The Overseas Private Investment Corporation (OPIC), the U.S. federal agency created to support U.S. business interests in developing countries, recently announced a new political risk insurance product designed to enhance bonds - including securitizations - sold by emerging market issuers to U.S. investors.
Traditionally, OPIC insurance has been used primarily by U.S. equity investors and by banks supporting the activities of their U.S. clients abroad. In the bank loan market, OPIC insurance has been available to cover currency inconvertibility, expropriation and political violence.
The agency started working on the adaptation of its insurance policy for the bond markets less than two years ago (ASRI 1/25/1999 p1). "We recognized the fact that capital markets are becoming an increasingly important source of financing for projects in the emerging markets," said James Brache, OPIC's regional manager for Asia and the Middle East. "The Asian and Russian crises and the subsequent crunch in foreign capital available made our product all the more relevant."
Under the new policy, emerging market issuers will be covered against inconvertibility and non-transferability of funds only. The price for this coverage will be in the range of 60 to 100bps.
"We are not covering expropriation or political violence for the simple reason that there hasn't been much demand for it," said Nelson Oliveira, senior commercial counsel at OPIC's legal affairs department. "Such coverage would be more costly and claims would take longer to process."
With an OPIC wrap, some emerging market transactions could receive higher foreign currency credit ratings, according to Chris Donnelly, vice president of Latin American structured finance at Duff & Phelps.
"Provided that the issuer has the right amount of coverage and that the policy has adequate reserve funds for liquidity, political risk insurance can be an effective means to breach the sovereign ceiling," he said. "In addition, the fact that OPIC is a U.S. federal agency gives it the power to open doors and access high level officials quickly."
For investors, one of the attractions of the OPIC policy is that it pays 100% of the total amount of the policy cover for valid claims. Also the coverage is backed by the triple-A credit rating of the U.S. government and OPIC has a strong track record of payment (in the 1990s the agency has paid 171 of the 175 claims received).
Unique Source of Recovery
OPIC also enjoys a unique source of recovery in cases of inconvertibility. "In cases in which a U.S. company doing business in a developing country runs into inconvertibility problems, OPIC will step in, take the local currency from the company and exchange it for dollars," explained Donnelly. "Since it is a U.S. federal agency, OPIC would then be able to sell that local currency to U.S. embassies, who would use it to meet their local currency expenses, and receive dollars in return."
Moreover, the policy is designed to ensure settlement of claims in time to avoid missing scheduled payments to bond holders.
"We see some important strengths in the new OPIC policy," said Willma Davis, vice president at John Hancock Financial Services. "However, as investors, we view these type of products as risk mitigators, not risk eliminators."
Indeed, while OPIC's policies are backed by the full faith and credit of the U.S. government, the protection provided is not comparable to that offered by a triple-A rated monoline insurer, as OPIC insurance is not a guarantee of payment. In addition, some important country risks such as currency devaluation are not covered under OPIC's inconvertibility/non-transferability contract.
OPIC also generally limits the amount of coverage for any one project to $200 million. Furthermore, OPIC usually limits its exposure under each form of coverage in any country to no more than 15% of its total exposure. Therefore, there may be limits on the amount of insurance available for certain risks in certain countries.
Some Markets are Off-limits
OPIC is presently authorized to operate in 145 countries. However, there are several important emerging markets where OPIC does not operate due to statutory and U.S. government policy constraints. "We still don't have a bilateral agreement in place to operate in Mexico," explained Brache. "In addition we were shut down in China after the Tiananmen Square massacre."
By statute, OPIC can only support investments in which U.S. citizens and U.S. entities have a majority stake. For a bond transaction, the statute is satisfied if bondholders who are U.S. citizens or eligible U.S. entities hold 51% of a deal's value.
Ford Otosan, a joint venture between Ford Motor Company and Koc Holding of Turkey, has already used the coverage for the issuance of debt notes. According to sources, the OPIC insurance, combined with Ford Otosan's financial and operational strengths, allowed the transaction to achieve an investment grade rating from Fitch IBCA, significantly above Turkey's sovereign rating of B-plus.
Argentina's oil exporter YPF (ASRI 3/8/99 p6) and Telefonica del Peru are soon to follow suit and, according to sources at OPIC, there are some securitizations in the pipeline.
Though many issuers of asset backed transactions - especially in Latin America - mitigate transfer and convertibility risk by capturing export receivables offshore, sources agreed that OPIC's new policy may be particularly useful for internationally-offered mortgage securitizations and other deals that rely on local currency payments.