NEW YORK--(BUSINESS WIRE)--Fitch Ratings has assigned a 'B-' rating to new 2016 Midwestern Disaster Area Revenue Bonds (the 2016 bonds) and placed the rating on Watch Negative. Fitch has maintained the Rating Watch Negative on the outstanding 2013 revenue bonds (together, the revenue bonds). The Iowa Finance Authority has issued a total of $1.185 billion ($1.156 billion outstanding) of revenue bonds on behalf of Iowa Fertilizer Company LLC (IFCo).
The ratings reflect that a limited margin of safety remains for repayment of the bonds, subsequent to the recent bond exchange. Along with the new issuance and exchange, bondholders agreed to a series of waivers and agreement amendments to resolve outstanding obstructions to project completion. While the maturity extension relieves near-term payment default risk on the uncompleted IFCo project, the facility could face ramp-up issues and is vulnerable to a volatile and potentially weak product pricing environment.
The Negative Watch reflects the potential for further negative rating action as a result of any of the following factors: further material completion delays, early operational performance below expectations, or weakening in near-term product prices.
KEY RATING DRIVERS
Construction Significantly Delayed and Over Budget: The engineering, procurement, and construction (EPC) agreement is a fixed-price contract, fully-wrapped by an experienced contractor, but ongoing change orders led to a substantial increase in EPC project costs. The project fully exhausted its contingency and issued an additional $100 million of combined senior debt and sponsor equity in June 2015, and additional funding will be required to complete the facility. Bondholder consent to a settlement agreement with the EPC contractor resolves all outstanding contractor claims and establishes a new schedule of delay damages. Along with the consent, sponsor OCI N.V. (OCI) has cash-funded remaining expected construction and start-up costs.
Limited Liquidity: IFCo has not yet begun generating operational cash flow. As such, IFCo funded the mandatory June 2016 payment with cash from the debt service reserve. Through the bond exchange and consents, IFCo has alleviated near-term financial pressure on forthcoming debt payments, ensuring a payment default can be avoided through the Dec. 1, 2017 payment. When the project achieves operation, relatively high equity distribution triggers will support debt repayment and replenishment of reserves during potential periods of low operating cash flow. Operating and major maintenance reserves will help shield the project during the operational phase.
Nitrogen Market Price Exposure: IFCo will sell its nitrogen products to farmers, distributors, wholesalers, cooperatives, and blenders at market prices. The project's main products have historically exhibited considerable price volatility. Pricing has fallen close to 10-year lows in the past quarter though there has been some recovery very recently.
Natural Gas Price Risk: The project will procure its natural gas feedstock via an existing pipeline at prices linked to Henry Hub. IFCo has entered into natural gas call swaptions for the first seven years of the project to moderate the risk of a reversal in gas pricing trends. In addition, the project will fund a feedstock reserve and can enter into further call swaptions to help mitigate price risk during the non-hedged period.
Unproven Operating Profile: Non-feedstock O&M and maintenance cost projections have increased significantly from original projections, and the project may require several years of operations to establish a stable cost profile. The use of commercially proven technologies and a plant design with oversized capacity could help mitigate operating performance risk.
Vulnerable Financial Profile: The bond exchange relieves very near-term financial concerns while extending the ultimate revenue bonds' maturity to 2027. Over the full debt term, Fitch's analysis suggests that IFCo's ability to meet ongoing mandatory debt payments is vulnerable to deterioration of operating margins. Given the ongoing uncertainty surrounding nitrogen product prices, Fitch's financial scenarios do not assume any improvement in operating margins over the debt term. If the plant begins commercial operations by February 2017 (a two-month delay from current sponsor expectations) and operates at a production capacity and non-feedstock cost profile in line with sponsor expectations, as is the assumption in Fitch's base case, debt service coverage at current product prices would average 1.45x through debt maturity.
Peer Analysis: IFCo's peer group includes merchant project financings in which product sales are susceptible to the inherent volatility of commodity markets. Merchant projects that have achieved ratings in the 'BB' category have demonstrated some combination of long-term feedstock price certainty, materially low leverage, structural enhancements, or a proven, quasi-monopolistic competitive advantage. Merchant projects in the 'B' rating category or lower typically face significant technology implementation or construction risks, are exposed to price and volume risk, and operate in a business environment with highly volatile margins.
Negative: Negative rating action could be warranted due to any of the following factors: further material construction delays, early operational performance below expectations, or weakening in near-term product prices.
Negative: A fundamental shift in the supply-demand balance or global producer cost curve that results in materially lower operating margins expected to persist over a long period.
Negative: Inability to effectively manage operating costs or failure to reach and sustain projected capacity and utilization rates.
Positive: Resolution of the Rating Watch and further positive rating action is contingent on completion of the project and commencement of operations at expected performance levels.
Construction of the plant continues to trail behind schedule and there remains the potential for further delays. In its third-quarter 2016 (3Q16) Construction Monitoring Report, independent engineer (IE) Nexant reported that ammonia mechanical completion, which as recently as mid-2016 was anticipated in September, had been pushed back to a target of November. This would indicate the start of ammonia production in December and downstream production in 1Q17. However, the IE expressed concern that the risk of further weather delays is increasing as winter approaches. The schedule is considered aggressive and requires all activities to proceed without any unforeseen problems.
Positively, the various consents and waivers approved by bondholders on Nov. 25 remove some outstanding obstructions to project completion. Bondholders have consented to a settlement agreement and amendment to EPC agreement to settle all outstanding claims with contractor OEC, reschedule delay damages, and waive any potential defaults that could arise from such agreements and amendments. OCI has committed to a combination of cash-funding and guarantees to fund remaining construction and start-up costs, support revenue shortfalls prior to provisional acceptance of the facility, and resolve mechanics' liens claims.
Once operational, IFCo's operating margins are dependent on favorable market pricing for nitrogen products. The pricing of nitrogen products is correlated to the price of feedstock, which may be oil, coal, or natural gas depending on the region and producer. In recent years, the substantial declines in oil and natural gas prices have driven nitrogen prices to levels approaching 10-year lows. These pricing trends have diverged significantly from market consultant forecasts that formed the basis for cash flow projections for the original financing. The market consultant provided an updated price deck in late October 2016 with a price curve indicating that the pricing will improve dramatically from the current environment, pending a significant rebound in energy prices, which Fitch views as optimistic.
IFCo's financial profile gained some relief from near-term pressure with the completion of a bond exchange. IFCo has issued additional pari-passu bonds (the 2016 bonds) to a portion of current bondholders and used the proceeds to purchase a portion of the 2019 Term Bond (a series that is part of the original 2013 financing). The exchange reduces the principal payments on the next three sinking fund payments (December 2016, June 2017, December 2017) to zero. The interest payments due on those three payments will be cash-funded or guaranteed by OCI. The 2016 bonds will be repaid with semi-annual sinking fund payments from June 2026 through December 2027. The bond exchange significantly reduces mandatory obligations through the December 2017 payment, providing IFCo with additional time to begin operations.
Fitch's base and rating cases both begin with the expectation that commercial operation will be further delayed to a start date of February 2017 for ammonia production and March for downstream production. These cases also utilize the same set of market pricing assumptions. In order to appreciate the risk of uncertain future nitrogen pricing, Fitch's cases assume that pricing remains flat at recent low levels for the entire debt term. Meanwhile, feedstock prices gradually rise over time (essentially at an inflationary rate), thereby holding operating margins flat (or declining). Under the base case, debt service coverage at current product prices would average 1.45x through debt maturity. Coverage is particularly strong (over 2x) in 2026 and 2027 when debt payments are less than half of the typical annual obligation. The majority of DSCRs range from 1.0x-1.3x from 2018-2025.
Fitch's rating case also layers on a downside scenario in which production capacity is 2.5% lower than expectation and non-feedstock O&M (including major maintenance) costs are 10% higher than expected. This scenario would put increased pressure on the financial profile and suggests that IFCo may face periods where debt service would fall below breakeven levels and be reliant on reserves to avoid payment default.
Additional information is available on www.fitchratings.com.
Rating Criteria for Infrastructure and Project Finance (pub. 08 Jul 2016)
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