Securitisation: The financial tool powering Kenya's roads, and Its risks

If there is one topic that Kenyans still struggle to understand about the country's finances is securitisation. 

It is a song that has been sang and chorused whenever President William Ruto steps on a podium to speak about the country’s economic future.

He has argued for it while his opponents have opposed. He says it will reduce the country’s ballooning debt burden. His opposers says securitisation is simply a debt clothed differently.

His administration has implemented this financial strategy on the Road Maintenance Levy (RML) in a bid to reduce pending bills to road contractors. The government issued a Sh175 billion bond on the backing of this financial instrument.

As such, fuel prices went up by Sh7, not because the landing costs were higher, but because road contractors need to be paid. It might be working because National Treasury Cabinet Secretary John Mbadi confirmed recently that all road contractors have been paid until December 2024. 

So, what is securitisation? And what is the worst that can go wrong?

An article by the International Monetary Fund (IMF) tracks securitisation back to the 1970s when mortgages were pooled by US government backed agencies to raise funds and by the 80s, the market had caught up, and other income generating assets began being securitised.

Securitisation is the transfer of assets or revenue stream by the originator, in this case the government, to a special purpose vehicle (SPV), which then issues a debt – like the way the Kenya Roads Board (KRB) issued the Sh175 billion roads bond – to raise money.

In Kenya’s case, Sh7 a litre from the fuel levy goes into the SPV where it acts as a guarantee to the owners of the bond that they will be paid.

The major challenge, as Dr James Muia, former National Treasury Principal Secretary who now works as a consultant, notes is in governance – how will this money be used?

Muia says it is an innovative strategy in such a way that the entity (the government) can get the money it needs now instead of waiting to collect it in bits over a period that may take years.

“There is an innovation around it,” he says. “But I think the catch is once you get the money upfront, what do you do with it?”

For KRB, the plan is to revive 580 stalled road projects and reduce dependency on the exchequer. 

If the money is not used prudently, on the intended purpose, then a fiscal risk would arise because that stream of income would not be available in future as it will be going to the SPV.

In the case with RML, this Sh7 will not be available to beef up government coffers.

As such, the governance structure around the SPV must be water-tight and transparent.

“If there is no transparency, then people will not invest in the SPV,” he says. Additionally, those who invest may ask for a very high return because of the risk which will be counterproductive of the strategy as it would appear cheaper to have waited to collect this money over the years.

Muia notes that while usually the government does not give security when it borrows, in securitisation, the cashflow or assets that have been transferred to the SPV are offered as security.

“If you go to a market that is functioning perfectly, the persuasion to use securitisation is sometimes difficult,” added Muia during the release of a report by the Institute of Public Finance (IPF).

The 2008 article by IMF titled "What is Securitisation" explains that this financial strategy started as a way for financial institutions and corporations to find new sources of funding – either by moving assets off their balance sheets or by borrowing against them to refinance their origination at a fair market rate.

“It reduced their borrowing costs and, in the case of banks, lowered regulatory minimum capital requirements,” the article says.

Yet, history reminds us how securitisation can mess an economy as this same strategy is what crashed the US financial markets in 2007/2008.  The practice of pooling mortgages in the 70s and 80s caught up as risk appetite of banks and investment firms was insatiable that even 'bad' mortgages were included in the pool.

IMF notes this fact in the article.

“The subprime mortgage crisis that began in 2007 has given the decades-old concept of securitisation a bad name,” it says.

It explains that in some markets, such as those for securities backed by risky subprime mortgages in the United States, the unexpected deterioration in the quality of some of the underlying assets undermined investor confidence.

“Both the scale and persistence of the attendant credit crisis seem to suggest that securitisation—together with poor credit origination, inadequate valuation methods, and insufficient regulatory oversight—could severely hurt financial stability,” it adds.

Former Budget and Appropriation Committee Chair Ndindi Nyoro claims that the first time securitisation was introduced by the President at the national economic level it was rejected. The Kiharu MP says he was part of the meeting, back in 2023, which was attended by former National Treasury Cabinet Secretary Prof Njuguna Ndung’u.

“That meeting had all the decision markers around our finances including the CS and the PS who is still in office. I want to confirm to Kenyans, we all declined this issue of securitisation,” he says. “It was common knowledge to us that any money you borrow through securitisation is a debt and therefore cannot be treated separately as anything different.”

He says securitisation is akin to having a hardware shop, whose proceeds you use to service a debt, but you decide to securitise sales from cement, walk into another bank and tell them to give you a loan against the proceeds of that product line.

Nyoro says the backing of the Sh7 a litre is based on a gazette notice by a Cabinet Secretary.

“What happens if another minister comes in tomorrow and writes off that Sh7? Where will the banks (who bought the bond) recover the money from?” he poses.