From its inception less than a decade ago, the securitization market in Latin America has been shaped by a distinct combination of characteristics associated with the countries in the region: low levels of financial intermediation and a lack of local corporate bond markets; highly regulated environments; and, most important and on the average, lower sovereign ratings than those of European and Asian countries.
Given these factors, structures were developed to mitigate the most prevalent risk in the region: sovereign risk. As a result, securitization in the international capital markets emerged as an interesting source of financing for large corporations in the region.
The First Stage
In this way, Latin America entered the first market stage in the securitization process: cross-border transactions in foreign currencies, mainly U.S. dollars, with innovative structures that aimed to mitigate direct sovereign risk. The most common ones to date have been future flow transactions, followed by B-loan structures. To date, Standard & Poor's has rated more than 50 transactions of this type in the region, with issuers from Argentina, Brazil , Colombia, Mexico, and Peru.
Nonetheless, the rating on these types of structures is closely correlated to the performance risk of the company generating the assets. Keeping in mind the relatively low ratings of most of the countries in Latin America, this type of financing has generally been available only to the largest and most sound companies within each country.
These internationally recognized operators usually have higher corporate credit ratings and access to hard currency in times of stress. Companies including YPF S.A. in Argentina, Alcoa Aluminio S.A. in Brazil, and Banco Nacional de Mexico S.A. (Banamex) in Mexico have taken advantage of these sources of financing in the past.
The Second Stage
Although, at least in dollar volume, cross-border securitizations are still the most prevalent form of structured financings in Latin America, some countries and issuers have started moving into a second market stage in recent years: securitizing existing assets in local currencies in the domestic capital markets (see chart).
However, countries in the region are in different phases of the process. Countries such as Argentina have had an active local market since roughly 1997 while others, like Mexico, have markets that are now starting to gain some pace. There are also countries such as Brazil that are taking very early steps.
Overall, "true" domestic securitizations, where the creditworthiness of the deal relies on a segregated pool of assets and not on the company's credit quality itself, are gaining ground with local investors. Domestic markets provide access to funding to a broader number of issuers, with smaller companies issuing structured securities as well.
As a result, in a country like Argentina, where this trend has been developing the longest, S&P has rated close to 40 transactions in the domestic market compared to 14 internationally placed deals from Argentine issuers. It is not only that securitization has consolidated within the local market as a cheaper source of financing but, in difficult times such as the second half of 1999, the Argentine market saw more structured financings going to market than unsecured bond issues because, in many cases, it was the only way some issuers could access the capital markets. Overall, since the trust law was enacted in 1995, there have been more than 100 transactions issued in the local market.
Driving Forces
Two major forces are helping countries move into the second phase of securitization: the changes made to the regulatory, tax, and legal frameworks; and the privatization of pension systems, with the consequent development of a local investor base. Other general factors contributing to the securitization of local assets in local currencies have been the general deregulation process that has been occurring in recent years, and, more recently, the general improvement in economic conditions, which brings stability to local markets. This stability has generally translated into lower interest rates, making it cheaper for issuers to issue securitized instruments.
In 1995, Argentina passed a new trust law relating to the securitization of residential mortgages and other assets. In 1997, Brazil enacted a law that created a new housing finance system and allowed for the creation of securitization companies. In 1999, changes to the original securitization law in Chile broadened the types of assets that can be securitized and eliminated some operational restrictions. In Mexico, recent years have seen changes to laws in most of the states directed toward the development of the securitization market.
Again, in the case of Argentina, the additional reforms implemented by the country's central bank following the enactment of the 1995 trust law opened the door for the securitization of financial assets like residential mortgages and auto and consumer loans. Those reforms brought a set of accounting and tax advantages for financial institutions that promoted securitization. These changes, together with the tax amendments implemented by its securities commission and central bank since 1997 have been the major drivers of the local securitization market in Argentina.
Adequate regulations are also key for the development of local capital markets and the acceptance of securitized transactions. However, regulations not only need to decrease systemic risk, protect investors' rights, and promote market integrity, they also must promote innovation and increase market efficiency and competition.
Constantly changing markets like the ones in Latin America require flexible approval processes by regulators to allow issuers to go to market when conditions might be favorable and to avoid making this option more expensive than a bank loan.
Furthermore, regulatory authorities play a crucial support role in the prompt resolution of problems in structured transactions, like a servicer's bankruptcy or a default. In this regard, Argentina and Brazil had opposite experiences, which led to opposite results.
The support provided to problem resolution by the Argentine central bank for some transactions like the insolvency of Banco Mayo Cooperativo Ltdo., the servicer of six ABS transactions, has helped strengthen the local securitization market . Conversely, the fact that some structured issues in Brazil went to market in the early 1990s and later defaulted due to poor structuring and regulatory approval closed the local market for years.
An increasing local investor base has been the second main driver for the development of this second stage of securitization. The privatization of pension systems in many countries has made pension funds, together with mutual funds and insurance companies, emerge as an important investor class. As an example, in Mexico, the pension system was reformed in 1997 to establish a defined contribution system and replace the current pay-as-you-go system. The regulatory framework was strengthened and domestic long-term savings are now increasing, deepening the local capital market. All these developments will increase the need for longer-term investment products like residential mortgage-backed securities.
Local securitization markets need:
An adequate legal framework and regulations that allow for the basic securitization concepts to be applied in transactions, and that provide the market with adequate predictability, thereby increasing investors' confidence and eventually providing liquidity to the market.
An investor base that views structured products as an interesting investment alternative to more traditional fixed-income securities.
A tax environment that fosters securitization. Transaction and withholding taxes present important obstacles to the development of securitization. Tax gross-up of interest payments to protect investors from tax increases is an interesting option for the corporate bond market, but it makes structuring securitizations a more difficult process.
Local investment bankers' and investors' expertise in securitization. This takes time to develop because it implies an educational process for both sides.
Economic stability and a risk differentiation culture. In countries like Brazil where government securities pay high interest rates, investors are not inclined to look into other investment opportunities that require more analysis but do not have significantly higher yield. Investors need incentives for evaluating credit risk.
An existing pool of assets eligible for securitization. For example, in Mexico, where credit has been almost nonexistent for the last five years, there is not enough of an asset base available for securitization.
What's Next?
There have already been some examples where Latin American countries entered into the third market stage, in which issuers tap international markets with existing asset securitizations denominated in local currencies (see table). For that, sovereign risk cannot be an obstacle as it is right now in most of the countries. Alternatively, additional credit enhancements, such as an insurance policy, need to be incorporated into the transaction. Currently, only issuers in Chile and Uruguay and, to a limited extent, Argentina, would be in a position to issue securities at this stage without any kind of external credit enhancement.
In any case, two or three stages can coincide in a single country at the same time. Argentina has seen all three of them, Mexico the first two, and Brazil only the first one. In the near future, Chile and Mexico are good candidates to move on to stage three in their markets.
While all this happens, securitization in both international and local Latin American markets will continue contributing to greatly increased flexibility for the market as a whole. Accessing new market segments of issuers and investors through new structures will continue to enhance the flow of funds. Overall, the innovation brought about by securitization will continue contributing to a more efficient allocation of savings into productive investments in the region.
