Project bonds not limited to refinancings

Author: Danielle Myles | Published: 7 Jan 2011
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Latin America’s project bond market has been reopened by Odebrecht Oil & Gas’s (OOG) $1.5 billion issue.

The deal shows that assets under construction can be financed through the capital markets - but refinancing risk must be addressed and the structure flexible enough to respond to a fast moving market.

Through its SPV issuer Odebrecht Drilling Norbe VIII/IX, Brazil’s OOG placed the 6.35% senior secured notes due 2021. These will fund the completion and refinancing of two drillships being built in Korea to be chartered to Brazil’s state-owned energy company Petrobras.

“This was a bond financing which was replacing a project financing midstream – not completed and up and running - so it was an interesting exercise,” said Victor DeSantis, a White & Case partner who acted for the initial purchasers.

It’s the largest debt offering out of Brazil in 2010 and one of the region’s largest project bond issues ever. But it’s most notable for being a rare case where lawyers had to overcome pre-completion issues about balloon repayment and bond investors’ aversion to construction risk.

Refinancing risk was dealt with through a retention account and call period mechanism. Completion risk through sponsor support followed by stringent completion test, plus a well established shipyard (Daewoo Shipbuilding & Marine Engineering (DSME)) building the vessels.

Another challenge was having the structure react to a dynamic market.

“Bond pricing is very volatile and bond markets can go away in a nanosecond,” said one lawyer on the deal. “So one of the benefits to a project when you are trying to reach a bond market is the incentive to move quickly.”

It means lawyers must work with a structure that is flexible enough to issue the bonds when pricing is optimal. In the OOG issue, this meant placing the bonds before the final transaction structure had completed.

“The project has been set up with US companies at the moment, but it’s part of the offering circular conditions that a reorganisation occurs and they [the ships] will be migrated to Austria, which is not common,” said Paul Doralt, a partner with Austrian firm Dorda Brugger Jordis which advised OOG.

A tax treaty between the two countries offers beneficial treatment of dividends for Austrian project companies. But there wasn’t time before the launch to get all consents for contract assignments to the Austrian companies.

The solution was for the ships (once construction finishes) to initially be owned by Delaware companies, the shares of which will later be transferred to the Austrian shell companies. The Delaware companies will then be liquidated and their assets moved across to Austria.

Investors aren’t used to a domicile change, and the offering circular had to provide all necessary information about investing in an Austrian company. This will enable the changes that couldn’t occur before going to market.

“It was a bit of a race to lock in the best financing terms,” said a lawyer on the OOG issue. “This is the context in which this deal was structured.”

OOG’s offering closed less than a month after a $270 million issue by Brazil’s Schahin Group to refinance its Petrobras-chartered drillships. Together the deals tested the market and the rating agencies’ attitude to project bonds.

It seems to have paid off. The OOG issue was more than three times oversubscribed.

“I assume there might be efforts to replicate it,” said DeSantis. Particularly given Petrobras’s plan to hire 28 vessels (not yet built) over the next eight years.

“Part of Petrobras’s programme to exploit pre-salt finds and take advantage of oil and gas resources is relying on the private sector and companies like Odebrecht to structure the financings for these vessels,” DeSantis added. “This was an innovative way to access financing for these purposes that hasn’t been used before, or certainly not on this scale.”

Bonds’ long tenor, better rates than loans and offer of operational flexibility, combined with a strong sponsor and offtaker, is thought a good rationale for the market’s expansion – in Brazil at least.

The OOG bonds were issued through a Cayman Islands company and the ships will be flagged in the Bahamas; the deal required legal advice from five jurisdictions.

Risk allocation

There was some concern surrounding the project’s refinancing risk. Credit rating agencies are reluctant to award investment grade status to securities carrying this risk, so mitigating it was a priority. This was achieved in two ways.

A cash-trap was built into the project companies to collect payments from the two charter agreements towards the end of their terms. This money will reduce the balloon repayment expected at the bonds’ maturity.

“The risk relating to the uncovered portion of the balloon is also addressed by the assessment of the residual value of the drillships at the balloon payment date, which are very likely to be substantially higher than the outstanding balloon amount,” said Clarice Garcia, in-house counsel for OOG.

The reliability of Petrobras revenues was key to minimising operational risk and obtaining investment grade ratings (BBBsf and Baa3 rating by Fitch and Moody’s, respectively).

The other tactic was making the bonds callable, but giving investors the comfort of a call protection period that ends only once sponsor support (covering up to $110 million of cost overruns) has been exhausted. The issuer can only call the bonds immediately before there would otherwise be the need to fund additional collateral accounts.

Bond investors’ aversion to construction risk has been a major stumbling block for the project bond market.

“In a bond as opposed to a financing, the investors are more detached from the documents themselves,” said Guilherme Forbes from Souza Cescon Barrieu & Flesch, Brazilian counsel to the issuer. Bond trustees don’t take a coordination role which makes it impossible for issuers to get waivers and amendments to project timetables, as happens in a bank financing.

This is dealt with through a covenant package that gives the sponsor flexibility to manage the project and investors adequate protection in case of material events, said Garcia. Also, there is relatively little technical risk of completion.

“The drillships are being built by DSME, a first class shipyard with a solid track record and the construction is in an advanced stage,” said Garcia. The construction risk there is, is substantially taken on by DSME which is building the vessels under turnkey, fixed price EPC contracts.

“Kexim has also issued a refund guarantee to the project companies in the form of a transferable, irrevocable, standby letter of credit to cover any refund payable by DSME to a project company following termination of the EPC contract due to DSME’s breach,” Garcia added.

Finally, an independent engineer will certify that the ships have been completed to the specifications.

Lender’s security

The security package replicated the initial bank loans, and is what is customarily granted in a project financing. It includes pledges over revenues from the Petrobras contracts and bond proceeds accounts; pledges over the shares of the issuer and guarantor (Delaware project companies); an obligation to mortgage the drillships once completed; a letter of credit covering the sponsor’s contributions prior to delivery; and assignment of the project contracts and insurance policies.

Tear Sheet

November 10

Odebrecht Oil & Gas through its project subsidiary Odebrecht Drilling Norbe VIII/IX issued $1.5 billion of 6.35% senior secured notes due 2021. The funds will be used to finance two drillships to be chartered to Petrobras. The initial purchasers were HSBC, Deutsche Bank, Santander and BB Securities.

Lead counsel to issuer: Davis Polk & Wardwell

Austrian counsel to issuer: Dorda Brugger Jordis

Cayman Islands counsel to issuer: Maples & Calder

Bahamas counsel to issuer: Constantakis Knowles

Lead counsel to initial purchasers: White & Case

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