Israel's Hadera desalination plant extension project was a challenging transaction to bring to financial close, but clearly demonstrates a growing confidence for the PPP model in the Middle East.

The greatest obstacle that had to be overcome was the extension to the facility that would be treated as a bolt-on to the existing transaction - an approach that has been used on other such deals where a capacity increase was needed to the initial facility.

The decision was taken early on to expand existing facilities rather than procuring a new, independent desal facility - working with the sponsor on the first project and altering the existing documentation.

The deal allowed for a temporary step-in concept - opposed to a permanent step-in, which the existing concession required - in which the extension lenders could run a part of the concession contract that related only to the extension.

Despite the difficult circumstances the state was co-operative and allowed the lenders to step in and come up with a solution that suited both existing and extension lenders.

Background

In 2006 the H2ID consortium won a tender to BOT the original €261 million Hadera Desalination Plant [Projects Database] and financial close followed in November 2007.

H2ID is a 50:50 Israeli partnership between IDE Technologies (which belongs to Israel Chemicals) and Delek with Housing & Construction Holding.

The project is being developed on a BOT model - where the H2ID team will DBFOM the installation and transfer it back to state ownership after the 25-year concession period.

In the original project financing, the European Investment Bank (EIB) provided a €120 million stand-alone facility on an unguaranteed basis.

Espirito Santo Investment and Calyon provided €191 million in senior debt commercial facilities, including:

• €105 million commercial loan
• €48 million equity bridge
• €10 million working capital
• €15 million stand-by loan
• €13 million debt service reserve

Pricing on the debt was at the time described as "attractive for an infrastructure deal with a state off-take agreement" and the tenor on the commercial loan was 23 years.

Pricing on the commercial debt in November 2007 is as follows:

• Construction - Euribor(3M) + 105bps
• Operation period (year 1-3) - Euribor(3M) + 110bps
• Operation period (year 4-8) - Euribor(3M) + 115bps
• Operation period (year 9-13) - Euribor(3M) + 125bps
• Operation period (year 13-23) - Euribor(3M) + 135bps
  

Syndication of the commercial debt closed in March 2008 with the following five senior participants, (listed in descending order of ticket size):

• KfW IPEX-Bank
• Bank Hapoalim (account bank, sub underwriter)
• BIIS
• Dexia
• Israel Discount Bank

The Israeli state badly underestimated demand for water in this region of the country when the plant was first tendered and was forced to take action this year, building on the relationship it had already built with the existing sponsor.

Extension Project

The extension option was selected as the quickest route to getting the additional capacity up and running, as well as hoping to achieve more favourable pricing.

The extension element will add production capacity to deliver an additional 27 million m³ per year - on top of the 100 million m³ per year existing plant which is currently under construction.

The Hadera plant is located on the premises of Rabin Lights - a state-run power plant in the city of Hadera, on Israel's north west Mediterranean coast.

The project is being constructed using the reverse osmosis method for the purification of 127 million m³ of potable water per year, at a cost of 2.54 shekels (US$0.65) per cubic metre.

The accountant general's department of the State of Israel negotiated the extension contract and ran the concession agreement, while the Water Desalination Authority (WDA) was also involved in the process.

WDA representatives are drawn from:

• the Ministry of National Infrastructure
• Water Coalitions
• Ministry of Finance

Israeli firm Gornitzky was the legal adviser to the sponsor, Calyon acted as financial adviser, while TASC was financial adviser to the authority.

Financial close of the extension was achieved on 11 June 2009.

Extension Financing

The Hadera extension deal closed with just Calyon and BES (Banco Espirito Santo) providing the US$21 million in debt on a 50/50 basis along with EIB contributing half of the US$97 million deal value - US$48.5 million.

Despite reaching financial close on 11 June, the final hold of the extension financing is yet to be fully finalised, as some of the existing banks from the original syndicate of the earlier facility will later take up a share. The final allocation is due when the banks draw down, which is expected in the next month (July).

The complicated financial structure was created so the extension financing would be provided entirely by existing banks, but not necessarily all existing banks would participate.

If all the same banks had acted as lenders on the extension, it would simply have been a case of increasing the existing amounts. There would have been no need for inter-creditor issues between existing lenders and extension lenders.

The original financing did not have any terms which allowed separate extension lenders to step in and one of the main challenges was creating a structure where they could be brought in without worrying the existing lenders.

In this respect the deal differs from some of the large LNG deals in the Gulf and elsewhere where original financiers can be persuaded to accept new extension lenders to share rank at the same level as the existing funders.

While it is conceptually difficult to separate the assets from a technical perspective, from a lender or security perspective there are distinct differences in the extension facility, such as contractual rights and bank accounts. Therefore, the extension lenders had total control over these specific aspects.

Existing lenders also did not want the extension lenders to cause a general security enforcement or acceleration of the concessionaire's debt. This had to be restricted in the inter-creditor arrangements - restricting the access the extension lenders had to security of the existing facility.

Another interesting structural feature was ensuring that the credit line for the extension facility could be refinanced, without having to refinance the main facility. This was a major part of the structuring challenge - creating a new facility that can be refinanced.

The sponsors, not surprisingly, are likely to refinance the extension facility when the market picks up.

The new facility was US dollars, whereas the existing deal was financed in Euros. From a commercial perspective - this was a decision driven by price, but creates additional complexity from a financing point of view.

The total extension project value was US$97 million and included:

• EIB - US$48.5 million
• Calyon - US$10.5 million
• Espirito Santo Investment - US$10.5 million
• H2ID - US$27.5 million in equity

The tenor of the extension facility was slightly shorter to bring it in line with the close of existing facilities. Senior debt priced at north of Libor +300bp.

Allen & Overy acted as legal adviser to the lenders, Arup was technical adviser, while JLT provided insurance advice.

The EIB didn't have a separate legal adviser. Its terms were part of the same set of common terms as the commercial banks, but set its own pricing.

Contractual Issues

The concession contract had to be amended so that if something went wrong with the extension element, it would not prejudice the existing lenders on the existing facility.

The state had to ensure that if something went wrong with the extension contract, it wouldn't bring down the whole concession.

This issue was overcome by adding the option to cut the extension route if needed during the construction phase. This means that if the extension isn't built on time or to standard, the "extension-only" part of the concession can be terminated.

If something goes wrong with the original plant it will automatically flow into the extension element of the plant - however, it doesn't go back the other way through the construction period.

At the end of the construction phase both elements will be treated as one whole plant.

Conclusion

The Israeli project finance market continues to bear fruit with ongoing water, road and solar energy deals in the pipeline. An increasing amount of work is being tendered out and much of it will be financed by international banks.

In April 2008, the Sea-Water Desalination Inter-Ministerial Tender Committee published a pre-qualification process for a BOT project for the DBFOM and transfer to the state of a desal facility, using the reverse osmosis method, for the treatment of at least 100 million m³ per annum. It will be located at Sorek, near Rishon Lezion and the concession period is 25 years.

Many firms are currently tendering for the project, including both sponsors for the Hadera project - although in different bidding consortia.

There remains a great need for water infrastructure in Israel and the wider Middle Eastern region.

Innovative PPP projects such as the Hadera plant - and the extension deal - demonstrate how this kind of essential infrastructure can be financed and developed.