Excerpt from FS Series #1: enabling sub-sovereign bond issuances
Case 3: Alternative Financing for Water Utilities — Lessons from a Failed Bond Issue in Indonesia
Background and Environment
PUBLIC INVESTMENT IN THE WATER SECTOR HAS BEEN VIRTUALLY ABSENT IN INDONESIA. ACHIEVING INDONESIA’S MILLENNIUM DEVELOPMENT GOAL, TO HALVE THE PROPORTION OF PEOPLE WITHOUT SUSTAINABLE ACCESS TO SAFE DRINKING WATER AND BASIC SANITATION BY 2015, WOULD REQUIRE A TENFOLD ANNUAL INCREASE IN INVESTMENTS IN THE SECTOR FROM THE CURRENT LEVELS OF APPROXIMATELY USD $50 MILLION TO $450 MILLION. THROUGH ITS ENVIRONMENTAL SERVICES PROGRAM (ESP), USAID EXPLORED A NUMBER OF ALTERNATIVE FINANCING STRATEGIES TO ENCOURAGE NEW INVESTMENT IN WATER AND SANITATION INFRASTRUCTURE. THE STRATEGIES INCLUDED THE POSSIBILITY OF SUPPORTING DISTRICT WATER UTILITIES (OR PDAMS IN INDONESIAN) TO ACCESS THE CAPITAL MARKET TO HELP BRIDGE THE FINANCING GAP.
Ultimately, ESP concluded that the most promising approach in the immediate term was the issuance of corporate bonds by PDAMs in the domestic capital market, and establishing a complementary new nationwide pool financing facility to be denominated the Indonesia Water Fund (IWF). Unlike the management of other municipal infrastructure services, district water utilities in Indonesia operate as separate legal entities, and their municipal governments are generally reluctant to borrow on their behalf. A straight corporate issue by a PDAM would demonstrate the viability of accessing the capital markets to meet the huge infrastructure financing needs of the sector.
To structure a corporate bond issue to finance a water treatment facility, ESP selected and worked intensively with PDAM Bogor, a strong regional water utility that supplies drinking water to the municipality of Bogor (Kabupaten Bogor). Complementing this initiative, the creation of the IWF would also allow several water service providers access to long-term financing at attractive terms. The IWF would secure credit enhancements and mobilize a revolving loan fund to consolidate loans into a size more readily marketable and adaptable to the credit and capital markets. Because of the proposed credit enhancement and pool financing characteristics of the IWF, it was envisioned as a critical tool to allow a larger number of regions to obtain long-term funding for their projects.
Despite ESP’s significant efforts to facilitate corporate bond issues for highly bankable projects and the establishment of the IWF, these did not materialize. The experience, however, provides some valuable lessons for future efforts.
Objective of Transaction
BY HELPING ESTABLISH THE IWF AND FACILITATING THE ISSUANCE OF A CORPORATE BOND, ESP EXPECTED TO INTRODUCE A NEW FINANCING MECHANISM AND ALTERNATIVE FUNDING SOURCES TO INDONESIAN WATER UTILITIES. FURTHERMORE, THE SUCCESSFUL OUTCOME OF THE FIRST PDAM BOND ISSUE WAS VIEWED BY THE MINISTRY OF FINANCE (MOF) AS A PRECURSOR TOWARD RESOLVING THE PROBLEM OF LONG-TERM FINANCING FOR THE MORE ROBUST PDAMS. ESP WORKED WITH PDAM BOGOR TO STRUCTURE THE CORPORATE BOND ISSUE INTENDED TO FINANCE THE WATER TREATMENT FACILITY.
Preconditions and Prerequisites
ESP CONDUCTED BROADER ANALYSES OF THE MOST VIABLE LONG-TERM FINANCING METHODS AND CONCLUDED THAT, IN GENERAL, THE LEGAL AND REGULATORY ELEMENTS FOR PDAMS TO ISSUE STRAIGHT CORPORATE BONDS WERE IN PLACE AND DID NOT REQUIRE ANY REGULATORY MODIFICATIONS. ON THE OTHER HAND, POOLED FINANCING SCHEMES SUCH AS THE IWF AND/OR REVOLVING FUNDS WOULD REQUIRE THE CHANGING OF TAX REGULATIONS.
Model and Financial Structure
THE TRANSACTION WAS DESIGNED AS A PARTIALLY SECURITIZED, DOMESTICALLY MOBILIZED CORPORATE BOND. THE PROCEEDS OF THE BOND WOULD FINANCE THE CONSTRUCTION OF TWO WATER TREATMENT PLANTS IN EAST AND CENTRAL BOGOR, WITH COMBINED CAPACITY OF 300 LITERS PER SECOND; AND THE EXPANSION OF THE WATER DISTRIBUTION NETWORK TO INCLUDE 9,000...
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