FUNDS: KfW's EFSE fund goes from little beginnings to big ends in Southeast Europe

FUNDS: KfW's EFSE fund goes from little beginnings to big ends in Southeast Europe
Monika Beck, former chair of the board of KfW's EFSE fund.
By Ben Aris in Moscow August 2, 2016

German development bank KfW is doing big things in Southeast Europe, by doing little things. The bank, an expert in the region, set up a fund in 2005 that has been supporting small business, agriculture and housing, while successfully giving Western high net worth and retail investors some lucrative exposure to a raft of projects that neither class of investor would normally look at.

The bank’s flagship European Fund for Southeast Europe (EFSE) covers a broad swathe of the region, according to Monika Beck, who has served as chairperson of the board since the fund’s inception in 2005 before stepping down in July.

“We concentrate on the former Yugoslavia, Turkey, the Caucasus, Ukraine, Romania and Bulgaria,” Beck told bne IntelliNews in an exclusive interview shortly before leaving her post. “We are the second largest international financial institution (IFI) working in the region after the World Bank and the third largest German fund managing projects in the region.” 

The fund is rooted in KfW’s work in the region, but is run autonomously. In the 1990s the bank began supplying credit to local lenders, and they in turn invested in the housing sector and in the modernisation of apartments to meet KfW’s brief for improving the quality of life. “Our money came back [from these investments], so we transferred the management to Luxembourg and expanded,” Beck said.

Beck has been a key player in the creation of the fund and its success. According to those who were around when KfW was considering consolidating its range of individual refinancing accounts for the former Yugoslavian states, Beck’s arrival as a project manager was integral to the creation of the EFSE. When it was proposed to push the project forward, Beck negotiated tirelessly with officials from government ministries and other development banks who had been providing KfW with funding for the post-Yugoslavian countries. Without her efforts it could have “taken years” to get the project off the ground, one manager close to the fund noted.

Griffin fund

At its inception, the fund was an unusual animal; part private investors, and the rest public money from IFIs and a variety of governments offices such as the European Commission, Germany’s Federal Ministry for Economic Cooperation and Development, and development banks from Austria and the Netherlands. The Swiss, Danish, and even the Albanian and Armenian governments became investors. Beck is especially happy about the local participation, as it allows the fund to raise money in local currency and so reduce its foreign-exchange exposure. These local governments participated not as part of any development drive (although the investment does contribute to their development), but simply because the EFSE was considered to be a safe and profitable investment. Today, the fund has a total of over €1bn of assets under management, largely in smaller projects.

About a third of the funds have been invested in housing improvement projects, with another third in housing renovations. The average loan size is $6,000 (€5,500) and distributed via a colourful variety of partners, including banks and non-bank financial institutions such as micro-financing companies. “Today we work with 74 qualified financial institutions. We take the risk for the partners’ banks, and they take the credit risk. It is working really well; last year was a tough year, yet we have no losses at all – a 0% default rate and below average [non-performing loans],” says Beck.

That is quite an achievement, as even Beck admits the region remains unstable after a series of crises in recent years. But the nature of the investments, mostly into housing, has sheltered the fund from much of the brouhaha. “There was the financial crisis in 2008-09, then the Greek crisis. More recently political risks have soared in Moldova, Ukraine and Belarus. And that is without mentioning the flood of refugees since 2014. Despite all these problems, we have not been badly affected. Life goes on and our loan size is small, which insulates us to an extent from all these problems.”

The investors have been attracted by its innovative structure as a “waterfall fund”. This system largely shields private investors from losses thanks to a cushion of public money. The structure earned the EFSE accolades at the G20 Summit in 2010, where it was honoured as the best worldwide concept to raise private capital for financing small and mid-sized companies in developing and emerging countries.

The assets are split into four classes. The first layer of junior C shares worth some €375mn are held by the public funds. The second mezzanine tier of B shares and the senior A shares worth around €450mn is held by the development banks and KfW’s own money. The last tranche of nearly €220mn in notes is held by the private investors.

The investments are amortised and pay out in instalments. If one of the 74 partner banks collapses, then it is the first tier of public money that gets hit while the other tiers continue to receive their payouts.

Beck says that for investors in the private senior tier to actually lose money, “about three of the bigger partners banks and five of the smaller ones would all have to go bust, but even then the senior investors would probably still make some return”. The fund pays out over three-seven years at a rate of about Euribor + 110 basis points. “It is an adequate return in this low interest rate environment,” says Beck.

Thinking local 

The fund has 11 offices in the region and a board of directors with many longstanding investors in the region as well as members from the local central banks who give advice. All these connections to the various markets provide the fund managers with timely information, especially since the EFSE employs people who grew up and live and work in the region it serves. “It means that if the partner banks are having any trouble, we get wind of it fast,” Beck said.

The fund also offers its partner banks technical assistance in order to help them develop and improve their businesses – one of the activities that sets it apart from other investors in the region. “All of the partners in the fund give a small share of their income to finance the technical development of the local partner banks,” says Beck, adding that this obviously improves the stability of partners.

The assistance often focuses on polishing the skills of a partner bank’s staff or teaching locals more about how the financial markets work so they can take advantage of available funding. This also supports the EFSE’s mandate, since one of its main goals is to increase access to finance for people in the markets it serves.

Retail investors have also been attracted to the fund with its steady and insured payouts, which are distributed via partners such as Deutsche Bank. Standalone investments in the fund start at about €250,000 and go up to €30mn for the largest, but some retail investors have formed investment clubs to pool even smaller amounts to get to the requisite €250,000 threshold.

Demand has been depressed by the recession and the fund has pulled in its horns recently. “We are not trying to double our assets as that would be irresponsible, but we are still growing organically,” Beck says. “We can keep this up indefinitely, as small enterprises are the backbone of the economy in the region. We have made 800,000 loans since setting up, and this sector is still growing.”