The first power deal in the Middle East using a two-tranche, ECA-backed loan combined with an Islamic facility has reached financial close. It backs the $255 million, 700MW expansion of Al Hidd power and water desalination project.

Arranged by BNP Paribas and HSBC Financial Services (Middle East) the Ministry of Finance and National Economy signed loan agreements on 10 April for a $200 million Swiss ERG-backed loan and a second tranche of $55 million in Islamic financing.

Joint arrangers for the project are Bank of Mitsubishi-Tokyo (BMT) and Bank of Bahrain and Kuwait (BBK). The deal took 11.5 months from start to finish and is the first to be done using a jointly structured Ijara wa Iktina Islamic facility and an ECA-backed loan in the Middle East power market.

This unique combination of ECA and Islamic financing, co-arranged by Kuwait Finance House and Islamic Development Bank with Amanah Finance as facility agents, makes sense. With industrial projects Bapco ($650 million) and Alba (over $1 billion) coming to the market, Bahrain needs to tap as many sources of financing as possible. The result was a two-tranche loan, a mixed sovereign and an asset-based transaction, using the combination of Swiss ERG (Export Risk Guarantee) backing and Islamic financing to free up commercial bank resources for these forthcoming, larger deals.

Because each loan is so different ? the Islamic tranche is asset-based while the ECA tranche is sovereign ? the transaction was complex, using two very different inter-creditor arrangements, cross default and pari passu.

Demand for power in Bahrain is rising at about 5% a year. It is a small country with much development ongoing, so ideally the commercial banks should be left open to fund further development. Although the premium on ECA insurance is initially high, long-term it is perceived as an ?unbeatable' solution, as described by one banker.

Using Islamic financing, which carries a principle of no interest payments, pricing on the deal was kept tight and commercial banks able to carry future larger deals, such as Bapco (which HSBC will also be working on). It also allows for a subsequent and relatively rare Sukuk issuance programme ? in practice a credit-linked note to pool risk and attract new deals, much like syndication ? but in this case, there is ownership of the underlying asset.

Says Declan Eggarty of HSBC: ?Islamic investors develop the market once the project is completed and cashflow is coming in. They issue paper on the fact that they have credit on their books and ask other investors, funds or possibly banks to participate in the risk ? this way they can remove risk from their books and go on into other deals.?

BNP and HSBC considered three options with the ministry. Option one involved commercial banks only ? however, says one banker, ?this would have been inadvisable, it would have sucked up the liquidity for Bahrain. Any banks involved would have put exposure on the loan and this would limit their capacity to cope with future deals.?

Option two was a 50/50 hybrid of both ECA backing and commercial debt, a middle-road option taking particular aspects from each and running them parallel. The third was the preferred combination of ECA and Islamic facilities, both with a tenor of 15 years, a relatively long maturity for Bahrain.

However, should the ministry have chosen the first option ? full commercial bank backing ? the project, say lead arrangers, would have been over-subscribed, which has been taken as an indication of increased confidence in the country's market.

?The maturity of 15 years further demonstrates the strengthening of the credit quality that the Kingdom has established,? said Christophe Mariot, regional head for export and project finance at BNP Paribas. Ahead of this tenor ? which is lengthy for the Middle East ? is the Shuweihat IWPP, a $1.6 billion project with a 17-year loan maturity.

Unsuccessful bidders for the mandate were two bank groups: Citibank with GIB and GIC with ABC and IBJ.

This expansion of Al Hidd is continued from Al Hidd 1, a $94 million similarly funded deal executed in November 1997 by a consortium led by ABB. The project added 280MW of capacity onto the 1.4GW capacity already established in Bahrain. Al Hidd 2 will add another 700MW to this.

Manufacturing materials for Al Hidd 1 came from Switzerland ? again with Swiss, and this time also Italian and American, ECA backing ? and the same principles will be applied to this second project phase, with ERG backing this second-time-round loan. Baden-based company Alstom has been contracted for the construction of the new combined-cycle turbines.

The deal is not strictly non-recourse. Being a sovereign facility, the government is borrowing the money and guarantees with a security package ? banking by Royal Decree.

Although this mix of financing is a first for Gulf power, it has been seen before, mostly in MidEast aircraft financing.

Mariot's belief is that the ECA's ?normally traditional approach? to backing has allowed this deal to set a benchmark. ?In respect, especially here, of the complementary financing, in the form of an Islamic financing, represented an opportunity to set a new benchmark further reflected in the pricing and the tenor offered by the banks. Having ECA support further enabled such terms and conditions.?

One banker close to the deal agrees the project financing sets a precedent for its kind, saying: ?Now that we have the documentation it can be used as a template in future deals.?

With dependence on desalination projects like Al Hidd growing due to somewhat limited resources of fresh water, this model may be a consideration for the Bahrain power market in the future, which looks set to grow in line with its power-hungry population.

Al Hidd 2

Status: Signed, May 2002

Location: Al Hidd, Bahrain

Description: 700MW expansion of the Al Hidd power and water desalination plant

Sponsors: Ministry of Finance and National Economy

Cost: $255 million

Debt: $200 ECA tranche, $55 million Islamic financing

Maturity: 15 years

Lead Arrangers: BNP Paribas, HSBC (Middle East), Bank of Tokyo-Mitsubishi, Bank of Bahrain and Kuwait

Arrangers (Islamic tranche): Kuwait Finance House and Islamic Development Bank

Legal counsel Bahrain: Al Mahmood & Zu'bi

Legal counsel Switzerland: Homburger

Lawyers to lead arrangers:

Norton Rose, Bahrain

Lawyers to Ministry: Hassan Radhi & Associates