ABS was previously governed by a bare law and restrictive prudential regulations that have since been amended for banks and DFIs by the State Bank of Pakistan (SBP). These guidelines cap total exposure of a bank/DFI towards securities issued by a SPV at 5% of its own paid up capital or 15% of the total value of the ABS issued by the SPV which ever is less. Further, the aggregate exposure on account of ABS is limited to 20% of the total paid up capital of the bank/DFI. This will encourage banks/DFIs to (a) invest in and sell-down these ABS, i.e. to churn their ABS portfolio to stay within the 20% cap and to (b) actively trade in ABS to develop a secondary market, rather than to simply purchase these ABS and hold them till maturity.

Pakistan however, suffers from a plethora of bad debts arising in a market not least exacerbated by an increased propensity for corporate insolvency, corruption and insider trading. Therefore, good governance is the buzzword echoed to attract investment in a growing economy where the fledgling market amounts to a paltry Rs.100 Million (approx. US$1,666,666) with only two major ABS transactions to date.

THE LEASING SECTOR

Earlier in June 2002, the specialized Companies Division of the SECP processed the registration of First Securitization Trust as the first special purpose vehicle under the Companies (Asset Backed Securitization) Rules, 1999. This trust has been set up to raise funds for Pakistan Industrial Leasing Corporation Limited (PILCORP) up to rupees one hundred million through issuance of debt instruments against the Securitization of PILCORP's lease receivables. The said transaction was arranged by Aqeel Karim Dhedi Securities (Pvt) Limited (AKD) and Orix Investment Bank Limited to provide funds to PILCORP for retiring its debt obligations. In emerging markets like Pakistan, where volatile economic cycles and sudden shocks are translated on the asset portfolio, protection against deteriorating credit quality is very important. This unstable nature of Pakistan's economy has highlighted the importance of a strong capital base which can provide protection against unanticipated losses. Furthermore, substantial capital provides a leasing concern with greater flexibility to leverage its balance sheet. On the other hand, for leasing companies in developed markets, deterioration in the asset quality usually occurs over the long run, thus enabling them to increase general reserves/provisioning against potential losses over a period of time. A serious issue plaguing the leasing sector is the high rate of non-performing leases and loans (NPLs), a situation that can be attributed primarily to the inadequacy of risk assessment procedures and, to a lesser degree, limited industrial growth that has led to sectoral concentration. Leasing across a spectrum of industries reduces the risk of impairment in the asset quality. Strict credit policies and continuous monitoring of the portfolio are looked upon favorably by credit rating companies and accounts are reviewed closely to establish a company's exposure in each sector, which if exceeds 20% of Net Investment in Leases (NIL) prompts a further examination. Similarly, a drag on ratings may occur if exposure to a single client exceeds 15% of total equity. SECP is paying increasing attention to this factor and has recently proposed an amendment in the rules that govern the leasing sector by restricting exposure to a single party to 30% of unimpaired capital and reserves instead of the earlier limit of 20% of NIL.

TELECOM

Most recently, the SECP has granted registration to Securetel-SPV Limited, a wholly owned subsidiary of United Executors and Trustees Limited, to operate as a special purpose vehicle under the Companies (Asset Backed Securitization) Rules, 1999. Securetel envisages mobilization of funds for Paktel Limited a local cellular telecom by issuing TFCs. Of the total sum of Rs840 million, TFCs worth Rs640 million would be offered as pre-IPO and Rs200 million in IPO. The TFC is rated "A" (single A) by PACRA, is for 3 year tenor and carries profit at SBP discount rates plus 200 bps with a cap of 16 per cent and floor of 12 per cent for the first year and 11.5 per cent for the last two years. United Bank Limited has acted as consultant for the ABS transaction. This securitization would enable Paktel to replace its short-term foreign currency debt with medium-term local currency debt. Considering the fall of the greenback following 9/11, the transaction would improve Paktel's liquidity position by reducing foreign exchange losses.

Securetel purchased a portion of Paktel's receivables and issued ABS notes in March 2003. Paktel in turn expects to utilize the proceeds in retiring partly its existing loans of United Bank Limited of Rs750 million and Pak Kuwait Investment Company's Rs240 million. Nearly 99 per cent shares in Paktel are held by the Luxembourg based Millicom International Cellular S.A, which is a fairly large holding company with 18 cellular operations in 17 countries. Another major player, Orascom Telecom is also expected to assign its nationwide receivables to a foreign bank in Pakistan.

Analysts at IP Securities (Pakistan) said that with the falling rate of returns on National Savings Schemes (NSS) and Government Securities for the general public and financial institutions, investment avenues were falling short and the facilitation of innovative instruments was needed. Paktel had suffered huge exchange losses till the financial year 2001, due to foreign currency borrowings, a significant portion of which had been paid off through internal cash generation and short-term loans. This had led to high reliance on short-term borrowings. Paktel had therefore decided to issue medium term securitized TFCs to rationalize its capital structure and to correct imbalance in asset liability maturity profile.

 

 

The telecom sector itself has seen substantial activity in structured finance. WorldCALL Payphones Limited is one of Pakistan's fastest growing telecom companies, with an installed base of over 5,000 smart card payphones throughout Pakistan. WorldCALL needed to raise Rs. 345 million in new equity financing to fund a major expansion plan, including 8,000 additional card phones and a proposed wireless local loop network supporting 50,000 additional phones. Following the unsuccessful attempts of another securities firm to effect the offering and reopen the Pakistani IPO market, after a dry spell of over two years, WorldCALL appointed AKD Securities as its financial advisor to raise the necessary funds.

Realizing the potential upside for well funded private companies in Pakistan's increasingly deregulated telecom sector, AKD underwrote the offering. After leading a Rs. 195 million pre-IPO placement with institutional investors, AKD generated demand for the IPO and as a result WorldCALL's Rs. 150 million IPO was heavily oversubscribed and the company received the funds necessary for it to continue on its growth trajectory.

MARKET PERFORMANCE

The country has already achieved a moderate level of capital mobilization through the bond and equity markets at 25 and 11 percent of gross domestic product (GDP) respectively, at the end of FY02. However, the figures are deceptive as government issues dominate the bond market with corporate bond market accounting for only 0.6 percent of GDP.

A Five-year bond issued in 1988 by the Water and Power Development Authority (WAPDA), a statutory corporation, was Pakistan's first corporate debt. The issue carried a coupon of 13.5 percent and raised Rs 3.1 billion (PLEASE CONVERT @ spot rates), exceeding the target of Rs 2 billion. Since then, WAPDA has raised Rs 23.2 billion with seven issuances, the first six guaranteed by the Government. However, only the third and sixth issues, both of 10-year maturity, are listed on the two stock exchanges of KSE and Lahore Stock Exchange (LSE). The last three issues between 1993 and 1997 failed to raise the targeted amount because of limited investor interest and the fairly illiquid secondary market.

 

 

As early as 1985, privately placed TFCs issued by development finance institutions (DFIs) had been in existence. However, it was not until February 1995 that the first public TFCs issued by Pakistan's largest paper manufacturer were listed on the stock exchange. The listing signaled the birth of a corporate debt market and was swiftly followed by three others, with yields of between 17.8 and 19 percent, bringing the stock of listed TFCs to a little more than Rs 2 billion. While listed TFCs were not approved securities for commercial banks SLR, non-bank financial institutions (NBFIs) were allowed to invest in TFCs for SLR from May 1997 onward.

In September 1997, additional incentives in the form of tax exemption (on the 10 percent withholding tax) were granted to TFC holders, including corporate entities such as banks, giving a boost to the investor base of TFCs. However, six months later, the withdrawal of part of the tax exemption, leaving only individuals tax exemption, dealt a heavy blow to the fixed income market. While it was expected that long-term securities would be priced relative to government bonds, in reality TFCs pricing (coupon and price) was based on the National Saving Schemes (NSS). The reason is two-fold: first, secondary market for long term government papers was not in a stage where their yields were long-term benchmark rates; and second, NSS constitutes more than a quarter of all domestic government debt and is aimed mostly at the public, which the TFCs, through listing at the stock exchanges, were also targeting. This put the TFC issuers at a disadvantage in raising finance through this instrument.

However, to provide a more enabling environment, the government took some important steps. Most prominent were changes in National Saving Schemes (rationalizing rates and banning incremental institutional investment in April 2000), and the launch of the Pakistan Investment Bonds (PIBs) with the aim of providing a benchmark for long-term securities. With the fall in interest rates, and more importantly, the cut in NSS rates since mid-1999, the effective benchmark for the pricing of corporate bonds has fallen sharply.

Since then, the market has picked up steeply and approximately 32 new issues were launched, approximately 25 were launched since FY02. Also in the wake of falling interest rate scenario and limited quality investment options, TFCs provide an attractive opportunity for the investors. However, secondary market for these issues largely remain dormant due to lack of liquidity and absence of market makers.

In order to make issues more flexible and affordable for the investors, issuers are adding different features from shelf registration to the green shoe option to TFC structure. Use of shelf registration implies that the issuer can split the TFC issue into tranches, which is useful for periodic financing requirements of the issuer and also allows optimal pricing of the individual tranche. Similarly, the green shoe option allows the issuer the right to retain the over subscribed portion of the IPO. However, the issuer has to specify the amount it would retain under this option in advance. A very interesting development is the gradual evolution is the pricing structure of the TFCs. Starting from the plain vanilla structure with fixed coupon rates, the market has witnessed an increasing number of bonds with floating structures.

Indeed, AKD Securities is Pakistan's largest player in structured finance within Pakistan. Being a pioneer in the Pakistani financial markets, AKD has been actively involved in structured finance, venture capitalism, mergers and acquisitions and the equity markets of Pakistan. They advised and arranged a Rs.1.8 billion TFC issue of a major synthetics company to finance an acquisition which was then the largest issue of its kind by a private sector company in the history of Pakistan. AKD was responsible for the complex structuring of the first ever TFC to be issued using the acquired assets as the initial security for the instrument. AKD underwrote the entire issue to enable the client to complete the transaction having successfully placed the largest ever private sector issue with leading financial institutions.

 

 

THE WAY AHEAD

Pipeline ABS projects are still a problem for the SECP and securitizing Pakistan International Airlines (PIA) domestic receivables remains an issue to be resolved. It is hoped that practices of good governance and transparency can overcome the accusations of financial mismanagement and corruption attached to the national carrier. In spite of credit problems PIA has managed to keep afloat by pledge financing their receivables and issuing TFCs. The future however, is encouraging following the 2002 Guidelines. DFIs are preparing to consolidate the market while the SECP assures the facilitation of a strong MBS market having registered a 75% increase in bank housing finance schemes since the issue of the guidelines in November 2002. There are also indications from the SECP and a Japanese holding company towards negotiating the securitization of small & medium enterprise receivables which analysts say, promise higher yields. Recent technical assistance by the Asian Development Bank has enhanced capacity to generate revenue amongst SMEs which capture a fairly large export market in Pakistan.

Pakistan is expected to see a marked increase in structured finance and successful transactions would inevitably spread out over a broad range of sectors. The call to foreign investors to inject funds and repatriate profits rings out clear as ever as the newly elected government tries to exercise its mandate. The growing market of trading corporations, banks, extractive industries and manufacturers has begun engaging legal counsel and accountants to carry out feasibility studies and documentation for a variety of future flows including oil & gas royalties and credit card receivables. Although the recent divestiture by Fitch and the IFC from PACRA may be cause for concern, the SECP is confident that good governance and rating processes installed at PACRA and JCR-VIS are sufficient to secure the investor.

Mr. Ghazali is an attorney at the chambers of Afridi, Shah & Minallah, Pakistan where he specializes in corporate law and finance, transnational commercial law, non-profit law and environmental law. For questions or comments regarding this article or structured finance in Pakistan, Mr. Ghazali may be contacted at lexmagna@hotmail.com