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Agency Lenders- Both Sides Now

Side 1 –Why Agencies Are Often the Best Lenders

This two part series examines the positive and negative aspects of working with “agency lenders” or “agencies”.  “Agency Lender” is a name given to a group of publicly controlled or officially affiliated lenders.  They have either “multilateral” relationships – support from and for a large number of countries - or “bilateral” relationships, which historically entailed affiliation with one sovereign lender, which had bilateral relationships with sovereign borrowers.  Agency lenders now lend to sovereign and non-sovereign entities and include export credit agencies, multilateral development agencies, and other bilateral and multilateral lending and finance agencies.  You now understand why these lenders are called agency lenders or agencies.  

I had considered naming this two part piece The Good, the Bad, and the Ugly, or adopting a Dickensian theme – that agencies were the best of lenders and the worst of lenders.  But I settled on a more anodyne and neutral title, which may only offend Judy Collins. 

Part 1 examines the positive aspects of agency lenders’ credit records and examines the positive attributes that make agencies efficient risk managers.  In Part 2 we see how many of these positive attributes come with costs.

Agency Lenders Often Manage Risk More Efficiently than Private Lenders

Surprising to most, agency lenders are often better at managing risks than their private sector counterparts.  This view is not the prevailing one in the world at large or in international lending circles, because no one expects public entities to be efficient at anything.  These low expectations are held not only by Tea Party adherents but by everyone who has ever stood in the line at the DMV or waited for months for a simple claim to be processed.  Government is inefficient – alert the media.

Loss rates of some agency lenders – especially certain export credit agencies (ECAs) – are not well known or very good, and some ECAs outside the U.S. have incurred losses while maintaining risky debt exposure.  However, overall public lenders – especially in the U.S. – are more efficient at managing these risks.  Compared to their private sector counterparts, they are better at booking sound loans that earn profits, avoiding losses and collecting on bad debts.  But, compared to the record of private lenders, especially in the Global Financial Crisis (GFC) that was sparked by the fall of Lehman Brothers, agency lenders have done very well.  

I’m sure many readers aren’t buying this.   After all, in his first debate with President Obama, didn’t Governor Romney tell us that DOE put $90 billon into a DOE loan guarantee program where over half of all loans went bad?  Want to know a secret? Governor Romney was wrong.    At the time of the debate DOE’s total exposure was only about $15 billion, 1/6 of what Governor Romney claimed had been wasted.   Only a few of those disbursed loans ever had problems.  Over time, the loss rate fell – as of November 2014, a DOE report showed losses had been wiped out. 

Other agencies have even better records.  Ex-Im Bank’s loss rate is about 0.2% and its fees that are many times that level.  Even with the lapse in Ex-Im Bank’s authorization, 2015 profits were $432 million; profits have been that level or higher in many years.  The Overseas Private Investment Corporation (OPIC) generates profits every year.  Before Ex-Im Bank discerned how profitable it really was, OPIC would boast that it sent more money to the Treasury than any agency other than the IRS.   The Multilateral Insurance and Guarantee Agency (MIGA) manages to avoid claims even in risky jurisdictions, and when claims are filed, MIGA collects from the host country.  The same is true for most or all of the entities of the World Bank Group. 

Furthermore, agencies manage risks effectively in more challenging environments and at lower costs than their private sector counterparts. 

What Makes Agency Lenders More Efficient Risk Managers

There are six major reasons why agencies are more effective risk managers than private lenders.

First, agency lenders don’t “syndicate loans” (i.e., a process whereby a lead bank approves and originates a loan and then sells participations to other lenders), whereas almost all private loans are syndicated.  Syndication changes lender due diligence and the entire lending approach.  If a bank makes a loan without intending to keep it over the long term, it won’t have a vested interest in its credit quality.    Almost all bank loans are syndicated. Especially prior to the GFC, lead banks would originate loans without much due diligence – not expecting to hold them, and following banks would defer to lead bank diligence that may have never been done.   Agency lenders on the other hand do not and usually cannot syndicate loans, and are duty bound to hold them through repayment.   As a result, agency lender processes are more typically more exacting than those of commercial banks.

The second reason agency lenders generally manage risk more effectively is the power of agency lenders in the market.  This is especially true for agencies of the U.S. and other large countries and for multilateral agencies, particularly in transactions involving government-related borrowers. Large government entities have muscle to collect when things go bad. In the late 1990’s, when government utilities in Indonesia and Pakistan threatened not to pay for power, ECAs from the U.S., Japan, Germany, and elsewhere and World Bank Group agencies asserted their presence.  Governments saw to it that utilities acted responsibly and problems were resolved.

The third reason why agencies better manage risks is the extended time horizon they have for debt collection. When collecting money on schedule is not possible, agencies have the flexibility to reschedule payments over a long period, aiming to collect 100 cents on the dollar.   In comparison, private lenders will more quickly write off debt at a loss in order to restructure portfolios so they can move on to the next quarter, appeasing management and shareholders.   Taking the long view not only means agencies hold out for 100 cents on the dollar, but it also communicates to borrowers that lenders are serious about collecting, enhancing lender leverage.

Fourth, agencies’ great leverage and ability to take the long view means that they are in a position to drive a tougher deal at every step in the process, from origination to documentation to collection.   This is the same competitive negotiation advantage that can, should, and usually does make government health care cheaper than private insurance.   Uncle Sam drives a hard bargain and is a tough negotiator.     

A related factor for agency lender success is that most agency loans have collateral security.  Most of us have car and house loans, which are classic secured loans, and for most of us the loss of the home or the car are powerful incentives to pay.  Agency loans are mostly for large infrastructure assets, which lend themselves to security.  In the loan process, agency lenders generally pay more attention to “perfecting security” (e.g. formalizing security through legally enforceable contracts and documentation, establishment of lender accounts) than do their private counterparts.

The fifth reason why agencies are often more effective lenders relates to the way commercial lenders charge fees and reward staff with bonuses.  In commercial lending, the lead bank collects upfront origination and commitment fees and awards individual bonuses accordingly.   Even in cases where banks take outstanding exposure into account before awarding bonuses, fees are often so large that lead bankers don’t need to await loan repayment before paying bonuses.   People can and do earn bonus income before the crows come home to roost, giving private bankers incentives independent of loan repayment.  Agency lenders may get bonuses but they’re tiny and never strong incentives to do bad loans.

Small bonuses also mean lending profits stay with agencies.  If bad debt does arise, agencies have a substantial base of retained earnings from which to draw.  Private bank profits paid as bonuses go to the individuals, leaving the private bank less retained income and reserves.

The sixth and final reason why many agency lenders manage risk more effectively is the high pressure environment in which they operate. Anyone familiar with civil service rules or private banking pressures is likely skeptical of this assertion. Civil service protections and bureaucracy do diminish traditional pressures, but the political microscope under which agency lending is held should not be underestimated.  Political pressure from the press, Congress, and other sources put decisions under a microscope.  Mistakes are magnified and decisions are scrutinized even if there are no mistakes.  In comparison, how many consequences have there been for bank behavior that led to the GFC?

On balance, this adds up to very prudent lending and demonstrably sound lending by a class of lenders that gets too little respect.   In Part 2, we will see how many of these same factors do have another side.

Miki Flamenbaum