IFR Mid East 2006 - Wrapped bond splash
In March, the US$180m Ajman Wastewater project reached financial close for the second time, with a 20-year wrapped bank loan. By Michael Dinham, managing director, and Stefan Ben, associate, ING.
This was a landmark deal for the United Arab Emirates and the Middle East. Initially awarded in 2001, the concession to finance, build, own and operate a wastewater collection and treatment system in the Emirate of Ajman soon experienced difficulties when residents became reluctant to pay up-front connection tariffs. Late 2003 saw the project fall into technical default, leaving a partly-completed sewer network and treatment plant, frustrated residents, and a considerable funding headache for the project sponsors. The second financial closing was achieved after a complex restructuring.
In December 2001, a consortium comprising Black & Veatch International and Thames Water Aqua International signed a concession agreement for the project, the first public-private enterprise undertaken in the UAE. A new utility company, Ajman Sewerage (Private) Company Ltd (ASPCL), was subsequently established. At the original financial close in February 2003 the Government of Ajman (GoA) and Six Construct Ltd (owned by Belgian contractor BESIX Group) were also a shareholders in ASPCL.
The term of the concession is 25 years starting at the end of substantial completion. The project includes the construction, operation and maintenance of 227km of gravity collection system pipework; 22 pumping stations; 30km of rising main transfers; and a 49,000 m3/day plant providing tertiary treatment, which would treat wastewater to a standard suitable for re-use in irrigation throughout the Emirate. Construction was originally intended to be completed in two phases over a 48-month period, with full treatment services starting upon treatment plant completion after 2.5 years and the full collection network build-out to follow.
A particular feature of this BOT wastewater concession was the obligation on the concessionaire to collect revenues through connection charges and service fees from users, rather than benefiting from a single off-take contract with the concession grantor. Hence, the concessionaire was bearing a high degree of demand risk and in that sense the concession marks the first utility project in the region to charge a full cost recovery-based tariff for delivery of wastewater management services.
The treatment plant is designed to serve an ultimate population of about 382,000 (against the current population of some 225,000) and there is a commitment to progressively develop the collection network to keep pace with expected residential and industrial development in Ajman. The treatment plant and network will replace the inadequate and environmentally damaging septic facilities and disposal processes currently in place.
The key aspect of the deal's initial structure was its reliance on the consumer in the first instance, with nearly half of the project's funding for construction coming from user tariffs. Of the remaining funding, about 20% was equity capital and 30% senior debt finance provided by two local and two international banks. The appeal of this structure to the GoA was clear, and given the enforcement mechanisms and structured financing in place, the project was expected to perform to schedule.
The promulgation of the Amiri Decree Regarding the Ajman Sewerage System (the Sewer Law) was a condition precedent to financial close. The Sewer Law was a vital part of the framework for the concession arrangements between ASPCL and the GoA as it set out the obligations of property owners and users to connect to the network and pay fees and charges, and the consequences of non-compliance.
By July 2003, the project began to experience difficulties. Property owners were reluctant to register their properties under the Sewer Law, which obliged them to pay the first two of four instalments of their connection fees (45% of the total connection charge), prior to being connected for service. It was ultimately the reluctance of the populace to comply with their registration and payment obligations under the Sewer Law, and the difficulties associated with its enforcement, that led to the project being in default under its original finance agreements.
The original financing tied drawdown on debt and equity to pre-determined revenue milestones. With property owners refusing to register and pay connection fee instalments, it was not long before ASPCL was in default and facing a drawstop on its funding. As early as July 2003, the shareholders and the GoA entered into discussions with a view to making up the apparent funding shortfall with additional commitments. The original financiers granted conditional waivers against these commitments, permitting further drawdowns that allowed the project to continue for the remainder of 2003 and into early 2004.
The funding issues were further compounded in December 2003. The GoA had made reasonable attempts to win support for the project and incentivise people to register and pay connection fees by amending the Sewer Law to reduce connection fees. With further revenue pressure, it was not long before ASPCL was unable to meet payments to the construction contractor, which inevitably led to a suspension of a material part of the works.
For the better part of 2004, ASPCL remained in default under the project loan while the shareholders, GoA, ASPCL and its lenders attempted to address the problems facing the project. However, the interim cures did not address the fundamental problem with the funding structure, namely full revenue risk on the consumer.
Following extensive negotiations, a restructuring plan for the project was formulated. The heart of the plan was an increased level of financial commitment from both the GoA and private shareholders to ensure successful completion, including partial guarantee of revenues. These commitments (and other cash amounts to cover previous shortfalls in connection fee receipts) were all backstopped by documentary credits. The incorporation of additional security/commitment into the structure largely reduced the demand risk (and entirely removed this risk during construction), and provided further incentive for the project stakeholders to perform.
As part of the restructuring, the EPC contract was novated to a joint venture between Black & Veatch and BESIX/Six Construct and was also revised to incorporate (inter alia) an accelerated completion programme of 31 months for construction. This was an important contribution to the restructuring, particularly with respect to keeping local residents' faith in the project. The view was taken that local residents' incentive to pay would be greater with visible evidence of the network build-out taking place. Furthermore, once residents were able to switch to the collection network, they would not be paying for periodic waste removal from septic tanks, in itself a relatively expensive process.
The final piece of the restructuring saw Thames Water exit the project (the timing of the restructure coinciding with the company's withdrawal from international activities) to be replaced by Veolia Water AMI and BESIX Group. The O&M Agreement was novated to a joint venture of Veolia and BESIX. The concession company (ASPCL) is now owned 50% by BESIX Group (including 10% by Six Construct), 20% by Veolia Water AMI, 10% by Black & Veatch International and 20% by the Government of Ajman.
ING first approached ASPCL in early 2005 with a proposal for a bond refinancing while negotiations on restructuring were ongoing. Based on the new project structure being contemplated, ING envisaged that it was likely to achieve an investment grade rating, opening up a number of financing possibilities. ING was duly mandated in mid-2005 to pursue a refinancing solution. Both Moody’s and S&P were appointed to undertake credit assessments, the outcome of which resulted in preliminary A3 and BBB ratings, respectively.
With good investment-grade status, ING then considered the possibility of monoline wrapping. The use of this structure had been relatively limited in non-OECD regions, and had never before been done in the Middle East. But at face value it offered a number of advantages and was considered worth pursuing. A number of monolines were approached and ultimately Ambac proved to be the most competitive and supportive toward the transaction.
The negotiations on the monoline solution continued over the Christmas period and a deal was broadly agreed early in the new year. Given both the timing pressures and existing complexities of the restructuring, ING proposed to underwrite the debt facility itself on a fixed-rate basis benefiting from the Ambac wrap. This removed the additional step of marketing the debt to institutions (and involvement of additional parties in the deal), which all helped to simplify the process.
Unlike bond investors (which to-date have been the main recipients of monoline guarantees), ING was at the negotiating table with ASPCL and Ambac, which meant discussions were directly with the ultimate financier. This helped to simplify various inter-creditor issues that arise under the wrapped structure. This is of particular importance to rating agencies, which look closely at inter-creditor arrangements when assigning Triple A ratings to wrapped debt.
Refinancing the original US$ 77.5m 14-year senior facilities, the US$100m 20-year wrapped financing provided a substantial increase in both the amount and maturity of the debt and a significant reduction in cost. The increased debt amount alleviated the financial pressure on the shareholders (reducing the cash equity required) and provided greater liquidity without placing a demanding financial burden on the project going forward. In addition, the facility was drawn down entirely at financial close, providing a readily available source of funding to accommodate the project's revenue-reliant construction schedule. Furthermore, ASPCL was now able to project a reasonable internal rate of return to shareholders, an unimaginable result prior to restructure.