Innovative Structured and Project FinanceWed, 01/25/2012 - 09:02
Q: What has been the impact of the global financial crisis and resulting volatility in the financial markets on both the structured finance market in Mexico and the development of NAVIX?
A: The crisis had a profound effect on the availability of credit overall and consequently had an impact on Navix’s business model. Even though we have been involved in structured finance for just over ten years, Navix as a company only emerged in late 2007, shortly before the onset of the financial crisis. As the crisis deepened and became widespread, it became evident that Navix would be unable to secure the lines of credit it required to pursue an intermediation-based business model. As a result, we reinvented ourselves and through a co-financing format sought investors that not only had an appetite for yield but that were also sophisticated enough to appreciate the unique platform that Navix has to underwrite (origination, credit analysis, structuring) and service transactions with a unique and very attractive risk-return profile. Once we secured the capital that gave viability to our business model, Navix focused its structured lending practice on sectors that our core management team had been actively financing in the preceding years and that had little or no correlation to the overall performance of the economy, most notably the oil and gas services sector. The demands for working and growth capital in this industry were increasing significantly as a function of Pemex’s massive investment programme aimed at replenishing reserves and offsetting the decline of its main oil fields.
Q: What is your main source of funding?
A: Certificados de Capital de Desarrollo, or CKDs, are our main source of funding today. Last December we issued MX$4 billion (US$310 million) to the pension funds and together with our contribution we have over MX$5 billion (US$390 million) of funding capacity for energy sector projects in Mexico. In addition, we have co-financing agreements with US-based financial institutions, roughly US$250 million, which we utilize to fund our portfolio of loans across different sectors and asset classes. We have been gradually expanding our funding sources to include local players and are currently in the process of closing a line of credit with Nafinsa, Mexico’s largest development bank, to complement smaller lines of credit that we have secured with local niche banks.
Q: Pension funds are generally not known for their large risk tolerance, which implies that NAVIX will have to operate with a client base that matches the desired risk profile. To what extent has Pemex’s relatively stable credit rating, and its position as the primary client for most companies in the Mexican oil and gas industry, influenced the focus of NAVIX on the oil and gas industry?
A: The credit rating of Pemex is very important. Most people who understand Mexico feel very comfortable with Pemex’s credit risk: it is a sovereign credit risk that is fully backed by the Mexican government. From an obligor perspective, Pemex is a great risk. You do have to understand that we are not financing Pemex directly; we are financing companies that provide services to Pemex, so there is an element of performance risk involved in all of our transactions. That is the reason why there is a spread differential between the rates that we charge companies operating in the energy space and the yield that a Pemex note would generate over the same period of time. If you can structure a transaction in a way that mitigates or eliminates most risks typically associated with a credit transaction, you effectively isolate that performance risk. We have specialized in evaluating performance risk, and by developing a unique capacity to measure and control this risk we are able to create a very secure product. We enable the company that we are financing to focus on what they are very good at doing from a technical and operational point of view, and that translates into preserving our source of payment, which are the cash flows associated with the Pemex contract. This is something that the pension funds perceived and appreciated when we did our road show for the issuance of the CKDs. The risk-return profile for this product is very attractive because it generates a very good yield with limited risk.
Q: The introduction of incentive-based integrated E&P contracts must present an opportunity for NAVIX, but also a headache because it becomes more difficult to assess the risk of a project since it is not just about money anymore...
A: That is true. Under the old contracting regime the only real criteria for contract assignment was lowest unit cost offered. The qualifications to participate in a tender were fairly basic and simple, and Pemex did not really have the ability to discriminate based on more qualitative issues such as reliability, transfer of technology or other variables that in a different context would be defining issues in awarding a contract. Pemex successfully transmitted the implications of these limitations to the legislators and has now been empowered to assign contracts on a value-driven basis rather than a cost-driven basis. The incentive- based contracts will certainly make the analysis of the underwriting of a project more challenging, because there is more uncertainty in the cash flows that are a function of production. For example, when a company is assuming the operation of a field that already has some amount of production, revenue is a function of increases to the base line production assumed in the contract. Conversely, when a field has no initial production, the impact of this particular variable in the calculation of the revenue and profit is non-existent. It is certainly more challenging and will force us to keep up with a dynamic environment as regulations and contracts are fine-tuned.
Q: The concept of providing capital together with financial advice and a certain degree of partnership has been very successful with Mexican companies. Are international companies not really in the market for the kind of product that you offer?
A: Some of the international companies that participate in the oilfield services space in Mexico typically have cheaper sources of capital. This is not a norm, but it is usually the case. We do have some international clients and have been working with clients that see a benefit in isolating their Mexican operation from the rest of their domestic or international operations. If we feel comfortable that they have the required expertise, then we will do transactions that are limited in recourse to their Mexican operation, which enables them to tie their financing to the local operation.
We do work mostly with Mexican companies. Not necessarily by design, but it is a reality that many medium- sized Mexican companies oftentimes have the operational and technical capabilities to perform a contract, but their balance sheets are very weak.