CHICAGO – The Iowa Fertilizer Co. LLC's construction and cash flow troubles led Fitch Ratings to downgrade deeper into junk almost $1.2 billion of project bonds that are now under an Internal Revenue Service cloud.

The disclosure of the IRS investigation came in an investor filing dated Friday in conjunction with the company's posting of a requested bond term waivers and a proposed tender exchange on a portion of its 2019 term bond the company says is needed to help get the project up and running.

The IRS is examining the company's $1.94 billion interim 2012 financing and the $1.18 billion 2013 permanent financing, sold through the Iowa Finance Authority.

"The IRS has not informed the authority or the company that it has made an 'adverse determination' regarding the tax exempt status of the 2012 Bonds or the 2013 Bonds," the notice said.

Fitch lowered the rating to B-minus from B-plus and put the bonds on negative watch. About $1.156 billion of the permanent financing remains outstanding. Fitch initially rated the bonds BB-minus.

The bonds were sold to finance construction of nitrogen fertilizer plant in southeast Iowa being developed by Orascom Construction Industries of Egypt. The private activity bonds were sold under the federal government's Midwestern Disaster Area Bond designation.

The interim financing allowed the company to meet the deadline for the disaster area bond program as it worked to finalize various project contracts and agreements.

The bonds are secured by a first priority security interest in all tangible and intangible assets of the project and a pledge by Iowa Holding LLC of its membership interests in the Iowa Fertilizer Co.

"IFCo's financial profile is under pressure due to ongoing costs to reach completion and the project's mandatory semi-annual payments of debt service on its bonds, repayment of the construction loan for the National Bank of Abu Dhabi (NBAD), and scheduled hedging premiums," Fitch said.

"The downgrade reflects that only a limited margin of safety remains for repayment of the bonds as currently structured," Fitch said in a report published Monday. "Failure to achieve final completion has placed significant pressure on the ability to make upcoming mandatory debt payments."

Project sponsor OCI N.V. is asking bondholders to approve various waivers to covenants and to tender on a portion of bonds "to ensure the successful completion of construction and first year of operations," the company reports in a consent and tender exchange notice on the Municipal Securities Rulemaking Board's EMMA website.

The company wants to exchange a $147.2 million of its $390 million in 2019 term bonds, pushing off sinking fund payments due in December of 2016 and 2017. The purchase price for the tendered 2019 Term Bonds is 103%, par plus a premium.

The exchange would provide breathing room to ramp up to full operations, fund the various operating reserves, and cover debt service in 2017, the notice said. The company says it would help resolve remaining obstacles to completing the project and relieve the near-term payment default risk.

Bondholder waivers are needed to permit the refinancing of the 2016 and 2017 sinking fund payments, allow a $21 million debt service draw to pay December 2017 debt service, amend the cap allowable on working capital loans to $50 million from $30 million and include inventory as collateral. Waivers are also needed to finalize a settlement over construction cost claims and to avoid any potential default that could be construed due to construction delays.

If the consent and tender exchange is not completed, OCI has committed to funding remaining development costs and the Dec. 1, 2016 payment, providing similar relief of near-term payment default risk, Fitch reported.

The tender has strong support among holders, sources said.

Under the timeline outlined in investor notices, waiver consents are due Wednesday and the bond exchange would be priced Wednesday with closing set for Friday. Citi is the dealer. A majority of bondholders would need to consent.

"Without bondholder consent to a settlement agreement, contractor claims would remain outstanding, indicating that final costs could rise further," Fitch said. More than $70 million of subcontractor liens remain outstanding. Bondholder claims are senior to mechanic liens under Iowa law.

The company retains liquidity to cover payments, but it's limited until the plant is operational. It funded a mandatory June 2016 payment with cash from the debt service reserve, which was replaced by a letter of credit. The balance is available to meet future obligations. If Iowa Fertilizer Co.'s tender exchange is not completed, sponsor OCI has committed to cash funding the December 2016 payment.

The rating could take another hit if the project sponsor fails to relieve near-term financial pressure, has further material completion delays, early operational performance is below expectations, or near-term product prices weaken.

Ammonia production is expected in the first quarter of 2017 but could be delayed by winter weather. The company faces a volatile market when it begins selling its nitrogen products to farmers, distributors, wholesalers, cooperatives, and blenders at market prices.

The project's operating margins depend on favorable market pricing for nitrogen products. The pricing is tied to the price of feedstock, which may be oil, coal, or natural gas depending on the region and producer. Substantial declines in oil and natural gas prices have driven nitrogen prices to levels approaching 10-year lows.

Once operational, Fitch said it anticipates that relatively high equity distribution triggers will support debt repayment and replenishment of reserves during potential periods of low operating cash flow.

"Over the long-term, Fitch's analysis suggests that IFCo's ability to meet ongoing mandatory debt payments is vulnerable to deterioration of operating margins," analysts wrote.

In the company's notice about the tax examination, it reported that the IRS has indicated it is investigating and evaluating some concerns about the timing of the issuance of the 2012 Bonds.

The IRS is examining the manner in which the proceeds of the 2012 bonds were restricted for an initial period of several months from expenditure for the project financed by the 2012 bonds and the 2013 bonds, the fact that the proceeds of the 2012 paper prior to expenditure served as security for the payment of debt service on the 2012 bonds, and the refunding of the 2012 bonds by the 2013 Bonds.

"The company has reviewed its files, expenditures and procedures and has consulted with counsel," the notice says. "It believes that the IRS examination should close with no change to the tax exempt status of the 2012 Bonds and the 2013 Bonds; but there can be no assurance that the IRS will agree."

The company said when the 2012 bonds were issued, it had already expended substantial amounts of money on the project and entered into binding contracts for most of the construction. It expected prompt and timely expenditure of the proceeds of the 2012 bonds, and the 2012 bonds were structured to be able to serve as the long-term financing for a majority of the costs of the project.

All proceeds of the issues were allocated to the cost of the project within less than two years after the issuance of the 2012 bonds to achieve the congressional stated purposes of 2012 bonds and the 2013 bonds were authorized to be issued and to satisfy the requirements of the code and existing IRS guidance, the notice says.

"As a condition to the exchange, bond counsel will deliver an opinion that interest on the 2016 Bonds is tax-exempt," the exchange notice says. "IFCo has agreed to protect bondholders in the event of an adverse tax determination ‒ bondholders can put their bonds at 108% of par to IFCo if IRS determines that the bonds are taxable ‒ IFCo will pay a 50% step up in interest rate six months after the IRS issues a notice of proposed adverse determination letter."

The deal was one of the largest ever junk-rated private activity bond issues, eclipsed a short time later by an Indiana-based fertilizer project that issued $1.26 billion under the same Midwest disaster bond program, which authorized $14.6 billion of private-activity borrowing for qualified projects in designated counties hit hard by storms in the spring of 2008.

The Indiana project also rolled over notes as it worked on a final financing structure.

The bonds were structured with terms due in 2019, 2022, and 2025 with yields between 4.8% and 5.3%.

Citi and Bank of America Merrill Lynch were underwriters and Dorsey & Whitney LLP was bond counsel.

The disclosure postings were just being digested by the market Monday so it the impact on secondary prices was not immediately clear.

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