Commonly asked questions about LGU Guarantee Corporation
What does LGU Guarantee Corporation (LGUGC) do?
LGUGC guarantees loans obtained by local government units (LGUs), water districts (WDs), electric cooperatives (ECs), renewable energy technology providers (RETPs) and medium and large enterprises (MLE's) from Partner Financial Institutions (PFIs) as well as bonds issued by these agencies/institutions. In 2017, LGUGC has slowed down on MLE guarantees as the % MLEs' share in LGUGC's guarantee portfolio has increased exponentially.
Is LGUGC a private or government corporation?
LGUGC is a private corporation, owned 51% by member banks of the Bankers Association of the Philippines (BAP), and 49% by the Development Bank of the Philippines (DBP).
Why should the private financial sector consider exposing itself to LGUs?
With the passage of the Local Government Code of 1991 (RA 7160), the financing options of the LGUs for infrastructure and other development projects have expanded. LGUs can now seek private sector support via direct loans, by issuing bonds which may be bought by private investors, or by entering into build-operate-transfer or joint venture arrangements. There is therefore opportunity for the PFIs to channel their financial resources to a new market and for the LGUs to tap a vast reservoir of capital to finance their priority projects, this time at competitive rates and longer tenors. By opening up the PFIs to the LGU market, LGUGC hopes to stimulate the development of an active municipal bond market.
How much is the LGUGC guarantee fee?
The LGUGC guarantee fee may range anywhere from 0.25% to 1.5% per annum, depending on LGUGC's over-all evaluation of the borrower and the underlying project. The better the borrower rating, the better the investment grade and therefore the lower the guarantee fee to be charged to the borrower.
Will this not make the total funding cost more expensive for the LGUs?
PFIs price financial products according to risk perceptions. Considering that the LGUGC guarantee mitigates, if not totally eliminates, the borrower credit risk, guaranteed borrowers will then be categorized as lower risks and therefore be offered prime or at least, competitive rates. The interest cost savings that will be realized by the borrower can amply cover the LGUGC guarantee cost.
How does LGUGC Determine the Guarantee % Coverage and Guarantee Fee Per Borrower?
LGUGC subjects LGUs to its internal LGU credit screening and rating system and WDs to its internal Credit Rating System for WDs. Both are designed according to international rating standards. Under the systems, LGUs/WDs are reviewed and assigned scores on demographics, management, political and financial factors, among others. The overall score is then given an equivalent alpha rating (AAA, AA, A, BBB, B, C or D). Other borrowers, on the other hand, are being evaluated through the Borrower Risk Rating System where the borrower's financial, business, management and technical risks are identified and assigned points. The total score will be given an equivalent credit risk rating (Excellent, Above Average, Average, Below Average and Poor) based on a scale of points.
LGUGC maintains a Guarantee Pricing Guide Program that takes into account a potential borrower's default probability based on its rating, probability of recovery including term and percentage, costs of guarantee evaluation and project monitoring; amount of guarantee coverage; term of loan and co-guarantee costs, if any.
When is the guarantee fee paid?
LGUGC typically collects its fee one year in advance. For some LGU bond issues, the guarantee fees for the first two years are paid front-end to coincide with the construction phase, while those for the third year onwards are paid annually, also one year in advance.
What is the possibility of claims not being honored for documentary or technical reasons?
LGUGC's guarantee agreement states clearly that LGUGC's guarantee does not have the benefit of excussion. This means that once a call is made, LGUGC honors the claim and will arrange the remedy later or go to court for any question regarding the claim. The guarantee is not accelerated, which means that LGUGC does not pay the entire principal outstanding balance upon default, but steps into the shoes of the borrowers and pays amortizations on due dates up to the percentage of guarantee coverage until loan maturity.
LGUGC lists the Internal Revenue Allotment (IRA) as a “must” collateral for LGU borrowers. Will LGUGC entertain applications without IRA backup? Also emphasized by the LGUGC is an assignment of project revenues. Together with IRA, isn´t this “over collateralization”?
PFIs operate in an uneven playing field. They do not have the LGU deposits. The most they hold is an assignment on the deposits maintained with GFIs and enforceable only when a default occurs. Based on current policy, the LGUGC is not inclined to entertain LGU guarantee applications where an assignment on the IRA deposit is not part of the collateral pool. We emphasize, however, that the projects guaranteed by LGUGC are revenue-generating and therefore not primarily dependent on IRA as a source of debt repayment.
Will LGUGC entertain guarantee applications for non revenue generating projects?
The 1991 Local Government Code provides that LGU can only issue bonds for revenue-generating and self-liquidating projects. However, LGUGC will entertain guarantee applications for non-revenue generating projects for direct loan transactions on a credit risk sharing basis with the PFIs.
With a limited capital base, How much contingent liability can LGUGC entertain?
The guarantee business is a leverage business. Since a guarantee company's liability becomes real only when there is a default and claim on its guarantee, the company can theoretically guarantee up to the inverse of its default rate. For example, a guarantor with a guarantee fund of P500 million and a default rate of 5% can guarantee up to 20 times its fund or P10 billion. This assumes that a separate fund is used for operations. While its default rate as of December 2016 is only 2.46% consisting of one MLE account, the LGUGC Board and Management continue to prudently cap the LGUGC's leverage ratio at 10 times its guarantee fund or 10:1. This translates to a maximum outstanding guarantee of PhP5.06 billion given LGUGC's 2016 guarantee fund of PhP506 million.
What assurance does LGUGC give investors/bondholders that it can service the claims as and when they are made?
First, a call on LGUGC guarantee does not accelerate payment of the entire outstanding obligation. When a call is made, LGUGC's commitment is to honor each debt service obligation as this becomes due. This policy protects the LGUGC guarantee fund from an abrupt erosion with only a few calls, and allows the corporation the time to cure the defaulted account without having to pay off the entire obligation even when this has not matured. Second, LGUGC has established a trust fund with DBP to be accessed only for guarantee claims payment. The trust agreement restricts withdrawals from the fund, which LGUGC calls the Guarantee Fund.
How confident is LGUGC that the claims rate does not go beyond its projected leverage ratio?
First and foremost, the LGU credits are all supported by an IRA deposit assignment, which is the strongest collateral one can get from an LGU. For other borrowers, there is an assignment of a reserve fund carved from the monthly gross revenues of the borrower. Secondly, there is an assignment of project assets and revenues. Lastly, the management of LGUGC provides a buffer in its leverage ratio.
What happens when LGUGC hits its leverage ratio?
LGUGC does not intend to rely on its current capital. It will invite other local or foreign institutions with potential for business synergy to invest in LGUGC. It can also work on the expansion of the LGUGC-USAID Co-guarantee Agreement under which the USAID re-insures up to 50% of LGUG's risks on an enrolled water project, or identify similar arrangements with other donor agencies and/or insurance companies. LGUGC obtained a second highest rating of PRS "AA+" (Corp.) As a result of the rating LGUGC received approval from the BSP that all LGUGC guaranteed loans and bonds will have a risk weight of only 20% pursuant to BSP Circular No. 538.