Compared with the more fertile terrain of other asset classes, deals backed by the Mexican government's revenue to states and municipalities have grown sparse.

The culprit is a stable of cash-rich banks happy to provide financing to subsovereign entities, sources said.

"The banking sector has become very competitive when it comes to rates," said Marcela Andrade, director of public finance at Fitch Ratings.

That has led states and municipalities to opt out of issuing deals that collateralize federal coparticipation revenue from the central government and opt into bank loans backed by the same collateral.

Recent bank funding for states or municipalities includes: two loans totaling Ps560 million ($53.1 million) for the municipality of Benito Juarez in the state of Quintana Roo; four loans totaling Ps2.5 billion for the state of Jalisco; three loans amounting to Ps739 million for the state of Morelos; and Ps120 million for the municipality of Guadalajara in Jalisco. Also, the state of Chihuahua and the Federal District have issued federal participation-backed bonds in the past couple of months.

Whether subsovereigns will remain more receptive to bank financing is open to debate.

"We're going through a moment in which the banking sector has abundant liquidity," said one financial consultant. "I see this lasting at least through the first half of the year."

But Angel Cespedes, general director of boutique investment bank Corporativo en Finanzas, sees the shift toward banking debt as shorter-lived.

"There's now a return of the sub-sovereign sector to the market," he said. "Particularly for the higher-rated entities, the best option is the capital markets."

Cespedes added that a 10-year Ps1.2 billion deal structured for Chihuahua by Cofinza and issued in mid-November was a sign that market-based deals were not out of the running.

The state of Guerrero plans to prepay two bond deals issued in 2003 with a bank loan totaling about Ps1.9 billion. The notes marked for early retirement consist of a 12-year Ps480 million bond placed in August 2003, and a 12-year Ps860 million bond issued in May 2003. Federal participation revenue made up the collateral for both.

But Guerrero might prove to be an exception.

"These bonds came out early and opened the market for others and that incurred a cost, which was paid in basis points," said the financial consultant.

Market-based deals for states and municipalities have faced scant competition from banks when it comes to assets other than federal participation revenues. The long, UDI-denominated collateral from toll-road receivables, for instance, is packaged into long, UDI-denominated bonds, which banks are hard-pressed to improve upon in terms of maturity and pricing, sources said.

But federal participation revenue, because it is denominated in pesos, is more appetizing to banks, enabling them to compete head-to-head with the capital markets. In a flip of the usual difference between bank and capital markets debt, banks have provided federal participation-backed loans with maturities as far out as 15 years, whereas the analogous bond deals have yet to break the 12-year barrier, according to one market source.

Cespedes argues that it's possible to set maturities of over 10 years at competitive prices and that, in the case of Chihuahua, the paper was designed to take out other funding that matured in 10 years, so there was no incentive to term out further. The fact remains that while bond deals backed by other sub-sovereign assets like toll roads have maturities beyond 12 years, so far bond deals backed by federal participation revenue do not.

Banks that have been lending to states and municipalities include Banorte, BBVA Bancomer, Banco del Bajio and Banamex. A newcomer to the loan market, Dexia, is expected to make waves this year. Having only established itself as a non-bank institution in Mexico early this year, the Belgian company is understood to have extended a loan to a Mexican state. An official at Dexia could not be reached at press time.

(c) 2006 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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