In recent years, fund raising in the Peruvian securities markets have shown an important growth: about 20% to 30%. Many more companies are seeking to obtain financing for their projects in the securities markets rather than in the traditional banking system. In any case, it is also an alternative to reduce financial expenses.
In order to have a successful offer of securities, the offer must be suitable for pension funds. They must be interested in the securities offered and acquire them. Indeed, as an example, pension funds subscribe approximately 35% of the securities offered in initial public offerings (IPOs).
However, there have been no IPOs of shares. This is not because of a lack of appetite by the pension funds, but because of a lack of interest of entrepreneurs in losing control over their companies. Therefore, capital raising in Peru is limited to debt instruments. This situation can, and must, be changed.
To achieve this, new instruments must be offered to pension funds in particular and to other investors in general. Securitisations could fill the gap.
Securitisation in Peru
Securitisation can be considered as the process that converts future cash flows of certain assets into securities that can be offered through private or public offers. The structure uses the underlying assets and the corresponding future cash flows as a guarantee.
The entity interested in raising funds (the originator) transfers the assets to a trust fund specifically created for such purpose and administered by a trust administrator (the trustee – an entity subject to regulations of Peruvian securities markets supervisor, Conasev) who issues the securities. The funds raised in the placement are transferred to the first entity in consideration for the transfer of the assets.
This process can be illustrated as shown in the figure.
| Transfer of the assets |
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Under this scheme, the originator can give non-liquid assets the ability to generate cash today from cash flow in the future. There are no legal preventions to the kind of assets that can be securitised (except for those subject to seizures or judicial orders). But in order to have a successful securitisation, the assets must be able to generate a predictable and stable income. Future assets can also be securitized: the originator can transfer bills to be generated and collected into the trust.
Big real estate projects
If the originator knows with certainty the cash flow that the transferred assets will generate, debt instruments may be preferable. However, if it is a new project with no historical record regarding revenues and cash flows, maybe equity instruments will work out better. And this is the trend of new infrastructure and big real estate projects.
Indeed, let's analyse two examples: (i) a shopping centre; and, (ii) an urbanisation project. In both of them, revenues are not as predictable as they may be, for example, in a toll road project. In Peru such real estate projects are usually financed by raising funds in the banking system and later in the securities markets through debt instruments. In both cases, the financial expenses are increased despite any equity contribution made by the current shareholders of the company carrying out the project.
First, the company takes a financial leasing agreement with a financial institution (bank). The client instructs the financial institution to buy a real estate property and construct the shopping centre. Once constructed, the shopping centre is leased to the client, who also administers it.
In Peru, financial leasing agreements are those in which the financial institutions acquire an asset according to the instructions of its client. After that the financial institution leases the asset to its client and, at the end of the term of the agreement, the client can exercise a call option and acquire the asset. Meanwhile, law allows the lessee to include the asset in its accounting and depreciate it in the term of the contract. (Depreciation could be an important way to reduce income tax if the common depreciation term for real estate is 33 years, while the standard leasing agreement term is no more than 10 years).
These agreements are guaranteed with the revenues of the project and the land over which the project will be developed. As the revenues are represented by the future leasing agreements with the different stores in the shopping centre, the security interest is a pay or pass through trust or just a simple assignment of rights agreement. The land is either transferred to a trust fund or backed-up with a mortgage.
Once the shopping centre is operative and revenues are assured, it is time to go to the securities market. Mostly this is accomplished through a securitisation of the project itself and is achieved by issuing securitised bonds. In order to maintain the depreciation benefit mentioned above, it is the financial institution that granted the financial leasing which transfers the installments to a trust, acting then as originator. Once placed, the interest rate obtained replaces the interest rate of the financial leasing agreement. Obviously, all the guarantees are also transferred to the trust for the benefit of the securities holders.
Traditional schemes are debt based structures, which necessarily stresses the profit and loss statements of the company. That is why we consider that by using an equity based securitisation schemes, institutional investors can take part financing these projects.
Proposed structure
Going back to our examples, the profitability in shopping centres is represented mainly by the leases of each of the stores, but in urbanisation projects it is by the sale of houses and lease of some commercial spaces. There is a much higher risk in this project that even an experienced manager may struggle to make attractive for investment in equity instruments. So how can this be accomplished?
Let's think for instance in a $90 million shopping centre project. Financial institutions might require a 2 to 1 debt to equity ratio. That is, $60 million that can be financed through debt and $30 million that must be granted by shareholders of the company carrying out the project. However, these shareholders want to share some of that risk without including their other projects. Thus, the risk of this particular project must be isolated from the other projects. Trusts work perfectly for such a purpose.
Indeed, assets transferred to trust funds are not exposed to the risks of the trustor: if the trustor was in default of some obligations, creditors cannot require the seizure of the assets transferred to the trust fund.
In order to use the accelerated depreciation mentioned above, the debt portion of the financing is the same as explained before.
Financial institutions will acquire the real estate and hire a constructor in order to develop the project. As guarantee, all the future incomes of the shopping centre are transferred to a trust fund, composed of pay or pass through accounts. Considering a pay through account, once the account has collected enough cash to pay the next installment. Subsequent deposits are transferred to the trustor.
Once the construction is completed, the shopping centre is leased to the trustor through a financial leasing agreement, which allows the lessee (trustor) to depreciate the goods during the term of the agreement even if the depreciation period for tax purposes is longer.
Now, for the equity. Revenues of the shopping centre are transferred to a trust fund in order to pay the financial institution. Once that amount is deducted of any tax or fees, the surplus (should it exist) is the net income of the project, and that cash flow can be securitised.
So, surplus are transferred to a trust fund and which issues equity instruments that grant stakeholders the right to such surplus. The money is then distributed as agreed. Also, these equity instruments can include certain specific rights to: (i) require the distribution of the incomes or to have a mandatory dividend periodically or (ii) remove the administrator of the shopping centre.
However, only the amount used in the financial leasing can be depreciated in the accelerated way mentioned above. Thus, it would be needed to raise the equity first and then take the financial leasing. So the amount raised in the equity placement is used as down payment for the leasing and therefore the financial institution makes all the payments to the constructor. This allows the lessee to depreciate the full amount used to finance the project.
Urbanisation
This same scheme can be used in our second example, urbanisation projects, but it is certainly more complex. As long as there is a transfer of the properties, there is no interest to depreciate them, and, a constant cash flow must be generated.
For such purpose, the structure can be as follows:
The client can receive a loan from a financial institution and directly acquire the land. It can then hire the constructor and carry out the promotional activities. In order to guarantee the loan, real estate can be transferred to a trust. Proceeds can also be transferred to a trust fund so creditors can supervise the progress of the project and how proceeds are being used.
The client will sell some properties and lease some others (the commercial section of the urbanisation). Most of the houses will be sold under mortgages loans. For such purpose, once the house is separated from the whole property and sold, the mortgage is released or the house is taken out of the trust. The new owner automatically grants a mortgage in favor of the client. Client will assign the loan and the mortgage agreements to a new and different trust.
This new trust will be composed of pay or pass through accounts in which lessees and new owners will deposit the rents of their leasing agreements and installments of the mortgage loans, respectively. These proceeds are used to pay the installments of the loan initially granted to the client, and the surpluses are transferred to the client in the same way as analysed before.
And equity works the same way as in our previous example. Proceeds are transferred to another trust account for the benefit of the holders of the equity instruments. The difference is that in this case there is no need to raise funds first in debt or equity. It is irrelevant as long as the debt/equity ratio is fulfilled.
As these examples have shown, it is possible to isolate the risk of any project through the implementation of trust funds and once done so, it is possible to raise capital through the offer of equity instruments that grant the holders the right to share the dividends of that particular project. This structure allows the project finder to share the risk of the project with third parties without compromising his other projects or its shareholders to loose the control of the company (only losing it for this particular project).
And from the position of investors, these schemes allow them to take part in project as semi shareholders. Likewise, these equity instruments can be offered in public offers and registered in a stock exchange, which will allow investors to transfer the instruments as soon as they want or obtain capital gain in the transfer. Finally, pension funds, according to Peruvian law, are authorised to invest in securitised instruments as long as certain requirements are fulfilled, requirements fulfilled in the examples explained above.
| Author biographies |
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Juan Carlos Escudero
Estudio Grau
Juan Carlos Escudero has been a partner of Estudio Grau since 1997. He graduated from Pontificia Universidad Catolica del Peru Law School in 1992 and pursued the Continuing Legal Education Program in George Washington University in 1996. He also has a Masters degree with specialisation in Contracts, Corporations and International Business from the University of Connecticut School of Law (1996).
He is responsible for the Corporate and Finance Departments of Estudio Grau. Escudero is experienced in corporate and commercial law, with emphasis on financing, project financing and drawing up investment and expansion projects for natural resources and industries. He has consulted several international financial institutions and multilaterals that were structuring and granting credits in complex transactions being carried out with foreign firms established in the country. He has advised a major player in the retail industry on most of its acquisitions in Peru and on the financing of its aggressive expansion.
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Carlos E Arata
Estudio Grau
Carlos E Arata has been a senior associate at Estudio Grau since 2005. He graduated from Pontificia Universidad Catolica del Peru Law School in 2002 and he is studying for a Masters degree in Finance and Corporate from Universidad Esan, Lima.
He has practiced in corporate finance and securities markets law since he graduated, advising a wide range of financial institutions and public companies in financing works, mergers and acquisitions and project finance.
Arata has advised International Finance Corporation and Inter-American Development Bank in financing Norvial in Red Vial 5, the first project finance of the toll road in Peru. He also also represented Compañía Minera Antamina, the most important cooper project in Peru, in a syndicated financing of over $400 million; as well as Grupo Falabella, the Chilean biggest retailer in Peru, in a $300 million financing.
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