The Development Bank of Japan (DBJ) and Mizuho Corporate Bank have completed the ¥22.3 billion ($200 million) Kurashiki waste treatment financing. The deal, one of the largest to close in Japanese PFI, is a landmark in the element of market risk attached to the concession, and the largest build-own-operate PFI yet in Japan. It also features a mezzanine loan - the first of its kind in the sector - designed to absorb market risk.

The arrangers will hope that this structure can be adapted to further financings in the country, since it should lower the costs of facilities to the local and provincial concession awarders. It also provides a potential solution to the current aversion of domestic lenders to accepting risks outside of the public sector. Future projects providing a service both to the government and the private sector will find a useful template here.

Kurashiki is a waste treatment plant, located in Mizushima Industrial Complex in Kurashiki City, Okayama Prefecture. It has a daily capacity of 555 tons of waste, of which 303 tons will be domestic and the remainder industrial. This mix is itself unusual - no PFI project has treated both at the same site.

According to Masato Kaizaki, who led the financing for the DBJ, "under Japanese law, municipal governments are responsible for treating domestic waste (or 'general waste') in their own areas, whereas the private sector is responsible for treating industrial waste. Kurashiki Municipal government had four general waste treatment facilities. When one aging facility had to be replaced, they decided to construct it as a PFI scheme, with the expectation of cost reductions."

As Kaizaki points out, the waste will be treated using the Thermoselect method, which is designed to be a closed process and emit as little dioxin as possible. The use of industrial waste will be invaluable in lowering fuel costs, since it has a high calorific content. Gas created under the process will be used to fuel the facility, while the unburned residue can be used in construction.

Kurshiki City's municipal government bid out the build-own-operate concession in July 2001, and the preferred bidder was selected in December of that year. The winner was Mizushima Ecoworks, which beat out a second, nameless, bidder. Mizushima's shareholders are JFE Steel Corporation (38%) Chugoku Electric Power (16%), Asahi Kasei Chemicals (2%), Kuraray (2%), The Japan Energy Corporation (2%), Nippon Oil Corporation (2%), Zeon Corporation (2%), Mitsubishi Chemical Corporation (2%), Mitsubishi Gas Chemical Company (2%), Mitsubishi Motors Corporation (2%), Okayama Prefecture (2%) the City of Kurashiki (10%), and others (20%).

The above named corporations all have factories in the area, and need to get their waste treated. They will account for 30% of the plant's contracted services, while Kurashiki City will take the remaining 50%. The further 20%, for which the project company has yet to find a contract, necessitates the use of the mezzanine facility.

DBJ, which began work on the deal in December 2002, provided a mezzanine facility of ¥4 billion directly. The equity amounts to ¥2.3 billion, senior debt to ¥10 billion, while subsidies from central government of ¥4 billion, and contingency funds of ¥2 billion round out the capital structure. The 10% equity figure is the minimum allowed under the concession. "The senior debt would be repaid in 16 years even if the project company could not find the remaining offtakers. The mezzanine would therefore be repaid in 20 years," says Kaizaki.

The 16-year senior debt is priced at 110bp over Tibor, while the 16-year mezzanine debt is priced at between 190bp and 300bp over Tibor. Their difference is explained by the fact that this is the first project loan in the Japanese market with an extension option. The higher pricing would kick in should the option be exercised.

Co-arrangers on the senior loan include the Bank of Tokyo-Mitsubishi, Chugoku Bank, Sumitomo Trust & Banking Co., San-In Godo Bank, Yamaguchi Bank, and Tomato Bank. Construction started in April 2002, and the engineering procurement and construction contractor is JFE Engineering, whose obligations its parent JFE Steel guarantees. Lenders are therefore isolated from construction risk. The plant is set to come into operation in April 2005.

Such large and innovative financings will maintain interest in the Japanese PFI market, which had been becoming the preserve of the small municipal players. And it will probably be heightened by the successful close of the 7 Central Ministries build-operate-transfer deal, which will be comfortably the largest deal to close in Japan when it approaches market. Close on that financing is now slated for July.

Mizushima Ecoworks, Ltd

Status: Closed 12 March 2003

Size: ¥22.3 billion ($200 million)

Location: Kurashiki City, Japan

Description: 555 tonnes per day waste treatment plant, the first PFI to bear market risk

Sponsors: JFE Steel Corporation (38%) Chugoku Electric Power (16%), Asahi Kasei Chemicals (2%), Kuraray (2%), The Japan Energy Corporation (2%), Nippon Oil Corporation (2%), Zeon Corporation (2%), Mitsubishi Chemical Corporation (2%), Mitsubishi Gas Chemical Company (2%), Mitsubishi Motors Corporation (2%), Okayama Prefecture (2%) the City of Kurashiki (10%), and others (20%).

Debt: ¥10 billion senior debt, ¥4 billion mezzanine, ¥3.4 billion guaranteed contingency facility

Lead arrangers: DBJ, Mizuho

Mezzanine provider: DBJ

Technical adviser: Towa Chemical

Lawyers to the sponsors: Asahi Koma

Lawyers to the lenders: Anderson Mori