CHICAGO – For buyers, the allure of attractive yields, diversification, and liquidity drowned out the project risks tied to investing in the Iowa Fertilizer Co.’s $1.2 billion of junk-bond paper.
The for-profit Iowa Fertilizer Co. – owned by Egypt-based Orascom Construction Industries - on Tuesday sold its long planned issue that tapped a big chunk of Iowa’s $2.6 billion allocation of Midwestern Disaster Area Bonds to qualify for tax-exemption .
Citi ran the books with Bank of America Merrill Lynch serving as co-manager. The Iowa Finance Authority issued the bonds and Dorsey & Whitney LLP served as bond counsel.
The company said in a statement the deal received more than $3.5 billion in orders from more than 75 major institutional investors, allowing for a 10 basis point cut in interest rates for a final average rate of 5.12%.
The sale then found an eager audience ready to scoop bonds up in the secondary market where they traded better by as much as 40 basis points. More risk-averse retail buyers also bought bonds.
“The bond execution represents a major milestone for Iowa Fertilizer and we look forward to working closely with all parties involved on the project to commence production in late 2015,” the company’s chief executive officer, Nassef Sawiris, said in a statement.
The deal – rated BB-minus by Fitch Ratings and Standard & Poor’s -- was one of the largest private activity and sub-investment-grade municipal bond issues ever. The company will use proceeds to finance construction of a nitrogen fertilizer manufacturing plant in Lee County, Iowa. The bonds mature in 2019, 2022, and 2025 with respective yields of 4.8%, 5.1%, and 5.3%.
The project has some strong fundamentals from the company’s international experience and low natural gas prices needed for production to strong Midwestern demand for a product that is now primarily imported. The project’s capital structure benefits from an upfront equity investment of $581 million and a prefunded debt service reserve. Interest is being capitalized.
But the project has a lengthy list of risks that are clearly spelled out for bondholders in the offering statement and ratings reports from commodity cost volatility and a potential future glut of nitrogen fertilizer to the hazards of nitrogen products and Egyptian political unrest.
Investors appeared to cast many of those concerns aside with the need for yield, investment diversification, liquidity, and the availability of cash from redemptions fueling the strong interest, market participants said.
The size of the deal lends itself to liquidity and for those that hold on to the bonds, if the project performs as planned there is likely to be a rating bump and improved value.
The novelty of the investment for high-yield, tax-exempt investors also lured buyers. “It’s less about project fundaments and more about maintaining investment in the sector with a lot of dollars out there to be put to work in the high-yield sector,” said Matt Fabian, managing director at Municipal Market Advisors.
The investment risks are diluted as part of a diversified book and muted somewhat by statistics with rated bonds making up just 27 of the 427 bonds now in payment default, he added. “The fact that it is rated at all has good implications for its long-term performance,” Fabian said. “It’s a reasonable source for them [high-yield buyers] to allocate their money.”
The attractive yields were not sufficient to overcome project concerns for some, especially given the recent explosion of a fertilizer plant in Texas. “This bond may be a mistake in the future but some people who bought in might be saying that because it’s so big and liquid they can trade out of it before any problems come up,” said one investor who asked not to be named.
Ahead of the pricing, the finance team released two supplements to the offering statement – one a few days before the pricing aimed at quelling investor questions over safety issues following the Texas explosion. The other came just ahead of the pricing giving bondholders more rights and expanding disclosure requirements. Market participants said the changes were likely driven by several lead buyers.
The Texas plant explosion killed 14 and injured 200. The supplement noted preliminary reports that attributed the Texas explosion to sodium ammonium nitrate. The Iowa plant won’t produce or sell solid AN but a liquid urea ammonium nitrate which the company described as safer.
The offering statement notes the investment risks, with repayment coming primarily from the sale of products and the company’s limited assets in the event of a default or bankruptcy. 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.
Reports from Fitch and S&P also spelled out the risks. S&P said the construction phase dominates credit risk due to the large scale and potentially hazardous nature of nitrogen facilities.
The Iowa facility is the first fertilizer plant of its scale to be built in the U.S. in more than 20 years; it’s among several such projects or expansions at some stage of planning, including one in Indiana that will also tap the MDAB program. Interest has been driven in part by lower costs of natural gas, which is needed in the production process, but future pricing volatility poses a risk.
The project will procure its natural gas feedstock through an existing pipeline and has entered into natural gas call swaptions for the first seven years. The project will have up to 2.2 million short tons of flexible capacity to produce ammonia, urea, urea-ammonium nitrate, and diesel exhaust fluid. Other long term risks include fluctuations in product demand from the agricultural sector and legislative or other industry changes that drive down fertilizer prices.
The second supplement to the offering statement outlined a series additional bondholder rights and protections such as the requirement that an engineer review the company’s maintenance plan should debt service coverage fall below a certain threshold, that any future natural gas hedger must carry at least a BBB rating, and that the company must pass certain financial tests before taking on future senior-lien debt obligations.
The company agreed to an expanded list of disclosure requirements, covering operations, natural gas hedges, and financial information. A majority of bondholders can reject a replacement engineer and it outlines events that would trigger a financing default.
The company used a short-term redemption structure to get into the market ahead of the Dec. 31 expiration of the MDAB program. In addition to the bond allocation, the Iowa project received other local and state tax incentives in exchange for the promise of 165 permanent jobs, several thousand construction jobs, and an estimated $740 million in annual savings expected for farmers because of reduced import costs.
