The S/.321 million ($116 million) financing for the Huascacocha water derivation PPP in Peru marks a significant advance in the use of capital markets financing for infrastructure in the country. It involves the first use of a delayed draw tranche for a Peruvian project bond, and the first investment by the infrastructure debt fund formed by the country’s largest pension funds. It also uses a payment mechanism that is robust enough to satisfy lenders without stressing the central government’s balance sheet.

The holder of the 20-year concession to build, finance, operate and maintain the pro­ject is Brazil’s OAS, which operates in Peru through its Epasa subsidiary. It examined a conventional multi­lateral debt financing through the Andean Development Corpor­ation, as well as the sale of bonds to Peruvian retail investors with minimal structuring. Earlier infrastructure financings in Peru have involved the sale of payment obligations by the government of Peru to special purpose vehicles, which have in turn sold bonds to a variety of domestic and international investors.

OAS won the concession in late 2008, and signed its 20-year concession agreement in January 2009. In May 2009 BNP Paribas won the financing mandate, in part on the back of its past capital markets financings in Peru, but especially because it had a Brazilian subsidiary that could advance working capital to the corporate parent using a standby letter of credit. Nevertheless, BNP’s experience assembling financings for the most recent wave of road projects in Peru gave it a head start working on the Huascacocha deal.

The counterparty under the concession agreement is Sedapal, the muncipal water and waste utility for Peru’s capital, Lima, and Callao, which has 8 million customers. Sedapal has been corporatized, and registered on the Lima stock exchange, but is still entirely state-owned. Sedapal’s debts have been taken over by the Peruvian Ministry of Finance, and in return the ministry has access to the master trust that holds payments from customers.

The first order of business was to persuade the ministry of finance that it since the master trust’s revenues were more than enough to satisfy the obligation, these revenues could also be pledged to the lenders to the Huascacocha project. The ministry for housing, construction and sanitation provides a contingent backstop to Sedapal’s obligations.

Sedapal’s obligations are known as RPICAOs, a transferable instrument unique to the water sector that consists of an RPI, or annual compensation for investment, and the RPMO, or com­pen­sation for maintenance and operation. These are issued to the project company, which in turn sells them to a Delaware-register­ed purchaser, which funds the acquisition by issuing bonds through a Caymans-registered issuer. Bondholders also benefit from a pledge over the concession and the shares of the project company.

The project involves building a dam and redirecting water from the Huascacocha to Sedapal’s treatment facilities. The project is not unique, since similar facilities exist in the Andes, though at 5,00km above sea level, OAS’ project is one of the highest. The maintenance of the project is not complex, and the cost of any energy that pumping operations consume can be passed on to the offtaker.

The most complex part of the construction process is schedul­ing it around Peru’s rainy season, which lasts from November to March. The existing infrastructure bond template in Peru involves considerable negative carry, because the issuer takes in bond proceeds at once, but only buys payment obligations when they are issued, typically when construction meets predefined milestone.

The Huascacocha bonds deal with both this pause in construction and the negative carry issue by having a substantial delayed draw tranche, meaning that the sponsor does not need to use complex, and mostly discredited, instruments such as guaranteed investment contracts or total return swaps to earn a return on proceeds. The Peruvian market has seen delayed-draw tranches before, but not in infrastructure, and not of the size of Huascacocha’s. Of the S./321 million issue, S./108 million will fund in April 2011, once the rainy season is over.

The deal was notable as the first placement to the infrastructure trust formed by Peru’s pension funds, or AFPs, to pool their investments in infrastructure debt. The idea behind the debt is to pool the funds’ due diligence resources, and allow them to make faster in­vestment decisions. The trust took roughly a third of the issue, and insurance companies most of the remainder, so the issuer was still able to benefit from some competition bet­ween providers. The financing is documented under New York law, so international investors with Peruvian soles appetite could participate.

The bonds mature in 2028 and priced at 520bp over the nearest government of Peru inflation-linked bond. The financing includes a reserve account to cope with any mis­matches between the wholesale price index, which governs the bonds’ repayment, and the retail price index, to which Sedapal’s revenues, and the RPICAO payments, will be linked.

The financing is set for a number of follow-ups. ACS is looking for roughly $300 million to fund the second of Sedapal’s water derivation concessions, Taboada, and OAS will adapt the structure for its Linea Amarilla toll road concession in Lima, which will have a more challenging credit profile.

But construction risk, and bondholders’ aversion to accepting it, will be the focus of future innovation. Sponsors are still being asked to put their balance sheets to work to overcome this aversion, and several have suggested that government might step up with a guarantee product that would free up sponsors to pursue more concessions.

Huascacocha Finance Limited
Status: Closed 27 May 2010
Size: S./339 million
Location: Lake Huascacocha, Peru
Description: Water derivation project involving the construction of 32km aqueduct, as well as associated pumping and transmission equipment, under a 20-year concession
Sponsor: OAS Group, through local subsidiary Epasa
Offtaker: Sedapal, with its obligations backed by the Peruvian Ministry of Housing, Construction and Sanitation
Debt: S/.321 million ($112 million)
Initial purchaser: BNP Paribas
Pricing: 520bp over Government of Peru inflation-linked bond
Maturity: 2028
Indenture trustee and collateral agent: Bank of New York
Sub-collateral agent: La Fiduciaria
Master trust account bank: Citigroup
Legal advisers to purchaser: Estudio Rubio, Leguía, Normand & Asociados (Peru), Greenberg Traurig (US), Maples and Calder (Cayman Islands)
Legal advisers to sponsor: Mayer Brown (US), Miranda & Amado (Peru), Tauil & Chequer (Brazil)
Legal adviser to indenture trustee: Rodrigo, Elías & Medrano (Peru), Hogan Lovells (US)