Taking structured products to the world

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Taking structured products to the world Powered By Docstoc
					Reprinted for IFC from October 2004

products to
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 products to
 the world

Latin American domestic structured issuance has caught up with the more
established cross-border market, thanks in large part to the work of the
International Finance Corporation and structured products expert Lee Meddin. But
this is just the start of Meddin’s plans for the emerging markets, with Latin America
likely to take a pioneering role again. • Felix Salmon reports

EUROMONEY'S FINANCE MINISTER of the          Emerging-market borrowers, then,                aid of a few hundred million dollars in
year award usually goes to an emerging-      inevitably have levels of currency, interest-   World Bank capital.
market official, and for good reason.        rate and rollover risk that their developed-       The man at the IFC in charge of making
Finance ministers outside the OECD might     market counterparts would never dream of        this happen is Lee Meddin, a former
not be smarter or more sophisticated than    having to deal with.                            structured-products expert at ABN Amro in
their G7 counterparts (although many are)       The problem is well known, and the solu-     Singapore, who was tapped to set up a new
but they certainly have a much harder job    tion has long been known in theory:             structured products group in Washington
to do when it comes to managing their        emerging-market economies have to               at the end of 2000. Since then, his group
countries’ debt.                             develop liquid domestic capital markets,        has helped to mobilize more than
  The problem is known as “original sin” –   with well-defined yield curves and the abil-    $2.5 billion, while putting up only $500
the fact that countries and companies in     ity to fund a wide range of credits.            million of its own money. Moreover,
emerging markets, when they can borrow,         That’s easier said than done, though, so     Meddin assures Euromoney, that $500
can usually only raise money in foreign      the International Finance Corporation has       million generated very impressive returns
currency, or at short tenors, or both.       decided to step in and help out, with the       for the Bank.

Reprinted from · EUROMONEY · October 2004                                                                   
   Meddin has set himself a highly ambi-         credit rating that will allow it to market      Ps500 million borrowing programme, and
tious goal: to create whole new asset classes    securities to domestic institutional            maybe even find entities that could be will-
in emerging-market economies around              investors. Now that most emerging-market        ing to lend to it directly.
the world. If he is successful, these asset      economies have low nominal interest rates,         Occasionally, a few hedge funds will even
classes will require zero involvement            along with a relatively solid legal and regu-   be allowed into the deal, in countries where
from the IFC once the first few deals have       latory framework for such issuance, there’s     domestic hedge funds are active, such as
been done.                                       really nothing preventing structured            Brazil and India. “Sometimes a small alloca-
   The initial conditions are certainly in       issuance from constituting the lion’s share     tion to a hedge-fund investor base is helpful
place. Structured products in general –          of the domestic non-sovereign capital           because it provides liquidity in the
asset-backed and mortgage-backed securi-         markets in some countries.                      secondary market,” Meddin says.
ties – are now a $7 trillion market in the US,      Meddin’s goal isn’t simply to increase the      One, investor, however, will always be a
accounting for 31% of the total size of the      quantity of structured-product transactions     part of any deal that Meddin is involved in:
bond market. Treasury bonds, by contrast,        in the emerging markets, however: he            the IFC itself. When he first started his
are just 24%.                                    wants the issuers that he is sponsoring to      group, Meddin got involved only as an
   Europe, too, has posted impressive            return at some later date with plain-vanilla    adviser in some deals. Those days are
growth in structured products: the market        issues as well.                                 over. Meddin’s keen to put his money
there grew tenfold, from $50 billion to             “With a partial guarantee, you’re having     where his mouth is, usually taking the
$500 billion, in the five years between 1998     the investors do due diligence on the           riskiest tranche of any deal. That helps to
and 2003.                                        underlying credit,” he says. “So the borrow-    reassure investors, as well as giving him a
                                                 ing paves the way for them to borrow in         good return on his investment of time and
An ideal market                                  their own name without further enhance-         expertise.
   The success of structured products in         ment.”
Europe and the US should be repeated in             Those credits do not need to be classical    In hiring mode
good measure in emerging markets. For            issuers, either. In August, the IFC provided       The IFC has now done 30 deals as what it
one thing, emerging-market economies are         a 34% partial credit guarantee to a bond        calls “a structuring investor”, mostly in
far more crisis-prone than those in develop-     deal from Financiera Compartamos, a             Latin America, and it hopes eventually to
ing nations, and structured products             microfinance institution in Mexico.             do that many each year. Meddin is in hiring
usually have much lower ratings volatility       Compartamos is based on the hugely              mode: with six professionals at the
than similarly rated plain-vanilla corporate     successful Bangladeshi model: 94% of its        moment, he hopes to have two more by the
issues.                                          customers are women, the average loan is        end of the year, and another couple in the
   Emerging-market pension and mutual            $300, and most of the loans go to small         months following.
funds with long time horizons, then,             groups of between 15 and 50 women,                 The IFC-sponsored deals have taken place
should love to invest in these deals. Even in    making repayment in full extremely likely.      around the world, in many shapes and
cases of multi-billion-dollar fraud, such as        Once the IFC got involved, the deal, for     forms. Meddin doesn’t really draw a
with Parmalat in Brazil, many structures         just Ps190 million ($16.5 million), received    distinction between the securitizations and
have held up perfectly, with no loss to          an investment-grade double-A local-scale        the partial credit guarantees. In both
investors.                                       credit rating from both Standard & Poor’s       instances the IFC puts up capital, takes risk,
   Emerging-market institutional investors       and Fitch. The lead manager, Citigroup/         and tries to bring new borrowers to the
certainly have cash – Meddin estimates           Banamex, then distributed the bonds to          markets.
that both Latin America and emerging Asia        more than 13 institutional investors. “Just        Because the IFC’s books are dollar-
have about $500 billion in domestic savings      as many as any deal of any size,” says          denominated, it can’t lend directly in local
looking to be put to work – not including        Meddin.                                         currency without hedging its foreign-
the money that residents of those countries         “We need good distribution,” says            exchange risk with a swap; those can be
have held offshore and that might be             Meddin. “We follow the bookbuilding             expensive in emerging markets, especially
repatriated if local investments started         process very closely,” making sure that         at longer tenors. Often, then, a partial
looking attractive enough.                       as many real-money investors as possible        credit guarantee makes more sense from
   The problem is that there are severe          are introduced to the credit and to the         the IFC’s point of view. Since it is just a
constraints on permissible investments for       asset class.                                    guarantee, no money needs to be disbursed,
most of the funds, especially in Latin Amer-        With an AA rating, that’s possible.          and no swap needs to be entered into. The
ica. A lot of Latin countries have only a very   Mexican pension funds are only allowed to       IFC can provision the guarantee at its dollar
small number of big blue-chip companies          invest 5% of their assets in single-A rated     value when the bond is issued, and charge
with the sort of credit ratings that the         assets, which is what Compartamos is, and       for it accordingly.
government regulators require – and those        they generally save that allocation for            To be sure, there is always the risk that
companies can usually get cheaper funding        fallen angels – AA-rated corporations           the currency will appreciate, and the dollar
from local banks than they can from the          which, for whatever reason, have been           value of the IFC’s guarantee will go up. But,
domestic capital markets.                        downgraded. Now they are comfortable            notes Meddin: “There’s a correlation
   With securitization and partial guaran-       with the credit, however, they will probably    between corporate defaults and macroeco-
tees, however, any issuer can get the kind of    happily take up the rest of Compartamos’s       nomic crises. If things improve, one might                                                                                   Reprinted from · EUROMONEY · October 2004
expect the currency to increase in value but       the use of domestic players.                     Meddin’s team. Eventually, Meddin hopes
the economy as a whole will improve too” –            In Thailand, the IFC provided a partial       to help out not only the big companies and
meaning that default, and an IFC payout,           guarantee in October 2002 on what was the        projects that he has been funding so far,
will be that much less likely. “We can pick        largest domestic corporate bond ever             but also the small and medium-size enter-
the better credits in a market,” Meddin            issued in the country – a two-tranche,           prises that account for more than 60% of
says. He’s confident that he is not going to       Bt18.45 billion ($425 million) deal for          global GDP.
invest in companies that will default              Telecom Asia. The six-year tranche had              Meddin doesn’t foresee SMEs individu-
despite an improving economy. So far his           no IFC guarantee at all; the eight-year          ally tapping domestic capital markets, of
results bear him out: he has never suffered a      tranche had a partial guarantee of just          course. But, he notes: “Banks can’t keep
loss on any of his deals.                          under 50%.                                       funding SMEs. They’re good at originating
                                                      In Argentina, the IFC got involved in the     and servicing loans, but they’re bad at
Groundbreaking deals                               domestic peso market post default, with a        warehousing them.” That’s where the IFC
   And it’s not as if Meddin is picking the        securitization of pre-shipment export loans      can come in. By helping move SME loans
easy deals. His first was a partial credit guar-   by three Argentine banks in August 2003.         off banks’ balance sheets and into the port-
antee for Indian paper manufacturer                   In Mexico and South Africa, the IFC           folios of institutional investors, Meddin can
Ballarpur Industries in February 2001,                                                              help free up more lending capacity across
when no issuer without a triple-A local                                                             the emerging markets.
credit rating had ever done a five-year
deal. Ballarpur, in contrast, came with a
                                                      Meddin usually takes                          Helping banks lend longer
10-year bond on an issue rated AA+ by                 the riskiest tranche of                          “Banks haven’t been lending long term,”
Standard & Poor’s.                                                                                  Meddin notes, “and you need long-term
   Then, in June, Meddin helped to create
                                                      any deal for the IFC.                         lending to a larger group of SMEs.” If banks
the very first mortgage-backed security in            That helps reassure                           can start securitizing their loan portfolios,
Korea. Issued by KoMoCo, a borrower that                                                            then they will have less of a duration
had been set up with the IFC’s assistance,
                                                      other investors and                           mismatch if they start lending at longer
the bond had a senior tranche of W228                 gives a good return                           tenors. So the IFC has already taken on
billion ($174.4 million) and a subordinated                                                         mezzanine risk at certain banks – Meddin
tranche of W9.7 billion. The IFC bought                                                             won’t say which – in order to build a track
W54 billion in all, hedged with dollar-won                                                          record that it can eventually show to the
swaps.                                             provided the first-ever partial credit guaran-   market.
   The deal was a huge success. “Today,            tees for municipalities: Tlanepantla in             Further out in the future are even bigger
there’s no role for the IFC in that market,        Mexico in February 2003, and Johannes-           possible deals – maybe a securitization
which is a very established market,”               burg in South Africa in June 2004.               of non-performing loans in China, or
Meddin says proudly. In Korea, just as in             And in Saudi Arabia, the IFC was              even, eventually, a securitization of the
South Africa, where the IFC did a similar          involved in the first ever corporate bond        entire IFC portfolio of structured bond
deal – the first MBS in Africa – for South         issue in the country, for Saudi Oryx Leasing     issues.
African Home Loans in December 2001, the           Company in March 2003.                              But even after just four years in the job,
MBS market is now mature, and needs no                All of these deals, however, essentially      Meddin has already seen domestic struc-
outside help.                                      took ideas that had been tried and tested        tured issuance in Latin America catch up
   Since the end of 2001, Meddin has been          elsewhere, and simply applied them               with the much more established cross-
active all over the world – especially in          to emerging markets. In Chile, Meddin            border market. If things go according
Latin America, but also in Russia and Asia.        went a step further, in an attempt to find       to Meddin’s plan, that could be just the
Eastern Europe is a tougher nut to crack, he       financing for the Universidad Diego              beginning.
says, “because the best corporates were            Portales, a university with an ambitious            The first hint of what such deals might
bought by western companies”. In any case,         expansion plan and no obvious funding            look like came in June, when the IFC
now that much of eastern Europe is in the          source.                                          provided a partial guarantee on Latin Amer-
EU, those countries are “not a target market          Student loan securitizations are nothing      ica’s first ever securitization of non-
for us,” says Meddin.                              new, of course, but UDP wasn’t lending its       performing loans.
   But Russia has seen a lot of IFC deals,         students money, so it wasn’t collecting             The deal was in Colombia, where
especially with Russky Standart Bank.              their loan repayments. Instead, it decided       Titularizadora Colombiana, Colombia’s
“When the longest issues in the market             to securitize its student’s tuition payments,    secondary mortgage market company,
were three months, we helped do a six-             with a UF1 million ($23 million) bond            issued the equivalent $67 million in bonds
month bond,” says Meddin. “Then the                denominated in Chile’s inflation-indexed         backed by non-performing mortgages at
market was doing six months, so we helped          currency unit. The IFC’s 30% guarantee got       two Colombian banks. The IFC’s guarantee
them do a one-year deal.” The lead                 the deal a AA– rating from all three ratings     helped the senior tranches, at five and
manager on the issues was Troika Dialog,           agencies, and the eight-year bond came 240       seven years’ duration, get a triple-A
in line with the IFC’s commitment to               basis points over the sovereign.                 local-currency rating, creating a real market
fostering domestic capital markets through            More innovation is forthcoming from           for non-performing loans in Colombia.                                                                                      Reprinted from · EUROMONEY · October 2004