Eurostat has unveiled its regulatory framework for government securitizations - a move that some market participants say places public sector accounting rules more in line with the recent changes in private sector accounting rules.
The guidelines will finally bring clarity to the debate of what is and what is not officially considered off-balance-sheet funding. As they read in their preliminary stage, they would treat future flows not attached to a pre-existing asset - like the Italian Lotto deal - as on-balance-sheet debt.
Securitizations with a government guarantee would also not be treated as off-balance-sheet debt. This includes all Greek and Austrian deals that benefit from a guarantee. According to Merrill Lynch, these deals will be treated as government debt - either by reclassification of the SPV within the government sector, or through a recording of an implicit loan from the SPV to the government.
But the biggest issue that has caused mixed reactions is the Eurostat clause that would require proceeds to be 85% of the asset transferred. It refers to the deferred purchase price in case of asset sales, explained Merrill. The ruling specifies that if the difference between the initial payment and the observed market price (or market-based price estimated by independent agents) exceeds 15%, the transaction will be treated as government debt, which means that the Italian real-estate deal SCIP would also be reshuffled onto the Italian GDP figures.
How it's applied
By the end of last week it looked clear that Eurostat was not likely to give these governments a grace period in which to put the debt back on balance sheet. Though most market participants largely expected the ruling to include clauses that would reject government guarantees and future-flow structures, the Italian government last week heavily contested the market discount aspect.
Eurostat officials argued that no commitment was ever made as to how these real-estate deals would be treated, and that it had reserved the right to change the rule on securitization at a future date. But Italian officials have countered that Eurostat had reached an agreement before the deals were launched.
The first real-estate deal was done at 50% at open-market value; the new deal will have to comply with the 15% discount factor. How it's applied is still unclear to some market sources. "Will the discount factors apply only to future cash flows, or every type of asset?" asked Christopher Arend, partner on the ABS team at Linklaters Oppenhoff & Rdler's Germany-based office. "Should the number be regulated, or should it be left to the free-market forces to take their course?
"Under the Eurostat decisions, there will be independent market experts who calculate the basis for calculating the 15% discount. This means that there could be competition among experts on the basis of who is the most generous' unless the rules for implementing the decisions give experts a fair amount of direction on how to calculate market prices." In the coming months, Arend added, more specific rules will follow, and the major task ahead will be to give adequate guidance.
To date, the deals that the government has launched have been fairly large and liquid, and the Italian budget for this year includes the sale of GBP4.9 billion in real-estate-backed securitizations. Italy's 2000 budget deficit is expected to now be at 2.1% to 2.2% GDP; just last month, it had estimated a GDP of 1.6%. Under the terms of the stability pact, countries in the European Monetary Unit (EMU) need to reach and maintain budget deficit levels of 3% GDP.
"Greece and Italy are liable to have problems - at least a good portion of their transactions will have to be revisited," said Arend at Linklaters. "It may change those governments' willingness to engage in this type of financing. Going forward, they may be more circumspect in using securitization."
This also applies to countries such as Poland and Hungry, who may have considered securitization as a tool for reaching the required 3% GDP levels in order to enter the Eurozone. "Now we may see countries that have depended on securitization for off-balance-sheet financing that will have to bite the bullet and engage in some spending cuts," he said.
Despite the ruling, Italy has shown no signs of shying away from securitizations. It's moving ahead with its planned INPS securitization, the third in its series that would bring the volume to EURO9 billion. Sources said that the government is still talking to banks, pitching a second real-estate deal and asking them to consider the new rules.
"Governments will have to look at rule and must look into restructuring old deals to comply with the Eurostat requirements," said one source familiar with the situation. "But the rules just make it much clearer, and governments will continue to employ securitizations as part of their strategy."
A possible measure that the Italians could use to address the 15% acceptable margin on deferred purchases will be to look further down the rating curve and issue subordinate (in terms of ratings) paper, which means that these deals will likely require more structuring.
As for the Greek government and its guarantees, it's possible that this technique might be considered as well. "The guarantee would have to be rethought," said the source. "Initially it was employed to achieve 0% risk weighting and not for any other purpose. They may consider piercing the sovereign ceiling as the Italians have done. It may cost a little, but risk weightings really depend on the government and the jurisdiction."
Nonetheless, countries will find it difficult to obtain a large amount of funding on day one of a securitization by using future cash flows, rather than raising a much smaller amount of funding by using existing assets in revolving transactions.
"You can use future cash flows to generate funding by selling the business that generates the cashflows - that's M&A and that's how you can realize the earning potential of a business," said Arend. "But then it's just a one-off transaction, and I doubt that this is doable in many cases because the government often can't pass an operation on to a third party."
In general, Arend expects that people will be exploring the concept of whole-business ABS, except not in the same way that it is done in the U.K. - where there are the advantages of floating charges and administrative receivership. "You could use business operations as a basis for raising financing," he explained. "As long as things are running well, the owner can keep control of the operations. If not, investors must have the option of stepping in through a trustee and running operations on a going concern basis."