Latin American Water Deal of the Year 2001
One of the quieter developments of the last 18 months has been the
consolidation of domestic project bonds in emerging markets.
Borrowers in countries as diverse as Chile, Malaysia, Kenya and
Bolivia have all created project bond markets with varying levels
of risk and volume appetite. Peru, like the last two mentioned, saw
the first issue of a project bond on the domestic capital markets ?
Rio Chillon. It is a sign that regional governments, as well as
their bankers, should look carefully at placing pensions system and
securities deregulation at the heart of their reform prescriptions.
The main problem, however, is that of liquidity ? whether there is sufficient capital available here for large-scale infrastructure investment, or whether much of this capital can be allocated to project bonds. In Peru, as elsewhere, regulators are struggling with the issue of how to treat project finance paper as an asset class. Indeed, the issue was accompanied by new regulations governing how pension funds can invest in project finance bonds ? the first such guidance on the subject in the country.
Rio Chillon is a 27-year build-operate-transfer (BOT) concession to provide drinkable water to the 2 million people living in the northern part of the Peruvian capital Lima. The state-owned water company for the city, Sedapal, bid out the concession in 1999, and it was awarded in January 2000. The winning bidder was a consortium of Acea and Impregilo of Italy (both with 45% stakes) and Peruvian construction firm Cosapi (10%).
The concession uses simple, relatively low-risk and proven technology, and has a relatively low capital expenditure requirement. It entails the construction of superficial and underwater derivation and treatment plant facilities and a 76km distribution system. This system incorporates seven head reservoirs. The outline work on the specifications was incorporated in a World Bank-commissioned study and was used by investors and ratings agencies to assess various aspects of technical and hydrological risk.
Citibank, as financial advisor to the consortium from the bid stage, examined various financing solutions, incorporating bank and bond debt. The most important factor to consider is that the Peruvian market is rarely comfortable with more than a $20 million hit in any one go. This meant that the proposed $45 million debt issuance would have to be staggered so as not to exhaust a system with at most around $6 billion in assets.
One key aspect of the concession agreement meant that a number of tranches were unavoidable. This was wording in the agreement that said that a mortgage of project assets could only be taken by ?permitted? investors. This definition did not include private investors, who cannot be excluded from any public bond issue. The result, a clash between two branches of government and another round of negotiations to see which side could give way.
In the end bond investors bore most of the fall-out from the clash (a testament to the rigidity of Peruvian bureaucracy), in that the bond debentures contained a negative pledge and a call on the shares of the project company, Consorcio Agua Azul. The largest source of comfort, however, was probably the take-or-pay offtake contract with Sedapal. Sedapal carries a triple-A local rating and its obligations in this instance are explicitly guaranteed by the national government.
Moreover, the contract, and therefore tariffs, are indexed to provide a repayment stream for the dollar-denominated debt. The Peruvian pensions system is dollarised, a legacy of the hyperinflation of the 1990s that led Peruvians to hold their savings in dollars. Since then a growing number of corporates have opted to list their bonds in the country, especially those with some element of dollarisation in the revenues.
The local investor usually prefers to hold bonds till maturity, and there is as yet little of a secondary market. This, despite the fact that the bond has a balloon repayment, with only 60% of principal amortized. However, buyers of project bonds appear to be very comfortable with government risk, despite current instability in Argentina. Peru recently issued a $500 million 10-year bond, through Citi and JP Morgan. About 10% of this issue was taken up by domestic investors.
This is an impressive figure ? Citi was forced to go to the bond market in three stages. The first tranche, of $10 million, closed in August 2001, and had to be sold entirely to mutual funds and life companies. The reason for this inability to access the pension funds was due to a delay in the government's proposals for the regulation of pensions funds' project bond holdings. The bookrunner could have pitched the pensions directly, but using the other sources still resulted in a 1.25 times oversubscription. This tranche came in with a 12-year maturity and a coupon of 8.75%.
Two further issues followed, a $15 million 12-year tranche with an 8.6875% coupon that October, and in January a $9 million 12-year offering with an 8.5% coupon. The pricing decreased over the three tranches as Agua Azul became a more familiar name with investors. Compare this pricing with that achieved on Peru's 10-year dollar global, which had a coupon of 9.125%. Peruvian risk perceptions are clearly more gnerous than their US counterparts.
The total of $34 million raised was some way short of the initial hopes for $45 million, but according to the bookrunners the money raised is sufficient to get the work done.
Further raids on the capital markets would probably be possible if required. The rating on the bonds was AA+ according to the legally-required two local agencies, Apoyo & Asociados and Pacific Credit Rating.
It is unlikely that this small deal will spark a large number of others. For a start the market does not really have the liquidity to support a number of project issuers, even if they are the size of Rio Chillon. Moreover, the marketing, an educational task involved in selling non-recourse paper, is still formidable. However, as a recent issue for the Transmantaro transmission project showed, there are several candidates for domestic financing in Peru and its neighbours.
Rio Chillon
Status: 3 tranches closed August 2001-January 2002
Size: $45 million
Location: Lima, Peru
Description: BOT water project for the northern half of Lima, involving treatment and distribution improvements
Sponsors: Acea (45%), Impregilo (45%) and Cosapi (10%)
Debt: 3 tranches of 12-year bonds, of $10 million, $15 million, and $9 million
Bookrunner: Citigroup
Lawyers to the bookrunner: Estudio Muhe bookrunneronds, of $10 million, $15 million, and
Lawyers to the borrower: Estudio Rodrigo, Elías & Medrano (Peru), Studio Legale Chiomenti (Italy)
The main problem, however, is that of liquidity ? whether there is sufficient capital available here for large-scale infrastructure investment, or whether much of this capital can be allocated to project bonds. In Peru, as elsewhere, regulators are struggling with the issue of how to treat project finance paper as an asset class. Indeed, the issue was accompanied by new regulations governing how pension funds can invest in project finance bonds ? the first such guidance on the subject in the country.
Rio Chillon is a 27-year build-operate-transfer (BOT) concession to provide drinkable water to the 2 million people living in the northern part of the Peruvian capital Lima. The state-owned water company for the city, Sedapal, bid out the concession in 1999, and it was awarded in January 2000. The winning bidder was a consortium of Acea and Impregilo of Italy (both with 45% stakes) and Peruvian construction firm Cosapi (10%).
The concession uses simple, relatively low-risk and proven technology, and has a relatively low capital expenditure requirement. It entails the construction of superficial and underwater derivation and treatment plant facilities and a 76km distribution system. This system incorporates seven head reservoirs. The outline work on the specifications was incorporated in a World Bank-commissioned study and was used by investors and ratings agencies to assess various aspects of technical and hydrological risk.
Citibank, as financial advisor to the consortium from the bid stage, examined various financing solutions, incorporating bank and bond debt. The most important factor to consider is that the Peruvian market is rarely comfortable with more than a $20 million hit in any one go. This meant that the proposed $45 million debt issuance would have to be staggered so as not to exhaust a system with at most around $6 billion in assets.
One key aspect of the concession agreement meant that a number of tranches were unavoidable. This was wording in the agreement that said that a mortgage of project assets could only be taken by ?permitted? investors. This definition did not include private investors, who cannot be excluded from any public bond issue. The result, a clash between two branches of government and another round of negotiations to see which side could give way.
In the end bond investors bore most of the fall-out from the clash (a testament to the rigidity of Peruvian bureaucracy), in that the bond debentures contained a negative pledge and a call on the shares of the project company, Consorcio Agua Azul. The largest source of comfort, however, was probably the take-or-pay offtake contract with Sedapal. Sedapal carries a triple-A local rating and its obligations in this instance are explicitly guaranteed by the national government.
Moreover, the contract, and therefore tariffs, are indexed to provide a repayment stream for the dollar-denominated debt. The Peruvian pensions system is dollarised, a legacy of the hyperinflation of the 1990s that led Peruvians to hold their savings in dollars. Since then a growing number of corporates have opted to list their bonds in the country, especially those with some element of dollarisation in the revenues.
The local investor usually prefers to hold bonds till maturity, and there is as yet little of a secondary market. This, despite the fact that the bond has a balloon repayment, with only 60% of principal amortized. However, buyers of project bonds appear to be very comfortable with government risk, despite current instability in Argentina. Peru recently issued a $500 million 10-year bond, through Citi and JP Morgan. About 10% of this issue was taken up by domestic investors.
This is an impressive figure ? Citi was forced to go to the bond market in three stages. The first tranche, of $10 million, closed in August 2001, and had to be sold entirely to mutual funds and life companies. The reason for this inability to access the pension funds was due to a delay in the government's proposals for the regulation of pensions funds' project bond holdings. The bookrunner could have pitched the pensions directly, but using the other sources still resulted in a 1.25 times oversubscription. This tranche came in with a 12-year maturity and a coupon of 8.75%.
Two further issues followed, a $15 million 12-year tranche with an 8.6875% coupon that October, and in January a $9 million 12-year offering with an 8.5% coupon. The pricing decreased over the three tranches as Agua Azul became a more familiar name with investors. Compare this pricing with that achieved on Peru's 10-year dollar global, which had a coupon of 9.125%. Peruvian risk perceptions are clearly more gnerous than their US counterparts.
The total of $34 million raised was some way short of the initial hopes for $45 million, but according to the bookrunners the money raised is sufficient to get the work done.
Further raids on the capital markets would probably be possible if required. The rating on the bonds was AA+ according to the legally-required two local agencies, Apoyo & Asociados and Pacific Credit Rating.
It is unlikely that this small deal will spark a large number of others. For a start the market does not really have the liquidity to support a number of project issuers, even if they are the size of Rio Chillon. Moreover, the marketing, an educational task involved in selling non-recourse paper, is still formidable. However, as a recent issue for the Transmantaro transmission project showed, there are several candidates for domestic financing in Peru and its neighbours.
Rio Chillon
Status: 3 tranches closed August 2001-January 2002
Size: $45 million
Location: Lima, Peru
Description: BOT water project for the northern half of Lima, involving treatment and distribution improvements
Sponsors: Acea (45%), Impregilo (45%) and Cosapi (10%)
Debt: 3 tranches of 12-year bonds, of $10 million, $15 million, and $9 million
Bookrunner: Citigroup
Lawyers to the bookrunner: Estudio Muhe bookrunneronds, of $10 million, $15 million, and
Lawyers to the borrower: Estudio Rodrigo, Elías & Medrano (Peru), Studio Legale Chiomenti (Italy)
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