Following on from looking at mortgage financing recently, and noting the impact that higher lending rates have on affordability, developing capital markets is clearly essential in reducing funding rates and also to allow for effective risk management. Securitization is widely used in developed markets, however in Central America the track record of this mechanism is not as well established, despite gaining gradual traction and to date with infrastructure related projects and other receivables – to date, El Salvador has been an interesting player in the region’s securitization markets.
Several aspects of the effect of securitization are important in changing the balance on risk management, not only does this allow groups to manage receivables risk but also provides an investable asset class for insurance agencies and pension funds. Banks can effectively lower their regulatory minimum capital requirements and free up capital to expand operations, reduce dollarization and generate a multiplier effect via initially reducing the cost of and thus improving access to credit.
As the take up of insurance products and pension funds grow – deepening the investment universe and capital markets play an important role in providing liquidity and suitable investment products. Securitization can also play an important role within the banking system by issuing local currency debt, allowing for the dilution of dollar denominated liabilities on an issuer’s balance sheet and inherently reducing currency risk.
A quick recap on how securitization works, courtesy of the IMF – this however assumes that all SPV legal framework exists and that issuers are able to transfer assets, the framework for this often does not exist in emerging markets:
An interesting characteristic of Latin American securistation is the focus on diversified payment rights (DPRs) and remittances. During the mid 2000s, DPRs such as MT-100s and MT-200s, which are SWIFT-based wire payments of hard currency to banks in emerging markets, surpassed export-based securitizations to become the dominant asset class being securitized in Latin America. In Central America specifically, there is also the high level of remittances and specific securitization framework focused on this sector, which offers a unique opportunity for banks in the region to reduce funding costs and ideally free up balance sheets for further lending. The fairly recent introduction of covered bonds also offers another angle for banks to securitize mortgages, although to date issuance has been limited since the region’s first in 2012.
Northern Triangle framework
In 2010, the US government signed MOUs with presidents of Honduras and El Salvador to facilitate securitization of remittance flows under the Building Remittance Investment for Development Growth and Entrepreneurship (BRIDGE) Initiative. The goal of this was to allow banks to use securitised remittance flows to reduce funding costs and create funding for more productive purposes such as infrastructure investment – in El Salvador there have also been moves to encourage private investment similar to those in Chile and Colombia regarding investor security and rights, as well as incentives.
El Salvador has been one of the more active players in securitizing remittances, raising USD650m between 1998 and 2004 from future remittance flows as well as other DPR such as export revenue and FDI. Typically remittance issuances are rated higher than the issuing bank and potentially higher than the sovereign credit, given the dollarized nature of the cash flows which mitigate currency risk. There is ample scope for growth of securitization, especially given that the two main Salvadoran pension funds have USD6 billion in assets under management, which can potentially also allocate to fund the nation’s securitised issuances.
Following the country’s Securitization Act 2008 – several innovative securitizations were launched, including:
- San Salvador Municipality which raised USD20.8m by securitizing tax receipts and was the first public institution to do so in Central America and reduced interest costs from 22% to 17%, freeing up USD4m for public works initiatives over the 5 year duration.
- The Road Maintenance Fund (Fondo de Conservación Vial ‘FOVIAL’)raised USD100m over two years, with the initial USD50 raising in April 2012, rated AA- by Fitch; the second issuance of USD50m in two tranches in April 2013 was rated AA- by Fitch (first tranche of USD35m for 14 years, second tranche USD15m for 5 years), priced at 5.75-6.70%
- Private entities have also taken advantage of the option of securitization, which includes a $55 million issue a few months ago for a hotel project (USD45m, 10 year duration at 6.5% issued by hotel chain Royal Decameron in September 2012), along with several education projects.
- Securitization is also under consideration for funding part of the planned USD492m airport expansion in San Salvador
El Salvador has also featured in cross border transactions, with financial structuring proven most innovative for the region in Panama – as an alternative to securitization, Panama’s Global Bank issued Latin America’s first cross border covered bond in 2012, using the same contractual law used in typical securitizations. The five year USD300m issuance was upsized from the initial USD200m, and was backed by US dollar mortgages originated in Panama. Global Bank’s issuance obtained cheaper funding than it would otherwise have achieved through a vanilla unsecured issue, and it also obtained a higher credit rating than the issuer (BBB- vs issuer BB+). Panama’s fairly inactive, yet sophisticated RMBS market witnessed some activity in 2013 after 2 years of no placements, with a RMBS transaction for USD45m, with the underlying collateral comprising residential mortgage loans in El Salvador. Most securitizations have been locally placed, with just a few cross-border transactions.
Guatemalan and Costa Rican securitizations continue to mainly be DPR and merchant voucher future flow securitizations as local banks leverage USD flows to access favourable funding from international markets, although transactions are limited in Guatemala owing to inadequate legal framework.
Whilst capital markets in the region remain underdeveloped and less able to appropriately manage risk, funding costs continue to be elevated, undermining investment capacity on behalf of public and private institutions. El Salvador has demonstrated interesting securitized transactions in recent years, and as these gain momentum, the ability of banks and other groups to free up capital and obtain better funding rates should have a multiplicative effect on consumption and infrastructure investment. Going back to the original theme of housing finance, the ability of banks to securitize mortgages will undoubtedly reduce funding costs which can eventually be passed on to borrowers, assisting in the affordability equation. That said, regulatory change rarely happens with any haste, let alone effective change…