Transcript Construction Finance Enabler

Construction Finance Enabler
By Michael Wong
December2014
Construction Finance
Definition
A construction loan is any value added loan where the proceeds are
used to finance construction of some kind. It is designed for
construction and containing features such as interest reserves, where
repayment ability may be based on something that can only occur
when the project is built.
Challenges:
:  The financial products demanded by construction contractors are
often not offered to smaller contractors or offered at a price that is
prohibitive
 Uncertainty of the construction industry as reflected in the risk
averse behavior of banks. Uncertainties include late completion
of projects and non-compliance with technical requirements of
the specific work
 Payment culture of the public sector and private parties e.g late
payments or non-payment altogether
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Background
Need for Construction finance
1. To purchase adequate machinery to meet tender
requirements
2. To post a bid bond for access to the bidding
process and/or a performance bond in case of
successful tendering
3. For working capital
4. For access to a reasonable overdraft to pre
finance contracts until first payments are
due
5. For the ability to late payments for the
completion of work
Elements often required in construction financing:
 Pre-finance instrument/product: 15% - 20% of
contract value paid upfront (advance payment)
 Financial instrument for construction
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Product Types (I)
Examples and key features
A project-related bond is a written instrument
executed by a bidder or a contractor, usually
issued by a financial institution to assure
fulfillment of the bidder’s or contractor’s
obligations to a client.
 Performance bonds/guarantee: a bond issued
by a bank or other financial institution,
guaranteeing the fulfillment of a particular
contract.
i) It requires a cash deposit in the account of
the issuing Bank without exposure to any
risks (contractor has the cash equivalent in
its account with the said bank)
ii)the bank has full benefits of charging an
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Product Types (II)
Examples and key features
(bid bond cont’d)
ii) performance bond will be provided to back
your work.
iii) If the bid is won and the contractor
backs out of the job or cannot post a
performance bond, a claim can be made against
the bid bond.
 Advance payment bonds/guarantee: Guarantee
supplied by a party receiving an advance
payment to the party advancing the payment.
i) It provides that the advanced sum will be
returned if the agreement under which the
advance was made cannot be fulfilled.
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Construction Finance (I)
North Dakota Housing Finance Loan Guarantee Program
Key Elements:
 Eligible Lenders : Any bank or trust company, national
banking association, savings and loan association, credit
union or other financial institution authorized to transact
business within the State which customarily provides service
or otherwise aids in the financing of construction loans.
 Guarantee fee: 0.5% of loan amount charged by NDHFA
 Maximum guarantee: NDHFA will guarantee up to 50
percent of each construction loan made to an individual
contractor.
 Maximum loan amount: Construction loans provided by the
Lender may not exceed 85 percent of the value of the
housing unit (including lot and improvements) or total cost,
whichever is less
 Guarantee term: The Guarantee will terminate automatically 6
Construction Finance (II)
Indian Housing Loan Guarantee Program
Key Elements:
 Firm Commitment Requirements: lenders must submit plans
and specifications for the construction or the rehabilitation
work.
 Timing.: Loan closing must occur after the receipt of a firm
commitment and prior to the start of construction or
rehabilitation.
 Interest Rate: The interest rate on the loan must remain
fixed throughout the term of the loan. Since the loan is fully
guaranteed, the interest should reflect current market rates
for permanent, rather than construction financing.
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Decomposition of Mutual
Guarantee Proposal
1) Partial Risk Guarantee
2) Group Lending
3) World Bank Project inclusion
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Introduction - PCGs
Definition: The terms partial credit guarantees (PCGs) defines
a program/product which encourages financial institutions to
provide loans to new sectors (e.g. agriculture, energy, health)
or to new borrowers (e.g. MSMEs) and can encourage
financial institutions to make longer-term loans
How PCGs Work: PCGs aim to lower the risk to the lender for
a defined period by taking part of the risk of the counterparty,
guaranteeing repayment of part of the loan upon a default
event.
Intervention due to deficient enabling environment and
information asymmetry. The combination of high
requirements (eg collateral) due to perceived high risks,
coupled with weak information and weak enforcement of credit
contracts, stifles bank financing of SMEs in many of WBG’s
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client countries.
Potential Impact of PCGs
Additionality – (i) capacity to provide additional finance that
would not have otherwise been available, (ii) developmental
impact and (iii) depth of financing
In Canada, 75% of guarantees are used by firms that would
not have been able to obtain a loan otherwise - Ridding (2007)
In Chile, the guarantee scheme increases the probability of
small firms to get a loan by 14% - Larrain and Quiroz (2006)
Leverage - ability to ‘leverage’ PCG endowment on lending
activity
Good practice for ratio of outstanding guarantee commitments
to the underlying funds of the PCG scheme is 6-7 times – Best
(2005)
Wider welfare benefits include higher income, employment,
and wages at small businesses – e.g. SBA-guaranteed loans
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Introduction – Group
Lending
How it works
 Group members guarantee the repayment of
each other’s loans.
 Collateral and co-signers are generally not
used, peer pressure and collective
responsibilities generated by the group take
their place
 Functions typically performed by the bank
staff are delegated to the borrower group
i.e. peers screen clients, determining who
to accept into their group;
 Loan analysis by the lending institution is
minimal, depending instead on peer
assessments of each other’s businesses
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 Operational costs for group lending tend to
Approaches to Group
Lending
How it works
 The solidarity group model became very
famous in 1976 after it was applied by the
Grameen Bank. They aimed to address various
social using the “Sixteen Decisions”
framework
 Later on this model was expanded to Latin
America; focus more on credit provision.
Solidarity group models in Latin America
chose to retain loan approval and
administration, using the already-existing
operational systems developed for individual
lending
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Approaches to Group
Lending
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Group Lending
Methodology
i. Grameen Group Lending Methodology
Source: http://grameenresearch.org/grameen-group-lending-model/
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Group Lending
Methodology
ii. Banco Sol
Banco Sol offers credit, savings, and a
variety of insurance products. Their initial
loan offering was based on Grameen-style
joint-liability lending, offering a maximum
of $3,000 per client to groups of three or
four individuals with
 At least one year of experience in their
proposed occupation.
 Using dynamic incentives, the size of the
loan is gradually increased based on good
repayment history.
 Annual interest rates average between 12
and 24 percent and
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Illustration 1
India SME Finance and development project:
The Small Industries
Development Bank of India
(SIDBI) served as the
implementing agency because
of its designation as the apexlevel financial institutional
responsible for SME financing
and development in India.
 60 percent of the total funds
allocated to the credit facility
(CF) was utilized by SIDBI
for on-lending to eligible
commercial banks (Tier 2
FIs) to refinance (new) term
lending to commercially
viable SMEs, and
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Illustration 2
China MSE Finance Project
The objective of
this project was to
provide working
capital and
investment finance
to MSEs on a
commercial basis.
 The funds of the
credit line were
channeled through
the China
Development Bank
(CDB), the
wholesaler, to
participating
financial
 The range of maturity and
grace period for PFIs
loans were determined at
design stage,
 interest rates for the 17
Proposed Solution
 Establish a Mutual Credit Guarantee Scheme aimed at
pooling and sharing risk would enable the financial
market to work for local mostly smaller construction
firms.
 How does it work?
i) Interested firms pay a sufficient contribution as a
disincentive to willful default, limiting possible moral
hazard effect on borrowers.
ii)Pooling of participants induces peer pressure,
encouraging compliance with contract terms and
conditions
iii)The public sector would provide a fund to cover default
to an agreed amount.
iv)A committee consisting of participants, participating
commercial banks and the respective Construction
Association will act as an oversight of the risk
covering facility.
v) Guarantee pools would then operate on a given size and
sequenced to ensure peer pressure, i.e. only 25-40% of
outstanding guarantees will be issued to members of any
one pool.
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Proposed Solution
Mutual Guarantee Fund: Set-up
Guarantee Fund
Contribution
from
members 50%
Matched by
GEM Project
50%
Banks
Guarantees
provided by
the Fund to a
few
Participating
Institutions
Developers
Development
Loans
provided to
Members
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Proposed Solution
Mutual Guarantee Fund: In case of Loss
Guarantee Fund
Banks
Contribution
from
members 50%
First 25% of the
loss borne by
members
contribution only
Matched by
GEM Project
50%
Remainder
shared 50-50
between Bank
and members
Developers
Project
abandoned
Development
Loans
provided to
Members
Developer
members in the
Fund taking over
failed projects
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Option 1 – in red
Option 2 – in purple
Next Steps
 REDAN members agree to basic principles
after wide consultations
 GEM Project to field financial expert to
develop detailed design operation manual and
legal agreement.
 REDAN finance to recruit the necessary staff
to implement the mutual guarantee.
 REDAN finance and GEM project sign a
collaboration agreement.
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