Capitalizing on easier market conditions and favorable reviews from rating agencies, the Mexican State of Veracruz slashed the yield on its debt by refinancing Ps2 billion (US$184 million) in asset-backed loans owed to federal development bank Banobras. Under the same terms, the state also took on a fresh Ps733 million (US$67 million) loan from Mexico's Banorte.

Veracruz stuck to the typically short cycle of bank funding because of gubernatorial elections in 2004, an event that cynical observers say may have indirectly led to the choice of Banobras. According to some domestic media, the head of the development bank, Tomas Ruiz, has been eyeing the governorship, now in the hands of Miguel Aleman, a former television magnate and scion of the opposition Ruling Institutional Party (PRI). Ruiz was a finance undersecretary is former PRI administrations.

At any rate, Santander Serfin, Inverlat, and Banorte matched the terms offered by Banobras for the bulk of the package. "It's not the case that Banobras was the only one to offer these terms," said Emilio Baez, general director of the financial consultancy Estrategia Financiera, which structured the deal. The firm Martinez, Algaba, Estrella, De Haro, y Galvan Duque was legal counsel.

The deal also grabbed the market's attention for its novelty. It is the first subnational transaction to be both publicly rated and entirely comprised of banking credit. "We had rated a transaction for the state of Morelos that was a mix of paper and loans, but not one that was just loans," said Eduardo Hernandez, structured finance analyst at Fitch Ratings in Mexico.

Pricing on the entire Ps2.73 billion (US$251 million) in financing was 75 basis points over 28-day TIIE, which normally fluctuates near six-month Cete treasuries. The retired loans were 200 to 250 basis points steeper. The Ps2 billion in renewed Banobras funding matures in 23 months and is made up of three loans for Ps900 million (US$83 million), Ps600 million (US$55 million), and Ps500 million (US$46 million). The Ps733 million in new financing from Banorte comes due in 12 months. The fresh funds will go to public works, largely in the education sector.

According to Moody's Investors Service, the refinanced Banobras loans yielded Veracruz a net present value savings of Ps323 million (US$30 million), about 16% of their principal amount.

With elections coming up in 2004, Govenor Aleman aimed to wrap up the program before the new administration took over, sources said. For such short-term funding, a bank deal proved cheaper than issuing in the market, particularly since certain tax benefits on domestic paper only apply to bonds with a grace period of at least three years. "That made it inconvenient," Baez said.

The deal hinged on approval from the Veracruz congress, which is generally the modus operandi of state and muni deals in Mexico. The budgets are structured for a single year and any changes must clear the legislature.

Collateral on the loans are rights to receive the state's federal participation revenue, which are generally disbursed twice a month. The trust is trapping 55% of those flows. The pledged revenues represent about 4x the debt service in the first year and shrinks to 2.5x in the second.

On the national scale, Moody's rated the four loans Aa2.mx', while Fitch gave them a AA(mex).' Moody's also gave the deal a local-currency global scale rating of Baa3.' Fitch put the structure two echelons above Veracruz' stand-alone rating of A' on the national scale.

In the case of Fitch, the national-scale rating of the structure exceeds the state's A+' by two notches.

One of the loans' main risks is the floating interest rate. The strong coverage ratio and a reserve fund would mitigate the impact of a jump in the TIIE, sources said. In the most recent minutes of the Mexican Central Bank, Governor Guillermo Ortiz reiterated his commitment to an inflation rate of 3% for this year, which some analysts translated as potential monetary tightening up ahead.

Veracruz represents 7.4% of the country's population, but only 4.5% of the gross domestic product. Hugging the steamy Gulf coast, the state relies on agriculture and oil as its bread and butter.

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