Setting a high benchmark
How the JAC project secured a competitive construction-phase refinancing. By Jonathan Robinson, director and head of project and export finance, HSBC Saudi Arabia, and Andrew Treble, director, HSBC Saudi Arabia.
In an environment increasingly restricted by tightening liquidity across international and regional financial markets, the Jubail Acetyls Complex Project (JAC Project) reaffirmed the resiliency of strong credits to attract significant amounts of project financing, while setting a new benchmark in the execution of construction-phase refinancings. The transaction has drawn considerable attention from developers, which, facing the confluence of surging project development activity across the GCC and hyper-inflationary pressures on construction costs, now have to compete for scarcer amounts of liquidity.
The JAC Project, sponsored by Sipchem(lead – Saudi Arabia), National Power Company (Saudi Arabia) and Helm Arabia (Germany), secured a long-term natural gas supply in 2004 and thereafter, signed key technology licences with Eastman Chemicals and DuPont for the production of acetic acid and vinyl acetate monomer respectively, both for the first time in the GCC.
This formed a solid commercial basis on which to proceed with the project development process. However, the engineering, procurement and contracting (EPC) market, posed a considerable impediment by the lack of interest in providing lump-sum turnkey (LSTK) contracts, the traditional mainstay of limited or non-recourse construction financing. Combined with the complexities of a multi-borrower structure, the transaction posed numerous challenges for the sponsors, HSBC (financial adviser), and Allen & Overy (sponsors' legal adviser) to executing a large-scale, project financing.
The resulting project configuration, the largest of its kind in the world, comprised three distinct plants – each owned by a separate company:
Managing a complex contracting strategy
Faced with major challenges in a resistant contracting market, the sponsors pursued a contracting package that combined lump-sum turnkey (LSTK) contracts and engineering, procurement and construction management (EPCm) elements across various construction "packages" under the direction of a project management contractor and integrated project-management team.
Alongside a heavily front-ended equity funding strategy, this allowed the financing to succeed in a difficult market and provided measurable capital cost savings. This was not without other cost, however, as the inherent risk of further capital cost escalation, technology wrap considerations, and multi-point responsibilities – all typical concerns of the project finance lender – required a significant element of sponsor support.
The full completion guarantee is the most common form of completion support, particularly in the GCC. It provides sponsors with a price advantage (the pre-completion period is effectively priced as sponsor corporate risk) and maximum flexibility in terms of contracting strategy. The downside is that this "blunt" instrument incurs substantial liability, often the total amount of commercial debt required for the project.
In addition, in the event of delays the lenders enjoy considerable leverage over the sponsors. Providing cost overrun support reduces the liability of sponsors by limiting the exposure to the amount required to complete the project, which should normally be substantially less than the total debt raised.
Though the value debate over LSTK contracts versus EPCm contracts rages on among sponsors, in many cases contractors will not bid on the basis of an LSTK, fearing an erosion of their margins by escalating raw materials costs. In such cases, EPCm contracts may be the only choice, but come at a potentially high offsetting cost of sponsor support, in the form of additional equity commitments or completion guarantees of some form.
Where feasible, LSTKs that may seem comparatively high-cost at first can provide a sensible mitigant against cost escalation affecting the project, and importantly will reduce the degree of sponsor support. In addition, a co-ordinated contracting strategy developed early in the financing process may allow for access to additional liquidity pools, such as:
* Export Finance Agencies (ECAs) – Providing for a global procurement strategy and emphasising early on in the bidding process that contractor-sourced (or supported) financing will be a material evaluation criterion, will increase the availability of ECA financing, and, in turn, international bank liquidity; and
* Shariah-compliant facilities – For Islamic financiers to assume the role of lessor, a contractual relationship should be established between the financiers and the contractor, though typically with the project company undertaking an agent role on behalf of the financiers. This is an important commercial structuring consideration prior to executing any LSTK or EPCm contracts.
The interplay between contracting and financing is often overlooked and requires close co-ordination between the sponsors' technical and financial teams and advisers to secure a commercial agreement that meets the objectives of all stakeholders.
Round 1 financing – Regional club transaction
HSBC and the sponsors first approached the regional bank market in late 2005 seeking to secure circa US$500m in commercial financing, of which half represented a bridge facility for the subsequent anticipated participation of the Public Investment Fund.
Despite having three separate borrowers, each contemplating multiple tranches of debt (commercial, the Saudi Industrial Development Fund, and Public Investment Fund), the transaction was structured to emulate a single credit risk, through carefully crafted commercial agreements (which aligned key provisions such as force majeure, scheduling, liquidated damages, and payment terms, among others), the use of cross-guarantees between the ring-fenced borrowers and sponsor support. The combined commercial and financing documentation package exceeded 150 key documents.
Though representing a complexity level previously unseen in the market, the invited banks responded very favourably, contributing to a sizeable oversubscription and the selection of nine mandated lead arrangers (MLAs), predominantly Saudi Arabia-based. The MLAs would be joined by multiple tranches from the Saudi Industrial Development Fund (SIDF) and the Public Investment Fund (PIF), with which the sponsors were holding advanced discussions.
The sponsors thus began the process of satisfying the conditions precedent for the loans, only to face the next major challenge sweeping the contracting market – dramatically escalating costs.
Round 2 financing – Take-out underwriting
HSBC and the sponsors re-approached the MLAs in early 2007 seeking an increase in underwriting commitments, to proportionately offset the increased JAC Project costs, which had escalated from US$1.4bn to US$1.8bn. The sponsors sought circa US$745m, again half of which represented a bridge facility for the subsequent anticipated participation of the Public Investment Fund.
With construction nearing 50% complete and funded entirely by equity, no clear sighting on securing increased commitments from the original MLAs, and visibly decreasing market stability, some market observers considered the JAC Project to be in a precarious situation. The Saudi British Bank (SABB) (an associated company of HSBC) thought otherwise and took the opportunity to aggressively pursue a sole underwriting of the entire commercial and PIF debt requirement.
The SABB underwriting shook the local and regional bank market, which hadn't seen such a move in even the robust liquidity period of 2004 to 2007, and demonstrated the opportunity for well structured projects to attract competitive financing, even in difficult times. In addition to laying claim as the first "construction-phase refinancing" of its kind in Saudi Arabia, and one of the largest single project finance underwritings by a Saudi bank, the transaction set other benchmarks as it:
* Was priced below the original financing, reflecting a measurable reduction in construction-phase risks and contributing to improved economics for the sponsors;
* Was executed in an extremely short timeframe – just over one month from termsheet offer to signing of the full suite of financing agreements, removing the risk of a disruption in construction activity;
* Was a "hard underwriting", mitigating the sponsors' exposure to syndication risk, including in relation to PIF participation, and market-flex pricing risk; and
* Provided a simple, one-stop-shop solution at the outset for the key administrative functions typical of a project financing.
Working closely with the sponsors and HSBC, SABB subsequently initiated a limited syndication and closed the financing with participations from Saudi Hollandi Bank, Riyad Bank and KfW. Soon after, as anticipated, SIDF began drawdowns and PIF-approved participation in the JAC Project. The project is now well into drawdowns under the commercial facilities, and construction activities remain on schedule.
Managing a complex financing structure
The complex, multi-source/multi-tranche financing structure reflected the challenges associated with the project-on-project risk endemic to the three separate but inter-related project companies (being the CO Plant Company, the AA Plant Company, and the VAM Plant Company).
However, before the financial structuring could advance to any detail, the underlying inter-project company agreements (for example the CO supply agreement between the CO Plant Company and the AA Plant Company) were structured in a manner that would limit subsidies between the JAC Project companies (accounting for different shareholdings between them) and thus present both individual plant economic sustainability and overall JAC Project economic sustainability.
Three separate but linked financial models were developed, alongside a fourth consolidator model, to allow for detailed evaluation of any component of the JAC Project plants and similarly support commercial negotiations, and the eventual structuring of the project financing.
The result – three separate loans for the commercial facility, SIDF facility and PIF facility, totalling nine tranches across the JAC Project. To achieve a functionally single-credit risk structure, a virtual necessity to secure financing of this type and magnitude, each of the JAC Project borrowers guaranteed the facilities of the other two such that a default under any one tranche, would simultaneously trigger cross-defaults across the other tranches, thus allowing lenders recourse across the entirety of the JAC Project.
Furthermore, no cherry-picking of individual facilities was permitted and thus SABB required participating banks to sub-underwrite pro rata portions of the commercial facility across the separate project companies. Last, sponsor support was provided by Sipchem as an additional wrap of the overall risks.
The financing further provided for drawdowns to be fungible between the project companies, thus allowing for any undrawn funds at completion of a plant to be used to fund cost overruns, if required, of another plant.
Timing is everything
Increasingly, large-scale projects are seeking to tap multiple liquidity pools (including domestic/regional banks, Islamic financiers, international banks, ECAs, and potentially capital markets) in order to maximise liquidity availability and price tension among providers thereof. The widely publicised sub-prime crisis has had a direct effect on global liquidity available for project financing as commercial banks have, in numerous cases, significantly written down their asset base and retrenched on adding new assets to their portfolios. Additionally, the cost-of-funds (to which the regional banks are particularly sensitive) has increased measurably, further pressuring minimum lending yield requirements.
Though having closed the original financing in 2006, well ahead of the present credit squeeze, the JAC Project sought additional liquidity at a precarious time in early 2008, with the local bank market beginning to feel the effects of restrained US dollar lines – pushing down liquidity and pushing up pricing across a broad range of projects and syndicated financings.
This coincided with a perceived peaking of contracting costs, particularly for projects employing specialised metallurgy, further exacerbating re-financing prospects. Importantly, however, the JAC Project had significantly advanced discussions with two other important sources of financing for industrial projects in Saudi Arabia, namely SIDF and PIF.
Both parties have a long and reliable track-record of supporting Saudi Arabia's industrial expansion and represent today, potential liquidity of US$1bn–$1.5bn for a single, qualified project. Nevertheless, approval times, wherein numerous ministries are typically involved, understandably lag more nimble commercial banks and thus the conundrum – wait for final approval from SIDF and/or PIF, or bridge finance them on the expectation of a near-term take-out.
HSBC has routinely worked with clients such as the JAC Project on structures to bridge-finance SIDF, PIF or similar providers, allowing projects to move forward on time yet benefit from attractive funding from these sources when they approve commitments. For the JAC Project, SABB took the risk, underwriting all of the PIF facility envisioned for the project and holding such through syndication, on the strength that PIF's track record and commitment to the industry would see them in the JAC Project. The result was certainty of funding for the sponsors, quick mobilisation of funds available to the JAC Project, and commensurate remuneration for SABB of a measured risk.
Attracting liquidity, on the best terms possible, will require increasingly creative financing structures and solutions, which:
* Maximise capacity from traditional pools and develop new pools of liquidity (such as private equity funds) to create excess liquidity and ensure as much competitive tension as possible;
* Look at potentially splitting mega-projects into discrete more manageable financings without creating undue project-on-project risks;
* Strike a balance between contracting costs and sponsor support to avoid over-burdening the project itself, the sponsors, or the lenders; and
* Control the lender due diligence process to ensure a practical understanding of the real risks and relative market positioning of a project.
HSBC Saudi Arabia acted as the financial adviser and SABB as the sole initial mandated lead arranger on the JAC Project refinancing.