The Latin American project bond markets have ripened in recent years, with Peru emerging as an unlikely standard-bearer. Sponsors can pick between several international dollar markets, as well as several onshore and offshore local currency markets. While signs of volatility in US fixed income in recent weeks have dampened enthusiasm at some issuers, increased buyer sophistication has already made the region much less dependent on commercial banks than before.

In May, Project Finance assembled representatives of BNP Paribas, Mayer Brown, Fitch Ratings, AIG and Pacific Life to discuss the options that developers have when using project bonds, and how other Latin jurisdictions can follow the leaders.

Brian Eckhouse (BE), Project Finance: Which project bond markets in Latin America are the most fertile?

Jean-Valery Patin (JVP), BNP Paribas: We’ve seen a very high level of activity in Peru. It started purely with infrastructure projects and has evolved into the energy sector and especially the power sector. Peru is considered a market of reference because it started earlier than other countries and had a successful programme. Transactions started as quasi-sovereign obligations and evolved over time, now including deals without government support and with construction risk, such as Vía Parque Rimac.

Olivier Baratier (OB), BNP Paribas: You can add Mexico to the list; maybe Brazil, too. In the Mexican domestic market, we have seen quite a bit of activity, particularly on the energy side where there were significant transactions, cross border transactions as well.

Wilfried Marchand (WM), BNP Paribas: In Mexico, there has been a lot of activity in brownfield/operating toll-road and other PPP-style projects, usually in local currency.

BE: How mature are local afores investors?

OB: They’re growing comfortable with the project bond markets – and they can do 30-year deals. They can buy large chuck of issuances, whether the deals are done in local currencies or US dollars. They proved extremely relevant to Acciona’s Oaxaca project bonds last year.

BE: Do US investors have preferences among Latin American countries?

Violet Osterberg (VO), Pacific Life: We don’t participate in local issuances; we’re strictly a US dollar player. In terms of how we play in foreign jurisdictions, we try to get our arms around the legal frameworks, specifically the bankruptcy laws. We would love to see some deals go through the bankruptcy processes and see how they work out – other people’s deals, of course.

We like Mexico, we like Brazil and we still like Chile very much, and we would also like to see some of the jurisdictions that have gone dormant, such as Costa Rica, and even Guatemala and Panama. We’re comfortable in Panama despite its size. This is because of the framework of the law and the way the country has developed in terms of institutions. We think there should be a lot to do in Panama, but we are just not seeing the pipeline. There were a couple of deals that were done for toll roads, and we hear that there should be some mining activity developing.

John Pollock (JP), AIG: We like Panama a lot. It’s a vibrant dollar-dominated country.

JVP: In addition to the major countries, what is your view on smaller countries like Costa Rica, Trinidad, and Uruguay. Are these places where investors would like to invest?

JP: We have just a handful of deals in Trinidad. It has a good history of securities law.

We’re not just looking for the upside of some equity return. If the situation turns, we want to be able to go in and sort something out – and we like places where there is an established rule of creditor rights. Trinidad has that. We like transactions that are secured by some physical asset, that, if we’ve done our homework, someone else will value it as much as we valued it initially.

BE: What does local bond market need to get established?

OB: The size of the capital markets in Peru, particularly for project bonds, is completely disproportionate to the size of the country and the GDP. Its success has been built on many things. First, ProInversión has been promoting long-term concessions of 30 years, whereas commercial bank funding typically topped out at 10 years. So that essentially compelled the capital markets to develop. Then you have a very friendly format for bonds – the fact that you can play cross-border bonds across domestic and US investors, so that has been very helpful and very different from what you see in Brazil or Mexico, where there is a forced separation of markets. Then you have the growth of the country and the need for infrastructure, which was in a very poor state about five years ago. And finally you also have pension funds contributions growing rapidly, coinciding with the government pushing pension funds to participate. Peru did very conservative transactions first – sovereign-backed monetisations – so that everyone could understand the rationale of the assets. Now, you see pension funds and insurance companies participating in full construction risk under project bonds.

JVP: That trajectory is really important, to start with what is basic and simple and then slowly add more risk. As Peru’s project bond market matured, the amount of guarantees waned, to where you now don’t have any kind of support in a transaction like Vía Parque Rimac. This happened over seven years. It’s important for a country with a developing framework to understand that it’s a gradual process for investors to get used to the risk. You show them stability, and then, little by little, they develop appetite for risk. Of course, countries may learn from past experiences and have a faster learning curve, but it will not happen from one day to the other.

OB: At the other end of the spectrum, there’s Brazil, whose sheer size would seem to suggest strong capital markets for project bonds. But then you have a series of elements that thwarts the expected growth. National development bank BNDES still finances the bulk of all projects. And the bond market plays like a bank market, with firm underwritings of bond offerings.

VO: Brazil actually needs a lot of investment, but they’ve made it so difficult for foreigners to come in and invest in bond format.

Glaucia Calp (GC), Fitch Ratings: BNDES says that it cannot meet all funds needs. According to recent public statements, it seems to be willing to expand its role by offering some credit-enhancements to capital markets transactions. In my view, BNDES should focus more on providing currency hedging and construction guarantees, for example, to address some of the issues constraining market development.

Christopher Erckert (CE), Mayer Brown: In Brazil, the law really restricts the ability for projects to have revenues that are indexed to dollars. There are lots of investors who would like to play in Brazil but don’t want to take the foreign-exchange risk. Outside of the rig sector, the government has made it difficult, if not impossible, to do deals in dollars.

BE: Are there signs that this might change?

CE: There was a lot of excitement when the government sought investments in the port sector. But at the same time, it announced that ports would not be permitted to denominate their contracts in dollars, unlike other countries in the region. If the revenues are going to be denominated entirely in the local currency, it’s difficult for dollar investors to lend to a project, or for a project to take on dollar debt.

If the goods – and the price of the goods – moving in international commerce are effectively set in dollars, why is it that the port charges that are implicitly part of the product and the product price can’t also be in dollars? It would seem that this would unlock a lot of the liquidity for financing in that sector.

BE: What is the status of Colombia’s push for project bonds?

GC: ANI, the National Agency for Infrastructure, is really trying to leave construction risk out at this first stage. The aim is to create a kind of sovereign obligation, milestone-based and backed by future budget allocations, inspired by Peru’s past experience. The idea is to structure a commoditised sort of instrument not exposed to construction risk, but to service and availability risk, for it is based on the PPP law. This law establishes that all obligations embedded in PPPs must be conditioned to availability and service. Thus, what we have been seeing at this moment is work by ANI to structure an instrument that is not subject to construction and traffic risk.

CE: There are plenty of reference points that the Colombians are looking at. The earliest deals in Peru are clean in terms of risks. In Mexico, some of the public works contracts were financed in either of the bank or the bond markets. Although there was some performance risk involved and there was some ability to go back a reopen the value of the works that had been certified so far, that was quantified and capped. So, you could look at what that risk was and build other credit enhancements or risk mitigants into a structure that then allowed the deal to move forward.

BE: How do the legal aspects of a project bond transaction differ from a bank or multilateral financing?

CE: First, the offering memorandum or private placement memo is very different by its nature than a bank book, and I think that disclosure document – and the effort that goes into it – often concerns sponsors about project bonds. But sponsors may be more concerned about it than they should be.

There seems to be skittishness from issuers about going into the US capital markets, the US securities markets – and what that could means in terms of liability. Some sponsors, particularly European and Latin American sponsors, have heard horror stories about securities-related class action lawsuits in the US.

Second, there is a certain art in designing the covenant package for a project bond deal that is a little bit different from a bank deal. Sponsors in bank deals want as much flexibility as they can and bankers always assure them, “We’re here for you and we can give you waivers and we always act reasonably and we have this long-term relationship with you.” Banks sometimes undermine that argument when they charge material waiver fees. But, at the end of the day, the borrowers and the lenders generally have long-term relationships that go beyond one particular project in one particular country, so I think borrowers tend to look at the negotiation of the covenant package through that lens.

When you take it to the project bond space, there isn’t that same one-on-one, direct, long-term relationship between the issuer and the bondholder. For the most part, the issuer doesn’t know who its bondholders are, and part of the reason the deal is getting done in the bond market itself is because the instrument is more liquid, so it’s going to trade more often. So, the issuer doesn’t have the same kind of relationship with the bondholders, and the bondholders don’t necessarily have the same kind of knowledgeable staff in place, to deal with waiver requests (though this obviously isn’t the case with certain investors like Pac Life and AIG). Issuers are interested in who their bondholders are – and will they be able to obtain a waiver if needed. So that informs the structuring of the deal at the outset. It’s important to limit the risk that the bondholders are taking; the covenant package should clarify the business of the issuer and that it’s not going to change significantly over time.

The flipside of that is that sometimes things come up that might not have been contemplated, that are in the interest not only of the equity holders, but also the debt holders. There has to be a mechanism to deal with these situations.

JP: On private placements, there’s often a misconception that the note holders are going to be this disparate, wild group that you’re never going to be able to find, but that’s not really true. There aren’t too many players. And for the most part, the Pacific Lifes and the AIGs and our competitors are also our counterparts on so many deals that have the same requirements from the National Association of Insurance Commissioners (NAIC) – the same kinds of capital constraints. But if an issuer wants to make a splash in the 144A market, sure you may get 150 buyers, but fat chance ever trying to get a waiver from them. Issuers need to recognise that each one of these groups satisfies a different requirement in your capital structure, and some work out and some frankly don’t.

VO: That’s a fantastic point: If issuers want to know their investors and they want to have cohesive groups when they need an amendment, why aren’t the advisers guiding these issuers to private placements instead of 144As? The private placement community has a long history of foreign involvement.

OB: But many traditional US private placement players don’t actually participate in Latin American issues, so you end up with a smaller, limited pocket of supply.

VO: If it’s a 144A, you’re not hearing from the company directly. You’re learning of it from the DTC. With a private placement, the company has time to explain what’s going on – and it’s easier for investors to embrace a request when a company has a chance to explain the story. While it’s true that private placement investors aren’t used to buying project deals in Reg D, I think that it’s because there hasn’t been a whole lot of supply, so that market hasn’t been built.

Michael Dickson (MD), BNP Paribas: No one is a greater evangelist for private placements than I am, given that it’s my vocation, but there is a concern about the amount of liquidity in the private placement market for a Reg D format, and it often dictates which project bond market is chosen. There are certainly investors that can do large deals, but there are not enough of them. The timeframes of deals also matters: arranging private placements can take a little longer, while there’s a tried and true format for the 144A process.

VO: But, depending on the deal and its size, there’s often limited liquidity in the 144A market when you need it.

JP: And there is in private placements. You may not like the price, but when things went sideways several years ago, forcing people to sell, the public bond market locked up solid and the 144A market was locked up solid, but you could still raise capital in the private placements market. We understand that there’s a size bias, so I see how the 144A makes absolutely perfect sense. But I’m not sure that there is a real difference. Let’s say that you have a $500 million 144A and a $500 million private placement and you circle up $300 million for each, is that final $200 million that much harder to get done in the private placement?

BE: John, do you have a market preference?

JP: Broadly no, but we don’t like certain 144As, which we euphemistically call “drive-bys.” There are well-conceived 144As, with an incredible covenant package and structured like a traditional project finance deal, with a 600-page engineer report and a market pool study. Then there are 144As that we’re told will launch on Tuesday and price on Friday; those won’t get done unless people essentially buy the rating, though there are there plenty of folks that will do that. People sometimes ask us, “Why didn’t you do that deal?” And the answer is: It was a drive-by. It didn’t make a lot of sense.

VO: I’m always calling the underwriters counsel because I need to go through that process of understanding rights, triggers and consequences; it’s like following a little bouncing ball until it rests. And so from that standpoint, a private placement tends to deliver that more than a 144A. Yet, if the 144A market delivered similar distribution and execution, I might lean toward that market because the deal will be rated. That isn’t always so for a private placement.

BE: What opportunities exist for governments to issue debt through – or based on the credit quality of – sub-sovereigns and parastatal organizations?

VO: In a jurisdiction like the Caribbean, where the projects are small or there may not be that many, I have been able to participate. I may have appetite for something that had a government guarantee. For example, I participated in a transaction where it was in the government’s best interest to develop the project so they added a small piece with a government guarantee – and that was enough to start the project.

CE: It was a government guarantee of the debt, not just of the offtake obligations?

VO: Yes.

JVP: And then you make a judgment that you’re comfortable with that country risk – you don’t necessarily seek anything to cover that country risk?

VO: No, this is a country that we’ve gotten comfortable with and we’ve done other deals in that country – even sovereign exposure – so this is a way where the government actually guaranteed the debt of this project, and it wasn’t the entire debt, but it was this particular tranche that I’d gone into, and because it’s associated with the project itself, it comes at a pick-up to the government rate.

OB: For some of these jurisdictions new to project bonds, maybe you offer something more palatable, like the sovereign or quasi sovereign, and then build up expertise amongst the participants, for something a little more “project-like” in the future.

JVP: I also think that can be true for projects in more established countries where the risk profiles are not completely self-sustainable. For instance, consider the $5 billion Line 2 light-rail project in Lima. Yes, they have taken away much of the civil work, but for the rest, there’s been recognition that there won’t be tremendous traffic all of a sudden. So there needs to be government support. So why not really support it, and get a great deal on the financing and some competitive offers for all the bidders?

Sam Fox (SF), Fitch Ratings: We’ve seen a couple of proposals recently where multilaterals or similar entities offered de facto guarantees through insurance contracts, as opposed to a guarantee from the local government. The value of a guarantee versus an insurance product is something that we could differentiate greatly. We think there are prospects out there that can get all the way up to the rating of an insurance provider, and then there are those that are more tied to the project risk.

JVP: Another possible mitigant to country and regulatory risk is the use of A/B bond structures, whereas a multilateral offers, among others, its lenders of record and umbrella features to bond investors under the B bonds, as well as its ability to provide the A piece. It has some unique and innovative mechanisms that differ from A/B loan structures and that we are putting together on a large transaction in progress in Central America.

BE: How do sponsors and investors mitigate appropriations and construction risks?

GC: Construction risk will always be an issue, and it has to be dealt with. We’ve seen certain cases in which investment-grade ratings have actually been achieved. Which would be those cases? Basically, low complexity projects involving experienced sponsors and contractors, which you as an analyst are confident will deliver on the project. Investment-grade can also be potentially achieved in cases involving, for example, experienced but not credit-worthy contractors. Fitch would perform a replacement analysis and get comfortable with the fact that there are a good number of available contractors in the market capable of taking over the project, with appropriate liquidity levels in place to allow for continued debt service until contractors are replaced. Another important factor relates to the project’s technology. Thinking about energy projects, which are projects that are dependent upon technology, the use of proven technology is clearly a must. Deal structure also plays a role as Jean-Valery and Olivier were saying. Deals can be structured in a way that allows for delayed completion depending on how the debt instruments are designed and default, defined.

And there is also the issue of termination payments. Some deals that we have seen have termination payments defined in a way that they are timely paid. The project’s rating can be affected by how the deal is structured, how strong the counterparties are and by whether termination payments are sized to be sufficient to cover debt service. We have seen termination payments sized to cover debt outstanding balance in Peru and Mexico, for example. Actually, we have rated a transaction in Mexico that would have been rated investment-grade had it been placed internationally in which termination payment clauses were very strong and payment, timely in nature.

JP: We’ve done deals where there have been multiple construction draws. We’re not interested in taking the Treasury risk; we’ll take the coupon risk, in the sense that you’ll lock a spread and let’s say you have 3 draws, we’ll fix the spread at X over, and draw three different times, and then the last draw do a blended coupon, so that you’ll only have one coupon at the end. Because, the other scenario on those deals is that we were to hedge, in the real meltdown cases, you never get to those second or third draws and now we’ve got a hedge and nothing to show for it. So now the project is in a much better position to take that interest rate risk than the investors are and that’s the reason we’ve shied away. But we’ve got several deals, we’ve done several deals – one that I have in mind is in America, where there have been multiple draws and we reset the coupon, and then we’ll take it out at the end.

WM: We could also deal with bondholder funding risk in the documentation. I can remember a note purchase agreement where we built in a clause stating that if one of the delayed funding bondholders defaulted on their obligation, that we would create a period of time for the issuer to re-market that portion to other investors – the existing or new ones – and if it manages to do so successfully, then the deal is not impacted.

BE: Glaucia, is there a ratings floor for local currency project bonds that international institutional investors won’t play beneath?

GC: It depends on the market. There are the regulatory floors, but these regulatory floors are really not the norm – I mean, they are like normally in the BBB category in the respective national scales. In general, ratings in the BBB category are equivalent to international scale ratings in the B category for most Latin American countries, but the fact is that, typically, something less than AA- in markets such as Colombia, Peru, Brazil and Mexico is not accepted by local investors. This is the reality.

Also, there are markets which are more receptive to more flexible and/or tailor-made sort of structures than others. Flow zero kind of structures, common in Mexico, for example, may help create stronger deals. Scheduled payments as opposed to rigid amortisation schemes may have a positive impact on the ratings by allowing for short-term difficulties to be overcome and ultimate payment achieved.

BE: Does the Vía Parque Rimac financing suggest that that there are limits to the appetite of bond buyers for revenue risk? Would an attempt to sell the issue offshore have been cost-effective?

OB: Well, I think in that particular case, the issue of selling bonds off-shore was linked entirely to the fact that they were local currency bonds indexed to inflation so that’s an extremely difficult piece of paper to swap for, in particular, the US private placement market. The main players for that kind of instrument would be asset managers, but then you sell something very neutral to them, being long the local currency, but at the same time you have project risk associated with it, so it’s something that is not really a good mix. We had some interest from some parties, but you’re going out to sell something that’s not the perfect fit for that market, and certainly not for the US private placement offshore investors. So I think that’s the main issue, and if we’d have had to distribute that issue to the US market, certainly we would have had to help them out with cross-currency swaps and those kinds of issues.

JVP: Under that concession, the concessionaire had a right to index up to 50% of the tolls to the USD/PEN exchange rate. But obviously, the reality is more complex; the image is always the trade driver coming in the morning, but everyone saying, “sorry there is a change in FC, so you’ll have to pay 20% more” – socially is not very palatable. Thus there is a natural incentive for the sponsors to favour debt in local currency to avoid this situation. The grantor, in this case the municipality of Lima, also favours this outcome. We maintained up to the very last month the ability and optionality to have a tranche in US dollars, which we consider fundamental to maintain price tension and high certainty of execution. In the end, however, we managed to garner strong interest from local players and the deal was eventually done 100% in local currency, which was beneficial to all parties involved.


Left to right: Olivier Baratier, head of specialised products, BNP Paribas; Christopher Erckert, partner, Mayer Brown; Brian Eckhouse, deputy editor, Project Finance; Michael Dickson, director of private placements, BNP Paribas; Wilfried Marchand, director, specialised products , BNP Paribas; Jean-Valery Patin, head of Latin American project finance, BNP Paribas; Violet Osterberg, co-head of specialty investments, Pacific Life Insurance; John Pollock, global head of project finance, AIG Asset Management.
Not pictured: Glaucia Calp, Latin America infrastructure leader, and Samuel Fox, senior director, Latin America structured finance, Fitch Ratings.