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Remittances & Migration Future-Flow Securitization Country Risk Rating |
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What is FF
securitization?
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Development
Financing through
Securitization of Receivables
Bonds
backed by foreign currency receivables can allow public and private sector
entities in developing countries to raise financing from international
capital markets. With proper planning,
such transactions can sustain external financing even during a crisis. This page is grossly outdated - was
created in October 2001 based on Ketkar and Ratha 2001 – but still has some useful
material. Securitization in emerging markets Structure of future flow securitization How does it improve credit rating? Benefits of future flow securitization Unused potential in emerging markets What is securitization?Securitization
is the process
by which a borrowing entity—a company or a bank in the public or private
sector, or a sovereign or sub-sovereign body—issues tradable securities
backed by dedicated cash flows from selected assets. The first securitized transactions
occurred in the (See also ABS, CBOs, CLOs, CMOs) See also Giddy (1994, pp 486-489) Securitization in emerging marketsRated
vs. unrated
transactions. Securitization transactions can be classified according to
whether these are rated or not rated by major credit rating agencies, and
within each of these categories, according to whether they involve existing
assets or future receivables. It is
hard to obtain information on unrated securities issued by developing country
entities which are typically underwritten by commercial banks that either
keep them on their own books or distribute them through private
placement. Nevertheless, it is
believed that rated transactions may be more prevalent in emerging market
economies with relatively more developed capital markets. Existing asset vs. future asset securitization. Securitization of existing assets (such as
lease financing) as well as future assets (such as workers’ remittances) are
being used by developing country entities for raising finance. Existing asset
securitization is increasing in importance and can be a big aid to the
development of local capital markets.
But since existing assets are denominated in local currency, their
role in raising external finance may be limited. The first important future flow securitized transaction in a
developing country occurred in 1987 with the securitization of telephone
receivables due to Structure of future flow securitizationIn a typical future flow
transaction, the borrowing entity in a developing country sells its future
product to an offshore Special Purpose Entity (SPE), which issues the debt
instrument (see box for an example). By a legal arrangement between the
borrowing entity and major international customers, payments for the future
product are directly deposited in an offshore collection account managed by a
trustee. The debt is serviced from
this account, and excess collections are forwarded to the borrowing entity in
the developing country. How does it improve credit rating?The transaction structure outlined above mitigates several elements of the default
risk. The ability of the government to interfere with debt servicing
is greatly reduced by the offshore payment arrangements. The market risk
arising from price and volume volatility is mitigated using
over-collateralization. The risk that
a product may be sold to other than designated customers depends on the
choice of collateral: such risks tend to be low for crude oil and for credit
card receivables (because crude such as Maya from Mexico is sold to a limited
number of buyers who have the refining capacity, and there are only a handful
of major credit card companies); in contrast, diversion risks are high for
agricultural staples. Keeping in mind the
performance, product and sovereign risks, the rating agencies have arrived at
the following hierarchy of future flow receivable transactions in terms of
deals that are most secure to those that are least secure. The securitization
of heavy crude oil receivables is deemed to be most secure while the
securitization of future tax receipts is thought to be least secure.
It is
possible to securitize future flow receivable transactions even at the lowest
end of the hierarchy shown in Table 1.
An example of this is the securitization of co-participation tax revenues
(via federal tax sharing) by several Argentine provinces (Standard &
Poor’s 1999). Of course, it becomes
more difficult to obtain investment grade transaction rating as one moves to the lower end of the hierarchy. Alternatively, it becomes necessary to
build in more safeguards to improve credit rating as one moves
down the hierarchy. (The ability to structure away sovereign risks is greatly
reduced at the height of a liquidity crisis.
The risk mitigation through future flows structure works best when
sovereign risk perception are high and liquidity is low, but not during a
full-blown crisis.) Insurance companies are
playing a rising role in the 1990s insuring the various elements of risk
described above. A number of insurance
companies – MBIA, Ambac, FGIC
among them – have provided financial guarantee. Benefits of future-flow securitizationIn the
1990s, many borrowing
entities in developing countries that had a higher local currency rating
than their government were able to pierce the sovereign foreign currency
credit ceiling by using securitization of future receivables. The innovative
structuring of these transactions allowed borrowers to obtain significantly
lower interest rates and longer maturity than on their own unsecured bonds or
government eurobonds. To the investors,
the attractiveness of this asset class lies in its good credit rating and its
stellar performance in good as well as bad times. Their investment grade
rating allows future flow-backed securities to attract a wider class of
investors including, for example, insurance companies that face limitations
on buying sub-investment grade papers. Also, the price of future flow
securities tends to be less volatile than that of unsecured debt which is
another reason why investors like this asset class. Moreover, there have been no debt defaults
on rated future flow asset-backed securities issued by developing country entities,
despite repeated crises of liquidity and/or solvency. An interesting example
is the telephone receivable deal of Does
securitization increase the cost of unsecured debt? According to the
efficient market hypothesis, pledging a part of receivables to back
securitized notes should affect the ability of the borrower to service the
remainder of its debt. However, market participants argue that this would be
the case only when securitized debt rises significantly above certain
critical levels. One reason behind
this lack of effect of securitization on unsecuritized
debt is that by achieving investment-grade ratings, asset-backed securities attract
a wider range of investors including insurance companies and pension funds
who are constrained to buy only investment grade assets (Giddy 1994, p
487). Another reason may be that the
benefits of securitization may improve the ability of the entity to service
its unsecured obligations. For
example, a bank may profit from lower capital costs (for meeting capital
adequacy requirements) if it offloads a part of its loans through
securitization. Other explanations
rest on the presence of market imperfections.
For example, unsecured liabilities may be guaranteed by the government
(e.g., by deposit insurance in the case of a bank). Unused potential in emerging marketsFuture flow securitization has significant
potential for growth because such transactions allow issuers to pledge
receivables over a number of years. The potential for future flow
securitization from developing countries appears far more than the level of
current issuance. The potential
outside Latin America, especially in Eastern Europe and Constraints on future-flow securitization. A major constraint on the growth of future
flow transactions arises from the paucity of good collateral in developing
countries. (Oil is an example of good
collateral for several reasons. The
stock of oil in a country is more or less known. Well-developed global markets make oil a
highly “liquid” asset. Given its
importance to a nation’s economy, chances of government interference in oil
exports are low. Finally, the risks that exports may be diverted to foreign importers not
covered in a securitization structure is low in the case of oil
exports, especially crude oil exports.) Other constraints to securitization include the absence of
high-quality issuers. Securitization deals tend to be complex and involve
high preparation costs and long lead-times.
The lack of legal clarity on bankruptcy procedures in many developing
countries adds further impedimenets to these
deals. In some cases, policy makers
are simply not familiar with this mechanism. Many issuers cannot—or do not
want to—assume the burden of full disclosure of information in a timely
fashion. Others worry about whether
pledging future receivables might taint their creditworthiness. Public policy issuesFuture-flow
securitization, however, increases inflexible debt of the issuer as
well as the nation. Although the
current level of future flow debt is nowhere near
the danger level in any country, such debt combined with debt from other preferred
creditors can reduce the flexibility in debt servicing and jeopardize
issuer creditworthiness. However,
inflexibility in debt servicing may be (arguably) a good thing in many
developing countries, especially in those with a history of misallocation of
public debt. (Rating agencies have not downgraded sovereign credit ratings of
either Nevertheless,
if developing country entities do need to borrow to smooth consumption or
investment over business cycles, they may find this asset class attractive.
If planned and executed ahead of time, it can provide a way of accessing
markets during times of liquidity crisis.
Another attractive aspect of this structure is that the value of the
underlying collateral—for example, worker remittances, credit card
receivables, or oil exports—may rise during a crisis, thus, making this asset
counter-cyclical in nature. (For example, Mexico’s real exports rose 30
percent and real imports declined 8 percent in 1995.) For many developing countries, future flow
receivable-backed securitization may be the only way to begin accessing
international capital markets. Considering the long lead times involved in
future flow deals, however, even public sector entities would need to keep
securitization deals in the pipeline and investors engaged in good times so
that the asset class remains accessible during a crisis. An
equally important incentive for governments to promote this asset class lies
in the externalities associated with future flow deals. Future flow deals involve a much closer
scrutiny of the legal and institutional environment than unsecured
transactions. Besides, the preparation of a future flow transaction often
involves reforms of the legal and institutional environment. These reforms would facilitate domestic
capital market development and encourage international placements as in the
aftermath of the Brady deals in the early 1990s. Public
policy to facilitate future flow-backed securitization should focus on
relaxing the above constraints.
Transaction costs can be reduced through expansion of the scale of
these deals by planning a series of issues by the same issuer (the so-called
master trust arrangement). The size of the deals can also be raised via
receivable pooling. (Telephone companies in several IBRD’s negative pledge. Future flow securitization can
potentially conflict with the negative pledge provision included in IBRD loan
and guarantee agreements. This provision
does not prohibit the creation of security in favor of other creditors. Instead, it prohibits the establishment of
a priority for other debts over the debt due to the IBRD. However, the IBRD
may grant a waiver in respect of this clause in certain circumstances, in
particular, when transactions involve small amounts (World Bank Operational
Manual OP7.20). Examples: Two Transactions by Petroleos MexicanosA. United Mexican States (Pemex) and the Amount $ 6 billion, closing date of transaction
August 5, 199, maturity 5 years (2001), interest
three-month LIBOR plus 2 percent, payable quarterly, Depositaries: Swiss Bank
Corporation, New York Branch and the Federal Reserve Bank of In August 1996, the United Mexican States issued
$6 billion in structured notes backed by exports of crude oil and oil
derivatives by Pemex. This transaction used a modified version of
the structure used in the ($20 billion) financing of the rescue package by
the U.S. Treasury in February 1995.
The proceeds were used for repaying the U.S. Treasury financing. In this structure, Pemex’s
export sales subsidiaries, PMI Comercio Internacional (PMI) and PMI Trading, irrevocably
instructed their customers to make all payments for exports into designated
accounts at the Swiss Bank Branch in New York (depositary), which was in turn
instructed to transfer 57.14 percent of all funds on deposit to a transaction
account owned by Banco de Mexico at the FRBNY, and
the remainder to a trustee account for servicing the structured notes. In the event of a payment default to the
U.S. Treasury or the holders of the notes, FRBNY was authorized to debit the
transaction account of Banco de Mexico for amounts
then due under the notes, for making payments to debt holders. According to Standard and Poor’s, the credit
rating of the structured notes did not benefit from the involvement of the
FRBNY which acted only as a depositary, nor from
that of the U.S. Treasury, since the obligations due to the latter were
scheduled to mature before the notes’ final maturity in 2001. B. Pemex Finance Limited Amount: Nine issuances during 1998 and 1999, each
up to $500 million. Future US dollar receivables owed to Pemex
Finance Ltd. by designated customers who will receive Mayan crude oil from Pemex Exploracion y Produccion (PEP), via Petroleos
Mexicos Internacional (PMI).
Rating BBB. PMI arranges to sell Mayan crude oil, or some other crude oil type if Mayan becomes
unavailable, to designated customers who agree to deposit their payments into
an offshore collection account. PMI, a
subsidiary of Pemex, is the distributor for Mayan
crude oil, which is produced by PEP. Pemex Finance Ltd. is the offshore issuer of notes. It purchases the receivables from PMI via
the offshore Pemex subsidiary, PMI Services. The diagram shows that sales of the crude oil to
designated customers and of receivables to PMI Services are out of the
jurisdiction of the Mexican government.
The first claim on the receivables is from the note holders, and the
Mexican central bank is not involved in the process. Chase Manhattan Bank has
agreed to administer the issuance of all debt and the payment of interest and
principal on such debt in accordance with Pemex’s
agreements. After paying note holders
principal and interest, excess payments, based on fluctuation in crude oil
prices, are paid to PMI Services and PMI, via the offshore collection
account. While this structure mitigates the usual
convertibility and transfer risks, other risks still remain. Primarily, there
is a risk that a fluctuation in crude oil prices will result in revenues
insufficient to cover the interest and principal due to note holders. The overcollateralization
of the notes minimizes this risk – PMI will provide a minimum coverage ratio
of three times the amount needed for payment of interest and principal.
Designated customers have also signed agreements acknowledging their
commitment to purchase crude oil and to make any future payments into the
offshore collection account. Further
enhancing the strength of such issuance is Pemex’s
track record of timely servicing of debt in the past. As a result of these enhancements, S&P
rated the credit of 1998 and 1999 tranches A-2 and
A-4 and 1999 tranche A-5 as BBB. Rated as AAA are 1998 and 1999 tranches A-1 and A-3, as they are insured by MBIA and
AMBAC. These ratings are clearly
favorable relative to the BB foreign currency rating of the United Mexican
States. Example:
Pakistan Telecommunications Co Ltd (PTCL)
No default on asset-backed papers even in the
face of selective default on sovereign
debt In 1997, the Pakistan Telecommunications Company
Limited (PTCL) issued $250 million in bonds backed by future telephone
settlement receivables from AT&T, MCI, Sprint, British Telecom, Mercury
Telecommunications and Deutsche Telekom. Even though the Government of
Pakistan owns 88 percent of PTCL, this issue was rated BBB- by S&P, four
notches higher than the B+ sovereign rating. Following the detonation of nuclear devices in
May 1998,
Further readingFitch
IBCA, Duff & Phelps. International Structured Finance Criteria Reports.
Various issues. Giddy, Ian H. 1994. Global
Financial Markets. Moody’s.
2001. Revised Country Ceiling Policy:
Rating Methodology. Standard
& Poor’s. 2001. “New Rating Criteria for Multiple-Credit-Dependent
Obligations.” May.
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