As one of the ugliest chapters in the history of securitization is being written, its hapless authors haven't had to devote much text to financial future flows. Consisting chiefly of diversified payment rights (DPRs) originated by emerging-market banks, the asset class has been performing nicely, at least through the third quarter of 2007. Historical events reinforce the idea that it would take more than a mere global liquidity crunch to upend this niche of ABS.
"The liquidity scare isn't as severe as what these entities faced in previous, true emerging market crises," said Gregory Kabance, director of Latin American structured ratings at Fitch Ratings. Indeed, it's hard to beat sweeping currency devaluations, double-digit economic recessions and military coups, none of which were able to push scores of deals to default.
But while the collateral retains its sturdy reputation, other facets of these deals - namely their recent affair with monolines and conduits - mean the sector isn't entirely safe from wider trouble. Just how these issues are sorted out will impact how soon future flows come back in appreciable volumes and how the marketplace might look altered from its shape of the last few years.
The blow-out in spreads has dimmed hopes of meaningful activity in much of the ABS world, and financial future flows are no exception. "Whatever is applicable to the sector is not going to be future-flows specific," said a London-based banker.
The estrangement of investors from monoline insurers is indeed not future-flow specific, but it does, at any rate, have an impact keenly felt in the sector. Publicly at least, the vast majority of future flow product of the past few years was wrapped, especially the hefty volumes coming out of Turkey. The country produced $5.7 billion in DPRs in 2006. Volumes grew thinner earlier last year and then vanished after late summer. The trouble facing the monolines certainly played a part in the disappearing act. Spreads on several monolines had gapped sharply out well before the disquieting news came in December that Moody's Investors Service put CIFG and MBIA on negative outlook and put FGIC and XLCA on review for possible downgrade and that Standard & Poor's placed Ambac, MBIA, XL on negative outlook and FGIC on Creditwatch negative.
Wrapped Turkish DPR paper with a tenor of several years actually traded in the ballpark of 300 basis points over Libor late in last year's season of turbulence, according to one London-based banker. "Some investors have gotten permission [to trade it] on the basis that the wrap's not there," he said. The idea was to turn a handsome profit when the monolines "came back" later this year.
But no one, of course, knows exactly when that will happen, and while the ratings actions single out the ones who are hurting most, it's still unclear that any are completely out of the woods. Turkish banks that issue DPR transactions are watching the situation closely.
"DPR deals were very beneficial for Turkish originators due to the [ease] of their structure and the additional guarantee provided by the monoline insurers," said a source at a Turkish originator that has placed a wealth of DPR paper. "If spreads decrease to desirable levels, banks will consider [whether] to continue to issue DPR deals."
The less affected monolines are reportedly getting pitched on DPR deals. FSA is a name being bandied around (the monoline didn't return a call for comment). But even if wraps come back, a leading source of demand for the deals, the conduits, have either shut down or are locked down. Whether others can pick up the slack is doubtful.
But there's always the unwrapped option. There are reasons to think this route might benefit from a potentially protracted absence of monolines. First of all, even in the midst of the Turkish wrap craze of '06, there were plenty of unwrapped, triple-B tranches coming out as well. In addition, when Brazilian banks were more active in the sector, they often went unwrapped. And, finally, Russian DPR transactions, which add up to about $2 billion, are by nature unwrapped because the monolines still haven't grown comfortable enough with Russia to take on exposure there.
"There's plenty of [unwrapped] accounts right now, it's just a question of price," said a London-based banker. More than one banker mentioned that many buyers of unwrapped future flow product had been priced out of the market by aggressive bids from the monolines and by Panterra Funding, an EM-fixated conduit that in the words of one New York player, single-handedly "affected [unwrapped] pricing across the board" (ASR, 12/10/07). Once the markets settle down, if originators are willing to agree with the pricing being sought by investors of unwrapped product, then activity will resume.
This might have resonance in Brazil and other Latin American countries. While no one is anticipating heavy activity from the still-liquidity-rich Brazilian banks, these originators haven't been entirely immune to the global crunch, and by ceding dominance of DPRs to Turkey over the past few years, they might have whetted the appetite of one-time and current DPR investors. "People are actively proposing DPR deals to Brazilian banks," one New York player said.
But another source, a New York banker, said that unsecured lending is still cheaper for Brazilian banks, and the picture would have to darken more for this segment to come back with sizable volumes. Even a return of activity won't translate into the mega-deals that came out over the past couple of years, sources said. The Turkish transactions that pushed past $500 million will remain a memory for some time.
At any rate, the market in Latin America isn't, and hasn't been, completely silenced by noise from subprime and the liquidity pullback.
Banco de Credito de Peru (BCP) might be doing a deal in the first quarter, said a source close to the bank. Stormy public markets will likely push the originator to do a private placement. "[The bank] will have to see who the investors are," the source said. "[They're] still in the exploratory phase." BCP has $880 million of DPR transactions outstanding. Flows into the program are being nourished by healthy exports piggybacking on strong commodity prices.
Brazil's Bradesco reportedly closed $400 million in two unwrapped deals in December via Dresdner Kleinwort and Sumitomo. As of press time it wasn't clear that the transaction actually went to market investors. Bradesco didn't return requests for comment and Dresdner bankers didn't return e-mail queries (the latter was understandable in light of at least one important lay-off in the Latin America team - see whispers). The Bradesco placements came after $500 million in DPR deals via ABN AMRO at mid year. Along with a $400 million unwrapped deal from Unibanco, these transactions sustained the only DPR activity from Brazil last year. Unibanco was reportedly sunk into the now defunct Panterra.
While the overall mood in DPRs isn't as dreary as in other ABS arenas, in Kazakhstan there's less to cheer about. The country has played host to both wrapped and unwrapped DPR paper. S&P cut the unwrapped and underlying ratings of Kazkommertsbank's outstanding DPR deals to BBB-' from BBB' in early December, citing a deterioration in the bank's survivability assessment. Moody's, for its part, put a series
of Kazakh DPR deals from Kazkommertsbank and BankTuranAlem on downgrade review in November (ASR, 11/12/07). At the time, each originator told Moody's that they intended to include features that "aim to reduce the linkage of the ratings of the notes" to that of the originator. No word yet on any alterations. When overseas credit was abundant, Kazakh banks were voracious borrowers, but the retreat in lending choked off much of their funding while exposing their reliance on foreign money.
The DPR sector may not be able to tune out the grim global picture, but players still tout the strength of the underlying collateral. In a recent report penned by analysts Gabriel Wieder and Marcio Rocha, S&P reviewed the performance through the third quarter for financial flow securitizations, including credit card merchant voucher deals, and found the results heartening. In most cases, the programs "remained at or exceeded historical levels in the third quarter of 2007," the authors reported. "The global credit market events in the second half of the year ... don't appear to have affected these programs."
The activities that generate the cash flows, such as exports and worker remittances for DPRs, are still motoring along. An economic downturn would have to be catastrophic to push these transactions to default, according to sources, since the debt service coverage levels tend to be quite steep. "In terms of cash flow, the economy of a country has to collapse," one New York banker said.
Where the deals can get hit is through the originator, as in the case of the Kazakh deals mentioned above. "There's a difference between future flows and other kinds of securitization," S&P's Wieder said. "You don't completely separate the financial risk of the transaction from the financial risk of the originator, as you do in an existing asset securitization. It's a reflection that you need the bank and business lines underlying the deal to continue operating."
As long as they are operating, these transactions have proved to be remarkably tough in topsy-turvy operating environments. Among the more popular future flow war stories is the one about
government-controlled Pakistan Telecommunications (PTCL). Structured in 1997 by ABN AMRO and Citicorp Securities, the deal collateralized net settlement payments on phone calls from overseas and totaled $250 million. By the beginning of 1999, the Pakistani government was overburdened with debt and nearly defaulted. An IMF program was suspended in July 1999. In October, General Pervez Musharraf seized power in a coup. By the time of the government takeover, Duff & Phelps had downgraded the transaction to BB', and S&P to CCC', as cash flows were drying up, and the originator's credit quality had gone south along with the government's. But the transaction endured. Receivables bounced back in 2002 and the deal matured, without payment incident, in August 2003.
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