CHICAGO – Struggling under the weight of rising costs and construction delays, the Iowa Fertilizer Co. LLC's nearly $1.2 billion of tax-exempt debt has fallen further into junk territory.

Fitch Ratings in a report published Monday lowered the rating on the Midwestern Disaster Area revenue bonds to B-plus from BB-minus. The negative outlook on the credit was maintained.

The fertilizer project will likely exhaust available contingency funding due to rising costs and delays in the project's completion. Once operational, the project's struggles may not end.

"The negative outlook reflects the potential for delays and cost increases that may exceed current projections," Fitch said. "Once operational, the project is exposed to potentially volatile operating margins with rating case coverage near breakeven levels in the early years."

The bonds were sold in 2013 by the Iowa Finance Authority to finance construction of a nitrogen fertilizer plant in southeast Iowa being developed by Cairo, Egypt-based Orascom Construction Industries.

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.

Though the engineering, procurement, and construction – EPC ¬– agreement set a fixed-price for the project, more than 30 change orders have led to $200 million in additional costs. The project issued an additional $100 million of combined senior debt and sponsor equity in June 2015 to some expenses.

Shortfalls are expected to be funded by a $150 million letter of credit-backed subordinated loan facility from the project's sponsor OCI N.V. The company now expects some operations to begin in September or October, one year late. The delay in operations will require a draw on the cash-funded debt service reserve this year.

Under the terms of the EPC agreement, Orascom E&C USA owes delay damages for failure to meet the original operational dates. The damages are capped at 10% of the EPC contract and Fitch expects damages will amount to about $130 million.

The fertilizer company's first payments on its senior bonds are due June 1 and Dec. 1. The combined senior principal and interest obligations, additional loan obligations, and required hedge premium payments amount to an estimated $168.3 million, according to Fitch.

"Construction progress, the status of OEC's claims, and market fertilizer prices over the next few months will further inform the likelihood that IFCo can meet its obligations relying only on projected sources of funds available to the project company," Fitch said.

Once operational, it's anticipated that relatively high equity distribution triggers will support debt repayment and replenishment of reserves during potential periods of low operating cash flow, Fitch said. Operating and major maintenance reserves will help shield the project during the operational phase.

The company faces a volatile market when it begins selling its nitrogen products to farmers, distributers, wholesalers, cooperatives, and blenders at market prices.

"The project's main products have historically exhibited considerable price volatility as evidenced by the average five- and 10-year one standard deviation ranges of 25% to 30% and 35%, respectively," Fitch said.

Natural gas price fluctuations also pose risk as the project will get its natural gas feedstock via an existing pipeline at prices linked to Henry Hub, a pipeline that serves as the pricing point for natural gas futures.

To offset pricing risks, the Iowa company has entered into natural gas call swaptions for the first seven years of the project. In addition, the project will fund a feedstock reserve and can enter into further call swaptions to help mitigate price risk during the non-hedging period.

Fitch is forecasting average debt service coverage ratios of 1.15 times over a 10-year term, with coverage being particularly vulnerable in the first four years of operations, during which time the project will repay the additional debt.

The deal was one of the largest ever junk-rated private activity bond issues. The project tapped the federal disaster bond program. The deal was eclipsed a short time later by an Indiana-based fertilizer project that issued $1.26 billion under the disaster bond program established a series of spring storms caused severe damage in a multiple states. The Indiana project has been rolling over notes as it works on a final financing structure.

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