Latin Finance - April 2008 - 52

guide securitization structure finance earlier in the decade. For instance, Chile has seen a slowdown since 2005 following a prepayment crisis in the residential mortgage backed securities (RMBSs) market and the emergence of alternative ways of funding mortgages. The types of assets involved in securitized transactions are indicative of a market that is maturing (Graph 1, right-hand panel). The most telling transformation has been the shift away from future flow transactions in the cross-border market towards more traditional ABSs in the local market. Indeed, while export and credit card receivables dominated the market in the 1990s, today a more diverse asset structure has began to emerge. A number of specific developments have contributed to this change in the landscape. First, there have been placements of subinvestment grade structured issues. Second, collateralized debt obligations (CDOs) began to make their appearance in 2006, with Brazil seeing the first CDO transaction in the local market. Third, in Mexico there have been successful placements of ABSs in which the underlying collateral has income flows denominated in pesos while the bonds are denominated in hard currencies. Of course, such a structure creates a currency mismatch that requires developed swap markets to hedge exchange rate risk. Given that swap markets elsewhere remain underdeveloped, it is doubtful that other countries in the region will be able to emulate this feature of the Mexican market in the near future. Nonetheless and despite the progress made so far, much remains to be done. For instance, with the exception of Brazil and Mexico, structured transactions tend to be dominated by one type of asset. In 2007, credit cards represented 58% share of all transactions in Chile, RMBSs reached a market share of 90% in Colombia, and in Peru 58% of all transactions were related to future flows. US. Subprime mortgage loans, for example, are not existent in the region and, in general, the quality of mortgages is much higher as they usually involve better quality debtors. Originating practices remain very conservative and mortgage credit represents a small percentage of total credit in banks’ balance sheets. Furthermore, highly leveraged instruments involved in the US crisis, such as CDOs, are far from being widespread in Latin America. Viewed from this perspective it appears that the incipient nature of structured markets in the region contributed towards avoiding similar problems to those that triggered the crisis in the US. Overall, this may be the advantage of being a latecomer. However, owing to changes in the perception of risk, signs of contagion have started to surface. As a result, the market has seen i) higher costs of issuance and, ii) less demand due to a shrinking investor base, which can be related to two factors. On the one hand, investors might fail to discriminate among different markets and simply decide to avoid structured products all together. This would be the case if they failed to recognize that in the region most of the collaterals are on average less risky than those that triggered the crisis in the US. On the other hand, investors may become less active (institutional investors, hedge funds and, possibly, some local investors) given the losses incurred with similar products in the US or because they reevaluate the risks of investing in these markets. Prospects The outlook regarding future developments in Latin American structured markets must consider the uncertain environment that has hit global financial markets since the summer of 2007. The turmoil in global credit markets originated by the defaults in the United States sub-prime mortgage market, and the related cuts in the value of structured bonds, left exposed a number of banks with these securities in their portfolios. The losses so far have been impressive and are expected to be much larger as the crisis continues to unfold. In Latin America, the effects of the global turmoil must be analyzed according to its impact in the cross-border and local markets. The cross border market experienced a virtual shutdown during the second half of 2007. In fact, rating agencies have reported that only 20% of all cross-border deals made last year were issued after the turmoil began. Thus implying that the overall expansion of this market segment during 2007 took place before the sub-prime crisis began. Local markets, in turn, did experience a halt during August and September of 2007. However, activity quickly resumed. For instance, issuance of RMBSs in Mexico was quite active during the last quarter, as reflected in the volume of new transactions issued ($1.4 billion). Nonetheless, it remains to be seen how markets will behave as further news and developments about the crisis continue to materialize. The resilience observed so far in the performance of Latin American structured markets is partly explained by its low exposure to risks similar to those that triggered the crisis in the 52 LATINFINANCE 2008 Lessons and challenges The region can learn several lessons from the recent turmoil. First, lax lending standards leading to uncontrolled credit growth can be significantly problematic and costly. In Latin America such concerns have already been expressed against the backdrop of the rapid growth in consumer credit products. For instance, of the 8.7 million credit cards issued in Mexico in 2006, 40% were handed out to individuals without credit history. Second, market participants have difficulties in assessing the risks involved in such complex products, which might become an important source of systemic risk. As a result, appropriate regulations need to be put in place, particularly, those increasing transparency of markets. Overall, the risk involved in the underlying assets being pooled, needs to be carefully evaluated and monitored, relying on agencies’ ratings only is not enough. Therefore, appropriate information, evaluation, and risk management systems will need to be strengthened for the market to develop in an orderly and sustainable fashion. In the region, there is limited data availability and some important statistics are simply not existent or do not span over a full economic cycle. All this complicates the assessment of risks and creditworthiness of the borrower. Finally, the crisis has also highlighted that financial education can enhance the stability of the system, even in developed markets. Therefore, its promotion in the region should be an integral part of the development of local financial systems. I Bank for International Settlements Camilo Tovar Economist Office of the Americas Phone: +52 55 9138 0293 Email: camilo.tovar@bis.org Michela Scatigna Research Analyst Phone: +41 61 280 8427 Email: michela.scatigna@bis.org Website: www.bis.org

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Latin Finance - April 2008

Table of Contents for the Digital Edition of Latin Finance - April 2008