The World Bank 2002 NUMBER 69 ECONOMIC POLICY Financing development through future-flow securtization Securitizing future receivables can allow developing country borrowers with good credit to overcome sovereign credit ceilings and raise financing in international 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- risks,ing seven-year bonds backed by future Visa card receivables. The bank estab- risk, hweve. Pedgig sarceforign 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 prop- FROM THE DEVELOPMENT ECONOMICS VICE PRESIDENCY AND POVERTY REDUCTION AND ECONOMIC MANAGEMENT NETWORK Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized
Transcript
The World Bank
2002
NUMBER 69
ECONOMIC POLICY
Financing development throughfuture-flow securtizationSecuritizing future receivables can allow developing country borrowers with goodcredit to overcome sovereign credit ceilings and raise financing in internationalcapital 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-
risks,ing seven-year bonds backed by future Visa card receivables. The bank estab-risk, hweve. Pedgig sarceforign 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 investorconfidence, 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 receiveda AAA credit rating from Standard & Poor's-higher than Peru's BB sovereignIn a typical future-flow securitization a devel- credit rating.oping country borrower sells its future prop-
FROM THE DEVELOPMENT ECONOMICS VICE PRESIDENCY AND POVERTY REDUCTION AND ECONOMIC MANAGEMENT NETWORK
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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 inthe 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, usingIn contrast, diversion risks are high for agri- onshore trusts, have defaulted.)cultural staples.
Future-flow securitization is attractive Trendsto 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 inas well as bad. The investment grade ratings 1987 with the securitization of telephoneof 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 mainexample, 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 $44maturity-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 ratedcrises 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 dealsdefaulted on its sovereign debt but contin- (table 1). Other receivables that have beenued 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 20011987-2001 public entities raised nearly $3 billion
through future-flow transactions, or aboutBillions of U.S. dollars Number of deals half the total in emerging markets.10 9.2 50
Potential8 7.8 40 Developing countries could raise up to $77
billion a year by securitizing exports of fuels,6.1 ores and metals, international tourism
66 3047 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 1.5 10 flow securitization from reaching its poten-
tial. One of the main constraints is the0.5 scarcity of good collateral in developing
Source: Ketkar and Ratha 2001, updated using data from Standard & Poor's, Fitch IBCA ings or are not rated at all. In addition, theDuff & Phelps, and Ambac. specialized skills needed to structure asset-
PREMNOTE 69 JUNE 2002
TABLE I 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)
Telephone services 2,519 7 15 10Worker remittances 1,731 5 14 9Other 1,443 4 11 7Total 36,372 100 148 100 Policies should easeSource: Fitch IBCA Duff & Phelps, Moody's, and Standard and Poor's data.
ease constraints onbacked 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-flowcosts are often $2-3 million a transaction. ing). In developing countries such pledging
Unclear bankruptcy procedures further reduces the authorities' access to foreign securitizationimpede 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 thePolicy issues Enron crisis, the use of special purposePublic 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-may be amen- TABLE 2 POTENTIAL ANNUAL REVENUE FROM FUTURE-FLOWable to a standardized approach. Clarifying SECURITIZATION IN DEVELOPING COUNTRIESbankruptcy laws is helpful for all financial (billions of U.S. dollars)
deals, including securitization. In addition, Low-income Low- andpolicymakers and potential issuers should Type of receivable countries middle-income countries
be educated about the benefits and risks of
this approach. Fuel exports 6.5 43.1
As noted, future-flow securitization is not Inernational tor s 1.3 10.2
without risks. For example, it increases bor- Worker remittances 1.7 5.1rowers' inflexible debt. Moreover, pledg- Total 11.7 76.9ing a large volume of hard currency Note: Calculations are based on a conservative 5:1 excess collateralization ratio for 1998receivables can worsen the terms of unse- receivables.
cured borrowing (though the use of excess thrce: Ketkar and Ratha 2001.
PREMNOTE 69 JUNE 2002
Still, this asset class can provide useful often involves legal and institutionalaccess 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 theonly way to begin accessing such markets. Further readingGiven 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." Policyinvestors engaged during good times so Research Working Paper 2582. Worldthat such deals remain accessible during Bank, Washington, D.C.crises.
An equally important incentive for gov- This note was written by Dilip Ratha (Seniorernments to promote this asset class lies in Economist, EconomicPolicy and Prospects Group,the externalities associated with future-flow PREM Network).deals. Relative to unsecured transactions, Ifyou are interested in similar topics, considerthese deals involve much closer scrutiny joining the Managing Volatility Thenatic Group.of a country's laws and institutions. Indeed, Contact Craig Burnside (09607) or click onpreparation of a future-flow transaction Thematic Groups on PREMnet.
This note series is intended to summarize good practice and key policy find-ings on PREM-related topics. The views expressed in these notes are those ofthe 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 PREMwebsite (http://prem). If you are interested in writing a PREMnote, email your
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