Private Sector Operations: Strategic Directions and Review

Table of Contents

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I. Introduction

II. Assessment of Past Performance

A. Country and Sector Coverage

B. Impact of Private Sector Operations

C. Financial Performance

D. Risk Exposure

E. Portfolio Administration

F. Lessons Learned

III. Rationale and Role

IV. Operational Strategy

V. Operational Improvements

VI. Resource Requirements

VII. Conclusions and Recommendations

Private Sector Operations: Strategic Directions and Review : II. Assessment of Past Performance

E. Portfolio Administration

28. The overall quality of the portfolio, the impact of significant new events, the risk rating of individual projects and the levels of specific provisioning for individual projects, are under constant administration by ADB and are formally reviewed each quarter.²⁵ Quarterly reports on PSO are furnished to the Board.

29. PSG has a proactive approach to portfolio management and, since the Asian financial crisis, has taken steps to strengthen credit risk management by reorganizing its staff functions and closer credit monitoring. Nevertheless, the PSO portfolio has shown some deterioration in asset quality since 1997 as nonperforming assets have increased, largely as a result of currency devaluation and economic slowdown related to the crisis. In 1998, PSG initiated detailed annual reviews for all projects utilizing a comprehensive checklist of matters to be considered in the review. A risk management unit was also created with two main functions: special assets management, to give special attention to the most vulnerable investments; and credit review, to evaluate and give an independent credit judgment, separate from the dealing officer’s judgement, on each project. These initiatives have improved risk management. More recently, PSG took the first steps to implement a credit committee as part of the staff decision-making process to strengthen risk management.

1. Project Classification

30. Risk management was further upgraded in 1998 with a revised project classification system to provide early recognition of problems and achieve more consistent and effective portfolio monitoring (Box 1). PSO projects are classified by four separate ratings: (i) risk rating, (ii) operational status, (iii) disbursement status, and (iv) recovery status. These classifications are designed to readily identify the status and condition of each project and provide a guide for any specific loss provisioning. The risk management unit of PSG determines whether the classification is appropriate.

Box 1: Project Classification

The Private Sector Group (PSG) tracks all of its loans and equity investments along four dimensions: risk rating, operational status, disbursement status, and recovery status. Performance of the portfolio is monitored quarterly by a formal interdepartmental committee (comprising of representatives from PSG, Office of the General Counsel, Treasurer’s Department, Controller’s Department, and Central Operations Services Office) and reported to the Board on a quarterly basis.

Risk rating is a proxy for probability of nonpayment and is assigned to each project or investment according to its financial strength. There are seven classifications from 1 (strong) to 7 (loss). Loss provisioning is indicated from category 4 (marginal) to 7 (loss), but the level of specific provisioning depends on the circumstances of each project.

Operational status consists of 10 categories, aligned to follow chronologically operating stages from implementation to liquidation. Subcategories indicate whether the project is problem-free, experiencing problems, or in severe distress.

Disbursement status comprises four classifications reflecting problems with disbursement and further implementation.

Recovery status reflects the repayment status of loans and the divestment status of equity investments.

2. Investment Recovery Operations

31. The effects of the Asian financial crisis reinforced the need for active management of ADB’s portfolio. Restructuring specialists have been hired since 1997 to intensively manage PSG’s portfolio of problem and vulnerable projects. Investment recovery operations generally are conducted on the basis of one of two strategies: (i) work-out, perhaps involving operational and/or financial restructuring; or (ii) foreclosure, which may include liquidation action. The special assets function has been particularly active in attempting to maximize recovery from problem projects, particularly those in Indonesia, Pakistan, and the Philippines.

32. In 1999, ADB, for the first time, exercised its foreclosure rights jointly with the International Finance Corporation (IFC) under a loan for a manufacturing project. Mortgaged assets were auctioned under an extrajudicial foreclosure procedure.²⁶ This action sent a clear message to borrowers that ADB will take all appropriate action to protect its investments and to pursue its remedies as a creditor. Similar legal action is being considered for other problem projects. Any such decision will only be taken after ADB’s Office of the General Counsel reviews the situation and Management approves the action.

3. Portfolio Management through Divestments and Sales

33. ADB first divested equity holdings in 1990. Since then, ADB has divested holdings in over 40 companies. While PSG has continued to dispose of its investments on a regular basis, there has not previously been a strong emphasis on this aspect of portfolio administration. However, PSG has recently focused critically on ADB’s role in each investment and now actively seeks to recycle funds in existing investments as quickly as possible after ADB’s development role in such investments has been fulfilled. Divestments are carried out in a manner consistent with good business practice and without destabilizing the concerned investee companies. PSG’s quarterly portfolio review meetings now include a specific review of the exit strategy for each equity investment. In future, opportunities for recycling funds committed in loans may also be considered. One way to do this is to sell participation in ADB’s direct loans while keeping ADB as the lender of record; another is to arrange for borrowers to refinance such loans with domestic borrowings or bond issues.

4. The Important Role of Resident Missions

34. The recent analysis of ADB’s resident mission (RM) policy emphasized the important role of RMs in implementing PSO in the field.²⁷ For example, the analysis noted the active promotion of PSO and liaison with local stakeholders, including chambers of commerce. ADB has found that in-country officers with appropriate skills may be better placed to administer private sector projects in the country, particularly those where the investment has been fully disbursed and the project is operating satisfactorily. RM-based officers can make regular site visits, interact more frequently with sponsors and local colenders, assess whether changes in local conditions are likely to affect a project, and represent ADB as directors in investee companies in which ADB has the right to a Board seat. The RM policy also stressed the often critical services RMs provide for resolving problem loans. Successful delegation to the RMs depends on the availability of RM-based staff with appropriate skills and dedicated to PSO. At present, ADB has a total exposure of close to $1 billion to assets at risk in DMCs with RMs that can actively assist PSG in project administration. A handful of RMs currently have national officers with suitable private sector experience providing PSG with some support for PSO implementation and portfolio administration. But for good risk management of the existing portfolio and effective marketing of PSO, it is critical that a PSO-dedicated professional staff member, responsible to PSG, is maintained in each RM at DMCs where ADB has significant and/or growing PSO exposures (para. 99). These include PRC, India, Indonesia, and Pakistan.

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On a quarterly basis, projects rated “satisfactory” or better are reviewed at a private sector investment management meeting and those rated “marginal” or worse are reviewed by a private sector portfolio assessment meeting. Representatives from the Office of the General Counsel, Treasurer’s Department, Controller’s Department, and Central Operations Services Office attend the meetings.
ADB and IFC recently exercised the power of sale to dispose of equipment and machinery held as security in this distressed company.
R57-00: Resident Mission Policy, 27 January.

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D. Risk Exposure

F. Lessons Learned