In December 1998 it was so hard to sell Latin American project finance bonds to institutional investors that Salomon Smith Barney decided to use an insurance company guarantee to boost the credit rating of a Chilean bond issue, even though the bonds had already received an investment-grade rating. After coming to a near halt in 1998 and 1999, business is beginning to pick up again. The region’s huge infrastructure needs, privatizations and strategic acquisitions in sectors such as power and telecommunications are driving demand.
However, the market for project finance bonds remains hindered by regulatory and legal issues in Brazil, and serious economic and political problems in Colombia and Venezuela. In Mexico, where the outlook is brightest, multilateral or export credit agency participation still is required to get a deal done. Capital market deals are viable only for unusually strong projects, often with top-name sponsors and dollar-denominated export revenues.
The Inter-American Development Bank is backing a few infrastructure projects with loans in which a multilateral agency lends alongside commercial banks. It is also starting to develop ways of encouraging sponsors to issue local currency bonds, particularly in Argentina, Brazil, Chile, and Mexico, which have both heavy infrastructure financing requirements and growing pension funds looking for good local investments.
Despite the growth in project finance activity in Latin America and increasing risk tolerance in the mid-1990s, the shock of the Asian crisis in 1997 curtailed deals. Still, the unusually strong projects could be financed even in the capital markets. The $213 million SCL Terminal Aereo Santiago bond financing in December 1998 to expand the international airport in Santiago was supported by diversified revenue streams, substantial dollar-indexed revenues and a strong Chilean economy. The $472 million term loan and Rule 144A private placement in May 1999 for Compañía Mega, an Argentine natural gas project, had three strong sponsors: YPF of Argentina, Petrobras of Brazil, and Dow Chemical, which provided completion guarantees and demand for products.
Since mid-1999, the situation has varied across the region. Thomas E. Lake, vice president in Dresdner Kleinwort Benson’s New York project finance group, sees a divided market with the best opportunities available in Mexico, Brazil, Chile, perhaps Argentina, and longer lasting problems in Colombia, Ecuador and Venezuela. Colombia and several of its notable projects financed in the capital markets maintained investment-grade credit ratings until late 1999, when problems related to drug production and guerrilla activity began to affect the economy. The rating of the TermoEmcali, the state-owned utility and single offtaker, tightened considerably. Ecuador has plans for privatization but it is too soon to tell how the new government will implement them.
Petroleos de Venezuela (PDVSA) is delaying plans for additional oilfield and port development projects at least until the forthcoming election, when the political landscape might become clearer. Lake thinks the prospects for selected mining projects are not bad in Bolivia and Peru but he is not sure the markets agree.
Even though the economic and political picture is not favorable in Colombia, Oleoducto Central (Ocensa), a pipeline built to transport crude oil from the Cusiana and Cupiagua oil fields in Colombia, retains an investment-grade credit rating from Duff&Phelps. Curtis A. Spillers, group vice president in Duff&Phelps’ global project finance group comments that the structure of many export-oriented projects with strong sponsors can often hold up even during difficult economic and political times. Ocensa is the only way to get oil from the fields to the port of Coveñas for export.
Ralph E. Scholtz, managing director in BNP Paribas’ New York project finance group, believes that the best opportunities over the next couple of years will be in Mexico and Brazil. He would include Venezuela if the political climate were more investor friendly. Given PDVSA’s outsourcing program and efforts through numerous projects to attract outside investors, Scholtz believes that Venezuela has the ability to turn itself around quickly, although the political will is currently lacking.
In Mexico the bank is financing expansion projects for Pemex refineries, power transmission lines, and independent power projects (IPPs). The US Export-Import Bank is involved in all these deals.
Jeffrey T. Wood, managing director in Société Générale’s New York project finance group, is also working on Mexican IPPs. Two years ago no financing could be done in Mexico or elsewhere in Latin America without political risk insurance. Today, short-tenor, quasi-corporate deals are being done without political risk insurance in some markets, says Wood. With more room in their country risk baskets, banks are starting to refocus on Latin America.
Wood notes that much of the forecast doom and gloom resulting from the Asian and Russian crises did not fully materialize in Latin America. Project sponsors with a long-term strategic commitment to the region, particularly in power and telecommunications, are actively doing deals both on and off their balance sheets. There will be a continuing need for infrastructure development in the region. For example, Brazil and Mexico need huge expansions in power plant capacity and many of the oil and gas exploration projects are waiting to be financed.
Mexico Powers Ahead
Mexico plans to meet increased demand for electricity over the next 10 years mainly through IPPs. Christopher Dymond, vice president of Taylor-DeJongh, a Washington, DC-based boutique investment bank specializing in project development and finance, observes that a large number of US, Canadian, European, and Japanese developers are submitting IPP bids to the Comisión Federal de Electricidad (CFE), the state-owned enterprise that oversees all transmission and distribution. Dymond says one reason is that Mexico has a well-established, relatively transparent process for competitive bidding. Another reason is that lenders and lawyers have worked with the commission through numerous legal issues to produce power purchase agreements (PPAs) that are mostly acceptable to both the commission and the lenders.
The downside of lending to Mexican power projects is uncertainty over possible future privatization of the electricity commission and deregulation of the natural gas industry. Multilateral agency participation is therefore likely to be required for Mexican IPP financing in the foreseeable future. Because of this uncertainty, power purchase agreements for the IPPs have provisions for privatization but also require consent from the lenders for any change in the status of the offtaker, the federal commission.
Brazil has huge power needs as well but is far behind Mexico in resolving legal and regulatory issues to develop PPAs that are acceptable to both lenders and the government. As a result, agreements for numerous IPPs are under negotiation but not finalized. The Brazilian system is about 90% hydroelectric, making the country vulnerable to a drought. Even aside from that risk, recent forecasts of GDP growth suggest a need for increased power capacity.
Christine Wood, who is responsible for business development in project and structured finance at the US Ex-Im Bank, says that Brazil is currently the hottest market for her institution. The bank has received applications for telecommunications projects and even for power projects that are under development. In Mexico it is working on three highly structured, non-recourse transactions for Pemex. Wood comments that because of long lead times, many of these deals were brewing six months ago.
Ex-Im activity, of course, is counter-cyclical. Four years ago, when the project finance bond markets were strong, there was little demand for Ex-Im guarantees. Then, for a time after the Asian crisis, no deals were getting done. Now, there seems to be enough equity and commercial bank financing to get the deals started, but no one is comfortable enough to try to finance an entire project solely with a bond tranche.
Multilaterals Step In
Recognizing the recent need for multilateral agency participation to get most project finance deals done, the IDB has been enhancing its product offerings to serve its member countries’ needs. The bank’s private-sector program began in 1995 with authorization to create exposures in the form of loans or guarantees equal to 5% of the total amount the bank lent in a given year, with a limit of $350 million. Since then, the annual amount of new loans and guarantees has grown to about $635 million and the authorized limit for the private program has been changed from 5% of the bank’s annual commitments to 5% of its total outstandings.
The IDB’s current private-sector exposure is about $1.5 billion. Given the dramatic increase in Latin American private-sector activity since 1995, the IDB private sector department can be expected to make proposals for additional increases in its exposure limits in the coming years – perhaps an increase in its percentage of the bank’s activity.
Between 1995 and 1998 the unit made A/B loans -in which the agency provides funds for the A loan and commercial banks for the B loan – for infrastructure projects in more than 12 countries. Since then it has diversified its loans to include power (including generation, transmission, and distribution), water, sanitation, gas transport, telecommunications, and the world’s first privatized postal system in Argentina.
In the past few years the IDB’s private sector department has broadened its product base to include B loans privately placed with institutional investors and political risk guarantees to cover bond financing. The privately placed loans are credit rated and placed with large, sophisticated institutional investors that have in-house capabilities to evaluate and follow emerging market paper. Bernardo Frydman, deputy manager of the IDB’s private sector department says: “We want our co-financiers to have a long-term view and know what they are getting into.”
In 1999, the IDB placed $400 million this way, which represented about 40% of emerging market paper purchased by large institutional investors (not including Rule 144A paper). Frydman explains that these loans have long terms and fixed rates, which are particularly appealing to Latin American utilities trying to maintain stable affordable tariffs for their retail customers.
New Products Available
Going forward, Frydman believes that guarantee products provide an efficient way for his institution to leverage its own exposure limits and provide the greatest amount of help to member countries. The unit’s next product development project will be to use its political guarantees to facilitate the issuance of local bonds to finance local infrastructure projects, particularly in countries with growing pension funds.
Financing infrastructure projects locally relieves projects of foreign exchange exposure and in the long run, saves a country the huge intermediation costs of both borrowing and investing overseas. Antonio Vives, deputy manager, for infrastructure, financial markets and private enterprise in the IDB’s sustainable development department notes that pension funds are well established in Argentina and Chile and show considerable growth potential in Brazil and Mexico once various regulatory issues are resolved.
According to Vives, the IDB may explore the possibility of creating special-purpose vehicles to finance portfolios of projects, similar to those recently created in the US. Such vehicles would help bond investors diversify their risk and would not require an IDB guarantee. Paulina Beato, principal economist in the IDB’s infrastructure and capital markets division warns that in the beginning it may be difficult to assemble enough projects in one country to diversify investors’ risks.
Perhaps multi-country portfolios will be considered, with bonds raised in several countries to diversify foreign-exchange risk. Clearly, further development of the local capital markets in Latin America under the auspices of a multilateral agency such as the IDB is an important step to avoid problems that will inevitably occur the next time overseas lenders and investors are afflicted with emerging market jitters.