Brianna Wilson,
Editor,
Monitor
As the nearshoring trend makes its rounds in the equipment finance industry, Mexico is gaining footing as a proximal convenience for U.S. and international manufacturing companies looking to gain access to the U.S. market. Nearshoring began as a concept around 50 years ago with the establishment of maquiladoras, which are low-cost factories in Mexico owned by foreign companies. Maquiladoras offer the advantage of having lower wages and a sound base of employees that can assist in manufacturing.
At the beginning, these companies were established in northern Mexico, closer to the U.S. border for ease of access to the U.S. market, but this has begun to shift toward central and southern manufacturing facilities in Mexico. Japanese companies like Nissan and Honda, for example, as well as German manufacturers like Audi, BMW and Volkswagen, have established themselves between northern and central Mexico.
“Now it’s shifting towards reducing the exposure that companies have with manufacturing operations — in China, most likely,” Alfredo Espino, managing director at FGI Equipment Finance, says. “It’s not just companies that are used to having global manufacturing and are going to decrease their exposure in China; even Chinese companies now want to move to Mexico. They’re moving into clusters in Mexico to take advantage of the closeness to the market in the U.S. and the ability to get their production qualified on their NAFTA or USMCA rules allowing them to access markets in Canada, the U.S. or Mexico.”
Equipment Financing in Mexico
Equipment finance in Mexico is limited to new manufacturing machinery. Banks, the largest lenders in Mexico, have shied away from equipment and manufacturing machinery following the 1994 banking crisis, which led banks to realize that it is very difficult to repossess equipment, making them weak against their borrowers.
Most Mexican banks will only finance new machinery and equipment if they have very long relationships with or know their customers very well. For a bank to approve a customer in Mexico today, the customer needs at least a three-year track record and to show profitable financial statements. “Also, know their customers’ is critical [for banks],” Espino says. “Banks and lenders really need to understand what the company is doing and their business model. They need to determine a sound cash cycle that can secure the loan or lease payments.”
Collateral machinery equipment is Mexican banks’ least preferred asset because they don’t want to have to repossess and sell. They want something more immediate, like cash, a guarantee from owners, real estate owned by the company or other kinds of special interest, according to Espino. Therefore, the industry is more likely to be polarized or controlled by leasing entities or captive vendor finance programs for new equipment, with financing for used equipment or monetizing existing assets very hard to obtain.
Entering the Mexican Market
U.S. or foreign companies looking at the Mexican market can have term loans, revolvers, equipment leasing, factoring and specific financing vehicles available to them depending on the way they are incorporated and registered in Mexico.
There are many lenders that offer equipment financing capabilities in Mexico; however, companies looking to enter this market should be wary and pay special attention to the lenders offering these capabilities. Through his experience in the market, Espino has observed two things that he would warn companies to be cautious of:
“My advice is there are institutions that offer capabilities in Mexico, but it’s always good to check history and experience,” Espino says. “In order to offer financing solutions for each company, lenders need to get comfortable with the different environment each company operates in to provide effective and proper types of financing according to each company’s particular operating profile.”
Espino says it is also pertinent that lenders considering the Mexican market don’t just file their interests under U.S. standards; they should know the equivalent in Mexico and have a sound understanding of how the standards operate. There are key differences between the U.S. and Mexican markets, so being involved and familiar in both is required to bridge this gap.
For example, most equipment financing in the U.S. happens in the form of loans and either capital or operating leases and is documented through invoices, which provides companies with the title to an asset. This is different in Mexico, which requires a more extensive paper trail of documents, such as purchase orders or the documents used for importation, to fully secure what a company is financing.
Existing Assets in Mexico
It is possible for U.S. companies to leverage existing assets in Mexico rather than new equipment? Yes, there are different financing structures depending upon how the Mexican operation is incorporated that may fall under the following three options:
1. Shelter program — A third party service provider is responsible for sourcing all requirements for the company, including hiring employees, managing logistics, building space, payroll and so forth. The main characteristic of a shelter program is the foreign entity has no tax or legal presence in Mexico.
2. Maquiladora or IMMEX (Manufacturing, Maquila and Export Services Industries Program) company — A registered company in Mexico which is a controlled subsidiary of a parent company abroad. This option is intended for international companies looking to export their production in Mexico. Advantages include the benefit of importing raw materials, inventory, machinery and equipment under duty free programs, preventing the 16% value added tax on the cost of materials and assets.
3. Standard Company — This is the most common approach when the goal is selling goods and services in the Mexican domestic market. This options involves a standard Mexican entity that is a regular taxpayer in Mexico. Applicable taxes are 35% income tax and 16% value added tax over any goods and services the company purchases or invoices.
To properly finance fixed assets in Mexico, such assets have to be identified by brand, model, serial number and corresponding backup documents, including original vendor invoices, import documents or purchase orders.
The easiest way to get financing in Mexico is using accounts receivable to support revolver lines and factoring facilities. In the U.S., these facilities are usually backed by inventory and accounts receivable, while in Mexico, receivables are the preferred option because inventory is very hard to document, according to Espino. To fully secure inventory in Mexico, companies must use a third-party-bonded warehouse that can provide control and report over the level of inventory, which isn’t easy nor cheap to operate.
U.S. companies can also leverage fixed assets in Mexico, though this is dependent on how the Mexican company is incorporated. “If you’re trying to finance or refinance, leverage or monetize assets for a standard Mexican company, it’s easy. You can use an industrial pledge. Most of the banks in Mexico and in the U.S. will put a blanket lien on everything, so every asset that goes into that operation is part of the guarantee,” Espino says. “But that doesn’t work when you try to finance specific, discrete assets because those have to be handled separately. And then, the structure of how the company is incorporated is critical. A certain type of financing which works for a company that is under a shelter program may not work for a company that is under IMMEX. If you are comfortable with a standard Mexican company, there is a big chance the lender may not fully understand or be comfortable with an IMMEX or shelter company, so what you need there is to develop knowledge and understanding of how these three different avenues of structuring work in order to properly perfect your interest.”
Mexico’s top manufacturing exports are automobiles, which recently have received significant foreign direct investment, followed closely by electronics and appliances, aerospace, medical devices and textile. “You can see the nearshoring trend is bringing a lot of manufacturing and more and more specialized manufacturing that require engineers or trained people that have the ability to perform per the U.S. required standards,” Espino says.
Obstacles and Challenges
While there are multiple ways for companies to enter the Mexican manufacturing market, each comes with its own set of caveats and challenges that companies must be prepared to learn about.
The shelter program lifts a lot of the work from the U.S. company; however, most U.S. lenders won’t feel comfortable having their collateral controlled by a third party they don’t have access to, and Mexican lenders won’t feel comfortable because their risk entity is the shelter service provider. “What’s needed there is someone who’s comfortable with the performance of the U.S. company but also comfortable having those assets placed on a third party,” Espino says.
An IMMEX operation or maquiladora is beneficial because such an entity exists in and is registered by Mexico. However, by definition, the purpose of this company is to keep very thin profit margins because profits are going to flow to the party company in the U.S. This is something Mexican banks and lenders typically don’t like. The fact that this operation is controlled by a foreign company is also unfavorable to Mexican lenders. “There are Mexican lenders that feel afraid of financing equipment that is imported on a temporary program because they feel that is a disadvantage,” Espino says.
Finally, a standard Mexican company which already has its roots and pays taxes in Mexico is the easiest to be financed both from a U.S. and a Mexican lender, but any new company needs to have at least a three-year track record and has to be able to evidence profitability trough financial statements, proving it can service its debt on a standalone basis.
In case of getting financing from abroad, Mexican companies must also retain and forward the Mexican IRS a 5% to 15% withholding tax over the interest portion of the loan (or, in the case of a lease, 15% over the whole payment). This adds up to the cost of doing business in Mexico, which presents very different reference rates; as an example, the U.S. reference rate (SOFR) today is 5.32%, while the equivalent reference rate in Mexico (TIIE) is 11.45%, marking a 600 bps difference just on the equivalent reference rates for each country.
The U.S. and Mexico also have different legal systems that generally discourage U.S. banks and lenders from leveraging assets in Mexico. “In the U.S., the substance rules over the form, and in Mexico, it’s the opposite,” Espino says.
Banks and lenders also need to know and define their exit strategy in case of repossessing or modifying a transaction. Lenders, Espinso says, typically are not familiar with this process, as they don’t understand the roots and interconnectedness of the legal, customs and tax systems.
“If something goes wrong with your current customer, 90% of lenders’ exit strategy is going after the equipment and sell[ing] it in the open market. That’s an option, but that’s not the most effective one,” Espino says. “You need to understand, as a lender, what avenues you have before you get to that stage.”
Espino notes that asset repossession could take upwards of several months even after a judge has provided a final resolution. “And you don’t know what’s going to happen in that window of time — if there are concerns with the union, or if the Mexican IRS has interest to secure themselves with the machinery or the assets of the company,” Espino says.
That leaves many things to consider for a lender to feel comfortable securing its interest and execution in Mexico. “As long as lenders are able to understand how these three worlds from the legal, taxes and customs interact, they will be more comfortable,” Espino says.
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