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p. 4 of 8 BACK | NEXT I. Introduction II. Borrower's Demand for New Loan Products III. Proposed New Libor-Based Loan Products IV. Withdrawal and Conversion of Pool-Based Loans V. Funding Risk Management Strategy VI. Implementation and Resource Requirements VII. Conclusion and Recommendations Appendixes

Review of Asian Development Bank's Financial Loan Products

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IV. Withdrawal and Conversion of Pool-Based Loans

A. Withdrawal of Pool-Based Loan Products

84. The rationale for withdrawing pool-based loans stems from two sets of factors. First, developing member countries (DMCs) are firm in their need for transparency in loan pricing, which is linked to the availability of debt management instruments in the market. This is the most compelling reason for introducing the LBL product. By definition, a pool-based loan product menu cannot coexist with an LBL product if transparency of pricing and the associated use of debt management market instruments are the reasons for introducing the latter.

85. Second, on the basis of ADB’s experience, pool-based lending can only be efficient in a single-product environment where continuous demand for the product makes the lending rate sensitive to changes in the market rates as sizeable annual borrowings are added to the pool of outstanding borrowings. When the demand for such a product is stopped or is reduced considerably, the lending rate can become significantly out of line with the market rate. Borrowers could, therefore, become dissatisfied. If ADB were to continue to offer pool-based loans simultaneously with LBLs, a product where strong demand is expected, the pool-based loans will entail significant risks to the borrowers, which would be compounded because the product is not hedgeable. Further, the prepayment risk would rise and this could cause substantial losses to ADB as the proceeds of prepayment may be invested at significantly lower rates than the original borrowing cost, for which ADB would continue to be liable.

86. There has been no demand for the pool-based multicurrency loan (PMCL) since the pool-based single currency loan PSCL in US dollars was established in 1994. Borrowers have indicated that they do not intend to use it anymore. Therefore, the PMCL should be withdrawn from ADB’s new product menu by 1 July 2001. To provide a smooth transition, the PSCL in US dollars be withdrawn from ADB’s new product menu by 1 July 2002.

B. Conversion of Pool-Based Loans

87. At the end of March 2001, the outstanding and undisbursed loan balances of PMCLs were about $7.9 billion and $0.115 billion, respectively. ADB is currently approaching each borrower to cancel the remaining small undisbursed balances as soon as possible.

88. Many borrowers are dissatisfied with the terms and conditions of the PMCL window. The disbursement and repayment currency are at the discretion of ADB, which creates uncertainty and makes borrowers’ cash flow budgeting, forecasting, and evaluation in the local currency difficult. The borrowers cited that, over the longer term, the consequences associated with not being able to identify actual currency exposure and manage it has made the PMCL relatively more expensive than other product. Most borrowers indicated their desire to convert a significant portion of their PMCLs into PSCLs or LBLs.

89. In response to these concerns, Management proposes to convert the PMCLs into PSCLs in yen, to help borrowers better predict the debt service payments on these loans. The proposed conversions will constitute the first and necessary step before further improvements may be considered in the future.

90. The PMCLs can be converted into PSCLs in yen. By recalling the remaining small amounts in other currencies (i.e., Swiss francs and US dollars) in the currency pool for loan repayments, which constitute only about 0.4 percent of the currency pool as of end of March 2001, the multicurrency pool can become effectively a single currency pool in yen. The withdrawal of non-yen currencies in the pool can be effected by the end of 2001. Subsequently, the yen in the pool will be allocated to each loan on a pro-rata basis. This will improve the borrowers’ ability to predict their debt service for these loans as each individual multicurrency borrower will now know exactly the amount of its yen obligations and the timing of repayments of this currency. To achieve this, it is not necessary to remove these loans from the exchange rate pooling system (ERPS). Nevertheless, since ERPS will become redundant, ADB intends to remove all the loans from the ERPS, to eliminate the ERPS from its present accounting system and thus simplify the current efforts in installing a new accounting system for all its loan products. This will require amending the relevant loan agreements. The removal of these loans from the ERPS through loan amendments will be implemented after the conversion of PSCLs in US dollars is completed, i.e., by 31 December 2003.

91. The pool-based lending rate on these loans will continue to be determined on the basis of the methodology in each loan agreement, i.e., by adding a spread above the average cost of outstanding borrowings used to fund such loans. To maintain the transparency of the lending rate, however, the currencies in the pool of borrowings that are no longer outstanding in the currency loan pool due to withdrawals from it will be excluded from the lending rate calculation.

92. Many borrowers have indicated that if ADB introduces LBL products, they will convert some of their current PSCLs in US dollars to LBLs. The conversion of disbursed amounts will entail serious asset and liability management issues for ADB because these have already been funded by ADB with noncallable, long-term fixed-rate borrowings. As the interest rate on these borrowings is at historic cost and can differ significantly from the current market situation, swapping these underlying borrowings will entail significant costs that will have to be passed on to the borrower. ADB will continue to assess the feasibility of reconfiguring its disbursed poolbased loans in the future.

93. At this time, ADB will only consider converting the undisbursed balances of these loans that are not prefunded by ADB. Conversions will not therefore involve restructuring existing debt, but will involve amending existing loan agreements. Converted undisbursed loan balances will be treated as new LBLs. Accordingly, it is proposed that ADB offer borrowers the opportunity to convert undisbursed single currency pool balances (in US dollars) to LBL in any of the three currencies—euro, US dollar, or yen. The principal terms and conditions of undisbursed PSCL loan balances converted into LBLs are summarized in Appendix 3.

94. The exchange rate to be used and the amortization schedule to be adopted for the converted amounts should be guided by the following:

1. in determining the currency amount of the new LBL, the exchange rate prevailing on the conversion date will be used;
2. undisbursed balances converted to LBL terms will have the same remaining maturity as the original pool-based loan;
3. the amortization schedule for converted amounts will be based on a pro-rata share of the amortization schedule of the original loan, the share being determined by the ratio of the converted balances to the sum of converted and unconverted balances (i.e., the original loan amount less cumulative repayments); the converted amount will have a new amortization schedule consistent with the technical improvements (paras 39-41) applicable for LBL; and
4. the amortization schedule for the unconverted amounts will also be equivalent to the pro-rata share of such amounts, but will continue to be expressed in US dollar amounts.

95. Of the 227 pool-based loans approved at the end of 2000 (pre-2001 PSCL in US dollars), 197 are still disbursing and have undisbursed loan balances amounting to about $12.4 billion as of the end of 31 March 2001. Of this total, about 171 loans have total undisbursed balances of at least 25 percent of their total loan amounts. About 170 more loans have undisbursed loan balances of at least $10 million. The projected disbursements on these undisbursed loan balances are estimated to be around $2.0 billion to $2.5 billion each year for the next three years. These statistics indicate the potential number of conversions from PSCLs in US dollars into LBLs and the potential build-up of disbursements from these conversions carrying LBL terms.

96. In determining the timetable for converting pre-2001 PSCLs in US dollars, it is important to recognize that (i) borrowers have strongly requested for a conversion facility for their poolbased loans, which at current market conditions will entail interest cost savings to them by about 200 basis points; and (ii) the implementation process could be long. ADB will first send information to all concerned borrowers on the offer of conversion. The communication will include a description of the offer, associated deadlines, implementation procedures, and the amendments needed to the loan agreements of loans to be converted. Then the borrowers will have to notify ADB of their intent to convert and subsequently complete conversion authorization for ADB. Borrowers may respond to this offer at different times.

97. Borrowers wishing to convert undibursed loan balances of their pre-2001 PSCLs in US dollars will be offered the choice of conversion into LBLs after 2 January 2002 and could begin to amend their loan agreements thereafter. The actual conversions could take place on specific dates to simplify the loan accounting process. Because a satisfactory interim accounting system is needed to handle such conversions, the first date on which actual conversions could take place would be 31 July 2002. Additional conversions could take place on 31 October 2002 and 15 December 2002. The aim of offering borrowers a choice of conversion dates only in 2002 and completing the conversion in the same year is to avoid disbursement delays in 2001 and 2002.

98. ADB will offer to convert undisbursed loan balances as of 2 January 2002. The conversion facility will only be offered to all PSCLs in US dollars approved at the end of 2000 with undisbursed loan balances not less than 40 percent of the loan amount as of 31 December 2001. The facility will also be extended to PSCLs in US dollars and MBLs approved in 2001, but for which invitation to negotiate is issued after 1 July 2001.

99. The 40 percent figure was chosen on the basis of the following considerations. With more than 50 percent of the project disbursements, any change in loan terms could delay completion of the project. With only those projects eligible for conversion into LBL terms, where 60 percent have to be disbursed yet, the number of requests for conversion would be reduced, thereby, expediting the processing. A reduction of loan conversion would enable ADB to use the interim arrangement established for the LBL product. This category will capture about 150 loans with $11.0 billion of existing undisbursed loan balances. Table 2 summarizes the proposed timetable for this initiative.

100. The new LBL product will be offered only to loans for which invitation to negotiate is issued on or after 1 July 2001. ADB could not offer new borrowers LBL terms for loans whose invitation to negotiate is issued before 1 July 2001. These loans therefore will have been negotiated on pool-based terms for public sector loans and MBL terms for private sector and financial intermediary public sector loans. Many of these pool-based borrowers have requested the opportunity to convert their PSCLs into LBL terms at the earliest possible opportunity. To avoid disbursement delays on some of these loans, Management recommends that PSCLs in US dollars and MBLs approved in 2001 and for which notice of negotiations will have been issued prior to 1 July 2001 will be given immediate opportunity to convert their loans into LBL terms.

101. To summarize, the PMCL will be withdrawn from ADB’s loan menu by 1 July 2001. PMCL loans will be transformed “effectively” into PSCLs in yen by recalling non-Japanese yen PSCLs in the pool for purposes of loan repayments. The PSCLs in US dollars will be retired by 1 July 2002. The conversion facility to be offered for PSCLs in US dollars is summarized in Table 3.

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