A first for Mexico and the region - and one that would have gone unnoticed had it appeared in its original incarnation as a private placement - Mexican Water Funding Trust (MWFT) (otherwise known as the Poseidon Water Refinancing) is a neat solution to post-project equity release on portfolio deals with multiple sponsors. The deal is not big - $68 million in project debt. But structurally it has the potential to be significant in future PPP water development in the region: particularly given the pro-PPP conclusions of the 2003 Camdessus Report which is fast becoming the Bible for water development in emerging markets.

Lead arranged by NordLB and closed in December 2003, MWFT is owned by a seven-strong bank group through certificates of participation. In February, MWFT funded new project debt for EarthTech and Trident Global Water Partners - two of the three sponsors (the third is Ionics) on the existing $35 million Cadereyta, $42 million Minatitlan and $35 million Madero Mexican water projects that were first financed at different times in the mid to late 1990s. The new loans are cross-collateralized by pooled dividends from all three projects. However, the structure incorporates a further twist - each sponsor is able to individually customize its level of leverage (and consequently equity release), irrespective of its partner's interests and policies. In addition the revolving conduit (like many in the UK) can be topped up with other projects as and when the sponsors want to release more equity by issuing more certificates.

Consequently, Ionics' decision not to leverage further this time around was not a problem - its dividends are paid before the pool services the new loans. Similarly, Ionics and the other sponsors can tap more debt in the future without the cost of creating a new facility.

The deal's reason for being is the high 40% equity and additional parent company support that the sponsors were forced to put in place to satisfy international lender credit concerns on the original project financings during the tempestuous 1990s in Mexico. Inflation rates have since declined, growth rates improved and volatility in the peso lessened. Mexico has an investment grade rating and the leverage and parental guarantees on the original financings needed bringing in line with current market conditions.

The deal first appeared as an idea in late 1999 when Steve Zoota, managing director of Trident Global Water Partners (now backed by Mitsui, John Hancock and New York Life Assurance, but then a part of Poseidon Resources) approached his then co-sponsor Cydsa subsidiary Atlatec, and Hypovereinsbank (HVB), which was arranging finance for the Tula plant (the fourth of the sponsor's Mexican plants and deemed too small and an over-complication in this latest deal).

EarthTech's acquisition of Atlatec put the refinancing on hold: EarthTech management wanted to become more familiar with their new portfolio before proceeding. But the deal subsequently reappeared in 2002 as a potential private placement led by ABN Amro which was privately rated by Standard & Poor's. The sponsors decided against the placement on grounds of speed and cost and put out a RFP (request for proposal), mandating NordLB for a bank facility in early 2003.

The final deal is a combination of groundwork done on the private placement by ABN Amro and the sponsors, and bank debt arranging by NordLB. In fact the structure is documented as a private placement comprising three Mexican Trusts at project level, under the umbrella of one New York Trust. This allows the arranger to approach institutional investors if bank debt is not forthcoming. But selling to the banks proved no problem. Primary syndication closed on 9 February with Bank of Tokyo Mitsubishi (BoTM), Bancomext, Caja Madrid, HSH Nordbank, Landesbank Baden Wuerttemberg, KBC Bank and Natexis Banques Populaires all joining NordLB with equal takes on the total $38 million and $30 million yen equivalent loans.

In addition to allowing each sponsor the option to leverage their individual equity interests, the structure is designed to preserve the basic features of the original limited recourse project financings while removing the series of parent company guarantees that enhanced the original structures.

The deal comprises five tranches - three to the project companies and two direct to the sponsors: a $10.5 million three-year Cadereyta tranche; a $13.8 million four-year Madero tranche; a $7.37 million six-year TGWP tranche; a $6.38 million six-year Earthtech Tranche; and a ¥3.2 billion seven-year Minatitlan tranche. Commitment fees across all tranches were 50bp over Libor and upfront fees 70bp. Although the spread has not been released, it is said, by bankers and sponsors alike, to reflect current market conditions plus a small first time premium.

In addition to the financial engineering and consensus building among the sponsors, tax arrangements for the deal proved complicated. It was unclear whether the deal would be taxed as a corporation or a bank in Mexico, thereby receiving discounted withholding tax for bank status. The authorities ruled in favour of a bank.

The MWFT template is not easy - but it is flexible and ultimately gives sponsors unprecedented freedom to put up big equity stakes to get difficult deals financed. The risk of those stakes can be spread among multiple partners in the knowledge that once the project is generating dividends beyond debt service, equity can be released irrespective of those partners' policies. At its simplest the deal is a net present value equation. But if the economics work and it catches on, it could go a long way to speeding up the pace of private investment in water PPP development in emerging markets.

Mexican Water Funding Trust

Status: Closed December 2003

Description: Project portfolio refinancing/equity release plan on three existing Mexican water projects.

Sponsors: Trident Global Water Partners; EarthTech

Lead arranger: NordLB

Co-arrangers: BoTM; Bancomext; Caja Madrid; HSH Nordbank; Landesbank Badenwürtenberg; KBC; Natexis

Legal counsel to lenders: Skadden Arps (US); Ritch Heather & Mueller (Mexico)

Legal counsel to sponsors: Dickstein Shapiro (US); Barrera Siquieros y Torres Landa (Mexico)

Tax counsel: Chavez Ruiz