A new World Bank report credits Mexico for developing a future flow credit enhancement mechanism for municipal bonds without a federal government (sovereign) guaranty.  The innovation led to a sharp rise in municipal bond issuances in Mexico from 2001-2003.

The credit enhancement adopted by Mexican municipalities was inspired by Citibank’s securitization of Telmex telephone service receivables in 1987, which was the first major future flow securitization in a developing country.  That transaction involved securitizing telephone receivables owed to Telmex that arose when Telmex completed more calls for AT&T customers calling into Mexico than AT&T completed for Telmex customers calling into the United States.  According to the report, “Telmex sold the AT&T receivables to a U.S.-based trust and instructed AT&T to pay its Telmex invoices to that trust.  This arrangement isolated debt service payments to bondholders from any possibility of misdirection by company or government officials and guaranteed the bondholders first access to reliable cash flows.  That allowed Telmex securities to earn a higher credit rating than Mexico’s sovereign debt.”

To adapt the Citibank/Telmex future flows model to the municipal credit context, the municipality created a trust administered by an independent financial manager, which would receive tax-sharing payments (i.e., future flow receivables) to which the municipality was entitled from the federal government.  The financial manager could then make debt service payments to bondholders before any of the tax sharing grant funds were delivered to local officials and the bonds issued by the municipality or the trust itself could receive higher credit ratings that they would absent the credit enhancement.