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Deepening local bond markets in the WAEMU through securitization

25.03.2013Anna Selejan

Securitization is a financial engineering technique that enables a private or public entity to raise cash by selling its cash-flow producing assets or its future revenues. These assets are sold to a Special Purpose Vehicle (SPV) which, in order to raise the needed cash, issues fixed income securities on the local capital market.

Although widely used in developed countries and in some parts of Africa (Morocco, Tunisia, South Africa and Nigeria), securitization is a new concept in most Sub-Saharan countries. In the WAEMU, asset securitization has been possible since 2010 when the regional regulator (the CREPMF) issued the relevant texts. The law allows for a very large spectrum of FCFA-denominated assets to be securitized: besides traditional mortgages, it is possible to securitize any kind of existing assets and even future cash flows. Moreover, there is no restriction on entities that can sell their assets: they can be financial and non-financial companies, as well as public sector entities. However, no securitization transaction has occurred yet in this part of Africa. This article explores how securitization can contribute to the development of the local bond markets.

The public debt market in the WAEMU presents numerous challenges to both potential issuers and investors. Issuing costs are high relative to other forms of debt financing and almost all corporate issuers need to have their bonds partially or fully guaranteed by a Development Financial Institution (DFI) or a guarantee fund, which further increases costs. Sovereign or quasi-sovereign issues dominate the bond market, and there is little credit discrimination among these bonds and the guaranteed corporate ones, they have more or less the same risk/reward profile. Maturities are concentrated in the 5-year segment with only a couple of bonds issued at 7 or 10 years. In a nutshell, the fixed income universe in the WAEMU is quite homogeneous, offering investors little choice in risk, yield and maturities.

The CREPMF has recently introduced the possibility of substituting a guarantee with a financial rating given by one of the 2 licensed rating agencies. This action would allow for more credit discrimination among securities, since interest rates would reflect the real credit risk of each issuer. However, the first bond without guarantor and with a credit rating is yet to be issued.

Asset securitization can be the solution for private and public sector entities looking to raise cash, as well as for investors keen on diversifying their portfolios, while substantially increasing the depth of the local bond markets. Through securitization, companies can monetize part of their good-quality assets or future revenues by selling them to a Special Purpose Vehicle (SPV), thus raising cash without having themselves direct recourse to capital markets. If the securitized assets are worth more off-balance sheet (translating into lower borrowing costs against the specific assets than against the company’s entire balance sheet), raising cash through securitization is much more cost-efficient than issuing company debt. With the advent of financial rating, securitization can help curb financing costs for companies that are considered risky and thus have a lower credit rating than part of their assets would.

For example, the first securitization transaction in Morocco that took place in 2002 involved a mortgage pool securitization for Crédit Immobilier et Hôtelier (CIH), a bank who wished to restructure its balance sheet. Through the true sale of a quality mortgage portfolio, CIH was able to raise DH500M (approximately $45M) through the indirect issuance of two senior and one junior tranche. The longest (16-year) senior tranche was issued with a 7.32% annual coupon, only slightly above the 7.1% coupon offered on a 15-year Moroccan government bond issued some months earlier. Had the CIH issued under its own signature, its borrowing costs would have been much higher.

Governments could also resort to securitization of existing assets or future flows, in order to reduce budget deficits, as well as to finance future investments. The Italian and Belgian governments in the late 90s both securitized outstanding social security receivables, thus putting them off-balance sheet in order to reduce their budget deficits to comply more easily with the Maastricht criteria. In 2004, the Government of Hong Kong SAR decided to securitize the future toll revenues from state-owned tunnels and bridges, thus raising a total amount of HK$6 bn (approximately $800M). The state government of West Bengal (India) raised Rs.15 bn (approximately $300M) through the securitization of future taxes levied on several fuel products. Apart from instant cash inflow in an alternative way, these kinds of transactions allow public authorities to have a better asset-liability management, by matching public asset cash flows to the repayment of the asset-backed securities, and a more efficient cost-benefit analysis and hence management of public assets, by clearly earmarking revenues to be used to fund them, instead of relying on general tax-backed funding. Moreover, future flow securitizations involve a thorough assessment of the sovereign originator’s legal and institutional environment, notably recovery processes and claim enforcement rules, which can foster necessary institutional reforms. This in turn can have a positive spill over effect on general investor confidence.

Securitized assets are carefully selected and their future behaviour (future cash-flows) is thoroughly modelled. The future cash-flows (and the risk of non-payment associated with them) are then structured into fixed income securities (tranches) of different risk-return profiles. Thus the same asset pool will serve as a funding source for senior (low-risk, low-return) and junior (higher risk, higher return) securities. The basic idea is to spread the risk unevenly among tranches and reward investors according to the amount of risk taken. For example, the above cited Moroccan mortgage-backed securities were issued in 3 different tranches, all offering different risk exposure, maturity and remuneration.

Getting exposure to a specified pool of assets and having the possibility to select the desired risk-return investment profile are clearly two important steps forward in the development of the local bond markets. While until now, investors could basically subscribe to two kinds of risks (sovereign and quasi-sovereign), with relatively low risk profiles, with the introduction of asset-backed securities, investors will not only be able to get exposure to a new risk classes, but they will also be able to select how much of it they want to hold (by choosing either the senior or more junior tranches). The asset-backed securities also introduce the notion of real credit risk: that of not being able to get back 100% of their initial investment or all coupons, based on the underlying asset pool’s overall performance.

Are institutional investors ready for the big change? Definitely. Are companies and national treasuries ready to add securitization to their list of financing options? Not quite so. Securitization, and financial engineering in general, are quite unknown concepts for the majority of companies in the WAEMU. The subprime crisis has not helped much either in popularizing the concepts in a positive sense. Since companies have traditionally raised cash through banks or DFI loans, a large part (if not all) of their asset base is pledged as guarantee, so there is little room left for alternative asset-based financing. Securitization offers a different perspective on assets: they are no longer considered as an end, but rather as a means to optimize a company’s financing. Realizing this concept may take some time and may need a more innovative state of mind.

We believe that education is key to the success of any financial innovation and that applies in the WAEMU as well. Once public and private sector decision-makers thoroughly understand the concept and philosophy of securitization, it will no longer appear as a mystical, complex and ultimately risky alternative. Bonds issued in this fashion will tap into huge reserves of regional savings (through asset managers and insurance companies) and thus further enhance the efficiency of local capital markets.  

Anna Selejan has been the Managing Director of ALC Titrisation, the first privately owned securitization SPV management company in the WAEMU, based in Abidjan, Côte d’Ivoire. Prior to setting up ALC Titrisation, she worked as Vice President – Investment Management with IC Securities, a Ghanaian asset management company and as Fixed Income and SRI (Socially Responsible Investment) portfolio manager with Allianz Global Investors in Paris (France) for several years. She holds a Master’s degree in Economics from the Budapest Corvinus University, Hungary and a Master’s degree in Portfolio Management from Université Paris XII, France.

Studying MicroEnsure’s “Obra Pa” Insurance in Ghana

11.03.2013Barbara Magnoni

Helping low-income Africans to improve their ability to manage financial risks is a key component of sustainable development. Insurers, intermediaries and others around the continent have been working to develop and improve microinsurance products that offer both value for clients and a business case for insurers. This blog focuses on one such product offered by a microinsurance intermediary to help market vendors and others manage potential financial losses due to flooding.  

In October 2011, the bustling Circle Market in Accra was devastated by a torrential flood, destroying many small businesses and bankrupting many of their owners. The MicroInsurance Centre’s MILK Project partnered with microinsurance intermediary MicroEnsure and German aid agency GIZ to explore the value of a microinsurance product in helping small business owners cope with the severe financial consequences of the flood. The “Obra Pa” product is mandatory for borrowers of certain microfinance institutions (MFIs), and offers clients two benefits: i) payment of their outstanding loan balance and one month of interest to the MFI, and ii) a cash payout of USD114.  

We applied MILK’s “Client Math” methodology, which aims to address some of the open questions about the value of microinsurance, using detailed surveys of small samples of insured and uninsured groups (20-30 each) to document their responses to shocks.  To explore the role insurance played in coping with the flood, we measured the full cost of the shock for the insured and the uninsured and examined the financing strategies used by each.  

What did we learn? That insurance, alone, was insufficient to cover the full cost of such a large shock. When our MILK team visited clients after the flood, we found that they had still not recovered from the devastation of the event. They had not fully regained their borrowing status nor returned to pre-flood sales levels in their businesses. Coping mechanisms used by both the insured and uninsured included the same strategies - borrowing from friends and family, reducing consumption and using their limited income to slowly re-start their businesses. These findings are consistent with MILK’s studies of other property insurance programs in Colombia, Haiti and the Philippines. Insurance provided some relief, but the insured still struggled to recover from the devastating consequences of the flood, even months later.  

One interesting value component of the product appeared to be that it offered some access to additional borrowing, albeit not from MFIs.  The promise of a payout and the deleveraging resulting from the loan forgiveness seem to have served as a type of “guarantee”, improving clients’ creditworthiness and enabling them to borrow from friends and family to get by.  We do not typically think of insurance as a “guarantee” for a loan, but we are seeing indications that beneficiaries use the promise of a payout (particularly when claims are paid slowly) as a type of collateral against new borrowing to cover immediate needs before claims are paid. Compared to the uninsured, who remained indebted and had a reduced capacity to repay that debt, this benefit proved useful, even if only necessary due to the slow payment of claims. For some clients, this access to credit seems to have been instrumental in their ability to move toward to full recovery from the shock, however slowly.  

Product limitations may partly reflect client willingness to pay. The Obra-Pa product in Ghana was a mandatory product with premiums included in MFI clients' loan payments. As such, it was a low-cost product that could be included in a loan payment without burdening the borrowers with separate, likely higher premiums. In all of our studies of similar products, MFIs offered property coverage on a mandatory rather than voluntary basis to address adverse selection and potentially low demand. This suggests that a higher coverage option, which would have proved more valuable in the wake of the flood, may be difficult to sell voluntarily, especially to the poorest and most price-sensitive.  

In studying the case of Ghana, we identified some of the limitations of microinsurance products that aim to help microenterprise owners cope with the effects of a weather catastrophe. These clients face uncovered risks due to the size (too small) and timing (too slow) of the insurance benefit and must therefore complement the insurance with other strategies. In contrast, MFIs can typically use these products to transfer their loan related weather risk to an insurer. Efforts to support non-insurance risk management strategies for microentrepreneurs as well as more risk-sharing between MFIs and their clients may be good next steps to helping microentrepreneurs cope with weather related risks.  

You can read the full brief on property insurance in Ghana and all the other MILK documents at: http://www.microinsurancecentre.org/milk-project.html    

Ms. Magnoni is President of EA Consultants and Client Value Project Manager for the MicroInsurance Centre’s MicroInsurance Learning and Knowledge (MILK) Project. She is an international development advisor with over 15 years of international finance and development experience. Much of her recent work has centered on understanding client needs and preferences and linking these to the development of products and programs to improve access to finance, markets and social protection for low income segments. She has designed microinsurance programs for various institutions, networks and government agencies. She is currently managing the collection and analysis of lessons around understanding the value for clients of microinsurance for the MILK Project. These studies have helped to further the industry understanding of the role microinsurance plays in mitigating financial risks in clients' lives. Ms. Magnoni has a Masters in International Affairs from Columbia University.

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