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A properly structured transaction in Zimbabwe with sound credit enhancement can reduce the loan interest rate significantly

Michael Tichareva


Investors, bond buyers and lenders typically look for highly-rated investment grade (BBB-/Baa3) cash-generating assets to reduce the chances of losing money. A common funding model uses credit enhancement products to reduce credit risk and subsequently obtain more attractive financing terms and interest rates.

For example, a properly structured transaction in Zimbabwe with sound credit enhancement can reduce the loan interest rate significantly.

In such a case, the typical form of security is a guarantee from an investment grade-rated corporate or sovereign entity sponsoring the project or other third-party guarantees.

International rating agencies such as Moody’s, Standard & Poor, Fitch and AM Best rate entities on the basis of how likely they are to default on their obligations. Investment grade is from BBB- to AAA ratings. There are many factors determining these ratings depending on the type of entity.

Most institutional investors concerned about risk place reliance on such ratings in selecting investments.

With Zimbabwe being way below investment grade, and not currently carrying a rating from any of the major international credit rating agencies, credit enhancement from “friendly” Development

Finance Institutions (“DFIs”) should be given serious consideration.

Most infrastructure finance relies on project cash flows as opposed to credit ratings, as projects are typically not rated.

Some investors, in addition to requiring a project or entity to have quality cash flows to service the funding, credit quality and liquidity in the event of payment delays are also key considerations.

Credit and liquidity enhancement can be achieved through guarantees from DFIs. This tends to lower costs of funding significantly compared to traditional project financing and introduces flexibility in funding structures, including the ability to do long-term loans into projects.

Such funding models are important for accelerated and sustainable infrastructure investment.

Guarantees as security to financing

A guarantee is an undertaking, usually on the part of the issuer at the request of a client, to pay a named beneficiary a specified amount of money in terms of conditions specified in the guarantee.

Fundamental to a guaranteed loan transaction is that the undertaking of the issuer is independent of the obligations between the client and the beneficiary of the guarantee, typically the lender.

It is like an insurance policy in the event that the client defaults on its financial obligation.

Guarantees take many forms, and are not expected to be drawn upon except in the case of default by the client. They function in the same way as insurance policies that pay upon predefined events and claims.

One such instrument commonly used in infrastructure finance in North America provides security such that it will be drawn upon by the beneficiary in the event of default or delayed payments.

The full amount covered is never intended to be drawn at once. This is usually reflected in the wording.

Although the full amount must be stated in the instrument, it must only cover shortfalls and missed payments.

Such instruments provide credit enhancement for debt and are issued for the account of the borrower for the benefit of the lender.

This prevents a loan or financial obligation from technically going into default. They provide the primary source of payment of the principal and interest on the debt.

As the credit of the issuer issuing such an instrument is better than that of the borrower, the borrower should generally be able to obtain significantly lower interest rates, long-term loans, and more flexible financing terms.

This type of guarantee is more appropriate in project and infrastructure financing.

International financing

Guarantees are long-standing proven instruments for institutional financial transactions for international financing. Most major institutional investors in international markets have a strong understanding of guarantee-backed financing. A well-structured instrument would shield the investor from bankruptcy by the borrower.

This allows the investor to receive a shadow rating of the financing equal to the guarantee issuer.

The transaction would then carry a strong investment-grade credit rating, under what is called credit substitution.

For foreign investors, this eliminates concerns related to underlying credit and political risk affecting repayment.

Such instruments are typically structured in such a way that the issuer is entitled to a first lien over the client’s assets to protect their position, giving them complete control over the project’s assets and cash flows.

The issuer would typically sign a reimbursement agreement with the client so that they are repaid any amounts drawn under the instrument.

This is what is needed for Zimbabwe to accelerate infrastructure investment. However, to secure such guarantees, the country needs to maintain a stable economic and political climate.

Michael Tichareva is the Managing Director of National Standard Finance Africa. He can be reached on mtichareva@natstandard.co.za




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