rating migrations on the risk profile of the outstanding non-sovereign portfolios.

o

The third section reviews the Bank’s capital adequacy framework and the provisions for non-sovereign operations, analyzes the past pricing of non-sovereign loans and concludes on the effectiveness of the Bank’s non-sovereign credit process.

In the first part of this presentation

Rating Trends

Rating methodology

Country rating trends

Loan, guarantee, and equity project rating trends

Portfolio Risk Profile

Risk Management Implications

5

Rating Trends

This

first section of the report

 

o

Reviews the Bank’s internal project risk rating framework and oversight process;

 

o

Assesses changes in non-sovereign country risk ratings from 2004 to 2006 with an indication on the current status in 2007; ; and

o

Evaluates

project

risk

rating

trends

for

the

Bank’s

active

non-sovereign

loan,

guarantee, and equity portfolios from 2004 to 2006.

The term “active” is used to describe all projects that have been approved by the Board. This means that a number of older projects, including those cancelled, repaid, or written-off, are not included in the active portfolio. The lists of active non-sovereign loans, guarantees, and equity investments are included on pages 12 and 14 of this report.

All non-sovereign projects are rated on a unified 10- point rating scale Risk Class International
All non-sovereign projects are rated on a unified 10-
point rating scale
Risk Class
International
Risk Rating
Scale
1 Excellent
A - BBB
Very Low Risk
2 Strong
BB
Low Risk
3 Good
B
Moderate Risk
4 Fair
5 Acceptable
CCC
High Risk
6 Marginal
7 Special Attention
CC - D
8 Substandard
Very High Risk
9 Doubtful
10 Known Loss
6

Rating Methodology

Rating Scale 1 to 10

The

Bank has developed its own internal 10-point rating scale to reflect the risk profile of its potential borrowers. These ratings are calibrated to reflect prescribed ranges of expected-losses.

o

At the first tail of the spectrum 1to 6 - the lowest risk end is a project rating of 1. Projects rated 1 are considered excellent credit risks. The Bank normally considers new projects from risk rating 1 up to risk rating 5 (acceptable). Under special circumstances a new project with a risk rating of 6 could be considered.

o

At the other end of the scale are project risk ratings from 7 to 10.

• Typically, a project rating of 7 indicates that the project is experiencing some repayment difficulties and immediate remedial actions should be taken;

• A project rating of 8 means that the project is having severe operating problems and the Bank’s assets are in jeopardy;

• A project rating of 9 implies re-structuring of the project or some other form of work-out is almost certainly required to save the Bank’s interest; and

• A project rating of 10 implies that liquidation is the only feasible solution envisaged.

Risk Classes

o

As illustrated above, the 10 point risk rating scale can be categorized into a five-class scale from “very-low risk” to “very-high risk”.

o

These internal rating classes broadly correspond to the international ratings of A to BBB at the top and CC to D at the bottom.

o

To facilitate comparison of the sovereign and non-sovereign portfolios, the principal analysis presented in this report measures the risk profile in terms of the Bank’s 5 risk classes. However, all portfolio average risk ratings are derived from the project ratings on the 10-point scale.

Non-sovereign project ratings are determined using four groups of factors

Project Risk

Rating

using four groups of factors Project Risk Rating PROJECT SPECIFIC RISK FACTORS COUNTRY RISK FINANCIAL •
PROJECT SPECIFIC RISK FACTORS COUNTRY RISK
PROJECT SPECIFIC RISK FACTORS
COUNTRY RISK
FINANCIAL
FINANCIAL

Cash Flow strength Earning generation Balance sheet strength

• Cash Flow strength • Earning generation • Balance sheet strength

7

BUSINESS
BUSINESS

Industry

Competitive position

Management quality

Information quality

• Industry • Competitive position • Management quality • Information quality
FACILITY ADJUSTMENT
FACILITY ADJUSTMENT

Terms and conditions Facility tenor Third party support Security

• Terms and conditions • Facility tenor • Third party support • Security
COUNTRY RISK
COUNTRY RISK

Macro-economic Debt Sustainability Portfolio performance Socio-political Business environnement

• Macro-economic • Debt Sustainability • Portfolio performance • Socio-political • Business environnement

Rating Factors – 4 Step Process

Non-sovereign project risk ratings are derived on the basis of four groups of factors:

Financial

The rating process begins with an assessment of the overall financial strength of the project company which factors:

oThe capacity of the project to generate cash flow to service its debt; oThe project company’s capital structure, financial flexibility, and liquidity position; and oThe company’s operating performance and profitability.

Business In the second step, four main non-financial parameters are analyzed:

oThe outlook for the industry of the project; oThe competitive position of the company within the industry;

oThe caliber/strength of the project management with a particular emphasis on capacity to sustain adverse conditions; and oThe quality of the information on which the analysis is based.

Facility adjustment parameters

oIn the third step, the company rating is further fine-tuned using four facility adjustment parameters such as oThe existence of any third party guarantees; oThe tenor of the facility; oAny conditions that would provide credit support for the Bank; and oThe value of any assigned collateral.

Overall Country Risk

In the final step, the project risk rating is ultimately adjusted to reflect the overall host country risk rating.

All new non-sovereign projects are reviewed on the basis of a three-step process

Project Review and Approval Process

of a three-step process Project Review and Approval Process Governance Organs Board Approval 8 Due Diligence

Governance Organs

Board Approval
Board
Approval
of a three-step process Project Review and Approval Process Governance Organs Board Approval 8 Due Diligence
of a three-step process Project Review and Approval Process Governance Organs Board Approval 8 Due Diligence

8 Due Diligence Assessment

Review Process

As illustrated schematically in the graphic above, all new non-sovereign project proposals follow an internal review process that consists of three primary steps before the Board final approval

Project Filtering by OPSM The first step in the process is the initial filtering of proposals by the Private Sector & Microfinance Department (OPSM). Each year OPSM receives hundreds of applications for financing that must be screened for consistency with the Bank’s policies and strategies and then assessed for commercial viability.

Due Diligence Review of the Investment Proposal - PSOC The second step is the review by an inter-departmental team called the Private Sector Operations Committee (PSOC). The PSOC typically meets at least twice for most projects. oThe first PSOC review is based on OPSM’s Project Concept Note (PCN) and usually leads to a preliminary risk rating by FFMA. Projects that successfully pass the PCN review are presented to Senior Management for concept clearance followed by appraisal and drafting of the first Investment Proposal (IP). oThe PSOC meets a second time to review the full IP and a risk rating is usually assigned at this stage.

IP Clearance and Rating Confirmation - PSIC The third step consists of senior management review by the Private Sector Investment Committee (PSIC). The PSIC examines the IP for policy and strategic issues. The risk rating is normally confirmed at this point.

Approval – Board Projects that successfully pass the PSIC review are then sent to the Board for final consideration and approval. In addition to the final IP, the Board receives a summary credit note on the salient issues underlying the credit risk rating assigned to each new proposal.

The risk ratings of all outstanding non-sovereign projects are reviewed quarterly

Risk Rating Review Process

Project Ratings
Project
Ratings

9

Risk Rating at Entry and Quarterly Portfolio Rating Review

In addition to assigning a risk rating to all non-sovereign projects at entry, the risk ratings of all outstanding non-sovereign projects are reviewed quarterly. As illustrated in the graphic above, the quarterly review process consist of :

Project Review Project-by-project reviews by the Portfolio Management Division within OPSM and the Credit Management Division of FFMA, with the objective of highlighting the principal downside risks of active projects and identifying trigger events that may affect each project’s rating. The review generally covers recent financial performance, compliance with covenants, and an examination of any supervision or management implementation and progress reports.

Non-sovereign Credit Risk Working Group Review Based on these project reviews, the Non-sovereign Credit Risk Working Group prepares a report summarizing the proposed project risk ratings and highlighting any projects where rating changes are proposed or appear likely in the future. The report also assesses the impact of the risk ratings in the Bank’s non-sovereign portfolio and proposes any changes to loan, guarantee, or equity provisions.

ALCO Review The quarterly report is submitted for review by ALCO before any rating changes are completed and any provisioning changes are implemented.

The bulk of the non-sovereign country risk ratings fall into the moderate risk class

non-sovereign country risk ratings fall into the moderate risk class 22 22 14 14 5 5
22 22 14 14 5 5 6 6 5 5
22
22
14
14
5
5
6
6
5
5
non-sovereign country risk ratings fall into the moderate risk class 22 22 14 14 5 5

10 As at 30.06.2007

Outcome of the Risk Rating Process

The chart above shows the distribution of non-sovereign country risk ratings at the end of 2004, 2005, and 2006. The horizontal axis shows the Bank’s five risk classes and the vertical axis shows the number of countries in each class. Non-sovereign country risk ratings are a key factor in determining the credit risk ratings of non-sovereign projects in any country. The situation as at June 30, 2007 is illustrated by the arrow lines.

Overall Rating Distribution

In terms of overall distribution, the bulk of the countries fall into the “moderate risk” class. It is also apparent that there are more “high” and “very-high” risk countries than countries in the “low” and “very-low” risk classes.

In general, the non-sovereign country risk ratings are weaker than the sovereign ratings. This is a reflection of the weight assigned to the business environment for the private sector ratings and the significant operating challenges that most non-sovereign projects must overcome to survive.

Movements within the Portfolio

During the period 2004-2006 there was a modest decline in the number of countries rated as “very-low risk”. The number of countries rated ”very-low risk” decreased from 6 to 4. At the same time the number countries rated “low risk” increased from 4 to 6. The year 2007 is marketed by a net improvement in the portfolio with an increase in very low risk and decrease in high risk groups as at 30 June.

In 2006, 8 new projects were added to the non- sovereign loans and 6 existing projects were dropped

non- sovereign loans and 6 existing projects were dropped 15 15 14 14 4 4 4
15 15 14 14 4 4 4 4 4 4
15
15
14
14
4
4
4
4
4
4
projects were dropped 15 15 14 14 4 4 4 4 4 4 As at 30.06.2007

As at 30.06.2007

11 * As at 30.06.2007, 5 new projects were added to the non-sovereign loans and 2 existing projects were dropped compared to December 2006

Risk Rating Trend - Active Portfolio of Loans and Guarantees

The chart above shows the distribution of the project risk ratings for all active non-sovereign loans and guarantees from 2005 to 2006. The horizontal axis is broken down into the Bank’s five risk classes and the vertical axis shows the number of loans and guarantees in each class.

Movements in the Portfolio in 2006

o

New Loans 7 new loans and 1 new guarantee were added to the active non-sovereign loan and guarantee portfolio.

Repayment and Cancellations During the same period, 4 loans were repaid and 2 loans were cancelled. As a result, the net growth was 2 new projects in the active non-sovereign loans and guarantees. Rating Distribution

o

o

In terms of the rating distribution of the Bank’s non-sovereign loans and guarantees, the bulk were rated in the “moderate risk” class. At the lower risk end of the spectrum, there were two loans in the “very-low risk” class and three loans in the “low risk” class. At the other end of the spectrum, there were fourteen loans and guarantees in the “high risk” class and four loans in the “very-high risk” class.

o

With respect to the rating movement during the year one project was upgraded and one loan was downgraded.

Bank’s equity investment portfolio is under the full management of OPSM.

Bank’s equity investment portfolio is under the full management of OPSM. 12 As at 30.06.2007

12

Bank’s equity investment portfolio is under the full management of OPSM. 12 As at 30.06.2007
Bank’s equity investment portfolio is under the full management of OPSM. 12 As at 30.06.2007

As at 30.06.2007

Risk Rating Trend - Active Portfolio of Equity Investments

The chart above shows the distribution of project risk ratings for all active non-sovereign equity investments. The horizontal axis is broken down into the Bank’s five risk classes and the vertical axis shows the number of projects in each class.

Movement in the Portfolio

The Bank’s public equity investments (8) made in the past have been transferred to the non- sovereign portfolio under the full management of OPSM. As a result of this transfer to OPSM, the number of active non-sovereign equity investment increased to 17. In 2006, there were no new investments added to the active non-sovereign equity investment portfolio.

Distribution of the Ratings

In terms of overall distribution of the ratings at the end of 2006, 35% (6) of the Bank’s non- sovereign equity investments fell into the “moderate risk ” class, another 35% (6) fell into the “high risk” class while another 24% (4) fell into the “very high risk ” class. One equity investment was classified as “low risk” class.

In the second part of this presentation

Rating Trends

Portfolio Risk Profile

Portfolio trends

Structure by country, industry, instrument, age, etc.

Outlook

Risk Management Implications

13

Risk Profile of the Bank’s Portfolio

The second section of the report examines the risk profile of the Bank’s portfolio of disbursed and outstanding non-sovereign loans, guarantees, and equity investments;

o

It assesses the combined non-sovereign loans, guarantee, and equity investments with a focus on how the overall portfolio has grown and how the overall risk rating has evolved from 1998 to 2006. This analysis takes into consideration both changes in the risk ratings of individual projects as well as changes in the composition of the portfolio due to the effects of disbursements, activation of guarantees, repayments, and divestitures;

o

Following the review of the overall portfolio risk profile, a more detailed assessment of the portfolio composition by country, industry, type, instrument, age, and repayment performance is provided; and

o

Finally, prospective assessment is presented by reviewing not only the risk profile of undisbursed commitments, approved but unsigned projects, but also the “projects in the pipeline” to see how the overall portfolio risk profile is likely to evolve over the next few years.

The average risk rating of the non-sovereign portfolio slightly weakened due to prepayment of low risk assets

slightly weakened due to prepayment of low risk assets 14 * total non-sovereign loans, guarantees, and
slightly weakened due to prepayment of low risk assets 14 * total non-sovereign loans, guarantees, and
slightly weakened due to prepayment of low risk assets 14 * total non-sovereign loans, guarantees, and
slightly weakened due to prepayment of low risk assets 14 * total non-sovereign loans, guarantees, and

14

* total non-sovereign loans, guarantees, and equity investments

**As at 30.06.2007

Highest

Risk

Lowest

Risk

Risk Profile of the Bank’s Portfolio

The chart above shows the size of the total outstanding non-sovereign portfolio (blue bars) and the weighted average risk rating (red line) from 1998 to 2006. The left vertical axis measures the size of the outstanding portfolio in UA millions and the right vertical axis measures the weighted average risk rating on the Bank’s 10 point rating scale. Key highlights can be summarized as follows:

o

Over the past nine years, the size of the outstanding portfolio (loans, guarantees, and equity investments) has grown almost nine-fold from about UA 50 million to UA 440 million at the end of 2005;

o

However, in 2006, the size of the outstanding non-sovereign portfolio contracted marginally to UA 404 million (reduction of 8%);

o

During the same period, the weighted average risk rating of the portfolio has improved from about 5.8 (high risk) at the peak in 1999 to about 3.2 (moderate risk) in 2005. In 2006, the average risk rating dropped slightly to 3.5;

o

Much of the weakening in the average risk rating in 2006 can be traced to the prepayment and repayment of low risk and very low risk assets ; and

o

A slight upward movement was recorded as at June 2007.

The high and very-high risk classes now account for less than 21% of the total outstanding portfolio

account for less than 21% of the total outstanding portfolio 51% 51% 23% 23% 9% 9%
51% 51% 23% 23% 9% 9% 12% 12% 6% 6%
51%
51%
23%
23%
9% 9%
12% 12%
6% 6%
portfolio 51% 51% 23% 23% 9% 9% 12% 12% 6% 6% As at 30.06.2007 15 *

As at 30.06.2007

15 * ( ) – is the weighted average risk rating for this portfolio segment

**As at 30.06.2007 the weighted Average rating was 3.7

Portfolio Distribution by Risk Class

The chart above shows the distribution of the combined outstanding non-sovereign loan, guarantee, and equity portfolios by risk class at the end of 2004-2006 and June 2007. The share of risk class is shown as a percentage of the outstanding portfolio at the end of each year.

oIn terms of overall profile, the non-sovereign portfolio continues to be predominantly centered around the “moderate risk” class. There has been a migration in the lowest and highest end tails of the risk classes;

oAssets in the “very-low risk” class decreased from 14% to about 11% of the outstanding portfolio;

oAssets in the “low risk class” declined from 20% to 15% of the outstanding portfolio as a result of prepayment of Mauritius Commercial Bank, which was rated low risk;

oIn 2006, “moderate risk” assets accounted for about 53% of the outstanding portfolio;

oThe “high risk” and “very-high risk” classes accounted for about 21% of the portfolio up from 13% in 2005. On the other hand,

This profile calls for targeting low risk class assets for entry in the portfolio.

Country risk always has a major influence on the risk profile of the non-sovereign portfolio test

9% 9% 40% 40% 9% 9% 18% 18% 1% 1% 16
9%
9%
40%
40%
9% 9%
18% 18%
1% 1%
16

Project Rating

profile of the non-sovereign portfolio test 9% 9% 40% 40% 9% 9% 18% 18% 1% 1%

As at 30.06.2007

Portfolio Risk Profile by Country Risk Classes

The chart above shows distribution (in percentage) of the outstanding non-sovereign loans, guarantees, and equity investments by risk class when grouped by country risk rating. The country risk class is shown on the horizontal axis.

Portfolio Distribution across risk classes

At the end of 2006 the portfolio depicts an improved profiles

o

18% of the Bank’s outstanding non-sovereign portfolio was located in “very-low risk” countries with

a

weighted average risk rating of 2.6;

o

9% of the outstanding portfolio was located in “low risk” countries with a weighted average risk rating of 4.7;

o

71% of the outstanding portfolio was located in “moderate risk” countries with a weighted average risk rating of 3.6; and

o

1% in “high risk” countries with a weighted average risk rating of 4.0; and 1% in “ Very-high risk” countries with a weighted average risk rating of 5.9.

Correlation between Country and Project Ratings

The distribution of the portfolio by country risk rating shows a positive correlation between the risk rating of the country in which projects are located and the project risk rating.

o

In general, projects located in countries with poor enabling environments (higher risk countries) tend to perform poorly and are typically rated as higher risk.

o

Likewise, projects which benefit from a favorable business environment (lower risk countries) have

a higher probability of performing well.

The country risk rating will therefore continue to be an important factor in the Bank’s project rating process and project selection.

Lines of credit to financial institutions (FIs) continue to remain the largest sector in the non-sovereign portfolio

to remain the largest sector in the non-sovereign portfolio 15% 15% 11% 11% 10% 10% 9%
15% 15% 11% 11% 10% 10% 9% 9% 5% 5% 2% 2%
15%
15%
11%
11%
10% 10%
9% 9%
5%
5%
2% 2%

17

the largest sector in the non-sovereign portfolio 15% 15% 11% 11% 10% 10% 9% 9% 5%

* As at 30.06.2007

Portfolio Risk Profile – Exposure to Sectors

The chart above shows the percentage distribution of the outstanding non-sovereign loans, guarantee, and equity investments by risk class when grouped by general sector. For this analysis we limit the segmentation to four broad sectors: (i) LSE (large-scale enterprises including infrastructure projects); (ii) FI (financial institutions); (iii) Funds (equity funds); and (iv) SME (small and medium-size enterprises). At the end of 2006, the portfolio depicts the following features:

o

Lines of credit to financial intermediaries (FIs) was the largest sector accounting for 45% of the outstanding portfolio as compared to 41% in 2005.

The Bank’s exposure to FIs was distributed principally between the “low risk” and “moderate risk” classes and had a weighted average risk rating of 3.1.

o

LSEs accounted for 36% of the total portfolio compared to 39% in 2005. Most of the Bank’s direct exposure to LSEs was in the “very-low risk” and “moderate risk” classes and had a weighted average risk rating of 3.2.

o

The Bank’s equity investment funds accounted for about 9% of the outstanding portfolio and was distributed over the “low”, “moderate” and “high risk” classes with an average rating of 3.9.

o Direct lending to SMEs represented the remaining 10% of the portfolio and had an average risk rating of 6.0. The higher risk profile of the portfolio with SMEs is not unexpected given the nature of lending to SMEs.

The outstanding portfolio is largely made of debt rather than equity instruments

is largely made of debt rather than equity instruments 43% 43% 17% 10% 17% 10% 9%
43% 43% 17% 10% 17% 10% 9% 9% 7% 7% 4% 4%
43%
43%
17%
10%
17%
10%
9%
9%
7%
7%
4%
4%

18

made of debt rather than equity instruments 43% 43% 17% 10% 17% 10% 9% 9% 7%

* As at 30.06.2007

Portfolio Risk Profile – Loans versus Equity Investments

The chart above shows the percentage distribution of the outstanding non-sovereign loan, guarantee, and equity portfolios by risk class when grouped by instrument at the end of 2006

o

85% of the Bank’s outstanding non-sovereign portfolio consisted of loans and guarantee facilities while the remaining 15% consisted of equity investments.

o

The risk profile of the portfolio by instrument shows the expected relationships, namely, that equity investments tend to be higher risk than debt instruments.

o

The weighted average risk rating of loans and guarantees was 3.4 whereas the average risk rating of equity investments was 4.3. It is notable that this differential has progressively decreased over the past few years.

Only about 4.5% of the outstanding portfolio is having some form of repayment difficulty

portfolio is having some form of repayment difficulty 51% 51% 23% 23% 12% 12% 9% 9%
51% 51% 23% 23% 12% 12% 9% 9% 4% 4%
51%
51%
23%
23%
12% 12%
9% 9%
4% 4%

19

portfolio is having some form of repayment difficulty 51% 51% 23% 23% 12% 12% 9% 9%

* As at 30.06.2007

Portfolio Risk Profile – Repayment Performance

The chart above shows the percentage distribution of the outstanding non-sovereign loan, guarantee, and equity portfolio by risk class when grouped by repayment performance.

o

As expected, projects with the weakest risk ratings are generally the same projects which have experienced difficulties to service their debts to the Bank.

• In 2006, about 4.5% of the outstanding portfolio was experiencing debt servicing difficulties; a marginal increase as compared to 4% in 2005 but still much lower than the 14% level of four years ago.

• This marginal increase in outstanding portfolio.

2006 was mostly due to the decline

in the size of the

o

It should be noted that because higher risk equity investments are reported as not in arrears (technically no dividend is yet due), this distribution may in fact modestly under- state the extent of potentially non-performing projects.

More recent transactions account for most of the lower risk part of the portfolio

More recent transactions account for most of the lower risk part of the portfolio Approval Year
Approval Year
Approval Year
More recent transactions account for most of the lower risk part of the portfolio Approval Year

* As at 30.06.2007

More recent transactions account for most of the lower risk part of the portfolio Approval Year

Age Analysis of the Portfolio

The chart above shows the distribution (in %) of the outstanding non-sovereign loans, guarantee, and equity investments by risk class when grouped by age of transaction. To

simplify the analysis, all transactions are grouped into three time buckets: (i) deals approved before 1997; (ii) deals approved from 1997 to 2001; and (iii) deals approved from 2002 to

2006.

o

o

o

o

Approximately 72% of the outstanding non-sovereign portfolio consisted of projects approved in the last five years. Another 21% of the portfolio was approved between 1997 and 2001 while only 7% of the portfolio dates back to approvals before 1997.

It is interesting to note that the distribution of projects by transaction date shows a strong risk rating bias. The older projects dominate the higher risk classes while the newer projects tend to dominate the moderate and lower risk classes. The average risk rating of projects approved from 2002-2006 was 3.0, compared to 4.4 for 1997-2001, and 6.6 for projects approved before 1997.

On major factor to contribute to this change in distribution profile is the Bank’s recent reforms that have strengthened the internal credit processes and resulted in better selection of projects.

Rating trends have shown a tendency for weakening of the risk profiles of projects after implementation begins. Although this trend was expected to a certain extent it is another indication that the Bank’s processes for supervising and monitoring of projects after disbursement need to be given particular attention.

The portfolio risk profile is expected to improve over the medium-term

The portfolio risk profile is expected to improve over the medium-term 21 Overall Portfolio Risk Rating
The portfolio risk profile is expected to improve over the medium-term 21 Overall Portfolio Risk Rating

21

Overall Portfolio Risk Rating - 3.5 3.04

Future Evolution of the Portfolio Risk Profile

Elements of the Portfolio

The chart above shows the projected distribution of the non-sovereign loan, guarantee, and equity portfolios by risk class when grouped by processing stage. For this analysis we consider two processing stages:

o

Current outstanding portfolio; and

o

Projected Portfolio which comprises of: (i) undisbursed commitments, (iii) approved but unsigned operations, and (iii) new projects in the advanced pipeline. New projects are defined as in advanced pipeline if they had passed concept clearance for full appraisal at the end of

2006.

o

This segmentation should provide insights into the future evolution of the portfolio risk profile.

Key highlights

The analysis indicates that:

o

Given the large number of projects in the advanced (190% of the outstanding portfolio), with an average risk rating of 2.8, the risk profile of the overall portfolio will improve;

o

There is a significant stock of projects in the unsigned portfolio (accounting for 30% of the outstanding portfolio) with an average risk rating of 2.8, will also contribute to an improvement of the portfolio risk profile; and

o

Assuming that all projects are approved, signed, and fully disbursed, the non-sovereign portfolio would significantly increase from its current size of UA 404 million to about UA 1.3 billion in the next few years. Given the risk profile of these new assets, the weighted average risk rating of the portfolio would improve to 3.04 from 3.5.

In summary

The average risk rating of the outstanding non-sovereign portfolio slightly weakened due to prepayment of low risk assets.

Loans to financial institutions (FIs) continue to remain the largest sector in the non-sovereign portfolio.

The risk profile of the portfolio shows a strong correlation with transaction age and country rating, with older projects being riskier.

In the medium term, the non-sovereign portfolio is expected to increase threefold in size and the average risk rating is expected to improve.

22

Key Highlights

Salient features of the risk profile of the outstanding non-sovereign loan, guarantee, and equity portfolios can be summarized as follows:

Lines of credit to financial intermediaries (FIs) remained the largest sector accounting (they account for 45% of the outstanding portfolio as compared to 41% in 2005;

The portfolio risk profile shows a strong linkage between the age of the deal and its risk rating.

o

As the Bank gains private sector experience it is getting better at avoiding riskier projects.

o

The older projects appeared to be lower risk at inception but have become increasingly risky as implementation has progressed and difficulties have arisen

o

This

highlights

the

importance

of

intensive

project

supervision

during

project

implementation.

 

Over the medium term, the portfolio is expected to continue its pace of strong growth. Given the profile of the unsigned loans and the advanced pipeline, the risk profile of the non-sovereign portfolio is expected to improve over the next few years.

In the third part of this presentation

Rating Trends

Portfolio Risk Profile

Risk Management Implications

Provisioning

Capitalization and Exposure

Risk Pricing

Credit Process

23

Risk Management Implications

This third section of this report examines the risk management implications of the current state of the non-sovereign loan and equity portfolios. It looks at the implications from four perspectives:

First, it examines the adequacy of the Bank’s provisions for non-sovereign operations at the end of 2006. It should be noted that in compliance with the revised international financial reporting standards (IFRS), the Bank has switched to the incurred-loss approach with respect to provisioning;

Second, after reviewing the risk framework, it evaluates the adequacy of the Bank’s risk capital to support the risks assumed in the non-sovereign portfolio. It also looks at compliance with the non-sovereign exposure guidelines;

Third, it analyzes the past pricing of non-sovereign loans to determine whether the Bank’s margins have been adequate to recover the cost of assuming the credit risks associated with these projects. This section also presents the results of the economic valued-added analysis of the non-sovereign portfolio.

Finally, it draws some conclusions on the effectiveness of the Bank’s non-sovereign credit process and evaluates the pace of implementation of the recommendations made in previous years.

The Bank uses the incurred- loss provisioning methodology

Methodology for Provisioning

Impairment is estimated using an “incurred-loss” methodology model.

Loan impairment is measured based on an estimate of the present value of recoverable cash flows.

For equity investment for which fair value can be reliably measured, changes in fair value flow directly through changes in reserves.

24

Adequacy of the Bank’s provisioning – The Methodology

International financial reporting standards (IFRS) Requirement

Prior to 2004, the Bank based its provisioning for loans, guarantees and equity investments on an “expected-loss” model. However, since January 2005 the revised international financial reporting standards (IFRS) require financial institutions to estimate impairment of assets using an incurred-lossmethodology eliminating the concept of “general provisions” for statistically probable future loss.

Loans

For loans where an impairment is deemed to have occurred, the magnitude of the impairment based on computation of the present value of the cash flows that are likely to be recovered. The financial institutions are required to include estimates for the realizable value of any collateral or other security on impaired assets.

Equity Investments

For equity investments whose fair value can be reliably measured, the (IFRS) requires that changes in their fair value is passed directly to the Bank’s reserves. While equity investments for which fair value can not be reliably determined are reported at cost less provisions.

Looking ahead, Management expects that provisioning will be highly sensitive to the default status of individual borrowers (i.e. provisions could increase or decrease substantially when borrowers default). As such, it is likely that provisioning will be more volatile in the future.

The average provisioning rate has evolved in line with the portfolio risk profile

The average provisioning rate has evolved in line with the portfolio risk profile 25 * As
The average provisioning rate has evolved in line with the portfolio risk profile 25 * As

25

The average provisioning rate has evolved in line with the portfolio risk profile 25 * As
The average provisioning rate has evolved in line with the portfolio risk profile 25 * As

* As at 30.06.2007

Evolution of the Bank’s Provisions for Loans and Guarantees

The chart above shows the evolution of the Bank’s outstanding non-sovereign loan and guarantee portfolio (blue bar), the associated provision (green bar), and the average provisioning rate (red line) since 1998. The left axis measures the outstanding portfolio and provisions in UA millions while the right axis measures provisions expressed as a share of the outstanding portfolio in each year.

Throughout the period 1998 to 2004 the outstanding portfolio increased faster than the required provision. As a result the average provisioning rate decreased from the peak of 59% in 1998 to 33% in 2000, 19% in 2001, and 8.4% in 2004.

The implementation of the new incurred-loss provisioning methodology in January 2005, has resulted in an overall decrease in the Bank’s non-sovereign portfolio provisions. In 2005, the average provisioning rate decreased to 4.1%. However in 2006 the average provisioning increased slightly to 4.4% mainly as a result of the reduction in the outstanding portfolio.

In 2006, provisions for equity investments increased to 5.8% of the outstanding equity portfolio

In 2006, provisions for equity investments increased to 5.8% of the outstanding equity portfolio 26 *
In 2006, provisions for equity investments increased to 5.8% of the outstanding equity portfolio 26 *
In 2006, provisions for equity investments increased to 5.8% of the outstanding equity portfolio 26 *

26

In 2006, provisions for equity investments increased to 5.8% of the outstanding equity portfolio 26 *

* As at 30.06.2007

Evolution of the Bank’s Provisions for Equity Investments

The above chart shows the evolution of the Bank’s outstanding non-sovereign equity portfolio (blue bar), the associated provision (green bar), and the average provisioning rate (red line) since 1998. The left axis measures the outstanding portfolio and provisions in UA millions while the right axis measures provisions expressed as a share of the outstanding portfolio in each year.

o

As illustrated above, the Bank made its first provisions for non-sovereign equity investments in 2000. The UA 1.7 million provision represented an equivalent of about 5% of the outstanding portfolio.

o

By 2003, the accumulated provision had increased to about UA 8.1 million representing close to 20% of the equity investments outstanding portfolio.

o

As a result of write-back of provisions, provisions for non-sovereign equity investments declined sharply in 2004 representing about 3% of the outstanding equity portfolio.

o

However, due to the implementation of the new incurred-loss provisioning methodology declined substantially to zero in 2005.

o

In 2006, provisions increased to UA 3.5 million representing about 5.8% of the outstanding portfolio. This was mainly due to the fact that the fair value of the 9 sovereign equity investments transferred to OPSM could not be reliably measured and therefore reported at cost less provisions. These equity investments typically relate to investments in sub-regional and national development institutions whose shares are not listed and also not available for sale to the general public.

In summary

The Bank complies with IFRS “incurred-loss” approach.

In 2006, the average provisioning rate increased slightly to 4.4% from 4.1% (2005)

Total provisions for the equity portfolio increased to UA 3.5 million in 2006 as a result of transferring 8 equity investments to OPSM

27

Key Highlights on the Adequacy of the Bank's Provisions

o

The Bank has been fully compliant with the “incurred-loss” provisioning requirement of the IFR since its inception in 2005 and the provision levels for both loans and equity are adequate

o

Total provisions for the loans and guarantee in 2006 decreased by UA 0.7 million but the average provisioning rate increased 4.4% from 4.1% in 2005, mainly as a result of the reduction in the outstanding portfolio. As at 30 June 2007 the provisioning rate is 4.1 %

o

Total provisions for the equity investment portfolio in 2006 increased to UA 3.5 million and the average provisioning rate increased to 5.8% from 0% in 2005. The provisioning rate as at 30 June 2007 stood at 5.9%. The increase in the provisions for equity was mainly due to the fact that the fair value of the 9 sovereign equity investments transferred to OPSM could not be reliably measured and therefore reported at cost less provisions. These equities typically relate to investments in sub-regional and national development institutions whose shares are not listed and also not available for sale to the general public.

o

The implementation of such methodology has led to an initial reduction in the required provisions. It may also lead to increased volatility of provisions in the future.

In the third part of this presentation

Rating Trends

Portfolio Risk Profile

Risk Management Implications

Provisioning

Capitalization and Exposure

Risk Pricing

Credit Process

28

Capitalization and Exposure

The element of the report addresses the issues of the adequacy of the Bank’s capital as cushion against low probability “unexpected-losses” in the non-sovereign loan, guarantee, and equity investment portfolios. The particular focus will be on:

o

The mechanics of the Bank’s capital adequacy policy followed by an analysis of the capital requirements for the non-sovereign portfolio.

o

The review of t he portfolio with respect to the Bank’s exposure limits for non- sovereign operations.

The capital adequacy policy requires the Bank to hold more capital backing for riskier assets
The capital adequacy policy requires the Bank to hold
more capital backing for riskier assets
Portfolio of
Used Risk
Assets
Capital
Very Low
25%
Total Used
Low
28%
Risk Capital
Moderate
35%
High
50%
Very High
75%
Equity
100%
29

Capital Adequacy Assessment

As illustrated schematically above, the Bank’s policy on capital adequacy specifies the amount of risk capital that is set aside to cushion against low probability “unexpected-losses” in the Bank’s outstanding loan and equity portfolios.

Risk Capital factors These risk capital requirements increase for riskier assets in both the sovereign and non- sovereign portfolios and are expressed as a percentage of the balance of outstanding assets in each of the Bank’s five risk classes. For example

o

“Very-low risk” loans require 25% risk capital backing. At the other end of the scale, “Very-high risk” loans consume three times as much capital at 75%.

o

By policy all equity investments, regardless of the project rating, require 100% capital backing.

o

For derivative instruments, such as guarantees or risk management products, the capital requirement is computed on the basis of the “loan equivalent” exposure of the instrument.

Risk Capital Requirements To determine the risk capital required to support the Bank’s non-sovereign portfolio, the risk capital consumed by each non-sovereign loan and guarantee is aggregated by risk class plus equity investments. The total used risk capital is the aggregate of the risk capital requirements for each risk class.

Risk Capital Requirement = (Asset Value by Risk Class * Risk Capital Class by Risk Class )

The Bank is adequately capitalized for the size and risk profile of its non-sovereign portfolio

Outstanding non-sovereign operations have consumed just 4% of the Bank’s total risk capital Uses of
Outstanding non-sovereign operations have consumed
just 4% of the Bank’s total risk capital
Uses of Risk Capital for Non-Sovereign Operations
(31/12/2006)
Very Low Risk
Low Risk
Loans & Gtees
Moderate Risk
68%
High Risk
Very High Risk
Equity
Equity
32%
4.5%
4.5%
30
* As at 30.06.2007

Unused Risk Capital Available for Portfolio Development

The pie chart above decomposes the usage of the Bank’s risk capital by major portfolio. At the end of 2006, the combined non-sovereign loan, guarantee and equity portfolios consumed about 4% of the Bank’s total available risk capital compared to 41% for the sovereign portfolio. The right-hand chart shows that within the portion of risk capital required to support the non- sovereign portfolio, about 32% is required to support equity investments and 68% to support loans and guarantees.

Available Headroom The 4% utilization of risk capital is well below the 20% risk capital limit set for non-sovereign operations. Given the large number of projects in the advance pipeline in 2007 coupled with the projected expansion of non-sovereign operations, this large available headroom (20% - 4%) for non- sovereign operation would reduce significantly in the near future. However there will still be enough headroom to sustain future expansion of the portfolio.

Projections show that both single country limit and single obligor limit will be exceeded soon

  Limit 2006 2007*
 

Limit

2006

2007*

Total Non-Sovereign

20%

4%

4.5%

12%

 

Single Country

15%

4%

6%

15%

Single Sector

25% / 35%

8%

15%

27%

 

(Fin. Services) (Fin. Services)

(LSE)

 

Single Obligor

4%

2%

2%

11%

(LSE)   Single Obligor 4% 2 % 2% 11% Projected** 31 * As at 30.06.2007 *

Projected**

31 * As at 30.06.2007 * *Assuming all approved projects plus the advanced pipeline fully disbursed

Credit Limits

Total Non-Sovereign A formal limit of 20% of total risk capital was set for exposure to non-sovereign operations. At the end of 2006, the Bank’s outstanding non-sovereign portfolio had used just over 4% of the Bank’s risk capital. This percentage stood at 4.5 % as at June 2007. The current level of exposure is well within the global limit of 20%. However, in view of the large number of projects in the advanced pipeline, the gap is expected to narrow significantly.

Single Country Limit No more than 15% of the risk capital for non-sovereign operations should be deployed in any single country. At the end of 2006, the highest level exposure was 4% for Nigeria (6 % as of June 2007). However, due to the large number of projects that are being booked, it is projected that South Africa will exceed the 15% single country limit very soon. The increased exposure to South Africa is not a big concern, as South Africa is one of the largest economy regional member countries with very low risk profile. Moreover, the limit will remain within the global sustainable lending program for South Africa which comprises of sovereign and non-sovereign.

Single Sector Limit No more than 25% of the risk capital for non-sovereign operations should be deployed in any single industry (35% for the financial sector). At the end of June 2007, the largest single sector in the portfolio was financial services, which accounted for about 15% of non-sovereign risk capital (as compared to 8% at the end of 2006). However It is projected that Large Scale Enterprises (LSE) Will reach 27%.

Single Obligor No more than 4% of the risk capital for non-sovereign operations should be deployed for any single obligor (project). This is commercially-oriented public sector entity with very low risk profile and diverse customer base.

In summary

The Bank’s risk capital requirements reflect the size and riskiness of the outstanding portfolios.

At the end of 2006, about 4% of the Bank’s risk capital was deployed for non-sovereign operations compared to a 20% limit.

Over the near-term the risk capital utilization rate for the non-sovereign portfolio is projected to rise to about 12%.

32

The Highlights on Capital Adequacy and Exposure

The Bank’s capital adequacy policy prescribes the amount of risk capital that should be set aside to support the Bank’s operations. The amount of risk capital required reflects both the size and the risk profile of the portfolios. All exposure limits are expressed in terms of risk capital deployed.

o

Currently, about 4% of the Bank’s risk capital is utilized to support the outstanding portfolio of non-sovereign loans, guarantees and equity investments. This is well below the risk capital limit of 20% that was established for total non-sovereign operations. Over the near- term the risk capital utilization rate for the non-sovereign portfolio is projected to rise to about 12%.

o

In addition to a global limit for non-sovereign operations, a number of exposure limits are applied to ensure adequate diversification of the non-sovereign portfolio. Currently there are no specific portfolio concentrations in terms of country, sector or obligor distribution. However, projections show that the loan for ESKOM will exceed the single obligor limit. This is commercially-oriented public sector entity with very low risk profile and hence the concentration risk is mitigated by its diverse customer base.

o

It is projected that South Africa will exceed the 15% single country limit very soon. This is not a concern, as South Africa is one of the largest economy regional member countries with very low risk profile. Moreover, the limit will remain within the global sustainable lending program for South Africa which comprises of sovereign and non-sovereign.

In the third part of this presentation

Rating Trends

Portfolio Risk Profile

Risk Management Implications

Provisioning

Capitalization and Exposure

Risk Pricing

Credit Process

33

Adequacy of the Past Pricing

This part of this report looks at the adequacy of the past pricing of the Bank’s non-sovereign loans and guarantees to cover the cost of assuming the credit risks associated with these projects as well as the direct costs of originating and supervising these assets.

o

It reviews the mechanics of the Bank’s pricing policy followed by an analysis of actual pricing experience for the non-sovereign portfolio.

o

It concludes by examining recent trends for the overall financial performance of the non-sovereign portfolio.

The Bank’s pricing policy allows for flexibility within a cost recovery framework

Pricing Non-Sovereign Credits

For each level of risk, the Bank estimates the cost of extending its risk bearing capacity.

Bearing in mind the cost of risk, each transaction is negotiated to be competitive in the market.

Cost recovery is monitored and managed at the portfolio level.

34

Adequacy of Pricing

Flexible Cost Recovery

The Bank’s policy for pricing non-sovereign credits can be described as one of flexible cost recovery”.

Cost Structure and Pricing Elements

Base Price

For each level of credit risk the Bank estimates the cost of extending its risk bearing capacity. The two main cost components are: (i) the costs of provisioning for expected-losses, and (ii) the costs of holding risk capital to cover unexpected-losses.

Transaction Specific Spread

o

On a transaction by transaction basis the Bank’s investment officers negotiate the pricing of each credit in an effort to recover the cost of extending the Bank’s risk bearing capacity while being competitive within each respective market.

o

In practice, this means the Bank is flexible in pricing its credits to avoid being uncompetitive on individual transactions but also bearing in mind the consequences of consistently under-pricing risk.

o

Although each new transaction is priced to be competitive in its market, the Bank monitors and manages cost recovery at the portfolio level. This allows management to adjust the pricing on individual transactions while ensuring the Bank is able to maintain a portfolio that is financially viable from a risk-adjusted perspective.

In summary

The Bank prices non-sovereign loans within a flexible cost recovery framework.

The cost of extending the Bank’s risk bearing capacity is estimated for each risk rating.

In the recent past, the Bank’s loans have generally been priced to cover the risks at entry.

Non-sovereign operations positively contributed to the overall financial performance and to the bank’s development assistance effort.

35

Key Highlights on the Bank’s Risk Pricing

o

The Bank’s policy for pricing non-sovereign loans can be described as “flexible cost recovery”. This means the Bank seeks to recover the cost of extending its risk bearing capacity but remains flexible to price individual transactions to be competitive within each target market. Cost recovery is monitored ex-post at the portfolio level.

o

The cost of extending the Bank’s risk bearing capacity is estimated for each risk rating from two components: the cost of provisioning for expected-losses; and the cost of deploying risk capital to protect the Bank from unexpected-losses.

o

Analysis of the active non-sovereign loan portfolio shows that the Bank has generally priced its new credits to reflect the cost of risk as estimated at entry.

o

Since 2005, the net economic contribution from non-sovereign portfolio positively contributed to the Bank’s overall financial performance .

In the third part of this presentation

Rating Trends

Portfolio Risk Profile

Risk Management Implications

Provisioning

Capitalization and Exposure

Risk Pricing

Credit Process

36

This last part of the report looks at the Bank’s internal process for evaluating, approving, and monitoring non-sovereign projects.

It also assesses progress in implementing the recommendations that were presented in previous years.

A number of measures have been taken to strengthen the Bank’s non-sovereign credit process

The Bank has successfully:

– Reorganized the private sector into functional divisions

– The responsibility of strengthening and supporting private sector micro-finance enterprises has been transferred to OPSM

– Enhanced the quality of portfolio reporting to ALCO

– Transferred all the Bank’s equity investment under the management of OPSM

But more needs to be done:

– Credit risk management function needs to be strengthened

– Investment committee structure and mandate needs to be redefined

– Credit review process and procedures needs to be enhanced and strengthened

37

Toward further strengthening of the Bank’s non sovereign credit process

In line with the private sector development strategy, OPSM was reorganized into five functional divisions. The key objective was to provide a resource framework and expand the Bank’s role in non-sovereign operations by strengthening OPSM’s transaction origination specialization. To enhance the support the Bank extends to private sector micro-finance enterprises, OPSM capabilities and capacity has been strengthened with the addition of micro-finance specialists. Moreover, all the Bank’s equity investments are presently included in the in the non-sovereign portfolio under the exclusive management of OPSM. As the Bank’s non-sovereign operations expand it would be appropriate to ensure that such expansion is sustained by adequate safeguards, review process while maintaining the flexibility required for private sector operation. It would be therefore appropriate to:

o

Further strengthening of the investment committee structure and its mandate in order to make the investment decision making process and procedures more transparent and inclusive. In particular, the decision making procedures should be streamlined to ensure that credit decisions fully reflect the collective will of all committee members.

o

Re-examine the credit review process and work flow process between OPSM and other departments with a view of ensuring adequate due diligence assessment and streamline the approval process. A full fledge credit committee would be more appropriate than the current institutional organ governing the review process (PSIC)

o

The departments supporting the non-sovereign operations review, assessment and monitoring such as FFMA and GECL needs to be strengthened with the addition of more staff in order to carryout its risk management function more effectively.

In conclusion

Due to prepayment of low risk assets , the risk profile of the non-sovereign portfolio weakened in 2006, also, the outstanding non-sovereign portfolio declined by 8%.

The credit risks in the portfolio are under control:

– The average risk rating of the non-sovereign portfolio has been brought down from 5.8 to 3.5.

– Only 4% of the 20% risk capital limit for non-sovereign operations is used. Given the huge headroom available, the Bank has the capacity to accommodate the large number of projects in the advance pipeline.

– However, the single country and single obligor limits are already becoming constraint and are being reviewed.

– Loan pricing has generally covered the cost of risk and the portfolio has positively contributed to the overall financial performance of the Bank.

A number of measures have been taken to strengthen the Bank’s non-sovereign operations, but further challenges remain.

38

Conclusion and Recommendations Going Forward

The key conclusions and recommendations of this report can be summarized as follows:

o

Low risky assets at entry are required to maintain the positive momentum towards further improvement of the portfolio quality. This report has shown that during 2006, there were a number of new projects added to the non-sovereign portfolio and that as result of prepayment of low risk assets the risk of the portfolio weakened from 3.2 to 3.5. The size of the outstanding portfolio declined by 8%.

o

The level of Provisioning is adequate - The average provisioning rate for the loan and guarantee portfolios increased slightly in 2006 to 4.4%, while the average provisioning for the equity portfolio increased to 5.8%.

o

There is enough headroom to support further expansion of non-sovereign operations - From a capital adequacy perspective, the outstanding non-sovereign portfolio currently consumed about 4% of the Bank’s total risk capital, well below the 20% global limit. However, over near future, the risk capital utilization is projected to rise to 12%. Also, the single obligor and single country limit are expected to be exceeded soon.

o

In terms of credit pricing, the spreads and other charges set on loans and guarantees have generally been in line with the Bank’s cost recovery objective. In 2006, the net economic contribution from non-sovereign portfolio positively contributed to the Bank’s overall financial performance.

o

A number of measures were taken to strengthen the Bank’s non-sovereign operations. But as more functions and responsibilities are shifted toward private sector, it would be appropriate to re-examine the credit review process with a view to strengthening the committee structures and the approval workflow.