[This page is a series of focused write-ups on applications in securitisation. For other applications, see the Securitisation Applications section on the Securitization asset classes.]
It is not only Wall Street but even the Governments in various countries which have been at the receiving end of securitization. The motivation of the Government is simple – if it is possible to raise money through capital markets as also transfer the risk of collections to the capital markets, it makes quite a lot of sense for the government. Securitization is only an additional source of funding for the government – it does not disturb existing avenues.
It would be interesting to see how governments account for securitization: in most cases, securitization of government revenues will be in the nature of future receivables. Therefore, securitization proceeds should be taken as a part of the capital budget, not revenue budget.
Federal, state and local authorities in various countries have been involved in securitization. Here, we deal with some prominent securitization deals.
Social security receivables securitization in Italy:
Italy made global headlines with its proposal for securitization of delinquent social security contributions. The Italian government aimed at reducing its fiscal deficit by the transaction. Financial Times hailed the offer as one of the outstanding deals for the year 1999.
The proposal, announced around June 1999 finally went through in late 1999 and was a sell out among the investor fraternity. Rated AAA, the deal was backed by overcollateralisation of 10 times.
Details of the transaction are available in the various news items on our news page – see references on the country page for Italy – click here.
Tobacco bonds by New York City:
In the realm of government revenues securitization, the transaction that made headlines world-over was the securitization of tobacco settlement revenues by New York City. Anti-tobacco lobby cursed the deal, and Wall Street lapped it up.
The genesis of tobacco bonds lies in tobacco settlement. On Nov. 23, 1998, 46 states, Washington, D.C., and various U.S. territories entered into a master settlement agreement (MSA) with the four largest U.S tobacco manufacturers — Philip Morris Inc., R.J. Reynolds Tobacco Co., Brown & Williamson Tobacco Corp., and Lorillard Tobacco Co. The four states not party to the MSA previously settled their claims against the tobacco companies. The MSA is a comprehensive agreement settling the states’ medical care cost claims against the tobacco industry in return for the industry making payments and taking certain other actions. The MSA payments include five initial payments through 2003 ranging from $2.4 billion–$2.7 billion per year, and annual payments beginning in 2000 and continuing in perpetuity in amounts ranging from $4.5 billion–$9.0 billion per year.
It is these payments that the various States, beneficiaries under the settlement, want to securitize.
Apart from New York City, Nassau and Westchester Counties have also securitized their tobacco settlement receivables.
See our news page for coverage of the tobacco bonds
- 27th July 2000 – Florida ruling may jeopardise tobacco bonds
- Tobacco bonds nearing fruition -news dated 6th July, 1999
- the announcement of tobacco bonds by New York – 8th October, 1999
- rating of tobacco bonds tobacco bonds a sell out
- Tobacco bonds rated the deal of the year
- Even the lawyers want their fees securitized – click here
Links on tobacco bonds:
- In June 1999 issue of Structured Finance, Standard and Poor's put up a detailed write up titled Tobacco Settlement Securitization Offers Benefits and Challenges.
Interesting: History of governments' borrowings from capital markets
A story of how "financial renovation" led to financial innovation
(Based on a news report in Financial Times, 19th Sept 2005)
According to history books, the first recorded instance of a marketable sovereign bond cropped up in 12th century Venice, where the rulers started to raise money from their citizens by issuing notes that promised to repay the funds after a period with 5 per cent annual interest.
However, drawing from subsequent experience in France and the Netherlands, it was the English government which arguably gave birth to the first set of co-ordinated debt market policies in the 17th century.
In 1693, England was bankrupted by war with France and the royal family's reputation was so poor it was unable to bully local bankers into extending loans.
So parliament asked officials to produce a plan to raise finance over a number of years, and consulted some Dutch, French, German and Scottish advisers operating in London at the time.
While London has long been an international marketplace, using foreigners in this way was contentious but set a trend that continues to this day. Mr Marès, who is French, is but one of a number of non-British now helping to sell UK debt.
The first foreign advisers produced some striking debt management schemes, one of which led to the creation of the Bank of England.
Among the most successful was the "tontine", essentially a longevity bond, launched in 1693 and promising a fixed rate of interest (initially set at 10 per cent) as long as the investor, or a designated individual, was alive. Interest was shared by investors whose designated individual was still alive. Thus tontines were a bet on a life. Investors appeared to make rational decisions, most of them designating a young girl who was deemed to have the best chance of a long life.
"Investors quickly found they should pick a child but not a toddler, who would have a greater chance of dying in infancy," says Mr Marès. In the 18th century came the "consol" for consolidated annuities, a bond more similar to those we know today. This was a bond that paid a fixed rate of interest, usually 2-4 per cent. However, the consols generally had no expiry date.
More schemes proliferated. prompting a very modern sense of anxiety about the soaring national debt. David Hume, the 19th century political economist, declared: "Our madness [in becoming endebted] had exceeded the madness of the Crusaders."
As this anxiety grew, the government took steps to consolidate outstanding instruments into one common pool of debt to make it more liquid and thus easier to trade. By the late 19th century, most of the consols, tontines, lottery bonds and other instruments had been converted into a small number of national bonds, eventually known as "gilts".
An author of the modernisation of the debt market was William Gladstone, the Victorian prime minister. However, by modern standards his role was not entirely glorious: Gladstone was running the government's bond programme and was also making a tidy profit trading them.
"Insider dealing wasn't considered inappropriate at the time," says Mr Marès. "It was customary for the people involved in debt management to trade on the basis of the information they held."
Other financial precedents have helped pave the way for today's dealmakers. "The bankers and advisers [in earlier centuries] were very creative, very innovative," says Mr Marès, as he waves a couple of dusty tomes borrowed from the Bank of England and Treasury archives.
"We tend to forget about what they did but the past can teach bankers today a thing or two."