Real roads
Closed in August 2000 ? oversubscribed and with a triple-A
guarantee insurance policy from XL insurance ? Chile's
Collipulli-Temuco toll road 20-year local currency bond issue ($203
million equivalent) is an emerging market toll road template with a
difference ? it is not overoptimistic.
The project
The deal finances a 144Km two-lane highway located 574Km south of Santiago. Collipulli-Temuco is one of eight segments along the Pan-American Highway, totaling 1,500Km and requiring approximately $2.3 billion in financing, that have been tendered to private sponsors in a build-operate and transfer concession scheme.
As a part of the Pan-American Highway, Chile's main continuous north-south highway, Collipulli-Temuco is an essential part of the national infrastructure. Essentiality is a keystone of zero-loss infrastructure project finance underwriting criteria, which require XL to underwrite only facilities (e.g., for transportation, energy, or sanitation) critical to the national purpose in their locations.
Significantly, this road has been operated as a toll facility by the Chilean government for 25 years. As guarantor, XL had 25 years of traffic data and affordable toll collections to analyze, as well as evidence that Chileans culturally accept the concept of paying tolls ? major advantages over the toll road financings that have experienced difficulties in other emerging market environments.
The concession begins in the town of Collipulli and ends just south of Temuco, the major city in the economically important region. The concession was granted to induce the private sector to improve the road ? adding a lane in each direction, upgrading approximately 75% of the project from two lanes to four lanes with grade-separated intersections, and improving the shoulders, overpasses, underpasses, and entrances to enhance road safety. The construction project is simple and relatively straightforward, with future capital improvements funded from excess net operating income.
Construction began in May 1999, financed by the sponsor's equity injection of $83 million. At the time bonds were issued in August 2000, the construction project was nearly 40% complete, slightly ahead of schedule.
The Chilean government currently operates only one toll plaza, 23Km south of Temuco; thus, currently tolls are collected in one direction only. This open system allows for local movements for the entire concession north of Temuco.
Once improvements are completed, the system will be closed. The existing toll plaza will be moved slightly south of its current location to accommodate tolling in both directions and a new toll plaza will be added 46Km south of Collipulli. Additionally, five ramp tolls will be constructed, virtually eliminating all free movements, including short local trips; these ramp tolls will charge 25% of the toll charged at the main plazas.
This tolling system will mean that the current toll of approximately $3.38 (at today's exchange rate) for a passenger car traversing the entire length of the concession will increase only modestly in exchange for a vastly improved road. Once all improvements are completed, the rates will be adjusted to $ .032 cents per kilometer, or $ .051 cents per mile ? a level consistent with other segments of the Pan-American Highway, and affordable for local commuters.
Collipulli-Temuco boasts a well-documented traffic history, notably 9.4% average annual traffic growth from 1990-98. Traffic consultants assessed alternatives to this road, formulated estimates of future traffic growth and opined on the reasonableness of the sponsor's own growth assumptions. While the consultants felt the sponsor's base case growth assumptions were reasonable and achievable, in keeping with zero-loss underwriting philosophy, this base case was severely stressed to create our own base case, which relies on much lower overall growth in traffic to retire debt.
Conservative assumptions were also the principal input for the Monte Carlo simulation model built by XL Capital's actuaries to determine the likely distribution of possible loss outcomes. The actuarial analysis supported the conclusions of the credit-based analysis. It found that the chance of an NPV loss was beyond a three-deviation event; in other words, the stochastic viewpoint is such that the chance of a loss to the insurer is significantly below the 1-in-100 threshhold.
Participants
XL's comfort with the quality and experience of its partners in the toll road project was a critical element in underwriting. Cintra (Spain), Grupo Ferrovial's dedicated concession subsidiary, is one of the world's leading companies in the toll road concession business, with 14 concessions throughout the world. Its parent, Grupo Ferrovial, is the fourth-largest construction company in Spain. Both are solidly capitalized, highly competitive and profitable companies. In Chile, Cintra has been awarded four out of eight toll road concessions along the Pan-American Highway, as well as an airport in northern Chile.
XL also took great comfort from the depth of commitment exhibited by the bond underwriter and financial advisor to the issuer, Banco Santander Central Hispano. US counsel came from Debevoise & Plimpton, and Chilean counsel, Claro y Cia., and various seasoned traffic and engineering consultants, including Vollmer Associates of New York and R & Q of Chile.
Legal structure
The third critical element in the transaction was the legal structure. The transaction took about one year to close. The legal documentation, reflecting the complexity of the transaction, featured numerous structural protections ? e.g., reserve accounts, cash traps, guarantees for the turnkey construction contract, and dividend restrictions, to name a few ? designed to protect XL as creditor and enhance the ?zero-loss? nature of the credit underwriting. A particularly challenging aspect for the legal and deal team was translating into a local Chilean context the role, rights and remedies of a bond guarantor ? a concept well understood in the US and Europe, but needing some legal trailblazing in environments like Chile.
A successful closing
Because of the exhaustive underwriting process, Standard & Poor's issued a ?shadow? investment grade rating on the underlying toll road transaction. Two Chilean rating agencies, Feller and Rate and Duff & Phelps, provided guidance to local institutional investors by assigning a local-currency AAA rating to the guarantee of XL Insurance on the bonds.
XL's deal team joined representatives of Banco Santander Central Hispano, Cintra and Ferrovial in a ?road show? aimed at marketing the bonds to Chilean pension funds, insurance companies and other institutional investors. The success of the road show can be measured not just in terms of the oversubscription of the amount offered to the market, but in terms of the superior trading value afforded by XL's guarantee relative to a prior guarantee offered in the local market by a monoline competitor.
The local currency advantage
A key structural element to the success of the transaction is the local currency denomination of both the toll revenues and the debt.
Economic policymakers around the world are debating the relative merits of hard currency (e.g., dollar or yen) financing vs. regional markets and currencies (e.g., the Euro) vs. strictly local capital market financing. The Chilean experience presents a strong case for the development of local currency capital markets in emerging market nations. There are at least three distinct advantages to this approach:
1. Local currency financing provides a perfect match of assets and liabilities for a project.
In Chile, if the peso depreciates or appreciates, Chilean motorists pay tolls and the concessionaire repays its debt in that revalued currency. In real terms, the toll and debt obligations retain a constant relationship in value over the life of the project.
By contrast, in countries where a local currency option is unavailable or unutilized, dollar financing is the usual alternative; typically, tolls will be pegged to fluctuations in the value of the local currency vs. the dollar in an effort to protect the creditworthiness of a project. While this dollar indexing is of some value, it cannot protect against severe devaluation risk. In a dollar-indexed project, if a local currency falls two or three times in value vs. the dollar, tolls must rise by a similar factor. In these situations, the continued affordability of tolls comes into serious question, with predictably dire implications for the ability of a project to service its debt.
2. The lower risk profile presented by a local currency financing has important positive repercussions for financial guarantee insurance companies, which are subject to rating agency capital charge methodologies.
As demonstrated in the table below, for most emerging market countries, the local currency rating is higher than the foreign currency rating of the sovereign. (This is the principal reason AA-rated XL Insurance was able to issue a AAA-rated insurance policy in Chile.) Additionally, in many cases, a non-investment grade (lower than BBB-) foreign currency-rated sovereign becomes an investment grade-rated sovereign in local currency terms. Rating agency capital charges for non-investment grade project credits are exceptionally onerous and effectively preclude financial guarantee insurance participation in such projects. Thus, local currency financing enables financial guarantee insurance companies to participate much more actively in emerging market project financings, because their capital charges for these investment grade credits are comparable to capital charges for projects in more highly developed environments.
3. Local currency financing benefits all parties to the project.
We have already pointed out how creditors and consumers benefit from local currency financing. But so also do project sponsors, who in this case obtained 20-year, fixed-rate financing not exposed to cross-border currency risk, a first for an emerging market project. Chilean policy makers also benefited by creating a project which has greatly enhanced prospects for long term success. They are justified in viewing this transaction as an exemplary accomplishment, one that can be held up as a model for emerging market long-term project finance.
If the advantages of local currency financing are so striking, why aren't more emerging market projects financed in this manner? The answer is that today dollar financing is much more available than local currency financing ? but that is likely to change as, following the model established in Chile, government pension funds are privatized, made solvent, and begin to accumulate assets seeking safe investment returns. Pension privatization and asset accumulation are occurring in countries like Mexico, Peru, Argentina, and Brazil, and well-considered projects boasting financial guarantees are exceptionally attractive, safe, long-term investments for these pools of capital.
The benefits of financial guarantee insurance
Financial guarantee insurance was a cornerstone of the success of the Collipulli-Temuco transaction. As in most developing countries, prolonged under-investment in public sector goods and services in Chile has created significant shortages and deficiencies in public infrastructure. The limitation of traditional government funding in meeting such needs is apparent.
However, the Chilean government began to take many of the right steps to addressing this situation years ago. Chile's stable political situation and the profound macroeconomic reforms achieved over the past 25 years have resulted in positive, and sustainable, economic trends which support the country's creditworthiness.
One of the most important early reforms in Chile was that of the pension system, which today has resulted in a vast pool of domestic savings, approximately $33 billion, administered by private pension fund managers. Another key early reform was the ambitious infrastructure concession program aimed at attracting private capital resources to the urgent task of upgrading the country's infrastructure. The Chilean government prudently established restrictions on how the savings could be invested, effectively making it impossible for these local currency pools to be directed at the complex, BBB- level project financing structures favored by the concessionaires bidding for facilities like toll roads, airports, and sanitation facilities.
How could these two well-implemented policies ? a massive capital pool seeking quality local investment opportunities, and Chile's system of infrastructure privatization, be safely linked? The financial guarantee.
Financial guarantee insurance becomes the bridge which allows pension funds, and other institutional investors to invest in high-quality, long-term instruments aimed at improving the country's own infrastructure. This development will likely trigger in Chile the classic ?multiplier effect? which is achieved when economies recycle local savings into new investment and discourage outflows of capital from the country.
The Collipulli-Temuco toll road transaction epitomizes how public policy, combined with financial innovation, can foster economic expansion ? a model for emerging market countries.
The project
The deal finances a 144Km two-lane highway located 574Km south of Santiago. Collipulli-Temuco is one of eight segments along the Pan-American Highway, totaling 1,500Km and requiring approximately $2.3 billion in financing, that have been tendered to private sponsors in a build-operate and transfer concession scheme.
As a part of the Pan-American Highway, Chile's main continuous north-south highway, Collipulli-Temuco is an essential part of the national infrastructure. Essentiality is a keystone of zero-loss infrastructure project finance underwriting criteria, which require XL to underwrite only facilities (e.g., for transportation, energy, or sanitation) critical to the national purpose in their locations.
Significantly, this road has been operated as a toll facility by the Chilean government for 25 years. As guarantor, XL had 25 years of traffic data and affordable toll collections to analyze, as well as evidence that Chileans culturally accept the concept of paying tolls ? major advantages over the toll road financings that have experienced difficulties in other emerging market environments.
The concession begins in the town of Collipulli and ends just south of Temuco, the major city in the economically important region. The concession was granted to induce the private sector to improve the road ? adding a lane in each direction, upgrading approximately 75% of the project from two lanes to four lanes with grade-separated intersections, and improving the shoulders, overpasses, underpasses, and entrances to enhance road safety. The construction project is simple and relatively straightforward, with future capital improvements funded from excess net operating income.
Construction began in May 1999, financed by the sponsor's equity injection of $83 million. At the time bonds were issued in August 2000, the construction project was nearly 40% complete, slightly ahead of schedule.
The Chilean government currently operates only one toll plaza, 23Km south of Temuco; thus, currently tolls are collected in one direction only. This open system allows for local movements for the entire concession north of Temuco.
Once improvements are completed, the system will be closed. The existing toll plaza will be moved slightly south of its current location to accommodate tolling in both directions and a new toll plaza will be added 46Km south of Collipulli. Additionally, five ramp tolls will be constructed, virtually eliminating all free movements, including short local trips; these ramp tolls will charge 25% of the toll charged at the main plazas.
This tolling system will mean that the current toll of approximately $3.38 (at today's exchange rate) for a passenger car traversing the entire length of the concession will increase only modestly in exchange for a vastly improved road. Once all improvements are completed, the rates will be adjusted to $ .032 cents per kilometer, or $ .051 cents per mile ? a level consistent with other segments of the Pan-American Highway, and affordable for local commuters.
Collipulli-Temuco boasts a well-documented traffic history, notably 9.4% average annual traffic growth from 1990-98. Traffic consultants assessed alternatives to this road, formulated estimates of future traffic growth and opined on the reasonableness of the sponsor's own growth assumptions. While the consultants felt the sponsor's base case growth assumptions were reasonable and achievable, in keeping with zero-loss underwriting philosophy, this base case was severely stressed to create our own base case, which relies on much lower overall growth in traffic to retire debt.
Conservative assumptions were also the principal input for the Monte Carlo simulation model built by XL Capital's actuaries to determine the likely distribution of possible loss outcomes. The actuarial analysis supported the conclusions of the credit-based analysis. It found that the chance of an NPV loss was beyond a three-deviation event; in other words, the stochastic viewpoint is such that the chance of a loss to the insurer is significantly below the 1-in-100 threshhold.
Participants
XL's comfort with the quality and experience of its partners in the toll road project was a critical element in underwriting. Cintra (Spain), Grupo Ferrovial's dedicated concession subsidiary, is one of the world's leading companies in the toll road concession business, with 14 concessions throughout the world. Its parent, Grupo Ferrovial, is the fourth-largest construction company in Spain. Both are solidly capitalized, highly competitive and profitable companies. In Chile, Cintra has been awarded four out of eight toll road concessions along the Pan-American Highway, as well as an airport in northern Chile.
XL also took great comfort from the depth of commitment exhibited by the bond underwriter and financial advisor to the issuer, Banco Santander Central Hispano. US counsel came from Debevoise & Plimpton, and Chilean counsel, Claro y Cia., and various seasoned traffic and engineering consultants, including Vollmer Associates of New York and R & Q of Chile.
Legal structure
The third critical element in the transaction was the legal structure. The transaction took about one year to close. The legal documentation, reflecting the complexity of the transaction, featured numerous structural protections ? e.g., reserve accounts, cash traps, guarantees for the turnkey construction contract, and dividend restrictions, to name a few ? designed to protect XL as creditor and enhance the ?zero-loss? nature of the credit underwriting. A particularly challenging aspect for the legal and deal team was translating into a local Chilean context the role, rights and remedies of a bond guarantor ? a concept well understood in the US and Europe, but needing some legal trailblazing in environments like Chile.
A successful closing
Because of the exhaustive underwriting process, Standard & Poor's issued a ?shadow? investment grade rating on the underlying toll road transaction. Two Chilean rating agencies, Feller and Rate and Duff & Phelps, provided guidance to local institutional investors by assigning a local-currency AAA rating to the guarantee of XL Insurance on the bonds.
XL's deal team joined representatives of Banco Santander Central Hispano, Cintra and Ferrovial in a ?road show? aimed at marketing the bonds to Chilean pension funds, insurance companies and other institutional investors. The success of the road show can be measured not just in terms of the oversubscription of the amount offered to the market, but in terms of the superior trading value afforded by XL's guarantee relative to a prior guarantee offered in the local market by a monoline competitor.
The local currency advantage
A key structural element to the success of the transaction is the local currency denomination of both the toll revenues and the debt.
Economic policymakers around the world are debating the relative merits of hard currency (e.g., dollar or yen) financing vs. regional markets and currencies (e.g., the Euro) vs. strictly local capital market financing. The Chilean experience presents a strong case for the development of local currency capital markets in emerging market nations. There are at least three distinct advantages to this approach:
1. Local currency financing provides a perfect match of assets and liabilities for a project.
In Chile, if the peso depreciates or appreciates, Chilean motorists pay tolls and the concessionaire repays its debt in that revalued currency. In real terms, the toll and debt obligations retain a constant relationship in value over the life of the project.
By contrast, in countries where a local currency option is unavailable or unutilized, dollar financing is the usual alternative; typically, tolls will be pegged to fluctuations in the value of the local currency vs. the dollar in an effort to protect the creditworthiness of a project. While this dollar indexing is of some value, it cannot protect against severe devaluation risk. In a dollar-indexed project, if a local currency falls two or three times in value vs. the dollar, tolls must rise by a similar factor. In these situations, the continued affordability of tolls comes into serious question, with predictably dire implications for the ability of a project to service its debt.
2. The lower risk profile presented by a local currency financing has important positive repercussions for financial guarantee insurance companies, which are subject to rating agency capital charge methodologies.
As demonstrated in the table below, for most emerging market countries, the local currency rating is higher than the foreign currency rating of the sovereign. (This is the principal reason AA-rated XL Insurance was able to issue a AAA-rated insurance policy in Chile.) Additionally, in many cases, a non-investment grade (lower than BBB-) foreign currency-rated sovereign becomes an investment grade-rated sovereign in local currency terms. Rating agency capital charges for non-investment grade project credits are exceptionally onerous and effectively preclude financial guarantee insurance participation in such projects. Thus, local currency financing enables financial guarantee insurance companies to participate much more actively in emerging market project financings, because their capital charges for these investment grade credits are comparable to capital charges for projects in more highly developed environments.
3. Local currency financing benefits all parties to the project.
We have already pointed out how creditors and consumers benefit from local currency financing. But so also do project sponsors, who in this case obtained 20-year, fixed-rate financing not exposed to cross-border currency risk, a first for an emerging market project. Chilean policy makers also benefited by creating a project which has greatly enhanced prospects for long term success. They are justified in viewing this transaction as an exemplary accomplishment, one that can be held up as a model for emerging market long-term project finance.
If the advantages of local currency financing are so striking, why aren't more emerging market projects financed in this manner? The answer is that today dollar financing is much more available than local currency financing ? but that is likely to change as, following the model established in Chile, government pension funds are privatized, made solvent, and begin to accumulate assets seeking safe investment returns. Pension privatization and asset accumulation are occurring in countries like Mexico, Peru, Argentina, and Brazil, and well-considered projects boasting financial guarantees are exceptionally attractive, safe, long-term investments for these pools of capital.
The benefits of financial guarantee insurance
Financial guarantee insurance was a cornerstone of the success of the Collipulli-Temuco transaction. As in most developing countries, prolonged under-investment in public sector goods and services in Chile has created significant shortages and deficiencies in public infrastructure. The limitation of traditional government funding in meeting such needs is apparent.
However, the Chilean government began to take many of the right steps to addressing this situation years ago. Chile's stable political situation and the profound macroeconomic reforms achieved over the past 25 years have resulted in positive, and sustainable, economic trends which support the country's creditworthiness.
One of the most important early reforms in Chile was that of the pension system, which today has resulted in a vast pool of domestic savings, approximately $33 billion, administered by private pension fund managers. Another key early reform was the ambitious infrastructure concession program aimed at attracting private capital resources to the urgent task of upgrading the country's infrastructure. The Chilean government prudently established restrictions on how the savings could be invested, effectively making it impossible for these local currency pools to be directed at the complex, BBB- level project financing structures favored by the concessionaires bidding for facilities like toll roads, airports, and sanitation facilities.
How could these two well-implemented policies ? a massive capital pool seeking quality local investment opportunities, and Chile's system of infrastructure privatization, be safely linked? The financial guarantee.
Financial guarantee insurance becomes the bridge which allows pension funds, and other institutional investors to invest in high-quality, long-term instruments aimed at improving the country's own infrastructure. This development will likely trigger in Chile the classic ?multiplier effect? which is achieved when economies recycle local savings into new investment and discourage outflows of capital from the country.
The Collipulli-Temuco toll road transaction epitomizes how public policy, combined with financial innovation, can foster economic expansion ? a model for emerging market countries.
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