Latin America's domestic project bond market began to flourish in 2001. Beyond the traditional powerhouse of Chile, other Andean economies (as well as Mexico) started to demonstrate the liquidity and promise required for sponsors seeking local currency funding. Banks have long memories when it comes to doing infrastructure deals in the region as several projects from the early 1990s went under during difficult economic conditions. But the signs are that this time around nervousness on the part of international debt investors will provide a spur to local currency (or at least locally funded) deals across the continent.

Chile

Chile is Latin America's pin-up for the development of a long-dated paper market. The market was created through the Pinochet regime's privatization of the pension system. That move, hotly debated by the General's critics, provided a useful source of liquidity to domestic corporates. Nevertheless, for much of their early life pension funds, as well as insurance companies, were compelled to restrict their investments to treasuries and highly-rated corporates.

Chile demonstrates that governments have two options when attempting to foster a project bond market: either relax the regulations on the ratings of securities that can be bought or create concessions that will ensure a high enough rating. Chile's option has been to ensure that the concession supports capital markets financing within its own stringent pension funds regulation. Indeed, it has been a feature from the start to encourage projects that will stimulate local market activity.

So far, with one notable exception, these have been confined to the country's road network. The first issue was the $200 million equivalent Talca-Chillan section of the Ruta 5 road (Chile's part of the Pan-American highway). It was wrapped by MBIA and issued by Banco Santander. At the time, cross-border issues held their own against local bonds if only because waiting for conditions to be right for a dollar bond might take as long as waiting for local market liquidity to recover.

2000 and 2001 saw several local bond issues. These included those for the Collipulli-Temuco section and the Chillan-Collipulli sections of Ruta 5 ? the former sponsored by Cintra and the latter by French construction group Vinci. These carried wraps from XL Capital Assurance and were issued by Santander. XL's team includes the nucleus of MBIA's Chilean specialists whilst Santander benefits from control of most of Chile's larger insurance and pensions firms.

As Chile's economic outlook improved, so did the prospects of a cross-border bond issue which duly appeared and was led by Morgan Stanley. $421 million in dollar bonds, carrying an MBIA wrap, were sold on the 144A market, the largest issue out of Latin America in 2001. The deal funded a section of road, Autopista del Maipo, just outside the capital. It featured a unique hedge that was put in place by the Chilean government to enhance international interest further. At the same time, the Inter-American Development Bank and FSA teamed up to offer a local currency wrap to fund the Santiago-Valparaiso road section, which is not part of Ruta 5. And Citibank looks set to go cross-border with a $450 million financing for the Autopista Central, sponsored by Dragados and Skanska.

The last two issues have yet to launch but the signs are that more creative concession structures (the Valparaiso concession has a variable length whist Central has electronic tolling) will wrest control from the existing players. In another development, Santander agreed to sell some of its life insurance operations to New York's MetLife. Thus, all the signs are that Chile is approaching mature market status ? albeit with lower levels of domestic liquidity than the dollar market.

Bolivia

Bolivia's debut project bond issue went almost unnoticed. This despite the fact that the issue, at $65 million, was equivalent to 0.8% of the country's GDP. The Hidroelectrica Boliviana project is a Tenaska venture that is designed to produce power for the mining sector and feed its excess output into the country's nascent merchant market. The issue closed in June 2001, led by local brokerage Sudamer Valores.

Bolivia's pensions system is now largely in the hands of BBVA which is sitting on $900 million in assets. Government restrictions on securities that can be held stand at the single-A level and the pensions system is effectively dollarized. Some estimates put the potential volume of paper that can go through at around $150 million per year.

The difficulty in creating a buoyant market in Bolivia is simply that it is not large enough to support all but the most small-scale projects. Until its government gains more freedom under the Highly Indebted Poorer Country scheme cross-border lending will also be difficult. That means waiting for an improvement in the macroeconomic situation and further growth in the financial services sector.

Some activity will come from potential midstream gas projects under consideration. Another of the ratings currently extant for a Bolivian corporate is the Bolivia-Brazil pipeline (or at least the Bolivian section). Bolivian pension funds hold small stakes in the venture, so a rating was necessary to ensure compliance with regulations. Debt issuance has not yet happened, but a further gas concern ? GasAtacama, based in Chile ? is currently examining financing proposals for an interconnection line between its northern Chilean properties and the mineral deposits of southwestern Bolivia. However, since the offtaker would probably be able to pay in dollars a local issue is highly unlikely.

Peru

The Peruvian market is at roughly the same stage of development as Bolivia although its economy is considerably larger. Pension funds in the country also have large dollar holdings and little in the way of outlets for investment. As in Chile, the government has moved on from seeing them as a useful way to prop up its budget deficit.

Nevertheless, Peru's first project bond launched in August 2001. The issue supports a water project, the Rio Chillon concession which entails the provision of drinkable water to two million people in the northern part of Peru's capital, Lima. The 27-year concession features a take-or-pay contract with Lima's state-owned water company, Sedapal.

The indications are that the Peruvian authorities went out of their way to structure a concession that would be robust enough to create a project bond asset class. Sedapal is rated at AAA locally and its performance carries a backstop from the government. The sponsors of special purpose company Aguas Azul are Italian firms Acea (45%), Impregilo (45%) and Cosapi (105), Peru's largest construction company.

The build-own-operate-transfer (BOOT) contract calls for the construction of superficial and underwater derivation and treatment plant facilities. Other work includes building a 76km master distribution channel and seven head reservoirs. Aguas Azul offered a tariff to the government of $0.21 per cubic metre, roughly half that offered by the highest of the four competing bids.

The key element in maintaining a creditworthy concession structure and in maintaining respectable coverage ratios is a minimum payment element. This formed a part of the concession awards for some of the less lucrative sections of Chile's Ruta 5. Here it is essential to the creation of a sufficient level of comfort amongst relatively inexperienced local investors.

The minimum payment accounts for 60% of the contractual monthly payment and therefore minimises operating risk for investors. Moreover, the payments are indexed to the US dollar ? essential for a dollarized pensions and insurance sector. Pension funds, however, were not greatly interested in the first issue but Citibank is confident that they will spearhead demand for forthcoming issues. The first $10 million A tranche of bonds closed in August 2000 and was mostly taken up by domestic mutual funds and life insurance companies.

This tranche had a 12-year maturity and an 8.7-year average life. Its fixed nominal coupon rate is 8.75%. This was the first part of a total $58 million to be invested. On 23 October 2001, a second $15 million tranche of bonds with the same tenor was issued. This series came in marginally cheaper, at 8.69%. A third, $10 million in size, closed on 8 January 2001. Credit rating companies Apoyo y Asociados Internacionales and Pacific Credit Rating rated the bonds at AA+ and pAA+ respectively.

Peru, in contrast to Bolivia, has a slightly more developed credit rating system. This is in part because, unlike Bolivia, all agencies have a sovereign against which to notch local issues. Fitch, despite its strong presence in Latin America, does not rate Bolivia. This advantage, however, is nowhere near as significant as the greater liquidity afforded by Peru's financial services sector.

Citibank, bookrunner on the first issues, is now looking to do a follow-up issue for a Peruvian electricity transmission project, Transmantaro. Transmantaro, whose principal shareholder is Canada's Hydro-Quebec, has built a line between Mantaro and Socabaya. Its debt requirement could be as high as $105 million.

Mexico

Mexico's infrastructure market has been focused on recovering from the difficulties at Tribasa. The company was at one point poised to expand across Latin America but eventually succumbed to its rising debt burden. Tribasa's Chilean assets and projects have been bought up by partner Vinci. But, even with Tribasa on the mend, foreign firms may have a greater role to play in future Mexican infrastructure projects.

Increased stability and low interest rates are spurring a rush to put projects ? in particular toll road deals ? out to domestic markets. Mexico relies on Peso debt, and is inching ever closer to a unanimous investment grade rating. Moody's upgraded it to Baa3 over a year ago while Fitch gave it a BBB- on 16 January 2002. Standard & Poor's says, however, that a review of its ratings on the country will wait for President Fox' new tax plans.

One aspect of the plans that will provide encouragement to local issuers is a plan to extend the 24% withholding tax to government issues. This move, which has few parallels elsewhere, would provide added stimulus to private infrastructure bond investment, by making government issues less attractive. The plan, however, does envisage certain incentives to investment in the energy sector. Infrastructure projects, therefore, could find themselves in competition with other sectors.

The two headline deals of the last year have both been refinancings ? attempts to get better terms during the current, more stable environment. In March 2001, BBVA issued a small MxP180 million ($19 million) refinancing for the Maxitunel concession, which links the coastal resort of Acapulco with inland regions. Maxitunel's restructuring was forced by weakness at another industrial concern, ICA, but traffic growth is solid and Standard & Poors rated it AA.Mx (local scale). The notes have a maturity of 2016 and bear 9.6% interest per semester ? better terms than the short-term debt with which the initial investment was funded.

BBVA is now back with a much larger financing for Autopistas del Mayab. This road links Kantunil and Cancun, and was constructed in four stages. The original concession was awarded in 1990 and the road is now operational and a ripe candidate for refinancing. This MxP1.8 billion bond transaction is in three series ? two senior A and B tranches and a subordinated C tranche, which is not rated. This was set to hit the market as Project Finance went to press.

Moody's Investors Service gave the project a rating of (P)Ba1 on the global scale and (P)Aa3.Mx on the national scale. Moody's cited as strengths the road's strong operational history and key importance but noted that the concession can be revoked under certain circumstances. The project has a robust legal structure with a full range of cash traps and limitations on additional pari passu debt.

Mexico is probably closest to attracting the monolines to its bond market. But strong concession structures ? albeit in the operational phase ? need to be allied to fixed-rate financing to settle some of their concerns. Given the current government's struggles to curb some of its obligations, however, more generous concessions and a hedge, such as that offered by the Chilean government, look less than likely in the near term.