With its first Latin American deal in the market and several other transactions in the pipeline, the Overseas Private Investment Corporation's (Opic) new political risk insurance is taking Latin America by storm.
Designed to protect emerging market transactions against the risks of transfer and convertibility (ASRI 8/9/99), political insurance such as Opic's is seen by many as an effective way to pierce the sovereign ceiling. So much so, that many companies are now pitching deals to investors without an asset-backed component, relying solely on insurance provided by Opic.
Telefonica del Peru is one such company. In the last quarter of 1998 it successfully closed a $180 million securitization of future telephone settlements, but for its latest deal it has opted for a $200 million corporate bond via J.P. Morgan and Merrill Lynch using Opic political insurance. While rumors doing the rounds at presstime suggested that the deal may be pulled from the market, if successful it will mark Opic's debut in the Latin arena.
According to a source familiar with the deal, one reason Telefonica del Peru decided to do an Opic-backed deal was because it had securitized almost 90% of its receivables in the 1998 transaction. "[But] I believe they would have decided in favor of an Opic-backed deal even if they had enough receivables to securitize," added the source. "It is just a good option that prevents them from having to make use of their assets."
Aguas Argentinas, Brazilian telecommunications company Tele Centro Sul, Electricidad de Caracas and YPF are also in the queue to launch Opic-backed transactions in the near future, market watchers said.
A similar convertibility and transferability insurance product from Zurich Re is also proving popular in Latin America, with Mexican brewer Femsa Cerveza likely to be one of the first issuers to make use of it. "The company was aware that spreads would be wider with this type of structure," said a source close to the transaction. "But they decided to pay the price and save their export receivables for a rainy day'."
However, while such insurance products are gaining popularity among issuers, they have also led to heated debate among bankers, investors and rating agencies.
For instance, the four international rating agencies differ on the significance of the political risks not covered by these types of policies. Fitch IBCA rated the Femsa deal A-minus, well above Mexico's double-B plus sovereign ceiling. Telefonica del Peru received a Baa2 credit rating from Moody's, piercing the Baa3 local currency government bond rating, while Duff & Phelps (DCR) rated the transaction triple-B-plus, equal to the country's local sovereign rating. Moody's also assigned an A3 rating to YPF's transaction, exceeding Argentina's Ba3-minus local sovereign rating.
Officials at Fitch explained that their basic rating assumption is that the local currency rating of a transaction can exceed the local currency rating of the sovereign based on the ability of the corporate entity to meet its financial obligations. While a rating can never be higher that the capacity of the company to pay its debt, Fitch sees no theoretical or historical reason to limit the rating of an Opic deal to that of the local currency rating of the sovereign.
"In our view, the fact that a country defaults on its local currency debt that does not mean that a company would do the same," said Gabriel Torres, director at Fitch in New York. "The company might run into short-term difficulties, but those would be sufficiently covered by the six-month reserve funds provided by Opic insurance."
Moody's shares this underlying assumption. According to Maureen Coen, head of the structured finance group at Moody's, Opic's coverage of transfer and convertibility risks is enough to pierce the local sovereign ceiling. "True, there are risks for which Opic offers no protection, but we evaluate those risks very carefully," she said. "Political insurrection is one of those risks and it is appraised on our local currency assessment of every company. As for the risk of expropriation, we believe that it is very remote. Overall, we put each company under very demanding stress scenarios and work closely with our sovereign and corporate analysts to make sure we do a thorough and accurate evaluation."
Other agencies disagreed with this rating rationale. "The insurance policies offered by Opic and Zurich only insure transfer and convertibility risks, there are many other significant political risks, such as currency devaluation, expropriation and political violence, that should not be overlooked," explained Daniel Bond, the chief economist of DCR's sovereign group.
This position finds echoes with Standard & Poor's, which is not rating the Zurich and Opic-backed deals. "For us, local currency ratings are the benchmarks from which we rate a company's credit worthiness," explained Rosario Buendia, S&P's director of structured finance ratings.
"Rating a transaction significantly higher than the sovereign local currency implies that, at a time when the sovereign is defaulting on its own local currency obligations, the structured transactions will continue performing. Since the consequences of a sovereign local currency default could result in frozen bank accounts, a liquidity crisis, currency devaluation and loan performance deterioration, we did not feel comfortable doing that."
What do investors think?
Some investors seemed to agree. "Opic insurance doesn't do a whole lot for me," said Paul Aronson, vice president at Lincoln Investment Management. "I think securitizations are much better structures for several reasons: they involve companies with dollar revenue sources, it is extremely unlikely that a sovereign entity will interfere with the company's export-related businesses and, finally, because an export receivable transaction is structurally senior to a debt investment."
Despite some investors' preference for asset-backed deals, bankers regard political insurance as a good alternative to securitization for certain companies. "Opic's inconvertibility insurance is useful for companies which have no more assets to securitize. It also offers clear advantages for companies that are domestic-based and have good credit records in their own right but are hampered by the sovereign," said Claire Coustar from Merrill Lynch's Latin America structured finance group. "Although Opic deals are blanketing the market right now, we will continue to see traditional export securitizations."
Still, the advantages of political insurance seem to be more appealing to issuers than to investors. "I would prefer to do deals without any kind of insurance. I believe that we are giving up too much spread for an insurance policy that may or may not be worth very much," said one investor. "If a company is fundamentally strong enough to do a deal, I see no reason why I should buy an insurance policy. If it needs the insurance to get the deal done, I doubt that I really want to waste my exposure on that type of credit."