The growing volume of public works contracts awarded by the Comision Federal de Electricidad (CFE) for both power generation and transmission projects are keeping bank lenders and arrangers busy, but there are concerns that the amount of CFE paper hitting the market is leading to concentration issues among lenders.

Though the short-term construction loans related to building transmission lines and sub-stations are to some extent being syndicated among different banks to those lending on long term IPP deals. There is nonetheless a significant overlap and, even with its investment grade rating of triple B from Standard & Poor's, the aggregate exposure to CFE risk is a concern.

A steady flow of transmission public works contracts is expected during 2003, with half a dozen or so contracts likely to be signed.

Last year was also busy. For example in September 2002, Long Beach, California-based Earth Tech was awarded two separate design/build/finance contracts. The $73.8 million Eastern Bajio System contract involves the financing and construction of seven transmission lines and seven substations. Work on the project is expected to be completed by March 2004. The combined lines stretch more than 153 kilometres and serve an estimated population of 34 million people.

For the $31 million Associated Network of Rio Bravo Earth Tech will provide financing and construction for the installation and construction of three transmission lines and three substations as a turnkey contract. Work on this project is scheduled for completion in January 2004.

Meanwhile, last summer Alstom won a $51 million turnkey contract to supply six new substations and extend 12 others in the 504 Norte Occidental project. And other successful bidders on transmission public works contracts during 2002 included Siemens, Dragados and ABB.

Last June global power and technology group ABB won a $115 million part of a larger contract to build a 242 kilometre high voltage power transmission system to strengthen the connection between Mexico's largest hydroelectric plant at Manuel Moreno and the national power grid.

Working with Mexico based consortium partner Techint ABB is constructing the 242 kilometres of line between Manuel Moreno and the Juile substation, and also building a new substation at Cerro Del Oro. The new transmission system, with a total cost of is scheduled to start operations at the end of this year. This was the fourth large transmission project that ABB has been awarded in Mexico since the end of 2000.

The Manuel Moreno project was financed with bank debt, and came to market under the name Elina Sureste, with Techint and Cobra as partners for ABB. The Elina Sureste financing closed in September 2002, and BNP Paribas was lead arranger on a loan totalling $236m. The paper was priced at 150 basis points over Libor.

?These are really construction loans, providing financing for the contractors,? explains Ralph Scholtz, managing director in the project finance group at BNP Paribas in New York. ?The contractors set up special purpose companies to sign the contract with the CFE and to undertake to build the power lines and sub-stations; the contract provides for CFE to pay at completion, therefore the lenders' primary payment source is CFE's obligation to pay.?

?If the contractor is part of a big industrial group, with a strong credit rating, they may choose to finance it on their own balance sheet,? says Scholtz. ?For some contractors bank financing is a necessity, since they don't have the financial resources, while for other contractors these financings are part of their risk management procedures. They may not want to have too much risk exposure with one single entity, such as the CFE, and would rather syndicate the risk through a bank loan.?

There is also a large amount of CFE risk being syndicated in association with power generation projects in Mexico, and so these transmission deals are affected by the much larger volume of loans to power generation projects. The transmission loans are short term, and so can be syndicated to a slightly different set of banks than might buy the longer term loans for generation projects. Nonetheless there is some overlap, and the aggregate exposure to CFE is something which lending institutions look at, and could in the future cause problems as they become full up.

?There is a lot of CFE paper in the market, and appetite for CFE risk is clearly not unlimited, but we have successfully syndicated all the deals that we have done so far,? says Scholtz .

According to market sources BNP Paribas currently has another financing being syndicated, this time known as Elina del Golfo which involves transmission lines in the Saltillo region.

This $127 million loan is being co-led by BNP Paribas, NordLB, and Fortis Bank. ?There are a fair number of similar Obra Publica Financiada (OPF) transactions with CFE following in the path of this one this year,? says a banker familiar with the deal.

?These are really supplier credits, where essentially we take the credit risk during the construction period, since CFE prefers to pay the contractor upon completion rather than on a month by month basis,? he says. ?Deals in Mexico are more do-able than elsewhere in Latin American because of the sovereign investment grade rating and because lenders are comfortable with the government support for CFE, upon which its own investment grade rating depends.?

The feeling is that the commitment of the administration led by President Vicente Fox is so strong to the critical task of improving the supply of electric power to the people of Mexico, that CFE will be fully supported.

These deals are essentially CFE risk, though there is also some construction risk should at some point CFE be unhappy with the quality of construction, and refuse to take over a package of transmission lines and substations. That has never happened yet, but the thought of owning an unconnected transmission system somewhere in Mexico is an issue for lenders.

?One concern that some banks have had are the conditions of acceptance for the transmission line,? comments Dino Barajas, an attorney specializing in Latin American transactions at law firm Milbank Tweed Hadley & McCloy. ?What happens if a developer builds a set of transmission lines and for whatever reason a dispute with CFE arises as to the quality of construction, or any other condition which may prevent the line from going commercial? The question for lenders is do you have recourse against CFE, and do you have recourse to the construction contractor??

?But there is good acceptance of the CFE credit in the market, with CFE being seen as one of the safer bets in Latin America,? Barajas adds.

There has been some interest in transmission deals from Export Credit Agencies, as part of their overall national export promotion efforts, but generally the additional cost of involving an ECA would hamper the ability of a constructor to submit a low enough bid on a public works contract.

?One of the concerns from a developer point of view is the cost of going to an ECA, and the time involved in the negotiation of the deal,? says Barajas. ?If they are able to go to a relationship bank, and put up a corporate guarantee backing the project, the documentation is fairly straightforward and the deal can be done in a very short timeframe. So unless the CFE comes up with a very large project that will justify the time and money that would need to be spent, ECA involvement may be unlikely.?

Thus the ECAs will tend to concentrate upon the many power generation projects that are coming up in Mexico, rather than on transmission deals. The planned programme of investment in the power sector is extremely large, with the Mexican government aiming to double generating capacity in the decade ending 2010, to over 76,000MW.

That will require $50bn of investment in generating plants and transmission systems, and the volume of commercial bank lending to CFE could yet become a problematic issue- even for the relatively small and short term transmission deals.