Mexico’s $12 Billion Deal to Aid Pemex Seen Spurring More P-Caps

(Bloomberg) -- An obscure financing tool used to chip away at the obligations of the world’s most indebted oil major, Petroleos Mexicanos, is now emerging as a model for other struggling borrowers. 

The Mexican government in July completed a $12 billion debt offering in the form of pre-capitalized securities, or P-Caps — the first time a sovereign deployed the tool. It’s a type of instrument that allows issuers, typically insurance companies, to borrow money without recording it as debt on their balance sheets and potentially endangering their credit rating. 

Credit analysts and advisers say other borrowers are taking note, too. One such person is Eddie Best, a partner at law firm Willkie Farr & Gallagher LLP, who said banks and issuers looking to learn more about P-Caps began to reach out after the firm served as structuring counsel to the lenders that put together Mexico’s P-Cap deal, including JPMorgan Chase & Co. 

“We started getting phone calls literally right after the Mexico P-Cap offering became public,” Best said in an interview. “We’ve been having discussions about how P-Caps or variations on the structure might be used in different jurisdictions or in different industries.”

Both sovereigns and corporates are mulling the move, according to Best, who said borrowers in Latin America and the Middle East are the most likely candidates. Based on discussions his firm is having, he said he “wouldn’t be surprised” to see three or four transactions before the end of the year, adding that they need to be large enough to compensate for the extra costs that come with the structure.

Peru is a potential candidate, said Jeff Grills, head of emerging market debt at Aegon Asset Management. It’s one of the few investment-grade rated countries in Latin America, and Petroleos del Peru SA, its state-owned oil driller, has been plagued by liquidity crunch. 

Peru’s Finance Minister Raul Perez Reyes this month said his department would receive proposals from as many as five banks for the reorganization of Petroperu’s debt. “Petroperu is a very, very logical one for them to try to do this,” Grills said. 

The company’s bonds returned 8.5% this month, the second-best performance in emerging markets, according to a Bloomberg index. 

A representative for Peru’s finance ministry didn’t reply to a request for comment, while a Petroperu spokesperson declined to comment. 

Roxana Muñoz, a vice president at Moody’s Ratings, also pointed to Peru as a potential candidate. “Normally, we saw these transactions in corporate holding companies that helped their subsidiaries. I think this transaction opens the door for other countries like Peru, which helps Petroperu,” she said.

Structure, Cost

In the Mexican P-Cap deal, the country — through an entity named Eagle Funding LuxCo. — sold the securities and used the proceeds to buy US government debt, including Treasuries. Pemex is able to use the portfolio as collateral for loans. 

There are a number of benefits to the P-Cap structure. In Mexico’s case, it enabled the government to support Pemex while keeping the obligations off its books and avoiding putting pressure on its credit rating. The structure can provide refinancings to businesses facing tight credit conditions, said Gimme Credit senior credit analyst Franck Bekaert. 

Given the demand for Mexico’s deal — it was two times oversubscribed, according to the government — the country could tap the structure again, Bekaert said. “Considering the company’s needs and the successful outcome of the issue, Pemex is likely to issue a new P-Cap in the near future,” he said.

Pemex and Mexico’s Finance Ministry didn’t respond to requests for comment.

In the case of insurance firms, the issuer creates a special purpose vehicle to tap public investors, but holds the debt off its balance sheet until it is needed. The raised cash buys assets, like Treasuries, generating income to cover some of the interest payments. That allows the issuer to lock in interest rates without affecting its leverage.

“The more a product spreads out by region and sector, the more issuers understand it’s not just for US insurance companies,” said Salvatore Seguna, head of capital solutions at Santander’s corporate and investment banking division, who was part of the group who created the structure more than a decade ago.

The structure makes sense for state-owned enterprises, or companies that can’t put additional liabilities on their balance sheets, according to Best. On the other hand, higher-rated companies will likely get cheaper funding elsewhere. 

Issuers looking to raise less than $500 million will likely find the complexity and cost are not worth it, he said. The expenses related to setting up a special purpose vehicle and hiring law firms and other advisers can make the cost “maybe double or triple the cost of a vanilla bond offering,” according to Best. 

The idea, which initially started as a rainy day fund of sorts, has evolved as a liability management tool, said Robert DeLaMater, a partner at Sullivan & Cromwell LLP. The law firm often represents banks arranging P-Cap deals. 

“I am bullish on the fact that use of this product will increase dramatically as interest rates fall,” he said.

--With assistance from Scott Squires.

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