When Nicholas Brady left the US treasury department at the end of the Bush administration, it was something of a no-brainer to figure out what to do next. Why not invest in the Latin American countries that his work in developing Brady bonds had helped get on the track to privatization? Starting up in 1994, his company, Darby Overseas Investors, raised $150 million for a private equity fund, one of the first of its kind for Latin America.
Now that private equity has become more common in Latin America, Darby has turned its innovative talents towards launching another first: a $500 million mezzanine fund, which got an initial $75 million loan from the Inter-American Development Bank. According to sources close to Darby the firm signed on Banco Bilbao Vizcaya as a core sponsor and another signing of a European bank was thought to be close.
The mezzanine fund was the brainchild of Richard Frank, Darby's managing partner and chief operating officer and the former managing director of the World Bank and chairman of its private sector development group.
The fund's aim is to provide long-term debt for infrastructure projects, just the type of finance that is often in short supply in the region. Though the first of its kind in Latin America, a couple of similar mezzanine funds are in the works in Asia. Asia Prudential recently closed on a $400 million fund, and Crédit Lyonnais is working on a $150 million fund. Both have received development bank support similar to Darby's co-investment promise from the IADB.
In terms of need, the timing couldn't be better as spreads have widened and maturities shortened since the Asia crisis began. Mezzanine finance, the middle layer between senior debt and equity, has been most often associated with leveraged buyouts in the US, says Frank. To entice lenders to subordinate their debt to senior bank lenders who come first in the case of a default, mezzanine finance provides some sort of equity kicker, such as warrants.
Darby plans to use the financing technique to fill a gap in the Latin American capital markets. Infrastructure projects typically require at least 10-year financing, while bank financing generally goes out only seven years. While bond markets generally can offer longer maturities, private bond issuance in Latin America has shrunk considerably since the Asian crisis. According to the World Bank, it went from $22.1 billion in 1996 to $16.6 billion in 1997. And the figures for 1998 are expected to show a further decline. Spreads have widened by about 185 basis points in Latin America over the past year, according to the JP Morgan emerging markets bond index.
Darby plans to raise two types of finance: first is an anticipated equity component of $250 million from banks. Originally it hoped to use the fund to lure Japanese banks back to the region, but as their woes continue to mount, that prospect is looking less likely. Now the focus is on finding an American bank partner. The rest of the money, another $250 million, will be debt, with $75 million of that from the IADB. Frank says the debt could be raised in one of two ways. One would be to raise the entire chunk from the syndicated loan market, anchored by the IADB piece. The second would be to invest in a basket of assets, go to the rating agencies (where it has been assured of an investment-grade rating), and raise the rest in the international capital markets.
The only catch to the financing structure is its double leverage. The fund, itself 50% debt, will be invested in debt, although with an equity kicker. Frank says the fund chose the unusual arrangement to boost returns.
The European banks involved in the mezzanine fund will also be helping manage it and find investments. BBV will be adding one staff member to the fund, says Robert Graffam, Darby managing director. The Spanish bank's experience in Latin American banking, where it has invested $3 billion, will help identify projects. And BBV's investments in large Spanish utilities, such as Telefónica, Repsol and Iberdrola, all of which are bidding for Latin American concessions in telecoms, oil and power, respectively, give the bank a reason for investing with Darby.
Darby hopes to complete financing for the fund by summer's end and start investing in projects by the autumn. Already, Frank says that the firm has a stack of inquiries, and is starting to gather documentation for about 10 projects. "We're getting an inquiry a day now, either a phone call or a visit," he says. He expects that the fund will commit an average of $25 million to each project.
Darby plans to launch a second private equity fund, with between $150 million and $250 million, within a few months. Michelle Celarier