In July this year, the Mexican government did something no other government had ever done. It used a corporate debt tool to reduce the massive debt pile of state-owned energy major Pemex. Now, others are using this as a template for their struggling state entities.
In July, the Mexican government issued $12 billion worth of something called P-Caps. Normally used in corporate circles, P-Caps, or pre-capitalized securities, allow a borrower access to debt funding in case of need but without being included in its balance sheet. The securities sit in a trust to keep them separate from the company’s liabilities and avoid having them affect its credit rating.
The way that Mexico’s government went about it was by setting up a special entity, through which it sold the freshly issued debt and used the proceeds to buy U.S. sovereign debt. Pemex was then given access to that debt portfolio to use as collateral for new loans, Bloomberg detailed in a report this week. Also, income generated from the interest the U.S. sovereign debt carries could be used to pay down interest on Pemex’s own debt.
Most commonly used by insurance companies, in this case, the P-Caps were classified as public government debt and kept separate from Pemex’s liability list, which features some $105 billion in financial debt and another $20 billion in payables to suppliers. It worked, too. Immediately after the news broke that the government would issue $12 billion in debt to help Pemex, the company’s own bonds soared.
“It’s a sign of support from Sheinbaum, which shows pragmatism and decisiveness,” one senior economist told Bloomberg at the time. “The financial challenges were clouding the outlook and taking attention away from the company’s management and operational challenges. We hope they can start to address the latter soon,” Armando Armenta from AllianceBernstein in New York said.
Now, Bloomberg is reporting that other governments are drawing inspiration from Mexico to help state companies with P-Caps. “We started getting phone calls literally right after the Mexico P-Cap offering became public,” one law firm partner told the publication. “We’ve been having discussions about how P-Caps or variations on the structure might be used in different jurisdictions or in different industries,” Eddie Best from Willkie Farr & Gallagher said.
There is, reportedly, so much interest in these debt instruments that, according to Best, another three or four transactions may be made public by the end of this year, with the most likely candidates to follow Mexico’s example being in Latin America and the Middle East. One of these candidates, according to an executive from the asset management industry, could be Peru, whose state energy company has been troubled by liquidity problems. A Moody’s vice-president agrees that Peru is a likely P-Caps issuer.
For all its benefits, such as off-balance sheet debt finance, P-Caps do have their drawbacks. Complexity is one of them and, related to it, higher costs for the privilege to have access to debt funding without having it on your balance sheet until you absolutely need it. The costs of P-Caps could end up being “double or triple the cost of a vanilla bond offering,” Best told Bloomberg, because of all the expenses related to setting up the special vehicle and paying for the related advisory services by law firms and others. This is, however, what makes it especially suitable for sovereign issuers and those with subprime credit ratings. The former tend to be able to afford more complicated debt arrangements, and the latter do not really have a lot of choice.
That unusual debt has not been enough to solve all of Pemex’s problems, however. Just this month, the Mexican government issued fresh debt not once but twice. Early in the month, the government issued a euro-denominated bond worth 5 billion, and then a week later it issued an $8-billion bond to help Pemex pay for a debt buyback it launched earlier in the month, Reuters reported last week.
By Irina Slav for Oilprice.com
