The Potential Role for Securitizing Public Sector Revenue Flows: An Application to the Philippines

IMF Working Papers, June 1, 2002

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Since the mid-1980s, the securitization of future flow receivables has grown in importance as a financing alternative for the public sector.
In a world of perfect capital markets, there appears to be little rationale—in terms of reducing the average cost of public sector financing—to resort to secured borrowing.
For many developing countries, financial markets are far from perfect, and secured financing may play an important role where increased uncertainty or financial market volatility leads to credit rationing driven by information asymmetries.
Secured financing subordinates existing and future creditors and, as a result, may raise the cost of future borrowing.
High transaction costs, the thin market in secured instruments, the risk of legal challenges, and reduced budget and debt management flexibility may offset the cost advantage of public sector securitization.

Securitization of future flow receivables can be an important financing alternative for the public sector in environments with imperfect capital markets.
The potential benefits are context-dependent:
- May mitigate credit rationing caused by information asymmetries during periods of increased uncertainty or financial market volatility.
- Offers secured financing options when unsecured access is constrained.
The potential costs and risks include:
- Subordination of existing and future creditors, with implications for the cost of future borrowing.
- High transaction costs associated with structuring securitized financings.
- Thin secondary markets for secured instruments, which can limit liquidity and pricing efficiency.
- Legal challenges that may threaten the enforceability of securitization arrangements.
- Reduced budgetary and debt management flexibility due to dedicated revenue flows pledged to creditors.

Consider securitized financing only after weighing trade-offs between short-term financing benefits and long-term fiscal and borrowing costs.
Account for institutional and legal capacity:
- Assess legal risks and the enforceability of security interests over public sector revenue flows.
- Strengthen legal support in revenue administration to reduce receivables generation risk.
Evaluate market conditions and transaction costs:
- Consider the thin market for secured instruments and likely high transaction costs when projecting net financing benefits.
Consider creditor relations and debt strategy:
- Recognize that subordinating future creditors can alter credit ratings and terms for subsequent debt issues.
Maintain debt and budget management flexibility to the extent possible when designing securitization arrangements, including reserve account structures and coverage ratio considerations.

Subject: Credit ratings, Debt service, Economic sectors, External debt, Financial services, Legal support in revenue administration, Money, Public sector, Revenue administration, Securitization
Keywords: coverage ratio, credit rating, Credit ratings, credit rationing, debt covenant, debt issue, Debt service, financing cost, financing need, Fiscal policy, flow receivables, future receivables, international finance, Legal support in revenue administration, North America, Public sector, receivables generation, receivables generation risk, reserve account, revenue flow, securitization, securitization arrangement, securitized financing, ticket receivables, WP