Despite the fact that political risk insurance (PRI) transactions have gained increasing popularity south of the border, Fitch Ratings announced in a report last week that the future-flow structure, the old favorite, is still the best bet.
While PRI provides a great deal of value to any transaction, Fitch said it cannot mitigate all fundamental credit risks. "Future flow transactions are better than PRI transactions because PRI doesn't insulate investors from a variety of sovereign risks that future flow transactions do," said Greg Kabance, an analyst with Fitch. "This is very apparent in Argentina, where future flow deals are performing while other transactions are not and banks and state-owned companies are highly susceptible to sovereign risks such as devaluations or interference in payment mechanisms causing deals to default."
While Argentina has proven to be a solid learning experience for market players, Fitch's report focused on transactions in Brazil, especially those of Banco Itau and Brazil's state-owned oil giant, Petrobras. Since the downfall of Argentina, Brazil has also become the most dominant country in the structured finance arena with a variety of transactions. Both entities, Petrobras and Banco Itau, have completed future flow deals as well as political risk insured transactions. "Petrobras and Itau have done both PRI and future flow deals and we believe that those future flow deals are much better and we want the investors to know," Kabance said.
According to Fitch's report, the hard currency revenues captured by future flow structures protect the transactions from the negative effects of devaluation. The collection of customer payments offshore also mitigates the sovereign risk. "Those two issues are very important because they allow the transaction to be rated above the sovereign ceiling," Kabance said. "The [PRI] insurance allows the transaction to be rated above the sovereign ceiling but its protections are more narrow."
While Fitch believes future flows are better than PRIs, Kabance also noted that there are certain PRIs that are better than other PRIs. "We believe the hierarchy of structured deals would be future flow transactions, then PRI transactions completed by private companies and non-state owned companies and then PRI transactions completed by banks and government owned companies," Kabance said. Banks that only operate in Brazil are expected to have a more substantial amount of sovereign risk compared to a company that exports internationally, and therefore Fitch believes transactions from these entities are weaker.
The PRI product was launched in the capital markets in late 1999 when the Overseas Private Investment Corp. (OPIC) provided a political risk insurance policy for an issuance from Ford Otosan. The product has become increasingly popular and between January 2001 and March 2002, six out of the 15 structured finance issues in Brazil used a PRI policy to mitigate sovereign risk in order to achieve investment-grade ratings.
According to the report, Fitch rated two PRI issues in 2001, assigning BBB' ratings to a $300 million issuance from AES Tiete Certificates Grantor Trust and a $500 million issuance from Companhia de Brasileira de Bebidas (AmBev). The remaining four PRI issues emanated from financial institutions and state-owned entities, and Fitch was consequently unwilling to assign investment-grade ratings on these issues.
At the same time, future flow transactions have continually dominated the market. Of the thirteen future flow transactions in Latin America between 2001 and early 2002, five derived from Brazil.
Although future flows are still expected to be the dominant structure for transactions this year, PRI deals are also continuing to gain popularity, as there are rumors of such deals in the pipeline. "While we believe PRI adds a lot of value in certain circumstances, it cannot be applied everywhere," Kabance said. "We would love to see these policies to include additional coverages as we believe it would then be more applicable for more types of companies."
