Panama Canal Railway: Expansion time

Kansas City Southern and Mi-Jack closed the bond refinancing for the Panama Canal Railway Company (PCRC) in October 2007. The deal is the first capital markets project financing in Latin America for a railway and achieved keen pricing in a post-crunch environment. Morgan Stanley underwrote $100 million in 19-year senior secured bonds to refinance the railway, which runs parallel to the Panama Canal, and is the only freight carrier train service in its vicinity.

The proceeds of the bonds will be used to prepay all the outstanding loans, from the railway's original financing in 1999, to the IFC and shareholders, to fund a debt service reserve, and to fund capital expenditure in the first two years. Of the $100 million, $37.5 million will be paid to the shareholders in dividends; $19.9 million is to repay the IFC loan; $20 million will be used for the capital expenditure on the railway; $3.4 million will fund a debt service reserve. Of the remaining proceeds, $14.2 million will be used for interest payments, and $5 million for fees and expenses.

The notes have a maturity of 2026 and a grace period on interest until 2009. Cashflows are subject to a waterfall, whereby dividends are only paid when the debt service coverage ratio (DSCR) is 1.2x, the reserves are funded, and the next scheduled payment is with the trustee. The project can only issue additional bond debt if the DSCR is greater than 2x.

The debt service reserve is for one year, structured for the first six months with cash in a secured account at the project level, and the remaining time as a letter of credit from the sponsor.

The notes priced at 256bp over a blend of the 10-year and 30-year treasuries, for a coupon of 7%, which was well inside the expected rate of 7.5%, and is also lower the cost of PCRC's previous debt. The debt priced at practically the same spread as the VTB Russia deal (255bp), which closed at the same time, but was rated four notches higher, at A2. Moody's rated the bonds as investment grade, at Baa3, higher than the government rating of Ba1, but within Panama's A3 country ceiling. Standard & Poor's rated, at BB, at the same level as its sovereign rating, but said that the sovereign did not constrain it.

Stephen Sung, of Morgan Stanley's project and structured finance group, describes the rail as "a conveyor belt between the Pacific and Atlantic ports. It has a different purpose to the canal, operating as a trans-shipment hub, and a logistics tool for the shipping companies. It is much more cost effective to make fewer stops to deliver cargo, and the railway effectively makes the two ports into one."

The PCRC concession runs until 2023, when the sponsor will have the option to renew it for a further 25 years. It also involves a long-standing contract with Maersk for intermodal freight carrying. Panama is central to Maersk's operations, since it disperses the lion's share of its North American cargo through the ports. The concession also benefits from an agreement with the Panamanian government that no competing railway will be built within 19km on either side of the route.

The original financing for the project closed in December 1999. It was used to pay $60 million for the acquisition of the asset from the government, and $30 million in required upgrading of the rail. The debt initially included a $15 million, 12-year A-loan from the IFC and a $30 million, 10-year B loan from ABN, Dresdner and DVB. The concession for the line was awarded in 1999, at the same time as the Panama Canal was transferred from the US to Panama.

The railway in fact predates the canal: The oldest of the transcontinental railroads, it has been operational since 1855, and was used to transfer cargo the 77km between the ports when land transportation was the only option. The railway was then remodelled in 1909, during the construction phase of the canal, which was officially opened in 1914.

In October 2007, the Panamanian government broke ground on its expansion of the Canal, which is intended to increase its capacity by 20%, though the full scope of this project, and its financing, is as yet undetermined. Contrary to market speculation, Sung explains that the expansion programme acts symbiotically with the railway, and will only improve its business. The canal will not necessarily see more carriers but rather have the capacity for larger vessels, post-Panamax limitations on size, thus increasing the amount of freight which needs to be processed and redistributed, and the need for effective distribution, without multiple dockings.

This most recent deal is testament not only to the continued financial strength of the asset, but also to its impact on the country's economy. The railway has seen robust revenues since its inception, and the sponsors have shown a marked aptitude for updating both the asset and its financing in line with developments and trends in global shipping trade.

Panama Canal Railway Company
Status: Closed October 2007
Size: $100 million
Location: Panama
Description: Bond refinancing of intermodal freight railway
Sponsor: Kansas City Southern (50%) and Mi-Jack (50%)
Underwriter: Morgan Stanley
Maturity: 19 years
Pricing: 256bp over 10-year treasuries, or a coupon of 7%
Legal counsel to underwriter: Shearman & Sterling
Legal counsel to sponsor: Baker & McKenzie
Market and shipping consultant: TranSystems
Engineer: RW Beck
Insurance consultant: Moore-McNeil
Environmental consultant: ENSR