We have highlighted in the past certain apparent inconsistencies between Operadora Mega’s leasing-centered business model and some of the elements of its financial statements, especially the balance of the client deposits and its relation to the total portfolio, and the commercial margin and its relation to the loan origination (See the Part I and Part II of the 4Q23 Credit Report). We even came up with some potential explanations at the time.

Eventually, the company gave the answer – its focus is no longer predominantly on the leasing business.

As such, we are somewhat relieved, as this cause for the apparent inconsistencies is the least dangerous among the ones that we had envisioned.

The Mexican non-bank financial institution (NBFI) has moved from historically having around two-thirds of its loan portfolio in the leasing business to only 47% as of the end of 1Q24 (See Table 1).

Certainly, the early repayment of the remaining contract by the government of Jalisco (management confirmed it during the call) and the portfolio sale carried out during the quarter contributed to the large decrease in the leasing portfolio between December and March. Here, we also need to remember that when a leasing loan becomes fully amortized the reduction of the portfolio is significantly larger accounting-wise, due to the non-cash cancellation of a 20% client deposit (See the 2Q22 Credit Report for a further explanation on this).

And we expect the weight of the leasing business to continue decreasing, at least in the short term, given the pace of amortizations and the current mix of originations.

Out of the MXN 831m (USD 49m) in gross loan origination in 1Q24, around half corresponded to leasing and the other half to simple credit. The company expects to maintain that mix in the upcoming months, at least until it manages to find a solution for the maturity of the 2025 bonds due next February (more on this below).

Only after that (and that “only” seems a big “if,” given the challenging nature of the refinancing) will the company maybe take a path back toward the historical portfolio composition.

It seems that, pressured to increase collections to face the rising interest expenses (11.1% up year-over-year in 1Q24), Mega has opted to focus its lending operations on the simple credit business, which generates higher interest rates.

On the flip side, we believe that, as a general rule, simple credit bears more risk as well, given that the company doesn’t have a physical asset as collateral and the client doesn’t put the 20% deposit upfront. On this, the management argued that the company does its risk analysis by client, rather than by type of product.

The strategy, though, seems to be working, as the interest income rose 1.1% year-over-year (YoY) in 1Q24, against a loan portfolio that was 8.9% lower YoY, while maintaining the non-performing loan (NPL) ratio contained (3.9% as of 1Q24, compared to 3.3% at 1Q23 and 3.8% three months earlier).

New secured debt is certainly a likely option… But, how much room is there?

During the 1Q24 earnings call, management reiterated that it is in conversations with different financial intermediaries for a refinancing of the 2025s, but that the talks are confidential. However, they indicated this time that they expect to have news on that front in the next 60-90 days and to have the problem solved by the end of 3Q24.

When downgrading the company’s rating earlier this week, S&P noted that Mega is in the process of obtaining a secured credit facility.

As the management admitted that it is analyzing with lawyers the existing caps on the encumbrance of the additional loan portfolio, we certainly believe the company may take the route of the secured debt. However, we don’t think this alone would solve the problem entirely.

As we have noted in the past, the indenture of the Cebures domestic notes caps the encumbrance of the loan portfolio to a maximum equivalent to 20% of the total assets, with the exemption of the debt that had already received the portfolio as collateral at the time of the May 2022 issuance (for the revolvers already existing then, the exemption continues to apply even when the debt is repaid and the facilities are tapped again).

The management indicated that currently around 25% of the total portfolio has been encumbered. With a portfolio of MXN 15.56bn (USD 941m) as of March, that would equate to ~MXN 3.89bn (USD 235m).

Meanwhile, the secured debt as of 1Q24-end was 21% of the total, therefore amounting to ~MXN 2.74bn (USD 790m).

All that results in an over-collateralization ratio of ~1.4x (equivalent to a loan-to-value, or LTV, of 71%).

Therefore, assuming that the entirety of the 20% bucket allowed by the Cebures indenture is still available (we do believe so), we estimate that Mega would be able to raise ~MXN 2.47bn (USD 150m) in additional secured debt.

However, as we also noted in the past, most of the debt with international funds includes covenants of negative pledges that force the company to give those creditors a similar treatment when encumbering some of the portfolio. As a result, we estimate that, out of those USD 150m in new secured debt, only ~USD 117m could be used to refinance the 2025 notes as of now (See Figure 1).

Our guess on what the potential refi strategy could look like

Against the current backdrop, raising unsecured debt, at least in large amounts, doesn’t seem feasible for the company right now.

Therefore, with the existing limitations on the amount of secured debt that can be obtained, we consider Mega will need to resort again to an exchange offer.

We believe that many of the bondholders would be glad to be offered again similar terms to the ones of the failed exchange offer of last year (i.e. a higher coupon and a partial cash repayment thanks to a loan from the controlling shareholder), and thus the company could push back the maturity of, let’s say, 50% of the outstanding amount of the 2025 bond.

Meanwhile, if it manages to pay down the debt with international funds that is due this year (See Figure 2) with the collections, the company could address the other half of the bond maturity with ~90% of the USD 150m from the new secured debt, or USD 136m (See again Figure 1), plus some smaller amount of additional unsecured debt.

However, the order of actions would be important here, in order to not encourage bondholders to stay out of the exchange, and thus avoid a size of holdouts in excess of what the company could digest. Therefore, the order should be 1) repay the debt with international funds due this year, 2) launch a tender offer for 100% of the notes, and 3) raise secured debt to address the holdouts at the February 2025 maturity.

On the call, management said that the budget of principal and interest collections for FY24 is MXN 4.2bn (USD 254m), excluding the interest from the new loans to be originated during the year. However, in 1Q24 Mega already collected MXN 1.3bn (USD 79m), which corresponds to more than a quarter (31% exactly) of the full year’s budget.

The company has guided a loan portfolio contraction of 3%-5% this year, after a decrease of 5.6% in FY23.