Blended Finance Housing Deal: FSD Africa and Sofala Capital
In June 2018, Financial Sector Deepening Africa (FSD Africa) – a development institution working to develop African financial markets – acquired a 25 percent stake in Sofala Capital, a housing finance company. Sofala currently owns a controlling stake of Zambian Home Loans (ZHL) and iBuild Home Loans, both of which offer long term mortgages and construction assistance to low-income earners, who are incrementally building their own homes. A portion of equity funds that Sofala received from FSD Africa will be reinvested into ZHL and iBuild Home Loans. Additionally, ZHL received a $500 000 credit line directly from FSD Africa. As such, the combination of private investment, impact investment and FSD funding into Zambian Home Loans and iBuild are examples of blended finance structure.
Blended finance refers to a mixture concessional loans and institutional investment. This blog will discuss how blended finance works in the case of affordable housing investment strategies. It will examine the specifics of FSD Africa’s agreement with Sofala and the capacity to which they are contributing to ZHL’s and iBuild Home Loans’ ability to help individuals construct homes in their respective countries.
Secondary research on blended finance was conducted. The summary of this research is detailed in the ‘Blended Finance in Africa’ section that follows. This section aims to give an overview of blended finance, the different forms in which it comes, as well as the challenges and successes that blended structures have seen in the past. Interviews and email correspondence were conducted with management at Sofala Capital and Zambian Home Loans for figures and perspectives. This was combined with primary document review provided by the organizations of interest. The results of this portion of research is discussed over the ‘Participants’, ‘Agreement Structure’ and ‘Impacts’ sections, with the goal of understanding the involved organizations, how the blended finance structure works in this instance and how its impacts have been received on the ground.
Blended Finance in Africa
Instruments and Allocation
Blended finance refers to financing that combines concessional funding from official development institutions (Official Development Assistance or ODA) and commercial funding from non-development sources, either private or public. The purpose is to mobilize larger sums of funding for projects where development financing alone is not enough, and commercial sources do not feel comfortable taking on the entirety of the risk or cost. In sectors and situations where there are no examples to show that returns can be made, the presence of development finance assistance can offer a margin of safety for hesitant commercial entities.
The types of concessional instruments that are commonly used in blended finance packages are:
- Investment Grants – non-repayable funding to reduce required investment
- Interest Rate Subsidies – grants reducing interest on loans from third parties (eg. DFIs)
- Technical Assistance – funding to improve technical capacities
- Loan Guarantees – covers lender’s losses in case of default
- First loss piece – loans with low repayment priority,
- Equity – direct capital contribution to a company or investment fund
Between 2005 and 2018, about $100 billion was mobilized in the form of blended packages, conservatively estimated by Convergence, a global network for blended finance. Sub-Saharan Africa is still the most popular target for these deals, with 42% of all blended finance deals directed to this region. For context, the next most popular is Latin-America and the Caribbean at 20%. Within Sub-Saharan Africa, East Africa receives nearly three quarters of the agreements. Deals targeting low to lower-middle incomes make up the majority of deals, as approximately 74% of all blended finance structures target this bracket.
Sector-wise, blended finance tends to target financial services and infrastructure (including energy) development, with only 1% going towards housing and real estate. However, blended deal sizes tend to be quite large in housing, at an average of $290 million.
Measuring Blending Effectiveness
Due to the varied conceptions of blended finance and its pairing with an interest in making returns, packages are not always geared towards development ends. The multi-purpose nature of development finance in a blended package, where it is meant to simultaneously support developmental initiatives for the undeveloped markets and poor, as well as act as leverage to garner outside commercial funding (whose interests may not be primarity focused on development objectives for the poor) can divide the usefulness of the structure. Nonetheless, when implemented strategically and responsibly, blended packages have the potential to vastly increase the power of an institution’s ability to contribute meaningfully toward development goals.
Two key concepts can help serve as measures of the size and effectiveness of blended packages: additionality and leverage. According to Oxfam, additionality is the “added value” that the development assistance provides in addition to those offered by non-concessional parties.
- Financial additionality is the amount of non-concessional financing that is added as a result of the addition of ODA.
- Developmental additionality is the added developmental value as a result of the addition of ODA.
Financial additionality usually exists in blended structures because ODA provides more stability or cheaper costs than commercial funds. If a project has no financial additionality, it means that the project does not gain any financial value by the addition of ODA that it could not have received from any other kinds of financing, (shown as the finance structure on the left). Without financial additionality, both funding structures in the diagram above would be the same size. Lack of financial additionality means that ODA is not necessary for a project.
The diagram above shows a normal commercial funding package versus a blended package. Though the left stack shows a blue and a grey section, these are really the same type of funding. The color differentiation is merely to show that the blue funds are additional, and comparable in amount to the additional development funding in the blended deal on the right.
Developmental additionality usually exists in blended structures because ODA has stricter economic development-oriented guidelines to its use, and serves as a cheaper, more stable source of finance. If a project lacks developmental additionality, it means that the ODA does not increase the development impact more than commercial funding would. In such a case, the white blocks in the graphic above would be equal in size.
Furthermore, while financial additionality implies some level of developmental additionality, they are not necessarily related. More money can lead to greater impact but not always. While the presence of ODA might still bring in more commercial funding (in other words, it might have financial additionality), this additional money does not necessarily serve a greater development value. More funding does not necessarily mean greater positive impact, if the funding is not directed towards impactful work.
A project suitable for blended finance packages should be able to show both tangible financial and developmental additionality for its official development funding.
Leverage, in a blended finance context, is the proportion of official development assistance over financing (could be total investment or commercial financing). It does not necessarily indicate additionality, because it does not show how much, if any, of the total financing or its impacts would be impossible without concessional development assistance. Defining additionality requires considering a counterfactual situation where the concessional development financing was not involved. Leverage is the ratio of concessional funding either to total or non-concessional funding. It does not tell us how much funding would or would not have existed without ODA, only the proportions.
Blended finance can fail to meet development objectives for a number of reasons. One of these is that key responsibilities such as preselection of projects are often transferred from the source of ODA to the purveyors of commercial finance. These parties rarely have the same obligation, mandate, or development goals, as the original developmental institution providing the assistance. Responsibilities for project design and management are also often shifted away from the source of concessional funding. This may allow for greater leverage and financial additionality, but at the expense of development impact.
Blended finance can also sometimes be less attractive than market opportunities, due to the extra monitoring and red tape involved in achieving development objectives. Whereas purely profit motivated investing need only assess profitability and legality, blended finance packages must ensure that many qualitative assessments are made as to the overall success. This extra barrier could deter private investors.
Nonetheless, blended finance could be a key to unlock socio economic development sectors embedded with barriers that do not encourage investment. With the integration of official development assistances, and state funds incorporated as stakeholders, the risk is often minimised. It can be an innovative way to mobilize greater funding than is directly available for social impact when done correctly and incentives align.
Financial Sector Deepening Africa, or FSD Africa, is a development program started in 2012 by the Government of the United Kingdom to develop capital markets in Africa. Its strategy is to reduce poverty by increasing access to financial resources for impoverished populations, encouraging inclusive economic growth, and collaborating with regional partners. Based in Nairobi, FSD Africa is part of a network of regional and national FSD organizations working towards this goal. Among FSD’s activities are building the capacity and efficiency of financial institutions, helping these institutions provide savings accounts to marginalized communities, as well as developing skills and analyzing data.
Sofala Capital is an investor in innovative housing finance institutions. Its purpose is to invest in housing finance companies that help finance individual home builders. Sofala is dedicated to addressing the scarcity of long-term affordable mortgages for people constructing their own homes. As a housing finance company, it does this primarily by investments in housing finance companies, which can issue construction mortgages. Among these are Zambian Home Loans and iBuild Home Loans in South Africa. Sofala’s businesses has systems built in to manage construction risk, such as feasibility assessments of projects, funding directly to contractors as opposed to home owners, and the right to cancel funding for failed projects.
Zambian Home Loans & iBuild Home Loans
Zambian Home Loans (ZHL) and iBuild Home Loans are mortgage finance companies based out of Zambia and South Africa respectively.  Though the companies do participate in micro-lending in some sense due to the size of funding provided, they are first and foremost mortgage businesses. Since the premium on completed houses in both countries is high while land remains relatively cheap, ZHL and iBuild are contributing to reducing the sizeable housing deficit in their respective countries while also helping small land owners build their assets. Currently management at these subsidiaries have detailed a few challenges towards further growth. Lack of title ownership means that ZHL and iBuild have had to extend their resources to helping individuals secure legal titles to land. Furthermore, long-term funding has been somewhat inadequate, which suggests the efficacy of a blended strategy.
Instruments and Allocation
On June 28, 2018, FSD Africa announced its acquisition of a 25% stake in Sofala Capital, valued at £1.6 million (about US$2 million). $850 000 of this will be reinvested into Zambian Home Loans and iBuild Home Loans, along with an additional $500 000 credit line to Zambian Home Loans at an interest rate of 5.88% including taxes. The deal qualifies as a blended structure because both subsidiaries of Sofala are funded jointly by direct concessional lending from FSD Africa, capital investments from Sofala and commercial funding from other sources. The graphic below shows the blended structure of Zambian Home Loans.
African Life Financial’s (ALF) stake in Zambian Home Loans is more complex than the graphic illustrates. It owns this portion of ZHL both directly (at 66%) and indirectly through subsidiaries. 3.83% is owned through Saturnia Regna Pension Fund Registered Trustees and the last 0.17% by Zambia Sugar Staff Pension Fund. Both of these are pension funds managed by African Life.
The development funding addition to Zambian Home Loans and iBuild Home Loans financing structure has a number of benefits:
- Lower cost funding – The rate of 5.88% charged to Zambian Home Loans from FSD pales in comparison to lending rates of almost 10% in Zambia as of 2019
- Diversification – Having a large development finance institution involved brings stability into the financing structure as Sofala and African Life Financial are more subject to economic shocks due to size and base of operations
- Credibility & network effects – The stamp of approval from a recognized international development institution lends credibility to Zambian Home Loans, lowering the barrier to entry for other DFIs in the future. Also, the inclusion into FSD’s conferences and seminars grows its potential investor network.
Within the framework discussed in the background section, financial additionality appears to be probable and development additionality is possible. The inclusion of FSD’s credit line and its stake in Sofala holds a large potential to create financial additionality for Zambian Home Loans. ZHL explains that the funds allowed Sofala’s exercising of its rights issue, which expanded ZHL’s capital base and will almost certainly help raise debt in the future. With access to a wider pool of investors due to greater credibility, network and stability, it is likely that financing will become easier from here on out.
There is also potential for developmental additionality in this case though this is more difficult to discern. Some significant challenges faced by mortgage companies to low-income lenders are not funding related but structural to the markets they operate in. As such, it is not clear that the additional financing will solve these problems. For, example, Zambian Home Loans sees its three greatest challenges as the following:
- Availability of funding
- Cost of local currency
- Availability of title deeds
FSD Africa’s cash injection into Sofala and its credit line addresses the first. However, the difficulty that Zambian Home Loans has faced in raising funds in the local currency for onward lending to the actual people it is targeting is only somewhat addressed by this blending. Furthermore, the lack of title deeds among borrowers is not surmounted by development funding. ZHL sees the latter as a minor challenge and the cost of currency as a greater obstable. These factors could potentially limit the developmental additionality of the blended structure.
Concessional funding in blended structures offer a plethora of opportunities to grow the finances and the developmental impact of development-oriented lenders like Zambian Home Loans and iBuild. Here the study suggests that there is room for optimism with regards to the likely effect of FSD Africa’s cash injection into these companies.
In considering financial additionality, it is relatively clear that FSD Africa’s credit line and equity in Sofala greatly increases the likelihood of growing Sofala’s, and thus ZHL’s and iBuild’s, financial base. Given the new access to a huge network of investors and DFIs, the certification of credibility and the safety net provided by relatively low-interest funding, the incentives for new investors to buy stakes in Sofala or lend to ZHL and iBuild have grown immensely.
In considering developmental additionality, it is less clear though still a possibility that FSD Africa’s involvement will result in better development results. This is simply due to the fact that there are challenges inherent to mortgage lending to low-income households, and to the countries and markets that ZHL and iBuild are operating in, that cannot be addressed with more funding alone. However, Zambian Home Loans is confident that quantity and diversity of funding was one of its largest hurdles, making a case for the developmental additionality of this project. If nothing else, the FSD funding greatly increases the probability that ZHL projects will be followed through with to completion, which is a development impact in itself.
Further study may be warranted to follow up with Sofala, Zambian Home Loans and iBuild Home Loans to determine whether in fact these predictions were on the mark.
- FSD Africa. June 2018. “FSD Africa invests £1.6 million in African housing finance.”
-  Pereira, Javier. “Blended Finance: What It Is, How It Works and How It Is Used.” Oxfam, Feb 2017. 8.
- “OECD DAC Blended Finance Principles for Unlocking Commercial Finance for Sustainable Development Goals.” OECD, Jan 2018. 4.
- “The State of Blended Finance 2018.” Convergence, 2018. 9.
- “FSD Africa.” FSD Africa. Accessed September 15, 2019. https://www.fsdafrica.org/.
- “Sofala Capital.” Sofala Capital. Accessed September 15, 2019. http://www.sofalacapital.com/.
- “Zambian Home Loans.” Zambian Home Loans. Accessed September 15, 2019. https://www.zambianhomeloans.com/.
- “Ibuild Home Loans.” IBuild Home Loans. Accessed September 15, 2019. http://ibuildhomeloans.com/.
- 34th Annual Conference & AGM 2018”. YouTube video. Posted Dec 9, 2018.
- Hamasute, Twaambo and Michael Waller. “Questions about the FSD Africa deal.” Email, 2019.
 FSD Africa. June, 2018. “FSD Africa invests £1.6 million in African housing finance.”
 Pereira, Javier. “Blended Finance: What It Is, How It Works and How It Is Used.” Oxfam, Feb 2017. 8.
 “OECD DAC Blended Finance Principles for Unlocking Commercial Finance for Sustainable Development Goals.” OECD, Jan 2018. 4.
 Pereira. “Blended Finance.” 12.
 “The State of Blended Finance 2018.” Convergence, 2018. 9.
 Ibid. 12.
 Ibid. 11.
 Ibid. 13.
 Pereira. “Blended Finance.” 14.
 Ibid. 14-15.
 Ibid. 16-17.
 Ibid. 20.
 Ibid. 21.
 “About Us.” FSD Africa. Accessed September 15, 2019. https://www.fsdafrica.org/about-us/.
 “About Us.” Sofala Capital. Accessed September 15, 2019. http://www.sofalacapital.com/about-us/.
 About Us.” Zambian Home Loans. Accessed September 15, 2019. https://www.zambianhomeloans.com/about-us/.
 “About Us.” IBuild Home Loans. Accessed September 15, 2019. http://ibuildhomeloans.com/about-us/.
 “34th Annual Conference & AGM 2018”. YouTube video. Posted Dec 9, 2018.
 Hamasute, Twaambo and Michael Waller. “Questions about the FSD Africa deal.” Email, 2019.