Structured Finance International Criteria Report Future Flow Securitization Rating Methodology Analysts Summary Gregory Kabance Future flow securitization became popular in emerging markets in the +1 312 368-2052 1990s as a mechanism to reduce sovereign-related risk and provide [email protected] more attractive access to international capital markets for the strongest of emerging-market issuers. A future flow transaction is a Samuel Fox securitization of a company’s future and existing receivables that are +1 312 606-2307 [email protected] due from offshore obligors. These transactions capture cash flows out of the emerging-market country and place investors in a relatively Mark Salgado senior credit position. From a practical standpoint, the physical control +1 312 368-2080 by as third party of cash flows also benefits investors by reducing any [email protected] willingness-to-pay issues. In addition, future flow securitizations mitigate many of the sovereign risks associated with an emerging- Wasif Kazi market borrower. +44 20 7862-4168 [email protected] Future flow securitization has grown in emerging markets over the past Dr. Stefan Bund 15 years, primarily in response to the search for lower cost funding by +44 20 7417 3544 companies that generate hard currency flows. While many of these [email protected] issuers historically relied upon bank debt and straight capital-market bond debt, the volatility and risk perception within emerging markets Wit Solberg pushed these entities toward future flow securitizations. Future flow +852 2263-9922 investments have consistently proven themselves to investors, and over [email protected] the years they have successfully mitigated a variety of the risks associated with emerging-market investments. Related Research • Criteria Report, “Rating Future Flow Transactions and Recovery Rates,” Annual Emerging-Market Issuance Feb. 15, 2006. Emerging-Market Issuance Emerging-Market Future Flow (US$ Mil.) 12,000 10,000 8,000 6,000 4,000 2,000 0 4 5 96 9 1 05 199 19 1997 1998 199 2000 200 2002 2003 2004 20 91–9 19 February 15, 2006 www.fitchratings.com Structured Finance Emerging-Market Future Flow Issuance by Latin America contributed only $2.9 billion to the Country/Region year’s total. It was Turkey, with future flow issuance (US$ Mil.) from six different banks producing approximately Argentina Brazil $5.5 billion that produced the most. 3,560 Caribbean Chile 11,628 432 200 Noteworthy, in the past five years, political risk Central insured (PRI) transactions have also become popular. Colombia America In 2001 and 2002, PRI transactions were 1,492 2,020 approximately 50% of the total issuance. In 2003 and 2004, these numbers declined, although PRI retains a Asia Mexico material presence. For the long run, Fitch Ratings 4,926 expects future flow to continue to dominate 18,377 emerging-market structured finance. Russia and Venezuela Until 2001, Mexico had always been the dominating Eastern 3,349 country for future flow issuance. Prior to Turkey’s Europe explosion in 2005, Brazil had taken over as the 1,775 Peru Turkey primary source for future flow paper. This is Africa 778 11,149 explained, for the most part, in the countries’ relative 1,900 sovereign ratings. Mexican issuers, because they are domiciled in an investment-grade country, are less in Future flow issuance remains the most popular type need of the structural protections provided by future of structured transaction rated in emerging-market flow. Brazil (and Turkey in 2005) on the other hand, countries over the past 15 years. Interestingly, 2005 which has been resting in the ‘B’ and ‘BB’ rating was the highest issuance year for the asset class with categories since 2001, represents a “sweet spot” close to $10 billion in total volume. Latin America where future flow is useful in mitigating sovereign- has traditionally been the strongest producer of future related risks and opens access to international capital flow volume. Issuers such as Mexico’s Petróleos markets for strong companies. Mexicanos (Pemex), who in 1996 placed US$6.0 billion and Venezuela’s PDVSA Finance Ltd While Mexico, Brazil, and Turkey could be considered placement of $3.4 billion, have enhanced Latin the historical heavyweights, there has also been a America’s volume over the years. In 2005 however, significant amount of issuance out of other countries. Emerging-Market Future Flow Issuance by Asset (US$ Mil.) 1991–2001 2002–2005 Credit Card Ex port Ex port Remittances/ Receiv ables Receiv ables Receiv ables Div ersified 5,287 6,769 22,803 Pay ment Rights Airline 13,007 Receiv ables Credit Card 611 Receiv ables Other 5,120 Remittances/ 1,712 Other, 110 Div ersified Airline Telephone Pay ment Rights Receiv ables Receiv ables 5,371 266 530 Future Flow Securitization Rating Methodology 2 Structured Finance Typical Future Flow Transaction Structure transaction’s structure mitigates many sovereign risks by keeping the cash flow offshore until the investors Receivables are paid. If certain events occur (trigger events), the Payment structures typically trap all cash flows going through Obligors Trust the collection account to accelerate amortization of the notes. In some cases, only a portion of excess Principal and flows are captured during early amortization events Interest in order to avert a liquidity crisis for an issuer. Future Future Product Receivables Ratings of future flow transactions are tied to the Collections Investors credit quality of the originator, which is typically Over Principal and Interest measured by its local currency issuer default rating Offshore (IDR). In some cases, it is possible for a transaction’s Local Country IDR to be rated higher than the company’s local currency IDR after considering the company’s ability Originator to continue operating beyond a general default and generate receivables for the duration of the deal. The going concern assessment (GCA) addresses these Argentina has produced more than $3.5 billion, although issues. Achieving a rating at the GCA level is a limited amounts since the 2001 financing crisis. Top tier twofold concept. The company must not only banks from various Central American countries have continue to generate these receivables by producing issued financial remittance future flows. Recently, and delivering the product, but the collections from Indonesia returned to the future flow market with a the receivables must also be legally protected through $600 million securitization of coal exports. Finally, a true sale structure. In some cases, transactions are Eastern Europe and Russia have shown significant rated above the issuing company’s local currency potential for strong future flow candidates. IDR but below the GCA. This analysis is explained in more detail in the Rating Future Flow Transactions The types of assets securitized by these future flow section on page 6 of this report. securitizations have varied over the years. The most common flow being securitized previously stemmed Description of Future Flows from export receivables. Over the past 15 years and There are two general types of future flow through 2005, there has been approximately US$54.2 securitizations: financial future flows backed by billion in future flow export receivables transactions. banks’ generation of hard currency flows and Since 2002, financial remittances have become the corporate-related transactions typically involving most popular future flow asset class, with US$13.2 export receipts of one form or another. Financial billion of remittances/diversified payment rights flows include credit card vouchers, electronic (DPR) securitizations. DPR transactions are closely (typically SWIFT-related payments, including MT- followed by credit card receivables, which have 100s and MT-200s) and paper remittances. totaled US$5.4 billion since 2002. Corporate-related transactions typically involve airline ticket receivables, telephone net settlements A future flow transaction securitizes the cash flow and, the most prevalent, export receivables originating from a specific business line of a bank or transactions, which are backed by products such as company that produces goods or services for foreign oil, gas, steel, iron ore, soybean, paper and pulp, obligors. The structure of the future flow transaction aluminum, coffee and chemicals. is designed to collect cash flows in a dedicated offshore collection account. The cash flows come A bank or company based in an emerging market from a variety of sources, including foreign importers securitizes existing and future receivables related to making payments on receivables, international credit offshore cash flows (usually in a stable foreign card companies making settlement payments to local currency) and receives the proceeds of the debt banks and international banks making remittance issuance denominated in the same currency. The cash transfers to local banks. All cash flows pass through flows originate from a specific line of business in the offshore collection account, and the excess flows which the bank/company has a strong history of are returned to the originating entity only after participation and which is expected to continue for periodic debt-service payments are made. The Future Flow Securitization Rating Methodology 3 Structured Finance the foreseeable future, or at least for the life of the on a letter of credit, cash against documents or cash structured deal. In the majority of structures, the against goods