On April 9, around the time the future-flow world was closely tracking troubled Kazakh banks, the International Finance Corp. (IFC) held an internal seminar on the product.
Invited to speak were David McCaig, global head of securitization for Standard Bank; Jim Patti, a partner at Mayer Brown; and Greg Kabance, head of Latin America structured finance at Fitch Ratings.
Overseeing the proceedings was Lee Meddin, global head of structured finance at the IFC. What follows is an abridged version of a few of the topics discussed, including a primer on the history of future flows and its sterling record, and where the product might be headed through the crisis and beyond.
The observation will be organized along thematic lines, akin to a Q&A.
First of all, defining the product
Future flows is a financing tool that monetizes a predictable hard currency cash flow coming from offshore into an emerging market. It can almost be any predictable flow: payment rights, MT100s coming through the swift network, worker remittances, net settlements for the telephone company, exports or other flows. But I'm not sure if Somali piracy proceeds would work.
Past performance is no guarantee of future results. But, all the same...
These deals have been through the Tequila Crisis of '94, the Asian Crisis of '97, the Russian Crisis in '98, the Brazil devaluation in '99, the Pakistan default and coup in '99, the Turkish banking crisis in 2000, the Argentine default in 2002, the event with the Brazilian elections in 2002, the Venezuelan crisis in 2003 and the global financial crisis of 2007.
[Through all these crises] there have been 180 deals that Fitch has rated, amounting to about $75 billion. One hundred forty have already paid down, and there was one default in 1997. If we take the five-year period - which is the duration of most future-flow transactions - the default rate is 0.6%. Most of the deals have been in the triple-B range, showing that the product performed better than U.S. corporate single-A. But what's important to remember is that the one loss that actually did occur was under $20 million. Divide that by $75 billion and you get something like a 0.03% loss rate, which equates to a performance better than triple-A corporates.
Efforts to expand beyond the traditional future-flow originators
Over the years, we've seen about $80 billion in deals. What we haven't seen is the much broader, more widespread use of the product [beyond systemically important companies]. It's always been kind of nichey - the Brazilians like it, the Turks like it, the Russians never really liked it, Korea and Kazakhstan did a bit of it. [In its recent history] there's been a shift to DPRs [diversified payment rights, typically originated by large banks].
Future-flow customers tend to be systemically important or other large institutions who usually have the ability to obtain their own funds from the market and so haven't needed the support of the IFI (International Finance Institution) or DFI (Development Finance Institution) communities - though this has somewhat changed in the current market. What I'd like to talk about today, however, are smaller companies - how can we take that technology [of the future-flow structure] and simplify it, cut out a lot of the unnecessary flexibility and bells and whistles and apply a simpler format to a textile manufacturer in a Central Asian country or agricultural exporters in Sub-Saharan Africa?
Credit Card Deal by Bank Internasional Indonesia (BII)
In 1996, Indonesia was investment grade. BII is an acquiring bank, so you stay in a hotel in Indonesia, for example, and this bank basically monetizes credit card vouchers of that hotel. Then BII sends those vouchers up electronically, and Visa/MasterCard will pay those proceeds directly to the bank. In the deal, you had Visa/MasterCard paying directly into the trust account. Debt service was paid to investors, and the proceeds would go back to BII. The transaction was $200 million dollars when it closed in '97, and the performance risk of the bank was 'BBB'. It was a market leader, and the sovereign was rated 'BBB'. BII had a very diversified merchant base, and coverage levels were 4x-5x.
But thereafter, in 1997, you'll recall there was a massive devaluation of the rupiah, very high interest rates, political turmoil and social unrest - all of which led to the toppling of the Suharto regime in 1998. This was the beginning of the crisis for this transaction. After the devaluation, the receivables performed relatively well. [It's important to keep in mind that] unlike some of the other future-flow products, credit card flows are susceptible to devaluation risk because the locals are charging in local currency. There was susceptibility to that [in the BII deal], and you need high debt service coverage ratios to cover it.
Another issue was that the bank was related to APP [Asia Pulp and Paper]. APP went bankrupt in 2001, and the company [had] borrowed from BII. APP also had a position in the bank, which led to the bank's nationalization. There was, again, little impact on the flows into the transaction. Then we had Sept. 11 - after which flows did drop significantly - and shortly thereafter there were bombings in Bali. The flows improved, but only to eventually face SARs and the Iraq War. There were a variety of different stresses, and throughout this entire period the flows proved to be pretty resilient. [A key advantage was that] this credit card business was important to the bank, it was profitable and the bank itself was systemically important.
Program vs. Single Issuance
In a program, an issuer can issue multiple deals off the same set of documents. All they have to do is sign a 20-page agreement. All the other underlying contracts are in place already. In the case of Turkey's Akbank, for example, [contracts] were drafted in 1999.
So the first deal in a program is relatively expensive - you have to build the infrastructure. After you do the first deal, it's very efficient, very cheap. In fact, we're working on a deal right now for another Turkish bank, and the cost to do that is probably about one-fifth of what it was when we put the program in place seven years ago. And we can close it in 10 days. That's a structure that works if you're a Pemex [oil giant Petroleos Mexicanos], an Akbank or another large institution that has large funding needs.
But it's not going to work if you are a textile manufacturer or an agricultural cooperative in Sub-Saharan Africa, Southeast Asia, Central or South America. In these cases, you might want to consider single issuances that don't anticipate every possible alternative in the future.
[There is a downside to a program]: as an investor, you don't control the destiny of the deal. In the Akbank program, there are slightly more than 20 issuances, so you have to vote as a group. You may hold only 5% of the total exposure in that program. So for any amendments, waivers or instructions to the trustee or administrative agent - anything that needs to be done - you face the risk of being pulled along with the majority.
Performance risk and what sets future flows apart
The performance risk is the main risk in these transactions. If it's an oil company [one asks]: what are the risks of this company getting the oil out of the ground, onto a tanker and into a ship. What can go wrong? What is the performance risk like? What's been the track record? What's the company structure? What is the government? We've got to be able to demonstrate, come hell or high water, that the oil will get out of the ground and onto a boat largely irrespective of what's happening to the sovereign's activity on servicing its own debt. And you witness a Pemex of Mexico, [with] 50 years of uninterrupted exports.
[What you're doing in a sense is] swapping a financial risk for a performance risk. What we have is a sale or a pledge of a hard currency receivable in favor of the foreign creditors. We have arrangements that monitor the cash flows coming through, period by period. If something goes ugly with it, we early amortize.
[In some ways it's like a covered bond]. [Like a covered bond], in future flows, you're interested in the credit quality of the institution in addition to the assets. It's different from a securitization, and more like a hybrid covered bond structure. But in a future-flow securitization, you often don't have full recourse to the company.
If it's a secured loan or covered bond, you have full recourse. In a true sale structure, sometimes your ability to have recourse is constrained because the local lawyers will tell you that if you have recourse, that undermines the true sale, which may invalidate the true sale [in the first place].
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