FIRSTRAND BANK RPA

• Reference: P-Z1-HAB-020
• Approval date: 01/04/2015
• Start date: 31/03/2016
• Appraisal Date: 13/12/1901
• Status: OngoingOnGo
• Implementing Agency: FIRSTRAND BANK LIMITED GROUP TREASURY
• Location: JOHANNESBURG

To support the expansion of First Rand Merchant Bank's (FRB) African trade finance operations across up to 35 African countries using a risk participation agreement (RPA). The Bank's support will principally target SMEs.

FFMA has assigned the project an obligor risk rating of 3, Low Risk in line with the Average weighted rating of the issuing bank portfolio based on the Bank's internal risk rating scale. 1.2. Currency Risk: This is the risk of FRB and AfDB incurring financial loss as a direct consequence of foreign exchange movements affecting transactions guaranteed under the RPA. In the context of the proposed RPA, the IBs could potentially face currency risk when their clients are unable to source the requisite foreign currency to settle their trade finance liabilities. FRB mitigates this potential risk by ensuring that only IBs that have demonstrated a track record of efficiently managing their currency exposures qualify for trade finance facilities. Moreover, the RPA is structured in such a way that the Bank does carry any currency risk. In the event of a default, the Bank would settle in the same currency as the underlying transaction and the resulting loan created in the name of the IB will be in that same currency. 1.3. Operational Risk: This is the risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events. TF transactions are susceptible to operational risk arising from the presentation of discrepant documents. FRB's vast experience in trade finance as well as its superior systems and processes help to reduce this risk. Furthermore, the Bank's guarantee under the RPA does not cover losses resulting from discrepant trade documentation. 1.4. Legal and Regulatory Compliance Risk: In the event of a default, the Bank would settle its portion of the guaranteed transaction and FRB would pursue recovery from the IB on behalf of itself and the Bank, without precluding the Bank from directly pursuing the IB for repayment. There is the risk that the Bank may lack full title to the underlying asset or to directly pursue the IB. To mitigate this risk, the RPA will have the necessary provisions to ensure that the Bank obtains the step-in rights necessary to facilitate recovery. FRB is compliant with all regulatory requirements. Furthermore FRB will ensure that there is full compliance with international regulations and statutes to avoid sanctions or the withdrawal of its operating licenses by regulators. 1.5. Information Asymmetry Risk: This is the risk that given its superior information about clients and transactions, FRB will cherry pick' low risk deals for its own book and place riskier assets in the RPA portfolio. This risk is mitigated by the fact that FRB will have as much or higher stake in the RPA as the Bank and therefore has every incentive to ensure only transactions with acceptable risk are admitted into the portfolio. 1.6. Issuing Bank Risk: Given that the Bank would not conduct its own full due diligence on the IBs, there is the risk that IBs that would not have fully satisfied the Bank's risk criteria are admitted into the RPA because they have met those of FRB. The Bank mitigates this risk by ensuring that all proposed IBs and IB limits are vetted for compliance with the TFP eligibility criteria, including adherence to exposure limits. Secondly, the RPA would bind FRB to ensure that only IBs that fully meet its stringent credit criteria are admitted. By conducting due diligence on FRB instead, AfDB derives a certain measure of comfort for not directly vetting these IBs The proposed Risk Participation Agreement (RPA) is designed with a view to contributing to the reduction in Africa's TF deficit by enhancing the risk bearing capacity of FRB to provide increased limits to African Issuing Banks (IBs). This facility will support inclusive growth, enhance macro-economic resilience in at least 40 RMCs through support of exports which positively impacts the current account, including Fragile States (FS), and help promote intra-African trade and regional integration.

The proposed RPA is a risk sharing facility of USD 100 million to be provided by AfBD while FRB, the Bank's partner in the Project, will provide at least matching capacity through the execution of an RPA. Under this arrangement, FRB would underwrite the credit risk on a portfolio of qualifying trade transactions generated by an agreed list of local issuing banks in RMCs, with the AfDB guaranteeing up to 50% of the value of these transactions against credit default. Payment/ reimbursement obligations would be eligible if they are generated from TF products such as Letters of Credit (LC) confirmations, trade guarantees, avalized bills of exchange, factoring and forfaiting, trade facilitation loans, invoice and supply chain finance among others. The RPA would be denominated in EUR and the underlying transactions may be conducted in EUR, USD or any of Bank approved currencies as may be agreed upon from time to time. The RPA tenor is 3 years while that of individual transactions would not exceed 2 years.

The primary beneficiaries of this RPA are African IBs whose ability to grow their TF business has been constrained by inadequacy of available confirmation lines from international banks. The facility is thus expected to positively contribute towards the enhancing the trade origination risk capacity of these IBs. The other beneficiaries are African firms and SMEs who depend heavily on these local IBs to fulfill their TF commitments.

Analysis of Strategic Alignment 1.1 Fit with Regional Priorities:' This project aligns with the priorities of RMCs who, at the 18th Ordinary Session of the African Union Assembly in January 2012, renewed their aspiration for the acceleration of the continent's integration by endorsing the Action Plan for boosting intra-African Trade and fast-tracking the establishment of a Continental Free Trade Area by 2017. The AfDB and other institutions were called upon to play an active role in actualizing the Action Plan. The proposed facility will contribute to intra-Africa trade and regional integration by supporting more trade in Africa. 1.2 Fit with AfDB Institutional Priorities:' FRB is a wholly African institution and the project is thoroughly aligns with the Bank's core operational priorities of regional integration and private sector development as outlined in the new Ten-year Strategy. The proposed facility is also in line with the various Regional Integration Strategy Papers (RISPs). 1.3 Fit with AfDB Private Sector Strategy: The project is consistent with 2 of the three pillars of the Bank's 5-year Private Sector Strategy (2013 - 2018):

(i) contributing to the improvement of the investment and business climate in Africa through enhanced trade lines for African FIs; and

(ii) promoting enterprise development in Africa through increased access to appropriate trade finance for FIs and by extension SMEs and local corporates. It also fits in well with the TFP through which the Bank seeks to consolidate and expand its engagement in Trade Finance in Africa. 1.4 Overall Strategic Fit: 'This proposed facility is closely aligned with the aforementioned priority areas. It is expected to contribute to the promotion of regional integration, the strengthening of African financial systems and the development of the private sector across the continent. The proposed project will support national and regional strategies to promote trade, economic growth and competitiveness in RMCs. Analysis of Commercial Viability 1.5 Financial Performance: 'FRB's current standalone credit ratings are BBB-, stable (SP) Baa1 (Moody's) and AA (Fitch). By implication of these ratings, FRB therefore has the same credit profile as the sovereign rating for South Africa this is clear evidence that it is well managed and commercially sound institution. The low risk nature of short-term and self-liquidating trade finance transactions, coupled with the robust credit risk management framework deployed by FRB also provide comfort. Table 4 below summaries FRB's financial performance for the period June 2010 - June 2014. Table 4: Financial Summary 2010 - 2014   2014 2013 2012 2011 2010 Total Assets (ZAR m) 949,535 865,732 765,528 697,927 845,240 Net Advances (ZAR m) 685, 926 601,065 524,507 464,953 434,793 Shareholders' Funds (USD) m) 88,217 79,033 68,919 64,219 68,963 NIACC (ZAR m) 8,172 6,196 4,163 2,364 1,594 Cost to Income Ratio (%) 52.9 54.7 54.1 51.8 56.5 Capital Adequacy Ratio (%) 20.8 20.8 19.0 21.8 23.9 NPL Ratio (%) 2.34 2.82 3.50 4.19 5.00 Return on Assets (%) 2.06 1.89 1.73 1.49 1.27 Return on Equity (%) 24.2 22.7 20.7 18.7 17.7 Earnings per Share (ZAR) 331.0 273.5 225.8 179.4 146.9 Dividend per share (ZAR) 174 136 102 81 77

1.6 Asset Quality: 'FRB has a high quality loan book due to its strong risk management framework, conservative risk acceptance culture, deep client knowledge and long standing customer relationships, tested preferred creditor status, and the general low risk nature of short term and self-liquidating trade finance assets. The portfolio is highly diversified and strategic initiatives continue to drive further geographic and sector diversification. The NPL has consistently declined over the past 5 years. 1.7 Earnings/Profitability: 'FRB has been consistently profitable and operationally efficient as reflected by strong fundamentals and steady growth over the last 5 years. Net income increased by 22% in June 2014 (YoY) to ZAR 18,7 billion with a Compounded Average Growth Rate of 23% since 2010 largely driven on the back of a strong business model and prudent cost management. Its cost to income ratio and NPL has also consistently dropped for the past 5 years.

The benefits of this RPA are three pronged;

(i) it will provide FRB with much required capital relief and vital visibility needed to strengthen its position and market share as a provider of TF across the continent

(ii) it will help alleviate some of the inhibitions caused to issuing banks by the difficulty in obtaining adequate credit limits to finance their TF transactions due to a dearth of risk appetite from confirming banks and

(iii) ultimately the facility will to a very large extent benefit African SMEs and indigenous firms who rely heavily on local issuing banks to fulfill their TF commitments. It is worth noting that FRB operates in Africa both as an originating institution and as a confirming bank.

Analysis of Expected Development Outcomes 1.1. Household Benefits The Facility will not directly contribute to job creation by FRB but employment opportunities will be generated at the level of projects to be financed by the additional capacity given to indigenous firms and SMEs. Increased access to finance for firms in FRB's countries of operations will translate into higher investment levels and hence new job opportunities. It is expected that the proceeds of the facility will lead to the creation of at least 500 job opportunities (directly and indirectly) at the level of the funded sub-projects given the linkages achieved by the AfDB's funding. 1.2. Environment and Social Effects This is a Trade Finance facility and given the unique nature of trade finance activities, this proposed facility is classified as Category 3 under the Bank's ESMS structure, however, one of FRB's guiding principles for sustainable development is to mainstream environmental and social (ES) issues in all its business activities 1.3. FirstRand has formal governance processes for managing Environmental, Social and Governance ("ESG") risks affecting the Group's ability to successfully implement business strategy. These processes involve the generation of management reports at Group and franchise level, which detail ESG performance on a quarterly basis, tracked through existing risk reporting structures. At FRB the appli cation of EP forms part of the Environmental and Social Risk Analysis ("ESRA") which the Group is currently in its 7th year of implementation and is a very specific credit risk management framework for determining activities including child labor, human rights abuse, illicit substances or other illegal activities. 1.4. Currently, the Group measures EP performance in line with the International Finance Corporation ("IFC") performance standards as either Category A (high risk), Category B (medium risk) or Category C (low to no risk), per the definitions set out in Annex IV. 1.5. Although the evaluation and monitoring of EP transactions is now embedded across the Group (see Annex IV), continued focus is expected to be given to the effective implementation of the ESRA process. The Waste Management Act is an area of integration into the ESRA processes which will be a focus for the Group going forward, particularly as it relates to the review of contamination risk in property financed or taken as security. 1.6. Gender and Social Effects FirstRand is a recognized responsible corporate citizen. Through its foundation, it has invested more than ZAR 800 million since the foundation's inception in 1998 in a number of initiatives focusing on education, community care, social development and health. Moreover, to address social and gender disparities, it has put in place transformation policies and practices aimed at ensuring diversity and sustainable ethical business practices. For example, women, particularly black women, represent the majority of its workforce while plans are in place to improve black representation at management and Board level, particularly in relation to black women. 1.6. The Group is also committed to Black Economic Empowerment ("BEE"). For instance, in 2005 FirstRand facilitated the acquisition of 6.5% of its issued share capital by the FirstRand Empowerment Trust ("FRET") for its black South African employees and non-executive directors. 1.7. Macroeconomic Resilience The Facility is expected to contribute to regional financial integration as a South African bank will be financing projects across Africa. Moreover, many of the countries in which the Facility's proceeds will be deployed have a large presence of the resources' sectors and this is expected to remain so for the foreseeable future. As such, the diversification of the economic base is an increasingly important means to sustaining growth and reducing the countries' vulnerability to price volatility. The Facility, which will indirectly lead to increased lending to non-resources' sectors, such as the telecommunication and transportation sectors which are mostly underdeveloped, will thus support sectorial diversification and the creation of employment opportunities for a broader portion of the population outside the resources' sectors. 1.8. Further, the Facility will contribute positively to the net financial positions of the target countries as it will reduce the r eliance on financing in hard currency. Indeed, the savings of foreign currency are expected to be for an amount of up to the size of the Facility, ceteris paribus. 1.9. Private Sector Development and Demonstration Effect The Facility will allow FRB to provide increased financial intermediation to large and medium-sized firms in LICs, in line with its strategic plans. The increased availability of funding to firms would help in promoting their operations and profitability and enhancing their competitiveness, contributing to private sector development and translating into sustainable economic growth in FRB's countries of operations. 1.10. Effects on Governments: Trade flows supported by trade finance instruments have positive fiscal effects in the form of import duties and other taxes. Many African countries rely on trade taxes as a major source of government revenue. FRB and its corporate and banking clients will pay various forms of taxation on their profits, therefore contributing to government revenue generation in their countries of deal originationBased on the assumed trade turnover of USD 1.2 billion over 3 years and assuming an import/export tax rate of 15%, it is projected that this facility will generate about USD 120 million of tax revenue for African governments. Analysis of Additionality and Complementarity 1.11. Economic Impact: Trade is a catalyst for pro-inclusive, sustainable economic growth and poverty alleviation. It creates new bu siness opportunities, allows firms to take advantage of new technologies, promotes innovation, and attracts foreign investment. This will ultimately help save existing jobs and create new employment opportunities. The facility is expected to support about USD 840 million in trade which should increase the trade density index of many RMCs. Reduced pressure in existing resources available to FRB would enable it create inroad into new markets and hence support the expansion of its African footprint. While it is difficult to determine ex ante the economic impact of this facility, it is highly probable it will generate millions of dollars of trade and value creation across Africa which should translate into support to existing jobs add additional income to African households. 1.12. Financial Additionality The proposed Facility will allow the FRB to significantly increase its trade portfolio and the supply of trade financing to African countries thereby helping address the trade finance deficit as well as providing a valuable platform for south-south trade. Confirmation and underwriting of trade finance instruments originated out of the continent has traditionally been handled by European and American commercial banks and it is therefore unlikely to expect such commercial banks to provide support to FRB who would be considered a competitor in this regard. 1.13. Improved Development Outcomes The AfDB cannot be directly involved in the projects to be financed by the Facility. This is because reaching out directly to the local firms and medium-sized enterprises in African countries including LICs and fragile states which will ultimately benefit from the proposed transaction, would be inefficient (due to the high transaction costs involved) and ineffective (due to high borrowing costs for the clients), which would put at risk their commercial viability. However, the AfDB will be channelling its resources through a highly reputable and creditworthy partner which, among others, has a strong credit acceptance criteria, good ESMS systems and strong intra-African and south-south focus. The facility will generate additional revenue for beneficiaries of the RPA leading to improved government revenue through taxation and creation of direct and indirect employment. 1.14. Complementarity The Facility from the AfDB to FRB is expected to complement existing efforts, including those of the AfDB such as the African Financial Markets Initiative, to develop Africa's local capital markets, particularly the bond markets, thereby providing a strong catalytic and demonstrative effect.

NEKATI Bleming - PIFD3