Securitisation was once seen by governments as a vital tool to address budget problems and develop capital markets. The events of recent years, however, have tarnished its image. Nevertheless, Chris Dammers discovers that the technique may still have a role to play as governments try to escape from deficits and stimulate their economies.
Starting in the late 1990s, governments across Europe turned to securitisation en masse as they sought to reign in their public borrowing.
Naturally, some were more active than others, but in many European countries, it was the government’s desire to take advantage of securitisation that led to the establishment of a legal framework to allow both public and private sector deals.
In Greece, for instance, the securitisation market was established when the government packaged dividends from a state owned bank. Several further government sponsored securitisations followed, backed by assets as diverse as air traffic control fees, lottery ticket sales, and payments from the European Commission, before the private sector was even allowed to participate.
Greece was far from alone in its enthusiasm for securitisation. Italy was by far the most prolific user of the technique, launching a string of deals backed by assets such as social security contributions, healthcare receivables and real estate. These deals included what were at the time the largest and most liquid ABS in Europe.
In the UK, direct and indirect use of securitisation was central to the country’s infrastructure investment plans. The Private Finance Initiative, which became the main tool to finance capital investment, was at its core a securitisation technology, even if it was in many instances bank financed.
The fundamental principle involves raising debt through a special purpose vehicle secured on long term contractual cashflows — in some ways the only meaningful distinction from more traditional securitisations was the typically high level of construction and operational risk.
For a while, government securitisation seemed a match made in heaven. Government deficits shrank, market participants were able to get access to government cashflows at hefty spreads, and everyone was happy.
Well, not quite everyone. In 2002, the European Union’s official statisticians, Eurostat, took umbrage at what it felt were abuses and laid down the first firm rules for government securitisation, banning off balance sheet treatment for securitisations of future flows and assets sold at a discount of greater than 15%. These changes hit Greece, Ireland and Italy particularly hard, putting billions of euros of ABS on to the national debt.
Nevertheless, governments adapted quickly and continued to use securitisation to deal with their mounting deficits — this time for existing assets. Despite its setback, Italy remained active with its SCIP series of real estate securitisations, joined by Germany, Ireland, Spain, Portugal, the UK, Finland, Belgium and others. But in order to keep the cost of funding low, they often took shortcuts that went against the spirit of Eurostat’s rules, if not the letter.
Taking the mickey
"When the whole Eurostat thing kicked off, governments decided to do all these whacky things and they took the mickey, frankly," says Julian Tucker, a securitisation partner at Shearman & Sterling. "These are supposed to be not part of the government debt, because there’s no government support, and there was basically a government guarantee sitting behind them."
So Eurostat refined its rules again after a lengthy consultation and review. Italy was forced to put some of its securitisations on balance sheet in 2005. Elsewhere, deals such as the financing for the Channel Tunnel Rail Link, which featured a government guarantee of track access charges, were brought on balance sheet by local statisticians. In 2007, shortly before the credit crisis spread to Europe, the agency unveiled tough new rules that ruled out almost all forms of explicit and implicit support. As a result, virtually all of the government securitisations that had been executed in the intervening years would have to be reclassified as government borrowing were they to be executed now.
"Unless there’s some degree of risk transfer, any attempt to achieve deficit reduction is going to fail," says one head of securitisation at a European bank. "We’re a long way off being able to use securitisation for risk transfer, especially for off the run assets, and most of the assets governments around Europe might consider securitising are off the run."
There is a precedent for such true sale deals, however. One of the few governments to escape Eurostat’s axe was Finland, which securitised social housing loans from the state owned Housing Fund of Finland during the late 1990s and early 2000s — the inaugural deal in 1995 was the first ever government securitisation. The Fennica deals were structured with no recourse to the government and only a small retained risk exposure — well below the 15% limit later imposed by Eurostat. This is the approach that governments will have to take now if they want to get any deficit benefits.
Explicit government support for ABS may, however, help economies.
"For SMEs, they need to start thinking about facilitating solutions for the market," says Scott Dickens, global head of structured finance at HSBC. "When the crisis kicked off, they felt the market would fix itself. Now they see it needs intervention."
Accounting treatment isn’t the only obstacle. Greece’s attempt to securitise delinquent tax securitisations was vetoed by the EU’s budget commissioner on the grounds that it was only a temporary fix and did not address the country’s long term fiscal imbalances — a stance that seems to have been borne out by this year’s horrendous budget projections. It is possible that the EU will take a similar line in the present fiscal crisis, although it may feel that any steps to reduce deficits are welcome.
"There’s a big structural element to the deficit," says Tim Conduit, a partner at Allen & Overy in London. "Given the scale of the deficit we have, talking about selling the Dartford Bridge [in the UK] or something like that makes a difference for one fiscal period, but it doesn’t make a difference over time. The only way that governments are going to get deficits under control is through fiscal means rather than flogging assets. Efficient securitisation financing is going to be useful, but it’s only one part of the equation. I would hope that the EU would see it as part of the solution."
US limits
Outside Europe, government use of securitisation has been far more sporadic — the US has largely avoided the technique given abundant demand for municipal bonds, an apparently bottomless market for Treasuries and minimal use of European-style public private partnership financings.
So far, the most extensive government securitisation programme by far has been the Resolution Trust Corp’s, which helped dispose of the assets seized from failed banks in the Savings & Loans crisis of the late 1980s and 1990s. The parallels with the present day crisis are painfully obvious, but the government’s approach has been very different — for the most part, banks have been bailed out rather than liquidated, and the bulk of problem assets remain on bank balance sheets, albeit often with government guarantees in place.
This approach has left less opportunity for government sponsored securitisation — the prospect of synthetically transferring some of the government’s exposure back to the private sector seems remote given the furore over credit derivatives, even if investor appetite were present.
Instead, somewhat ironically, the US government has taken massive exposure to securitisation, whether through purchases of agency RMBS, loans to support the Federal Reserve’s Term Asset Backed Securities Lending Facility and the Treasury’s Public Private Investment Programme, or capital injections and balance sheet guarantees for banks loaded up with CDOs.
Japan’s Asian leadership
In Asia, securitisation has been central to some governments’ support for housing markets. In Japan, Korea, Malaysia and Hong Kong, state owned mortgage agencies have formed the backbone of the securitisation market, albeit often with recourse to the agencies.
Japan has, however, used securitisation to transition its mortgage agency from a direct lender to a Fannie Mae-style secondary market liquidity facilitator, reducing the government’s balance sheet liabilities and accelerating repayment of the former Government Housing Loan Corp’s obligations to the Fiscal Investment and Loan Plan.
In 2008, Japan also inaugurated a master trust securitising loans extended under the FILP as part of a seven year plan to reduce its balance sheet by ¥140tr. But securitisation can only nibble at the edges of Japan’s rising debt burden, especially given market conditions.
While Asian ABS markets including Japan have not suffered from credit problems quite as badly as those in the West, they have not been immune either and issuance has fallen off sharply in most jurisdictions.
Meanwhile in other Asian markets, a handful of governments have opportunistically securitised assets — as in Europe’s early days, often as much to help along the private market as to address governments’ budget problems. Hong Kong securitised the Lantau Link bridge in 2004 while Thailand funded the construction of new government offices with the technique.
Malaysia’s state mortgage agency Cagamas pioneered RMBS, asset backed sukuks and SME CLOs, while its regular RMBS issuance provides a pricing benchmark for the private sector in other asset classes. This role continues, but the agency has reverted to primarily unsecured issuance in the wake of the credit crisis.
Asian governments may not be constrained by supranational accounting bodies, but they arguably face greater market constraints than in Europe. In many jurisdictions securitisation was a novel product when the crisis hit, and confidence has been badly damaged.