Company: Mariner Investment Group
Category: Real World Impact Initiative of the Year (shortlisted)
In the spirit of showcasing leadership and raising standards of responsible investment among all our signatories, we are pleased to publish case studies of all the winning and shortlisted entries for the PRI Awards 2019.
Project overview, objectives, and reasons for undertaking it
Room2Run is a synthetic securitisation that helps development banks to expand their lending capacity, engage private sector investors, maintain or even improve their rating, and reduce reliance on limited public-sector resources.
Mariner Investment Group, through its IIFC Strategy, served as the anchor investor for Room2Run, alongside the Africa50 infrastructure fund, and spent four years working with the African Development Bank (AfDB) to develop the transaction. The primary objective of Room2Run was to help AfDB manage its existing balance sheet, giving the bank additional headroom for lending in socially and environmentally critical areas.
The transaction shifts mezzanine risk on a US$1bn portfolio of pan-African loans to private investors. By absorbing losses on the mezzanine tranche of the portfolio, the transaction meaningfully reduces the risk weight on the bank-retained senior portion of the structure, and hence the risk capital that the bank must hold. AfDB is then able to recycle this released capital, enabling $650 million of new development lending in Africa.
The need for additional infrastructure and development lending is vast. And in order to make meaningful progress towards achieving the UN’s Sustainable Development Goals, multilateral development banks (MDBs) need more power. This is why the G20 called on MDBs to optimize their balance sheets in 2015, stretching every public dollar for maximum impact.
Another key objective was for AfDB to maintain its relationship with the borrowers and remain the lender of record. By structuring the transaction as a synthetic securitization, investors can cover future losses on the portfolio through a contractual structure, rather than buying the loans.
AfDB therefore retains the relationships and continues to service the loans just as it otherwise would have done.
Finally, Mariner was motivated by the chance to create a structure that could be scaled up and duplicated at other development finance institutions (DFIs). Now that the structure has been established, the opportunity for future impact is immense.
Financial scale of the project and impact
Room2Run’s US$1bn reference portfolio consists of 45 loans from AfDB’s non-sovereign lending book, spread among 16 African nations and 13 different MSCI Global Industry Classifications.
About half of the loans are to infrastructure project finance assets, with the other half split among development and commercial financial institutions, many of which are earmarked for particular development objectives.
In exchange for mezzanine risk protection on the 2% to 17.25% tranche of the reference portfolio (totalling US$152.5m), AfDB will pay investors a floating rate, plus a spread. The transaction creates a risk capital reduction for AfDB, which is equivalent to additional lending headroom of US$650m.
In addition to the immediate impact of new capacity for AfDB, the Room2Run transaction has set a precedent for other DFIs to follow. Mariner, Africa50, AfDB, and Mizuho (which served as an advisor to AfDB) have all engaged heavily with other DFIs to educate them on the structure, the process, and the benefits of such a transaction.
Room2Run created about 65% more headroom from the initial reference portfolio. Assuming no additional efficiencies in future deals, the structure could in theory take the US$1.95trn of DFI balance sheet rated by S&P and create US$1.25trn of new development lending capacity.
Project delivery and challenges overcome
The biggest challenge was the rating agency process. Development banks do not have a regulatory body, so rating agencies serve as de-facto regulators because they rate the banks’ debt. S&P has the most quantitative approach to its DFI model, so a core question was how S&P would quantify and incorporate the transaction’s benefit to AfDB. Ultimately, S&P calculated the impact of the transaction through its Risk Adjusted Capital Framework, reducing the risk-weighted assets of the portfolio.
Additionally, education was needed on all sides. Mariner spent a great deal of time conducting due diligence into understanding the assets and AfDB’s lending processes. This included site visits across Africa and several weeks of meetings with bank employees. Furthermore, because one of the goals was to engage private sector investors in development, it was also important to educate institutional investors on the robust lending track record of DFIs.
It was unusual for the AfDB to share loan-level information to the extent that the investors required, and internal education was needed on the benefits of risk sharing transactions.
All parties showed exceptional determination through these challenges, buoyed by the knowledge that Room2Run would pave the road for others, not just at AfDB but also across other DFIs globally. Despite many difficulties associated with a first-of-its-kind deal, the transaction successfully closed in autumn 2018.
Measuring success and lessons learned
As the first synthetic securitisation between a DFI and private investors, Room2Run has created a framework that can be broadly applied across DFIs, allowing them to more aggressively work toward achieving the UN’s 17 SDGs.
Success can be measured in two ways:
- The first is the direct impact on AfDB’s lending capacity, which has increased by US$650m. The social and environmental impact of this capacity will be demonstrated as the bank continues to finance solar fields, roads, and water projects across Africa.
- The second, and larger, impact is in creating a new market. Now that Room2Run has successfully closed, other DFIs that had been watching its progress are now advancing their own programmes.
The impact of Room2Run as a catalyst could easily be in the trillions of dollars, all directed towards the socially- and environmentally-critical projects to which DFIs were established to lend.
Room2Run proved the concept and established the framework, and now it serves as a learning tool for others. Finally, Room2Run confirms private investor interest in amplifying development efforts, and has built channels between some of the largest international institutional investors and AfDB. Additionally, DFIs often think that private sector investors require DFIs to take the equity, or provide guarantees, to lower the risk sufficiently to generate private sector interest. Room2Run proves that private sector investors are interested in investing alongside DFIs at various places in the capital stack, not just in the most senior positions.