Three issues were sold into the market in December: two nominal bonds of A$250.4 million ($185 million) and A$191.8 million, both maturing December 2013, and a A$112.8 million capital-indexed bond, maturing September 2020. The nominal bonds are fixed and floating rate respectively, while the indexed bond carries a quarterly coupon of 4.495%. ABN Amro was the sole lead manager and arranger.

The deal is a landmark transaction for the Australia market in several respects. Firstly, as Mark Kidston, partner at Allens Arthur Robinson notes, there will be no bank debt in the overall finance package. "This is the first Australian toll road construction to have been financed purely by the capital markets," he says.

In fact, although there have been other Australian project financings with a very heavy bond component, like the A$1.6 billion ETSA Utilities deal, this is the first time Australia has seen such a large greenfield deal financed entirely with bond debt, in any project category.

It is also the fist time that a credit wrapped issue has been used to finance construction of a major infrastructure project in Australia, says Kidston. MBIA is the wrapper and the bonds are rated AAA/Aaa/AAA by the major ratings agencies. The issuer, Lane Cove Tunnel Finance, has an underlying investment grade rating of BBB-/Baa3/BBB-.

According to Malcolm Macintyre, director at ABN Amro, two more issues will be offered in 2004. A tranche of indexed annuity bonds are scheduled to be sold at the end of the first quarter 2004. A tranche of fixed and floating rate nominal bullet bonds will be offered to the market in the fourth quarter. Both tranches will be wrapped by MBIA.

Macintyre says the staggered issue cuts financing costs, as the timing of the fundraising will match the project's cashflow requirements. Details of the planned issues are: A$125 million of indexed annuity bonds (the first quarter 2004 deal), maturing in December 2028, and a A$445 million nominal bullet issue, maturing in December 2011.

What has most surprised other project finance professionals is the high gearing achieved. Design and construction and maintenance costs for the project are put at A$1.1 billion, but total costs have been kept confidential. "Preliminary development costs and fees push that figure considerably higher," says Macintyre.

The bond program, however, will be over A$1.1 billion and while Macintyre was unable to divulge the gearing ratio, he says it is well above those of other recent toll roads deals, including Western Sydney Orbital (55%) and the Cross City Tunnel (60%).

The debt volume is materially above what would have been achieved if it had been a bank debt deal, says a banker not involved in the transaction. Market observers suggest it was the potential for higher gearing rather than lower finance costs which made the bond option appealing to equity.

ABN Amro is underwriting the whole bond program and will carry the risk of the last tranche on its books for 12 months - the only way it was possible to propose a staggered financing of this nature.

A key reason why both the bank and investors are comfortable with this level of gearing is the relatively high confidence in traffic numbers. The Lane Cove scheme will replace an existing road once it is operational and is therefore quite different from a greenfield roads project, dependent on untested traffic demand.

ABN Amro gains additional comfort from being the largest single shareholder in the venture, with an opportunity to actively manage its investment. Other major shareholders are Thiess, and Transfield Holdings.

The fourth significant feature of the transaction lies in the fact that no letters of credit are being called on to cover the construction phase. "This is the first time in Australia that an arranger has put a project finance deal together without an LC," says Macintyre.

There is also, as to be expected, a comprehensive security package from the construction company, Thiess, backed by a Leighton Holdings (BBB+) guarantee. This security package falls away on completion of construction.

As has become common in the toll roads sector, there are no government guarantees to support the financing, confirms Macintyre (in other infrastructure categories state balance sheet support is still commonplace). The ratings therefore, strongly reflect the level of patronage risk. Lane Cove also continues the trend that has developed in recent years of government having a greater share in the upside of the project. "To the extent that super profits are achieved (which are defined at a certain level of return), there will be benefit sharing," says the banker.

The risks involved in tunnel construction were recently highlighted in Sydney's other live road tunnel project, the Cross City Tunnel venture. Unforeseen problems regarding ventilation have led to increased construction costs. The consortium is rumoured to have got additional concessions from the transport authority to compensate for the increased cost, but opposition groups are protesting that this will lead to increased public costs for the scheme.

Despite this, the three bond issues drew a strong response from both domestic and international investors. They all priced at the lower end of the indicated pricing range. The indexed bond was priced at 58bp over Commonwealth Government CIB 8/2020. The A$250.4 million nominal bond was priced at 58bp over 10-year swap. The A$191.8 million bond was priced at 58bp over 3-month BBSW.

According to market reports, some Australian investors are uneasy about the level of exposure they have built up to MBIA, which has been very active in insuring infrastructure projects in the country in recent years. But Macintyre says there was no great evidence of concern over concentration limits while the bank was making its sales pitch.

"Around 30% of the bonds sold to the international market," says Macintyre, "and there was a strong uptake from fund managers rather than just conduits".

Lane Cove Tunnel Finance

Status: Closed December 2003

Size: A$1.1 billion

Location: Sydney, Australia

Description: construction and operation of twin 3.4km tunnels and associated roadworks

Sponsors/investors: institutions include ABN Amro, Thiess, John Holland, AMP Henderson, Westscheme, Motor Trades Association of Australia and Transfield Holdings.

Arranger and underwriter: ABN Amro

Lawyers to equity: Minter Ellison

Lawyers to bond underwriter: Freehills

Lawyers to government: Clayton Utz

Lawyers to MBIA Insurance Corporation: Allens Arthur Robinson