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A premiere in many respects: the first BOT project in the Israeli water sector, the largest
seawater reverse osmosis desalination plant in the world, the first project to beat the
ambitious target price of 0.50 US$/m3 for desalinated seawater, the first limited recourse
financing package arranged for a water project in Israel. The main innovation of the Project
lies, however, in the structuring of a mixed bank/institutional local financing. A remarkable
achievement that paves the way for upcoming transactions. By Pierre Coindreau and
Christian Rasoamanana, PricewaterhouseCoopers.

The Ashkelon Build, Operate and Transfer Project ("the Project") involves the financing,
design, construction, operation, maintenance and transfer of two sea-water desalination plants
with a total production capacity of 100 million m3 per year. The Project will use the Reverse
Osmosis technology. The plant is due to start partial operations in February 2005 with full
operations scheduled for October 2005. The Project was awarded to VID Desalination
Company Ltd ("VID"), a special purpose company sponsored by Véolia Water (formerly
Vivendi Water) and its two Israeli partners, IDE Technologies Ltd and Elran (D.D)
Infrastructures Ltd. (Elran Group – a Dankner Co-operation).

The total Project Costs is approximately NIS 1 billion (USD 250 million). The whole project
debt was raised locally and is NIS-denominated. The Ashkelon deal has set a precedent on the
Israeli financial markets as the first Israeli deal to be financed by way of bank debt and
institutional private placement. The financing was arranged by Bank Leumi Le-Israel B.M.
who also provided the bank debt. The institutional bond issue which represents 60% of the
total financing was managed by Gmul Sahar Underwriters Ltd. and Leumi & Co.
Underwriters Ltd. The institutional financing process is particularly noteworthy since it
involved more than 60 institutional investors.

PwC acted as financial advisor to VID from bid preparation through to Financial Close. Goren
Capital Group, a Tel-Aviv based investment bank, coordinated the institutional financing.

The Ashkelon desalination project is the first of a series of coastal seawater desalination
projects launched or to be launched by the Israeli Government to reach financial close.

A project of strategic importance for Israel

Since 1998, Israel has been experiencing a water crisis, the most severe one since the State of
Israel exists. The crisis is first a supply crisis. The combination of climatic factors (low
precipitation level, prolonged droughts) and the lack of management of water reserves led to
the drying up of the existing resources (mainly Sea of Galilee-Lake Kinneret and coastal and
mountain aquifers) which reached their lowest level on record. There is a rising concern that
the over-exploitation of these resources and their pollution due to insufficient treatment of
waste might lead to an environmentally hazardous situation and more particularly to an
increase in the salinity rate.

On the demand side, the rising trend in the water consumption – the household sector
consumption almost doubled in 15 years – is expected to continue as a result of the increase in
both population (expected population of 7.5 million in 2010 compared to 6.4 million in 2000)
and standard of living. In addition, water supplies that Israel undertook to supply to Jordan in
the peace agreement with the latter, are to increase gradually in the future. The Water


Commission's master plan foresees in 2010 a total demand for water amounting to 2,288
million m3 per year (compared to 1,930 million m3 in 2000), the Ministry of National
Infrastructures expecting 2,400 million m3 by 2020.

In order to bridge the widening gap between a growing demand and lacking water resources
without continuing excessive pumping, several measures are considered/implemented:
(i) implementation of a water preservation program (mainly reduction of water usage in
agriculture), (ii) increased use of recycled sewage water, floodwater and saltwater for
irrigation, (iii) water imports by ship or pipeline, but subject to political considerations, (iii)
desalination of brackish water in coastal aquifers and their subsequent replenishment, (iv)
regulation policy of the water consumption by way of price increases so that tariffs reflect the
actual production costs, (v) accelerated implementation of the desalination plant construction
program (one 50 Mm3 capacity plant needed every 2 years according to the Water
Commission). The Government decided in April 2002 to double the initial 200 million
m3/year desalination plant construction program that is expected to be full operational in

The Ashkelon desalination facility is in this context a major step towards a solution to the
water crisis in Israel. Located in the South of Israel, the Project is aimed at supplying large
southern Israeli cities.

Development history

Diagram 1: project milestones

 Jul 00             May 01            Sept 01                       Jan 02                                   Jan 03             May 03
               Bid submission       Preferred                Award of capacity
                                                                                                     Financial Close           First Drawdown
                                 bidder selection               extension
                                                                             Negociations with govt
                                           Contract negotiation              Technical modifications
  PQ and bid             Re-bid and
                                           Financing Plan finalisation       New financing plan                       Fulfilment of
  process                BAFO stage
                                           Lender selection                  Rating process                           CPs
                                           Project due diligence             Syndication to institutionals
                                                                             Project due diligence
                                             Excecution of BOT            Execution of additional
                                           Agreement n°1 (Nov 01)        BOT agreements (Apr 02)

In July 2000, the Ministry of National Infrastructures and the Ministry of Finance, acting
through the Tender Committee, launched the tender for the financing, design, construction,
operation and transfer of a seawater desalination facility with guaranteed production capacity
of 4,170,000 m3/month and 50 million m3/year. The Project is governed by a Build, Operate
and Transfer Agreement ("BOT Agreement") to be entered into with a government agency,
the Water and Desalination Authority (“WDA”) whose obligations (including payment
obligations) under the Agreement are deemed to be obligations of the State of Israel. The
BOT Agreement is awarded for a period of 24 years and 11 months. The production of the
facility will be sold to the WDA on a "take or pay" basis.

The proposed price of desalinated water was the key selection criteria (70% of the score vs
15% for the technical offer, 10% for the financial proposal and 5% for general impression).
The price comprised fixed and variable elements. The energy costs made up a large
component of the variable costs. In this respect, the bidders were offered two alternatives: buy
electricity from IEC, the national power utility or build their own IPP. The choice of the


technology also heavily influenced the cost of water. The bidders had the option to formulate
their bid on distillation technology, reverse osmosis or hybrid design process. It is interesting
to note that all bidders have elected the RO technology.

The bid submission took place on 1 May 2001, with a 2-month delay compared to the initial
schedule. Following review of the Technical and Financial Proposals contained in the Bids
and the clarification process, the Tender Committee declared all Bids non compliant and
decided to permit all Bidders to amend their bids (including to revise their price proposals) for
15 August 2001. This possibility to submit downward revisions to price proposals at this stage
of the tender process was viewed as a first round of price negotiations as the tender
documents provided for such a revision only later on during the Best and Final Offer. On 3
September 2001, the Tender Committee declared all bidders qualified for the BAFO stage
during which they were allowed to change only their price proposal. Shortly after the BAFO
submission, VID Desalination Company Ltd. ("VID"), the special purpose company
established by Vivendi Water, IDE Technologies Ltd and Dankner Ellern Infrastructures Ltd
was designated Successful Bidder, over the American Ionics and the Spanish Cadagua. With a
price of 52.7 UScents/m3, VID has set a precedent on the desalination market (the previous
lowest price submitted for desalinated water was 65 UScents/m3). The signing of the BOT
Agreement took place in November 2001. Financial close was expected to take place within a
maximum of 6 months from the award of the 50 million m3 p.a. project, i.e. by end of
February 2002.

The BOT Agreement stipulated that the Consortium could be requested to double the plant
production capacity from 50 to 100 Mm3 a year at the request of WDA. The decision of the
State to exercise this option so rapidly - negotiation on the additional 50 Mm3 started in the
course of December 2001, i.e. one month only after the execution of the first BOT
Agreement, and the capacity extension was awarded on 28 January 2002 – came as a surprise
even if the doubling of the capacity was likely given the severe water shortage prevailing in
Israel. The very attractive water price offered by VID was certainly a key factor in the go-
ahead decision while casting doubts on the economical viability of other solutions to the water
crisis considered by the State such as the import of water from Turkey. The capacity
extension enabled VID to lower the desalinated water price below the 0.50 US$/m3 mark, a
first in the desalination history. The additional agreements were executed in April 2002.

If the doubling of the capacity has made the Ashkelon project the largest seawater reverse
osmosis desalination plant in the world, it also strongly impacted on the financing of the
project. The nearly doubling of the financing resulted in a capacity issue as Bank Leumi was
no more prepared to underwrite the full amount of the facility and requested to syndicate as
much as 50% of the total financing. Two alternatives were then available to VID: syndicating
the facility to banks and/or to Pension Funds. The situation of the banking market in Israel at
that time (and still today) - most Israeli Banks were constrained in their lending capacity due
to problems with capital adequacy ratios - combined with the reluctance of foreign banks to
participate in long term financing because of the security situation, made extremely difficult a
traditional syndication to banks. The only eligible bank was Bank Hapoalim, one of the two
Israeli largest banks with Bank Leumi, but its "Related Party"1 status with one of the member
of the Consortium prevented it from participating in the VID's financing. The only possible

 The "Related Party" regulation restricts the extent of indebtedness of related parties to a banking corporation. A
"Related Party" is any party who controls or applied for a permit from the Bank of Israel to acquire control in the
bank, the controlling parties (more than 10% of the means of control) to this party or a party the banks controls
or in which it holds more than 10% of the means of control.


alternative was therefore the "Pension Funds" route. The participation of the institutional
investors necessitated a rating of AA- minimum from Maalot, the local rating agency. The
discussions with Maalot started from end of April 2002. The rating process took some 3
months and in August 2002, Maalot announced its decision to grant a AA- rating for the
project debt subject to the meeting of some requirements including the arranging of additional
- but limited - guarantees and commitments (in particular, Maalot did not require completion

In parallel to the discussions with Maalot, a road show was organised to present the project to
most key large and mid-size institutions in Israel, including insurance companies, pension
funds and provident funds. In order to help to raise institutional financing, VID appointed a
Tel Aviv investment boutique, Goren Capital Group with a good experience in dealing in the
Israeli institutions market. A tender for the institutions was launched at the end of October
2002. The institutions were offered two disbursement alternatives: drawdown or one-time. In
the drawdown option, the money raised ("the Drawdown Institutional Tranche") is disbursed
after Financial Close along with the bank debt. The money raised under the one-time option
("the Upfront Institutional Tranche") is fully disbursed at the time of the institutional tender,
deposited in an interest bearing trustee account and released upon Financial Close. The
interest rates for both the Drawdown and Upfront tranches were fixed at the tender date. The
strategy to favour as much as possible the drawdown option was a success as the Drawdown
Tranche made up more than 92% of the total institutional financing. It was important to
complete the tender rapidly as some other important transactions were expected in the market.
However, raising funds before certainty of Financial Close - successful syndication of the
financing was a condition precedent to financial close but not the only one - created several
risks. One of the risks was the legal risk of material changes to key documents by either Bank
Leumi or WDA who had to approve the final financing documents before financial close.
Indeed, the institutions gave their commitment based on draft documents and a fundamental
worsening in the loan documentation between the institutional tender date and financial close
could have caused some institutions to pull out of the deal. The greater risks lied, however, in
delaying the Financial Close beyond 90 days from the date of the institutional tender as after
this date, the institutions were released from their commitment. The Facility Agreement was
eventually signed on 23 January 2003.

In light of this complex credit story, the fact that the project took almost two and half years to
complete is hardly surprising.


Contractual structure

The diagram 2 shows a typical BOT project structure with VID passing risks, through the
contractual structure, down to the subcontracting parties.

Diagram 2: contractual structure


   O&M Company
    IDE, Vivendi, Dankner                 1st BOT                      2nd BOT               Insurance Companies
                                          Agreement                    Agreement
                                                        Agreement                   Insurance policies
                        O&M Contract

                                              VID DESALINATION
 EPC Company                   EPC                                                  IPP                      IPP
    IDE / Vivendi                               COMPANY (VID)                     contract     Mishor Rotem/ Delek Energy Limited
                               contract       IDE 50%, Dankner 25%, Vivendi 25%

                    Equity and
                    Subordinated Debt                           Financing                                   Loan
                    Agreements                                  Agreements                                  Agreement

                                                  Senior Lenders to                          Senior Lenders to
        Sponsors                                        VID                                         IPP

From a legal point of view, the extension has been dealt with by a new contract executed
between VID and WDA ("the Second BOT Agreement"), while the initial agreement ("First
Agreement ") remained valid. A “Supplement Agreement” made the bridge between the two
Agreements. This Supplement Agreement provided, inter alia, for the unification of the
project schedule (e.g. one Financial Close for the extended Project), the water quantities
requested, the water price, the procedures for force majeure, termination and buyout.

One major change in the contractual structure of the extended project compared to the initial
50 million m3/year project was the power supply structure. The power island moved from a
smaller open cycle gas turbine (entirely dedicated to the desalination plant) to a larger
combined cycle unit with excess power to be sold to third parties allowing a lower energy
price to the plant.

The financial part of the contractual structure is relatively straightforward as there is only one
financing agreement executed with Bank Leumi and the pension funds - the expectation was
that VID would not avoid signing two separate financing agreements with one inter-creditor
agreement between Bank Leumi and the pension funds -. This reflects the fact that eventually,
the addition of the pension funds to the financial scheme brought less complexity than
expected, the institutional tranches being in many respects similar to the bank tranche.


Raising finance: the challenges

Syndication issue: the successful syndication of at least 50% of the total financing became the
biggest challenge for VID and its advisers.

The syndication issue has been exacerbated by:
                                                                                   The financing
   the difficult situation of the local banking                      Total Financing: NIS 800 million
    market that faced increased liquidity
    constraint: most Israeli banks were closed to                     Bank Leumi Tranche (including Standby
    the minimum capital adequacy ratio required                        Facility): NIS 320 million – Interest rate
    by the Supervisor of Banks and hence were                          fixed at each drawdown, option for one-
                                                                       time fixing at closing finally retained
    limited in the amount of funding they could
    make available;                                                   Institutional Tranche (bond issue): NIS
                                                                       480 million split into:
   the economic and political environment: the                        - "Drawdown" Tranche: disbursed in
    global economic slowdown and particularly                               parallel with the Bank Tranche –
                                                                            Interest rate fixed upfront
    the crisis in the high tech industry combined                      - "Upfront" Tranche: fully disbursed at
    with the security situation harmed the Israeli                          the time of the Institutional Tender
    economy, which contributed to the low
    performance of banks and further restricted                       Maalot rating: AA-
    their potential for providing new credit;
                                                                      Interest rate: CPI-indexed fixed interest
   the reluctance of international lenders
    (including those already operating in Israel)                     Drawdown period: 3 years
    to participate in the financing of long-term
    projects in the political context prevailing in                   Maturity: 23 years (compared to the BOT
    Israel. In addition, participation of foreign                      agreement's term of 25 years)
    lenders      would      have      considerably                    Repayment: sculpted repayment profile
    complicated the financing and was never                            with an average life of approx. 14.5 years
    considered as a realistic option;

   the limited number of banks: only two major banks (Bank Hapoalim and Bank Leumi) can
    play a significant role but they often tend to avoid to work jointly;

   the banking regulatory constraints which further limit access to bank financing: two
    regulations raised problems: (i) the "Group of Borrowers"2 regulation that sets the credit
    exposure limits of a bank towards a borrower and a group of borrowers and (ii) the
    "Related Party" regulation that restricts the ability of a party related to a bank to raise debt
    from this bank (see above). In the case of VID, the Israeli members of the Consortium
    were affected by both rules.

Competitiveness of the financing terms: in addition to the issue of availability of sufficient
lending volume, which actually limited the range of alternatives offered to VID for

  The group of borrowers includes the borrower itself, its controlling parties or the parties controlled by him, its
debt guarantors and its commercial-related parties, provided the indebtedness of each party exceeds 5% of the
bank's capital and there is material commercial interdependence between them, not limited to the short-term


syndicating the financing, it was important that the potential finance providers match, to the
extent possible, Bank Leumi's financing terms that have been used de facto by VID in its offer
to the State of Israel, mainly regarding:

   debt maturity: 23 years at minimum. Clearly, foreign banks were unable to match such a

   availability and grace period

   flexibility for the drawdown: miminum amount for each drawdown, maximum number of

   currency: the strategy was to favour NIS-denominated funding in order to limit foreign
    exchange exposure as the fixed price is linked only to the local CPI.

   repayment profile: the acceptance of tailored-made repayment was a key criteria for the

   average life

   interest rate: Bank Leumi offered the flexibility of fixing the interest rate at each
    drawdown or upfront.

   security package: one of the biggest challenge has been to convince the lenders and
    particularly the pension funds and Maalot, the local rating agency, to accept the
    construction risks without any completion guarantee, which could not be taken for granted
    given that the plant is the largest of its kind in the world and that there are few precedents
    of limited recourse financing of desalination projects in the world.

Key factors of success

   a strong project rationale: the project is of the highest national importance, particularly in
    light of the continuing and deteriorating crisis in Israel’s water market

   the ultimate government nature of the risk: the project is based on a take-or-pay type
    agreement with the State of Israel as counterparty

   the quality of the sponsors, with a right mix of local and international experience

   a well structured project with well structured contracts and appropriate allocation of risks

   the historical credit appetite of the local debt market for infrastructure projects in Israel
    offering very long term NIS denominated CPI linked loans (up to 28 years)

   the large volume of institutionals credit: Israel benefits from a remarkably high level of
    institutional financing reinforced by recent amendments to regulations permitting an
    increased participation of insurance companies in AA rated project bonds


   and last but not least, the high level of determination of all parties involved “to make it
    happen”: although the project took a very long time to achieve financial close, its closing
    demonstrates that the arranging of a limited recourse finance package, even in a difficult
    environment and in a market with few precedents, is possible if there is sufficient will
    from the different parties (sponsors, lenders and government).


The closing of Ashkelon is of wider significance and represents a major step forward in Israeli
infrastructure projects. It is expected that the deal will be a catalyst for upcoming transactions.
The success of the financing and notably the syndication to institutions is a positive signal for
the future of the Israeli project finance market. With several large infrastructure projects to
come (Jerusalem LRT, Tel Aviv LRT, the next 100 million m3 p.a. desalination plant, etc.),
the participation of banks and institutions in project financing is expected to continue.


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