Tiete Emprendimientos, a Brazilian subsidiary of U.S.-based utility giant AES Corp., will sell a $300 million 15-year securitized bond via Banc of America with a variety of structural enhancements from the Overseas Private Investment Corp. (OPIC). If the deal prices as expected it will mark the first sale of a Latin American bond featuring an insurance policy against currency devaluation.
Banc of America will take the 144A Reg-S on the road in the U.S. April 17 to April 24 and in Europe April 25 to April 27. Syndicate bankers on the deal hope to price April 30 and close May 7. Fitch and Moody's Investors Service have granted the transaction investment grade ratings of BBB- and Baa3, respectively thanks to the three-fold enhancements built into the deal. While the structure should allow Tiete access to term financing - a goal that is typically off limits to Brazilian corporates - it is highly specialized and will only be applicable on a case-by-case basis going forward.
In order to avoid certain taxes Tiete will issue the bond through a fully owned offshore subsidiary named AES IHB Cayman Islands Ltd. Investors buying into the bond will have recourse to holding company AES Tiete Holdings. The structure of the deal is built upon a three-tiered base.
The first - and most substantial - of these tiers is the securitization of dividends from the operating company, Tiete, that are upstreamed to the holding company level. The relatively predictable revenue and cost streams for electricity-generating plants allows for an accurate prediction of the dividend stream and the resulting securitization. Additional covenants in the bond require the operating company to upstream all dividends to the holding company while keeping debt levels under a fixed cap. A two-times collateralization level doesn't hurt either.
The second tier of the structure is the standard OPIC transfer and convertibility (T&C) package with an added kicker protecting against expropriation risk. OPIC has provided an $85 million policy to protect against these risks part of which is placed in a six-month reserve account that rolls throughout the life of the bond.
But the piece de resistance is without a doubt the $30 million of devaluation risk insurance OPIC is extending the issuer. Critics of OPIC's T&C product have consistently poked at its lack of protection against currency risk but the task of separating currency risk from operational risk had seemed an insurmountable obstacle, until now.
Tiete's revenue streams may be predictable but they are real denominated but if they are balanced against dollar-denominated debt there is still exposure to a mismatch. However, The steady revenue streams do allow OPIC to quantify expected operating performance and then set measuring sticks to indicate whether revenue losses are due to operational or commercial failures.
Once the operational risk is stripped away OPIC can accurately determine whether a credit event is due to a devaluation and provide the funds needed to make up for a change in the real/dollar exchange rate. OPIC determined that $30 million would doubly cover potential payments - even in the case of hyperinflation - by running the structure through a model comprising currency events throughout the emerging markets over the past 30-years.
This triple level of coverage cuts investor exposure down to basic corporate credit risk, which is additionally limited by the fact that Tiete is 71% owned by AES Corp. The question remains will investors buy it and, if so, at what level? Pricing the bond will be no easy task as the only deal that begins to be comparable is the $180 million `8-year/17-year average bond featuring a rolling credit guarantee that Transportadora Brasiliera Gasoduto (TBG) priced last year at a spread of 435 basis points over Treasuries. That deal was privately placed by Credit Suisse First Boston in December of 2001 and received a BBB+ rating from Fitch. There are no outstanding Brazilian utility bonds in the 10- to 15-year range but the sovereign's 14.5% bonds due 2009 are trading at roughly 743 basis points while the 12.75% 20s are at 767 basis points, according to data from Warburg Dillon Read.
It is as yet unclear how much spread the issuer expects to save itself through its reinforced structure but investor education will be key to achieving those levels. OPIC's T&C coverage was hamstrung in initial deals two years ago by miscommunication between the buy side, the sell side, ratings agencies and the public sector.
But a lot of water has passed under the bridge since then and OPIC made a credible effort to establish a dialogue with institutional investors in 2000. Tiete's deal will prove a good bellwether of just how effective that dialogue has been.