The Italian Treasury may be signaling that it's on track toward writing some debt off of its balance sheet; market analysts, however, are questioning the prudence of such one-off measures in the long run.
The latest development shows that analysts have now joined the ranks of the EU government accounting watchdog Eurostat, questioning just how viable securitizations might be in terms of addressing the government's deficit. "One-time revenues such as securitizations, which have become a common feature of the Republic of Italy's debt-reduction strategy, are no substitute for recurrent measures to address the country's structural fiscal deficits," reported Standard & Poor's.
In an attempt to better control last year's rampant use of securitization as a means to transfer government debt off balance sheet, Eurostat initiated a series of guidelines (see ASR, 1/13). In theory, the more stringent criteria would make it difficult for governments to use securitization as a tool to simply reshuffle serious debt problems. According to Standard & Poor's, Italy's debt burden is the highest among rated European sovereigns, at an estimated 106% of GDP in 2003; Greece's general government debt burden is an estimated 104% of GDP in 2003.
For issuers such as the Greek sovereign, which in the past depended heavily on its issuance of off-balance-sheet paper, the prospect of issuing debt that might be counted on balance sheet debt proved enough of a deterrent to cool issuance volumes. The Italian government, however, pledged to forge ahead with what they say is a legitimate means to address certain aspects of the country's balance sheet. Earlier this month, it issued a gigantic real-estate securitization that was met by much enthusiasm by investors still hungry for this type of paper.
The agency charges Italy with becoming the "run-away leader" in Europe in the securitization of state assets. Unless securitizations lead to efficiency gains in the management of public sector assets, it is unlikely that one-off debt reduction through securitization would structurally improve the country's budget balance in the long term.
As a result, S&P announced late last week that it revised its outlook on the Republic of Italy to negative from stable. The decision reflects the persistence of large structural fiscal deficits and the lack of a well-defined, medium-term fiscal strategy that would lead to a notable deceleration in the decrease of the government's debt ratio.
According to the rating agency, securitizations benefit a sovereign's fiscal flexibility in the short-term given the immediate benefits to its cash flow. (S&P defines fiscal flexibility as the ability of a public-sector issuer to adjust to economic trends and to react quickly in the wake of economic shocks, modifying policies in a way that will safeguard smooth debt-service payments).
However, these benefits are outweighed by an inevitable loss of control over the assets and the consequent loss of future receivables from those assets, which in the long run could limit fiscal flexibility. "Securitizations worsen fiscal flexibility going forward if the receipts from them are partially or fully used for purposes other than reducing the issuer's stock of outstanding debt," said S&P analysts. "Moreover, the credit quality of the issuer's unsecured debt may decline as fewer public assets are left to back it. Only where securitizations lead to efficiency gains in the management of public-sector assets is a net improvement of longer-term fiscal flexibility a plausible outcome."
And because the immediate benefits of a securitization are generally a one-time gain, securitization receipts are not counted toward budgetary revenue. Instead, suggested analysts, they should be recorded below the line in the same vein as government privatization initiatives. Since the Italian deals carry no government undertaking, they should also not be lumped under general government debt.
"Under Eurostat rules, securitization receipts can still be recorded as budgetary revenue if they fulfill certain characteristics - for example, if they are within a limit set for the degree of over collateralization allowed," said analysts. "As a result, government revenue and balance figures as recorded by S&P can differ from national figures reported in accordance with official European accounting rules (ESA95), which are, for example, used to establish whether or not to invoke the EU's excessive deficit procedure under the Stability and Growth Pact."
The same applies to government municipalities. This time last year, market participants regarded the rise of municipalities as the next big wave in government securitizations. There have already been a series of deals executed by the Italian region of Lazio, and the state of Lower Austria also partook in a deal last year. "Regardless of the nature of the assets backing bond issues, the ratings on sub-sovereigns could be negatively affected by the allocation of proceeds," explained analysts. "Resources raised via SPVs may eventually lead to downward rating pressure for those regional and local governments consistently resorting to one-time revenues to finance recurrent deficits."
More deals are sure to come via this avenue because the national budget law now authorizes regional and local governments to quicken the collection of property divestments by issuing bonds backed by future real estate sales.
Going forward, S&P said that further rating action would be heavily dependent on the disclosure of Italy's 2004 budget. The government has committed itself to realizing a fiscal adjustment of about 2% by that point - this is required in order to replace one-time revenues, which will account for approximately 1% of GDP in 2003, while pushing the deficit below 1% of GDP, explained one analyst.