E4 Th-e Wortd Bank -H--5 5 _ E ~~~~~~~~~~~~~~~~~~~~~~~~~~~~J U N E l r1 hl notes N UMNUMBER 6 9 __ : _ ___:_____ _ _____ __JL ~ . ECONOMIC POLICY Financing development through future-flow securitization Securitizing future receivables can allow developing country borrowers with good credit to overcome sovereign credit ceilings and raise financing in intemational capital markets. Most developing countries lack ready access duction to an offshore special purpose to international capital markets, while those entity, which then issues the debt instru- with access are prone to crises. Moreover, ment (box 1). Through a legal arrangement the foreign currency ratings of developing between the borrower and major interna- country borrowers are often constrained by tional customers, payments for the products sovereign credit ceilings. As.a result even are deposited in an offshore account man- companies with better local currency ratings aged by a trustee. The debt is serviced from than their governments face credit rationing this account, with any excess collections or exorbitant terms on foreign borrowing. transferred to the borrower. Securitizing future hard currency This transaction structure mitigates sev- receivables-that is, converting them into eral elements of default risk. Offshore pay- tradable securities-can enable such bor- ment arrangements significantly reduce rowers to break through-sovereign credit government's ability to interfere with debt ceilings and access international capital mar- servicing. Excess collateralization mitigates kets, obtaining lower interest rates and the market risk arising from price and vol- longer maturities than on unsecured bonds ume volatility. The risk that products will be or government eurobonds. For example, in sold to customers other than those desig- late 1998 Pemex, Mexico's state-owned oil nated depends on the choice of collateral. and gas company, issued oil export-backed securities that received higher ratings from international credit rating agencies than Box 1 BANCO DE CREDITO DEL PERU'S SECURITIZATION OF CREDIT Mexico's sovereign debt. Relative to unse- CARD RECEIVABLES cured debt, securitization lowered interest rates on Pemex borrowing by 50-338 basis After a credit card sale the merchant presents the resulting voucher to a voucher- points (0.50-3.38 percentage points). acquiring bank and receives cash. The bank is then reimbursed by the credit Securitization structures are not without card company. In 1998 Banco de Credito del Peru raised $100 million by issu- ing seven-year bonds backed by future Visa card receivables. The bank estab- risks, however. Pledging scarce foreign lished Banco de Credito Overseas Ltd., a special purpose entity in the Bahamas, exchange to a specific creditor leaves less and issued structured notes. Visa International was instructed to transfer all for others. This is especially relevant for mul- future payments on credit card vouchers to the BCOL Master Trust, an offshore tilateral lenders, including the World Bank, account. The trust makes principal and interest payments to the bondholders that have preferred creditor status. and forwards excess collections to Banco de Credito del Peru. To increase investor confidence, the amount of future-flow receivables transferred to the trust was How and why set at 2.5 times debt service requirements. In 1998 this transaction setup received a AAA credit rating from Standard & Poor's-higher than Peru's BB sovereign In a typical future-flow securitization a devel- credit rating. oping country borrower sells its future pro- I FROM THE DEVELOPMENT ECONOMICS VICE PRESIDENCY AND POVERTY REDUCTION AND ECONOMIC MANAGEMENT NETWORK Such risk tends to be low for crude oil More recently, deals backed by future (because a limited number of buyers have exports have continued to perform in the capacity to refine crude oil) and credit Argentina. (Though some deals by Argen- card receivables (because there are only a tine provinces that used future co-partici- handful of major credit card companies). pation tax revenue as collateral, using In contrast, diversion risks are high for agri- onshore trusts, have defaulted.) cultural staples. Future-flow securitization is attractive Trends to investors because of its good credit rat- The first important future-flow securitiza- ing and stellar performance in good times tion in a developing country occurred in as well as bad. The investment grade ratings 1987 with the securitization of telephone of future-flow securities allow them to attract service receivables owed to Mexico's Future-flow a wide range of investors-including, for Telmex. By the end of 2001 the three main example, insurance companies that face lim- credit rating agencies-Fitch IBCA Duff and securities attract a its on buying sub-investment grade paper. Phelps, Moody's, and Standard & Poor's- Though these securities are traded less had rated more than 230 future-flow secu- wide range of often-investors tend to hold them to ritizations with principal exceeding $44 maturity-the prices of some more liquid billion (figure 1). Issues of future-flow secu- investors future-flow securities (such as Pemex 18- ritiesjumped after Mexico's 1994-95 crisis, year oil export-backed notes) appear to be with borrowers from Argentina, Brazil, Mex- less volatile than unsecured securities from ico, and Venezuela dominating the market. the same issuers. But new borrowers and new types of future Debt defaults are rare on rated future- receivables continue to emerge. flow, asset-backed securities issued by devel- During 1987-99 oil and gas export receiv- oping country entities, despite repeated ables accounted for 45 percent of rated crises of liquidity, solvency, or both. For future-flow transactions in U.S. dollar terms, example, in 1999 Pakistan selectively and for 17 percent of the number of deals defaulted on its sovereign debt but contin- (table 1). Other receivables that have been ued to service bonds backed by the future securitized include credit card transactions, receivables of its state telephone company. telephone services, worker remittances, and even future export receivables to be gen- FIGURE 1 FUTURE-FLOW SECURITIZATIONS IN EMERGING MARKETS, erated by new investment projects. In 2001 1987-2001 public entities raised nearly $3 billion through future-flow transactions, or about Billions of U.S. dollars Number of deals half the total in emerging markets. 10 9.2 50 Potential 8 7.8 40 Developing countries could raise up to $77 billion a year by securitizing exports of fuels, ,5.6 6.1 ores and metals, international tourism 6 5.6 30 receipts, and worker remittances (table 2). There is also further potential for securi- 4 20 tizing telephone service receivables. 2.0 / * - - - 2.2 Several constraints have inhibited future- 2 10 flow securitization from reaching its poten- * / - 0.7 - - - - - tial. One of the main constraints is the m 0.5 - - - - - * - - scarcity of good collateral in developing 1987- 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 countries. Mostdevelopingcountries have 90 sub-investment grade foreign currency rat- Source: Ketkar and Ratha 2001, updated using data from Standard & Poor's, Fitch IBCA ings or are not rated at all. In addition, the Duff & Phelps, and Ambac. specialized skills needed to structure asset- PREMNOTE 69 JUNE 2002 TABLE 1 FUTURE-FLOW SECURITIZATIONS IN EMERGING MARKETS BY TYPE OF RECEIVABLE, 1987-99 Value of transactions Number of transactions Millions of Share of total Share of total Type of receivable U.S. dollars (percent) Number (percent) Oil and gas exports 16,362 45 25 17 Other exports 7,537 21 40 27 Credit card transactions 4,314 12 37 25 Project finance 2,467 7 6 4 Telephone services 2,519 7 15 10 Worker remittances 1,731 5 14 9 Other 1,443 4 11 7 Total 36,372 100 148 100 Policies should ease Source: Fitch IBCA Duff & Phelps, Moody's, and Standard and Poor's data. ease constraints on backed deals, together with long prepara- collateralization in future-flow securitiza- tion times, imply large fixed costs-legal tion contracts tends to limit excess pledg- future-flow costs are often $2-3 million a transaction. ing). In developing countries such pledging Unclear bankruptcy procedures further reduces the authorities' access to foreign securitization impede these deals in many developing exchange. countries. And in some cases policymakers Although future-flow debt is nowhere are simply not familiar with future-flow secu- near a dangerous level in any country, such ritization. Finally, many borrowers do not debt-combined with debt owed to other want to assume the burden of complete, preferred creditors-can reduce flexibil- timely disclosure of information. ity in servicing debt andjeopardize sover- eign creditworthiness. (Because of the Policy issues Enron crisis, the use of special purpose Public policy to facilitate future-flow secu- entities has recently come under scrutiny. ritization should focus on easing the above But that may not affect investor percep- constraints. Transaction costs can be cut by tions of risk about future-flow securitiza- arranging a series of issues by the same bor- tion, because the risks and rewards rower (the so-called master trust arrange- associated with securitization deals are thor- ment). Establishing and using local credit oughly scrutinized in conjunction with the rating agencies to provide domestic credit issuer's other exposures.) In addition, the ratings can also reduce transaction costs, use of such deals by public entities under- though care has to be taken in mapping mines the preferred creditor status of mul- local ratings to international scales. Certain tilateral lending institutions. segments of this asset class-such as secu- ritization of oil receivables-maybe amen- TABLE 2 POTENTIAL ANNUAL REVENUE FROM FUTURE-FLOW able to a standardized approach. Clarifying SECURITIZATION IN DEVELOPING COUNTRIES bankruptcy laws is helpful for all financial (billions of U.S. dollars) deals, including securitization. In addition, Low-income Low- and policymakers and potential issuers should Type of receivable countnres middle-income countries be educated about the benefits and risks of this approach. Fuel exports 6.5 43.1 As noted, fu o sOre and metal exports 1.0 12.4 As noted, future-flow securitization is not International tourism receipts 1.3 10.2 without risks. For example, it increases bor- Worker remittances 1.7 5.1 rowers' inflexible debt. Moreover, pledg- Total 11.7 76.9 ing a large volume of hard currency Note: Calculations are based on a conservative 5:1 excess collateralizadon ratio for 1998 receivables can worsen the terms of unse- receivables. cured borrowing (though the use of excess Soaure: Ketkar and Ratha 2001. PREMNOTE 69 JUNE 2002 Still, this asset class can provide useful often involves legal and institutional access to international capital markets dur- reforms. These reforms facilitate domes- ing liquidity crises. Moreover, for many tic capital market development and encour- developing countries securitization backed age international placements. by future flows of receivables may be the only way to begin accessing such markets. Further reading Given the long lead times involved in such Ketkar, Suhas, and Dilip Ratha. 2001. "Devel- deals, however, issuers need to keep secu- opment Financing during a Crisis: Secu- ritization deals in the pipeline and ritization of Future Receivables." Policy investors engaged during good times so Research Working Paper 2582. World that such deals remain accessible during Bank, Washington, D.C. crises. An equally important incentive for gov- This note was written by Dilip Ratha (Senior ernments to promote this asset class lies in Economist, Economic Policy and Prospects Group, the externalities associated with future-flow PREM Network). deals. Relative to unsecured transactions, If you are interested in similar topics, consider these deals involve much closer scrutiny joining the Managing Volatility Thematic Group. of a country's laws and institutions. Indeed, Contact Craig Burnside (x39607) or click on preparation of a future-flow transaction Thematic Groups on PREMnet. N This note series is internded to summarize good practice and key policy find- ings on PREM-related topics. The views expressed in these notes are those of the authors and do not necessarily reflect the views of the World Bank. PREM- notes are distributed widely to Bank staff and are also available on the PREM website (http://prem). If you are interested in writing a PREMnote, email your idea to Sarah Nedolast. For additional copies of this PREMnote please contact l the PREM Advisory Service at x877B36. Prepared for World Bank staff