Emerging markets, both in Asia but particularly in Latin America, have been on a three-year bender. Demand for dollar-denominated emerging markets debt, both structured and corporate, has been strong. But this has not, so far, led to particularly generous terms for emerging markets project bonds.

There are several reasons for this, including strengthening local capital markets, and the fact that the smaller pool of project bond buyers has a longer memory of previous defaults. Monolines have a strong grip on the market, given the quantities of structuring work required, and new concessions have been less common than in the busy mid-1990s.

The refinancing of ICA's Corredor Sur concession in Panama shows that pent-up demand exists for quality infrastructure assets in emerging markets – providing currency risk is not an issue. Panama is, in this respect, an anomaly, a dollarised, but not developed economy. But the ability of the lead manager Merrill Lynch to sell down the bonds without enhancement is impressive.

Corredor Sur is a 19.5km toll road linking Panama City's financial district to the Pan-American highway and the city's main airport. It runs parallel to a free route, but has a five-year operating history, and strong fundamentals.

ICA won the concession from the country's Ministry of Public Works in 1995, and funded the road's construction using bridge loans. The first section of the road was complete in June 1999, and the second in February 2000. It was then financed through a $70 million loan from the International Finance Corporation, although ICA put up most of the capital cost of the project in equity.

The road, therefore, was a strong candidate for a refinancing, although it carried several challenges. One of these was the endemic issue of whether Panama's economy would stay robust enough to support high traffic levels on the road. Panama's ecomomy lacks a central back, and is thus at the mercy of US economic conditions.

The second main challenge was overcoming investor perceptions of the country's toll roads sector. Corredor Sur has a counterpart – the Corredor Norte – in woeful financial condition. The Norte section was financed through a bond offering, and has suffered from poor traffic levels and financial hardship. Lenders to Norte are among the group of accounts that were targeted by the Sur section's bookrunner.

Against this background, a thorough explanation of the road's fundamentals would be essential. Norte serves a less prosperous part of the city, and stops well outside of the centre of Panama City. Sur, on the other hand, runs between the centre of the city, and the country's main airport, through an area that is undergoing major development. This will resemble the prosperous suburbs that have grown up outside several major Latin American cities.

Moreover, the road has already undergone a real-life stress test. The toll rates for vehicles travelling along the length of the road are $2.40, $4.15 and $6.05 for cars, buses and trucks, respectively. The concession brought in revenues of $17 million in 2004 and $4.3 million in the first three months of 2005. These rates were set in 2002, and were a sharp increase on the introductory toll levels. Despite this, traffic levels recovered, and the sponsor has been able to demonstrate that demand for the road is inelastic enough to survive some stresses.

The 30-year concession also consists of the right to reclaim and redevelop some land on the route of the road. The government has transferred 25.4 hectares out of the 29.5 hectares of land promised under the concession and 23.4 hectares out of 35 hectares of fill-in rights. ICA has so far sold 48.3 hectares of this land, but the remaining land is not among the concession rights assigned to the issuer.

However, this land is tied up in several layers of litigation. Some disputes have been between government and the concessionaire about the scale of some additional works, although these were largely settled in arbitration. ICA was awarded a payment of $25 million, although the money had not yet been collected at the time of the refinancing.

However, several additional challenges were lodged as the refinancing was launched, mostly over the environmental impact of the redevelopment. These were, according to one source close to the financing, timed to disrupt the marketing of the bonds. The sponsor, however, had anticipated the challenges, and the bonds fund a $1.8 million litigation reserve, on top of existing debt service and major maintenance reserve accounts.

The refinancing gained a rating of BBB from Fitch, and the gained a coupon of 6.95%. Since they were sold at a slight discount, they have an effective yield of 7.01%. The notes are due 2020. According to Mike Lucente, responsible for the transaction at Merrill Lynch, "investor response to these structured issues is deep and responsive regardless of market conditions. None of the deals we've seen since 1994 have triggered."

This is the first cross-border project bond that Merrill Lynch has issued, although Lucente says that the deal would be easily replicated elsewhere. It will be difficult to attempt a replica however – emerging markets with dollarised economies are rare. But Corredor Sur is a well-structured and robust rarity, nonetheless.

Corredor Sur Trust
Status: Closed 20 May 2005
Size: $207 million
Location: Panama
Description: Refinancing of 19.5km toll road
Sponsor: ICA
Bookrunner: Merrill Lynch
Maturity: 2020
Coupon: 6.95%
Lawyers to the underwriter: Mayer Brown Rowe & Maw (international), Arias Fabrega & Fabrega (local)
Lawyers to the borrower: White & Case (international) Galindo, Arias & López (local)
Traffic consultant: Halcrow
Onshore trustee: BG Trust
Offshore trustee: Bank of New York
Auditor: Deloitte