Yurts and kraals go off balance sheet

More and more emerging countries are developing asset-backed securities markets as a way to improve on inefficient bank financial intermediation. The aim is to stimulate domestic investment, as well as to attract international investors that have long bought emerging-market issues backed by hard-currency receivables. With a little help from the IFC, mortgage securitization schemes are now running in Argentina and South Africa. The IFC has also helped develop more complex lease securitizations in Korea and Turkey. If securitization markets are to grow as big as those in Europe and the US, radical changes are needed in bankruptcy laws, regulation and standards of disclosure. James Smalhout reports

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"The fundamentals are in place in several countries," says Arun Sharma, head of structured Wnance at the International Finance Corporation. "Something significant could happen." Sharma thinks that securitization is becoming much more important for emerging markets.

Progress has come in fits and starts for almost a decade. But now, the fundamentals are shifting. Many developing countries are balancing their budgets or even running surpluses, for the very first time. Inflation is down and governments have been privatizing their old pay-as-you-go social security systems. "Crowding out, particularly by governments in Latin America, is becoming less and less of a problem and now they need to develop new securities for domestic markets," says Maureen Coen, a managing director with Moody's in New York. Cross-border deals originating in developing countries meanwhile are becoming more innovative than ever. "We are seeing more creative proposals from investment bankers for both domestic and cross-border transactions," she observes. "They are finally getting deals done, but the cost of securitization is not yet where issuers want it to be. So, some cross-border deals are not coming to market."

Sharma's busy little team at the IFC has been spreading the gospel of securitization from Ankara to Argentina, and from South Africa to Seoul. The IFC announced in June that it is putting $150 million into a start-up, the Secondary Mortgage Market Company (SMMC), Argentina's Wrst major venture in this area. The new venture will concentrate on placing domestic mortgages initially with Argentine investors. The IFC is providing $50 million to buy up to 20% of SMMC's stock. The rest of its commitment will take the form of credit enhancements to support up to $1 billion of debt securities - both mortgage-backed and corporate issues - by the new company.

The SMMC will set standards for the primary mortgage market in Argentina. It will also stand ready to buy all qualifying mortgages presented to it for sale, either for its own portfolio or for eventual securitization. That, in turn, will bring added liquidity into the banking system. Banco Hipotecario (BH), a state-owned mortgage bank that was privatized in January 1999, is the principal sponsor of the new company.

Earlier this year, the IFC bought a 10% stake in SA Home Loans, South Africa's first home mortgage securitizer. Other shareholders in SA Home Loans include Peregrine Holdings of South Africa, International Bank of Southern Africa (a joint venture of Dresdner Bank and BNP Paribas) as well as executives of SA Home Loans. The firm has been in business for approximately one year.

SA Home Loans is creating triple-A securitizations that it sells locally in South Africa. And several of South Africa's retail banks have followed suit, securitizing mortgage pools that they have originated. Sharma estimates that home mortgage rates have dropped by at least 400 basis points as a result of the competition.

But the IFC is taking a risk on market growth. "Mortgages account for 4% of GDP in Argentina," according to James Scriven, Banco Hipotecario's CFO. That compares with about 57% in the US. And it remains to be seen whether home mortgages, not to mention a secondary market, are about to catch on. Lenders usually insist on big down payments from homebuyers in most developing countries and mortgage tenors tend to be short.

Hard to copy

"Fannie Mae clones are diffcult to establish," says Mahesh Kotecha, president of Structured Credit International Corporation in New York. Mortgage assets tend to be hard to transfer because there is a conflict between two sets of rights: the individual's right to his property and the market's right to recover that property in the event of default. "Typically, the individual's rights are the ones that are protected," he observes. "Fannie Mae is working with a lot of players. The technology is spreading and they do good work, but it will take a long time for new mortgage securitizers to pick up a big share of the market."

If domestic securitization does take off across emerging markets, a huge new asset class might be in the making. Corporate treasurers in the US issue asset-backed securities (ABSs) in roughly the same volume as conventional corporate debt. They have achieved this level 15 years after the birth of the ABS market there. "Nothing in principle says that we can't do that in emerging markets," says Kotecha.

But getting from here to there won't be easy. The reality is that issuers from developing countries float perhaps $10 billion to $20 billion in securitizations per year. That compares with about $70 billion in Europe and $300 billion in the US. Bank credit still accounts for the bulk of financial intermediation in emerging markets.

But banking systems have been damaged by recent crises and the call has gone out for functioning capital markets to be built as a safeguard against future systemic bank seizures. Kotecha therefore sees the Asian crisis as something of a milestone. "It pointed to weakness in the banking systems and the need for alternative channels of intermediation," he says. "So, there now is a much more focused attempt to develop capital markets, coming from institutions like the World Bank and the regional development banks."

On the ground, securitization can produce big changes in the way financial institutions operate.The IFC's Sharma points out that the first step is for securitization companies to bring their origination and underwriting up to snuV, so that the rating agencies and investors will feel comfortable. Countries also need to meet international standards for supervision and enforcement.

"That requires a lot of transparency and a culture change," he notes. "When doers of due diligence - lawyers, accountants, rating agencies, etc - know exactly what's happening in the business, a lot of things come to the notice of management." And the greater scrutiny doesn't end when a deal closes.

"A securitized product imposes ongoing discipline," Sharma adds, "because it's continually rated."

"These things boil down to an ethos of doing business," says Kotecha. "Better accounting standards, capital adequacy standards from regulators, and standards for bankruptcy remoteness established by the legal profession are all a great boon to financial market development." But merely wishing securitization markets into existence is no short cut to financial market development. Other capital markets infrastructure is required, along with a suppy of underlying assets.
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