Emerging market players in the structured finance world might soon have a new platform to develop mortgage covered bonds: Peru. Legislation on this product is currently before the Peruvian congress and is piquing the interest of foreign and domestic ABS devotees alike.

"We're monitoring the situation there," said Reggie de Villiers, head of LatAm structured finance at Bank of America Merrill Lynch.

The legislation could lead Peru to introduce the product before its peers, although its passage does not guarantee the market will be a dynamic one.

"Peru is more advanced in passing covered-bond-specific legislation than other Latin American markets where the framework is being discussed, such as Mexico or Brazil," said Bernardo Costa, director of Fitch Ratings.

Among the bill's proposals is the authorization to issue covered bonds in foreign currency and soles and as either public or private placements. Overcollateralization also has to equal at least 10% of the outstanding principal of the bonds.

To be sure, the legislation is specific about the segregation of the ring-fenced assets in the covered bond pool, stating that "in the event of an intervention, dissolution or liquidation of the issuer, the collateralized assets will be separated from the bankruptcy estate." Also in the bill is the flexibility to use assets apart from mortgages in the covered bond pool, namely cash, sovereign paper and other relatively safe instruments. But in total the non-mortgage collateral cannot exceed 30% of the total.

As an additional safeguard, the legislation establishes the role of a monitoring agent, which would follow the performance of the bond pool and perform duties akin to a trustee.


Barely Tapped Potential

The Peruvian mortgage market currently stands at PEN12.43 billion ($4.3 billion) in both dollar and sole-denominated loans, while the outstanding volume of mortgage-related instruments is the equivalent of $43.7 million, according to the covered bond bill. It is unclear whether this figure already takes into account a 20-year, $35 million RBMS deal that represented the debut of secondary mortgage agency Titularizadora Peruana last February. All the same, it is clear that RMBS has scarcely made a dent in the mortgage market, which in itself is undeveloped.

Titularizadora Peruana was created in 2006 with a mandate to acquire residential mortgages and cobble together RMBS. It replicates a model that has successfully created an RMBS market in Colombia.

For Peruvian banks, the appeal of relatively long-dated covered bonds is obvious. The tenor mismatch between mortgage loans and the most common forms of bank funding is becoming increasingly acute in the country. Falling interest rates and a political mandate to extend mortgages lower down the socioeconomic ladder has led to a heady growth in origination over the past few years.

There is still ample room for growth, as the country faces a housing deficit of 1.2 million homes. Mortgage loans make up only 8.6% of total bank assets in Peru, a paltry number compared with neighboring countries. In addition, the ratio of outstanding mortgages to GDP is tiny at about 3%, compared to 15% for Chile, 11% for Mexico and 3% for Colombia.

While Peruvians can take out mortgages in both dollars and soles, origination is growing faster in local currency, a trend encouraged by the government. Currently the market is roughly 50/50, having been overwhelmingly dollar-denominated only nine years ago.

For the first time, mortgages are available to middle-class Peruvians, a trickle down from the past when only the upper crust enjoyed access.

Finance Minister Mercedes Araoz has been touting the bill in the local press, saying it will stimulate the secondary market in mortgages and potentially help keep mortgage rates down by increasing loan supply. A lawyer familiar with covered bonds in other countries said the hopes of a more active secondary market as a result of covered bond legislation are not farfetched for an undeveloped market like Peru's. As banks issue covered bonds, it should generate a more standardized approach to origination and reporting, which would, in turn, facilitate secondary market trading of loans.





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