Modeled after the U.K.'s public-private partnerships, Mexico's new regime for financing the development of infrastructure has local players rhapsodizing about the potential financing volumes and the advantages for federal, state and municipal governments. What's more, they are confident it will prove an attractive alternative to the traditional concession system.
But it remains unclear whether securitization will latch on to this vibrant sector during its infancy as it did in the U.K.
"It's still too early to see how this will develop," said a source at a bond guarantor. No one expects Mexico's PPS's - the Spanish acronym for Projects of Providing Services - to unleash the torrent of business that U.K.'s PPPs have showered on monoline insurers, which have wrapped most of the $75 billion in completed projects there, according to sources. The potential, however, is inarguable.
The first 30 projects up for bid under Mexico's PPS regime carry a total price tag of roughly $2.2 billion, according to Derek Woodhouse, counsel at the Mexico City office of Thacher Proffitt & Wood.
Mexico's federal government has awarded three PPSs so far, and a fourth is up for bidding. The state of Oaxaca has already awarded one and other states and municipalities are expected to follow.
"A lot of states are looking at it," said Pablo Pena, head of investment banking and corporate finance at Vector Casa de Bolsa. "For them it's going to be more attractive [than the traditional concession system]."
The PPS system features a number of differences from the traditional concession regime in Mexico, which has so far been the primary vehicle for fostering infrastructure in key sectors such as roads, while providing fodder for securitization through the asset class of toll road receipts.
Using highways as an example, in a traditional concession the revenues received by the operator come directly from the user; that is, the risk is essentially a function of traffic and the level of tolls. As a result, only roads that charge tolls work well under this scheme, sources said. In a PPS, the government agrees to dole out payments to the company that has won the contract, which typically requires construction, design, and operation of the highway. The bulk of the government payments are tied to milestones in the contract, e.g. building a road to certain specifications by a deadline, keeping service at a determined level. A smaller portion of the payments - Woodhouse said it could run at about 20% - would be determined by actual traffic. If a toll isn't charged on the road, then the government uses the concept of "shadow tolls," basically calculating the traffic that flows through. The differences in the regimes apply, with varying degrees of nuance, to other infrastructure projects.
"[Traditional concession to PPS] switches the proposition from build it and they will come' to build it and we'll pay," the guarantor source said.
PPS, then, works better when the project in question might not be profitable on its own and thereby wouldn't provide sufficient revenue to an operator in a traditional concession regime. "A school [for instance, sometimes] isn't easily translatable into a fee from the public; so instead of having the returns come via tolls or fees, it's done by the government annual payment," the guarantor source said.
There are other differences as well. One that has been a strong selling point in trying to win states and municipalities over to PPS is that payments in the newer alternative are off balance sheet, a factor that helped get the regime quickly off the ground in the U.K., Woodhouse said. Since the contract obligates the government to make future payments for services, it doesn't book the investment. "It becomes part of current spending and not public debt," Woodhouse said. In a traditional concession, at least initially, the government must book an investment on its balance sheet. "The PPS has less liability for the state," said Vector's Pena.
In a PPS, the private operator also has more of an incentive to maintain a high level of performance, as the government can punish the operator for sub-par service by withholding payments, sources said. Under a traditional concession, service normally has to be appallingly bad for the government to withdraw the concession. And rescinding a traditional concession contract can be lengthy and onerous.
From the perspective of the operator, a PPS can be less lucrative than a traditional concession, but the returns are predictable, and when the contract is with the central government, the payments come from the highest-rated credit within the country, sources said. By default, the central government has a triple-A rating on the national scales of the major ratings agencies.
When the payments come from a state or a municipality, however, the obligor risk is higher. A number of states and municipalities are in the triple-B category and some are even sub-investment grade on the agencies' national scales. Oaxaca State, in a PPS for a complex of buildings to house courts and offices of the state's executive branch, came up with a payment structure that helps mitigate the obligor risk. A trust was set up to trap a portion of the co-participation revenues that flow from the central government to Oaxaca. If the state fails to make a payment, the construction company and operator, Impulsora de Proyectos de Oaxaca, can tap the trust. Financial consultancy Estrategia structured that particular contract.
The Oaxaca transaction might offer ideas as to how to mitigate risk in order to attract guarantors into a securitization of state and municipal payments for a PPS. A number of sub-sovereign issuers in Mexico have backed bond deals with their co-participation revenue as a way of elevating the credit strength of the transaction to that of the government.
"The devil is in the details," said the guarantor source, adding that the question will be whether Mexicans can convince outsiders that the sector is a safe investment. "For this to work there has to be a deep consensus that it will be respected over the long-term," he said.
Another consideration is, of course, the pricing of alternative funding. Banks operating in Mexico are flush with capital and have become aggressive competitors with well-established securitization sectors. In addition, the traditional concession system in Mexico is not going to disappear anytime soon. In toll roads, for instance, the regime has gone a long way in helping heal the scars from massive defaults that pounded the sector following the drastic peso devaluation of the Tequila Crisis in the mid-90s.
Still, players are already beginning to talk securitization. Ingienieros Civiles Asociados, which has won two highway PPSs from the central government, has already uttered the S' word in discussing future financings to take out current loans (ASR, 5/22/06). But as in the U.K, it will probably be guarantor appetite that will shape whether this sector becomes a new focal point for Mexico's domestic ABS sector.
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