by Ben Miller

Long before failed presidential candidates stirred passionate debate over the future of state oil monopoly Pemex, attempts at finding efficient ways to involve the private sector in government projects challenged Mexico. As long-term financing for projects starts to become more available, there have been a few success stories at the federal level, but generally it has been an uphill slog.

“At the federal level there has clearly been a lot of thinking about how to respond to the needs they have and the tremendous growth they’ve had and to implement projects to improve infrastructure and take advantage of existing assets,” says Cherian George, managing director in the global infrastructure group at Fitch. He notes the 270 billion peso Fonadin national infrastructure fund as an example of how Mexico has been learning from other countries, like the UK and Canada, where public-private partnership (PPP) has produced results. But George cautions that it is an ambitious plan that will take time and be characterized by fits and starts.

Mexico needs to spend $120 billion on infrastructure in the next three years, according to Merrill Lynch, second in the region only to Brazil, which requires $225 billion. The federal government piqued the interest of the world’s major infrastructure players last year with the 37 billion peso Farac toll road concession. It must now generate the same enthusiasm for projects in other sectors.

Down the ladder, where lower credit ratings and murkier policy complicate matters, state-PPPs have been few and municipals unheard of. At the federal level, lawmakers still struggle to find ways to channel interest to areas other than toll roads, including politically sensitive areas like water. Mexico is also slowly emerging from an era of heavy limits and restrictions, and it is going to take time to fill the pipeline.

States have additional social issues to deal with, and officials are much more constrained than at the federal level. It can also be more difficult to set aside budgeted funds. Progress has been slow, but a few governments are testing the waters.

State of Mexico Test
In the first week of August, the State of Mexico was to open the bidding on 3.6 billion pesos in five infrastructure PPPs. Although relatively small, the series will provide something of a test for state-level PPPs.

The package’s three road projects were to be staggered between August and September, with the largest, the 1.3 billion peso Vial Urbano road in the city of Toluca, up first. Also to be bid in early August are an 800 million peso cultural center near Texcoco and a 700-800 million peso specialty hospital in Zumpango. The second and third roads will follow by mid-September. The state plans to name winners in January.

“To confront our enormous needs, we need private partnership,” says state finance minister Luis Videgaray. “Not to export the budget, but to make it better.” Lack of a streamlined approval processes is a major challenge for state and local entities across Mexico, he adds.

With the projects, the State of Mexico aims to leap two major hurdles facing state-level PPPs: lack of guarantees that funds will be budgeted, and a dearth of transparency in bidding. It has developed what it claims are the first state-level PPPs in Mexico supported by budgeted funds.

“There have been some successful [PPP] projects at the state level, but those have been projects where revenues cover the cost of the project,” says Carlos Puente, the state finance ministry’s director of projects. The PPPs have been approved by the State of Mexico legislature, which has also allocated the necessary funds in its budget.

A special trust set up to receive state payroll taxes will guarantee monthly payments to the winning bidder, Puente explains. As the contracts are technically designed to be for services rendered – rather than for a completed project – payments can be withheld if a project is not moving to schedule.

“Our responsibility is to make the process as easy and transparent as possible,” says Videgaray. Each step of the bidding is posted online with ample time for comments. Interested parties so far include international names such as FCC, OHL and Acciona, as well as domestic heavyweights ICA and Ideal.

Testing Support
The projects will also be an opportunity to test new means of support from the federal government. “At the state level, we are just getting started with the PPPs, so we are very hopeful about the projects announced by the State of Mexico,” says Alonso García Tamés, president of state development bank Banobras. “We are looking into how to cooperate with the State of Mexico.”

Typically a creditor to states and municipalities, the development bank’s function has been usurped by ample private liquidity. García Tamés says the role Banobras can play is in providing instruments to channel resources, rather than lending directly.

Banobras provided a first-loss guarantee, its debut product of that type at the state-level, for the State of Mexico’s 27 billion peso refinancing of loans in May. In another new feature for Banobras, the bank was structuring agent on the state’s deal, and also acted as intermediary on swaps to fixed rate. The groundbreaking transaction opens the door for other borrowers to leverage the development bank’s rating.

“This is a very efficient product that will help us support states in collaboration with the private sector,” says García Tamés. This would apply to local and foreign firms working on projects in Mexico. “It’s a way for the development bank – instead of competing with the private sector – to collaborate with it,” says García Tamés.

García Tamés sees Banobras providing two types of guarantees for state projects. Performance guarantees at the pre-operation stage would reduce the cost of funding and provide better financing rates. The first stage is riskiest, as operators have to work without cashflow.

In the operating stage, the bank’s participation would change. “We see our role more as structuring and making sure that the source of payment of the funding is strong and reliable,” the official explains. “We also see ourselves providing guarantees if that source of payment is interrupted.”

Beyond Roads
Private involvement at the federal level is being highlighted by last year’s Farac toll road concession auction and innovative financing. While not a PPP, the concession won by ICA and Goldman Sachs Infrastructure Partners underscored the attention being paid to Mexico by international infrastructure players, as well as the level of development in local capital markets.

The government expects to name the winner of the next roads concession – known in the market as Farac II and the first to come out of Fonadin proper – in October or November, says Fonadin director Federico Patiño. This concession, featuring roads in the Pacific region, will offer a Greenfield component that its predecessor lacked. The parameters of a Farac III package – focused on roads in the northeast – could be announced in the next few months, Patiño adds.

In what could be a test of federal support for infrastructure projects, Fonadin is set to help the next toll road concession winners battle volatile market conditions by providing credit to concessionaires in the absence of capital market funding. “Financial markets have changed, but on the positive side there is now the Fonadin in place to mitigate some of the problems,” Patiño explains. He points to wider spreads and reduced clout of monolines as the biggest challenges to winning bidders getting financing.

Fonadin also expects to provide some subordinated debt financing. The key for the fund is supporting the project’s rating to entice local lenders, particularly Mexico’s highly liquid pension funds, Patiño says. He expects the 200 million peso Puebla airport expansion to provide a testing ground for the fund to provide its first mezzanine debt.

Airports and seaports are also priorities. The $300-$400 million Maya Rivera greenfield airport is slated to go up for bid this year, Patiño says.

Other kinds of projects will also be competing for capital. “Despite the fact that roads are going to obtain large amounts of funding from Fonadin, I think water and solid waste treatment are urgent areas whose importance will gradually increase,” says Banobras’ García Tamés. Fonadin is supporting two desperately needed water treatment projects in Guadalajara and San Luis Potosí, he explains, that will come up for bidding this year. It is also looking for other similar projects.

The Jalisco state government cancelled the bidding for the Guadalajara project in late June due to technical problems with the bids. It is expected to be relaunched later this year. The Agua Prieta y El Ahogado plants together would treat 100% of the waste water produced in Guadalajara’s metropolitan area, versus less than 10% in July. Fonadin has approved participation of 1.36 billion pesos of the 2.77 billion peso total cost. In San Luis Potosí, it will commit 134 million pesos out of a 335 million peso total. The El Morro facility would raise the water treated in the city to near 100% from 70%.

With water projects, asset quality is more difficult to asses than roads, explains Fitch’s George, as large parts of the asset are underground or in hard-to-reach places and likely to be less often looked at. Political risk frightens investors wary of putting long-term money where prices – and thereby returns – are often manipulated by politicians to please electorates that see water as an inalienable right. LF