In May, a water project vital to the Peruvian capital of Lima issued a securitization in the domestic market.
The Huascacocha deal signaled that the industry was branching out from the handful of infrastructure transactions that had until then monopolized the market. Those were all dollar-denominated, cross-border ABS backed by payment obligation certificates (CRPAOs) issued by the Peruvian government.
Huascacocha was ultimately backed by RPICAOs, a variation on the CRPAO theme, and it was in Peruvian soles.
Players said newer mechanisms as well will be used in the coming years to finance infrastructure in Peru via the ABS market. The PPP regime in the country is flexible enough to allow for a variety of options, sources said.
To be sure, the sector is in dire need of funding. While Peru ranked among the fastest-growing countries from 2002 to 2009, and is expected to see 4.8% growth this year, much of the country's infrastructure is outdated or inadequate.
The introduction of infrastructure funds domestically might help the local market sop up a significant share of ABS, but if transactions are to be large enough to significantly modernize the country's infrastructure then the cross-border arena will have to come into play.
Indeed, a RPICAO-linked deal for water treatment plant Taboada due out by November is expected to be much larger than its predecessor and is going to be hard pressed to fund itself entirely with local money as Huascacocha did. Other deals in the works are a toll-road transaction for Autopista del Sol that breaks from the CRPAO model and a hospital deal linked to social security provider ESSALUD.
Step One: CRPAO
Until Huascacocha came on the scene, ABS in Peruvian infrastructure basically spoke only the language of CRPAO. CRPAOs are promises of payment issued by the Peruvian government and governed by New York law. The payment can come from any ministry of the government or from a government-owned entity. Instead of having the total amount of the debt on balance sheet, the government has to book only for the year in which the payment is made.
"The government has to ensure only that it can make the payment for that year," said a banker active in the sector.
The way CRPAOs work in a deal is that the agency overseeing the construction of a project issues work progress certificates (CAOs) when a certain project milestone is reached. When the CAOs are issued, the Ministry of Transport and Communications issues payment certificates (PAOs). Upon the issue of a PAO, the Ministry of Public Works hands the project sponsor the CRPAOs, which recognize the concessionaire's right to collect on the PAOs.
Since the CRPAO is linked to reaching construction milestones and not to project performance, the creditworthiness is generally perceived as being closely tied to that of the sovereign, which is fundamentally the ultimate obligor.
The timing of CRPAO payments is crucial for debt payments on the corresponding ABS. The way deals have been structured there is a lag of a few months between the approval of CRPAO payments and the next debt service payment. Generally there are cushions built in for a potential delay, such as a reserve fund.
Step Two: Huascacocha and RPICAOs
The Huascacocha deal gave a few twists to the CRPAO template.
Closed on May 27, Huascacocha Finance consisted of PEN212 million ($76 million) in inflation-indexed fixed-rate notes and PEN109 million in inflation-indexed floating-rate notes. BNP Paribas was the sole lead on the deal, rated a local-scale 'AAA' by Apoyo y Asociados. The bonds help finance the construction of a dam on Lake Huascacocha, which sits in the Andes, and a series of waterways and tunnels linking the dam to the Rimac River.
The project is part of a 20-year concession that will provide 48 million m3 of additional water to Lima's water utility Sedapal. The sponsor, Brazil's OAS Group, will take an estimated two years to complete the project.
Debt payments will be secured by RPI payments, which are irrevocable payments tied to completed milestones under the concession agreement. RPI payments will be made through a master-collections trust set up by Sedapal that will receive consumer water payments made through Peruvian banks. The trustee of the trust will activate enough banks to cover the RPI payments. Should the flows fall short of meeting the RPI payments, then Sedapal has to provide the trust with sufficient funds to make the RPI payments. The Peruvian Ministry of Housing, Construction and Sanitation guarantees the RPI payment obligations through the trust.
The master trust will also be used in the Taboada project, which has ACS as the sponsor, and also in La Chira, another water treatment plant whose concession has yet to be awarded. Taboada is a project for treating a large portion of Lima's wastewater. It is expected to reduce the contamination in surrounding beaches.
Unlike in the CRPAO transactions, the Huascacocha deal is backed by payment rights that aren't linked to a particular note governed by New York law, said Gianluca Bacchiocchi, a partner at DLA Piper. "We had to build an additional security package because we no longer had a N.Y. law remedy," Bacchiocchi said. That legal buttressing included a mortgage over the concession, a shareholder pledge from the sponsor OAS and an irrevocable power of attorney from the concessionaire.
The local currency denomination, which is indexed tothe VAC inflation index,sets the Huascacocha deal apart as well from CRPAO-backed deals. "The government has made a concerted effort to move away" from dollar-denominated obligations, said Bacchiocchi. "Having a local-currency, inflation-indexed bond ismore palatable to local pension funds."
Step 3: Guaranteeing Minimum Revenues
Sources said Peru's solid PPP system also allows for deals that are based on the actual performance of an infrastructure project, with the government acting as a risk-mitigator by guaranteeing a minimum of revenues.
"In cases where the government wants to finance strategic projects that won't have sufficient cash flows to support the required debt financing, the government may be required to offer additional support to help the sponsor raise debt in the capital markets," said Julian Broide, vice president at Bank of America Merrill Lynch. "This was the case with the CRPAO transactions that helped fund the IRSA roads connecting Peru to Brazil."
The scheme of minimum-revenue guarantee is expected to apply to Autopista del Sol.
Whichever approach works for each project, if it's significantly larger than $100 million, then a portion at least will have to attract foreign capital.
New Funds Make Deeper Pockets
But local-currency denomination - which would follow naturally for local-currency collateral such as in RPICAO deals - also raises a hurdle for going cross-border, with either a hedge or sole-hungry foreign investors a necessary ingredient.
At any rate, recent efforts suggest that the Peruvian market is greatly increasing its capacity to absorb infrastructure deals.
Last year, the country's four pension funds - AFP Horizonte, AFP Integra, Prima AFP and Profuturo AFP - started what they termed an "infrastructure trust" with an initial target amount of $300 million. The trust made its first move by buying PEN100 million, or nearly a third, of the Huascacocha bonds, which also went to local insurance companies. In recent press reports, pension fund officials said that the trust could easily be boosted to $500 million.
Also on the horizon is the Peru Infrastructure Fund, with a target size of $500 million. U.S. firm Brookfield Asset Management won a mandate from the Peruvian government to manage the fund in September 2009 and has paired up with local consultancy Apoyo to form a management consortium for the team, said a Brookfield spokesman. The U.S. asset manager will be a leading investor in the fund, holding up to 20% of capital. The infrastructure trust can also invest in this fund.
"The Peru fund builds on Brookfield's operating expertise in infrastructure," the spokesman said, citing the company's investments in the power sector in Brazil and Chile. "Peru's economy has performed well in recent years, and Brookfield sees a number of promising opportunities in the country."
As of press time, the Peru Infrastructure Fund had yet to receive final government approval to become operational.
Poor Showing for Peruvian Infrastructure
Funds are badly needed to modernize and expand the country's infrastructure.
The last World Competitiveness Survey by the World Economic Forum ranked Peru number 97 among 134 countries in the quality of its infrastructure: a fairly dismal showing even though the country advanced by 13 spots from the previous year. The report cited the country's "poor infrastructure" as a major weakness in improving its business appeal.
Cross-border investors have been paying more attention to Peru not only because of its exceptional economic performance. The government has also been managing the economy far better than it has historically, leading the country to hit investment-grade status at all three major rating agencies. Fitch Ratings and Standard & Poor's brought the sovereign over this momentous threshold in 2008, and Moody's Investors Service followed suit late last year.