Biggest Junk Sale in Limbo After Deaths in U.S. War: Muni Credit

The largest-ever U.S. municipal junk bond sale remains in limbo after Indiana learned that a Pakistani company backing a fertilizer plant financed by the biggest borrowing in state history is linked to explosives causing the most U.S. casualties in Afghanistan.

The Indiana Finance Authority in December sold about $1.3 billion of tax-free notes for the initial phase of a facility near the Illinois border for a unit of Lahore, Pakistan-based Fatima Group. The proceeds are in escrow until July 1, after which they will convert into bonds if the plan proceeds.

Indiana Governor Mike Pence halted the project upon taking office in January after a U.S. general said the company wasn’t cooperating with efforts to eliminate improvised explosive devices in Afghanistan. Fatima is the only producer in Pakistan of a chemical compound used in the weapons.

“Economic development is important, but the safety and security of our troops in harm’s way is more important,” Pence, a 53-year-old Republican, said in a Feb. 1 statement. “We’re in the process of making a careful evaluation of the appropriateness of Indiana’s involvement in this project with those priorities in mind.”

Indiana’s borrowing is an example of tax-exempt bonds sold for industrial development. While the securities have the best returns of all revenue debt in the $3.7 trillion municipal market, they also account for the most entities defaulting. Local agencies sell the securities for companies, hospitals and nonprofit organizations, whose credit backs the bonds.

Eclipsing Allegheny

Proceeds from the Indiana deal would be converted into bonds with a tentative maturity of 2046, offering documents say. Those securities would probably be rated below investment grade, which would make the deal the biggest high-yield muni sale on record, according to Mark Paris, a senior portfolio manager at Invesco Ltd. in New York. It would eclipse a $750 million deal in 2007 for West Penn Allegheny Health System, the largest tax-exempt junk deal since at least 1990, Bloomberg data show.

The December borrowing for the 300-person plant was the largest from Indiana, Bloomberg data show. It priced the same week as the Iowa Finance Authority issued $1.2 billion to help finance a nitrogen fertilizer plant for Cairo-based Orascom Construction Industries.

Gas Boon

The projects will take advantage of a 65 percent drop since June 2008 in the price of natural gas, a fertilizer component, as supply has increased because of hydraulic fracturing.

Iowa is the biggest corn-producing state and the largest consumer of nitrogen-based fertilizer, according to Orascom. Indiana is the fifth-largest corn producer, according to the U.S. Department of Agriculture.

The Defense Department’s Joint Improvised Explosive Device Defeat Organization is focusing on Fatima’s production of calcium ammonium nitrate. It is an ingredient in improvised explosives, which are the “leading cause” of civilian, military and law-enforcement casualties in Afghanistan and Pakistan, according to U.S. Lieutenant General Michael Barbero.

In 2012, the devices caused 1,874 U.S. casualties, with about 60 percent of the explosives used against military forces made from calcium ammonium nitrate, according to testimony Barbero made in December to the Senate Committee on Foreign Relations.

At least 18 of the 52 Indiana soldiers who have died in Afghanistan since 2003 were killed by improvised explosive devices, according to data from The soldiers ranged in age from 19 to 44.

Safer Product

In the last 18 months, Fatima developed a less-explosive ammonium-nitrate fertilizer, Syed Ali Nasir, the company’s manager of corporate communications, said in an e-mailed statement. The group has suspended sales of calcium ammonium nitrate in provinces adjacent to Afghanistan, Nasir said.

“The new product minimizes the ability to misuse ammonium nitrate,” Nasir said in the statement. “Once it is ready for commercial distribution, it will offer a solution to a worldwide and long-term problem.”

Fatima’s safer product and voluntary suspension of sales represents “a significant economic cost for Pakistan and is an illustration of how seriously we take this issue,” Nadeem Hotiana, a spokesman for Pakistan’s Embassy in Washington, said in an e-mail.

Barbero has seen “positive developments,” in talks with Fatima, he said in a Feb. 26 statement. The project is still on hold, according to Christy Denault, a spokeswoman for Pence.

High-Yield Supply

Shares of Fatima Fertilizer Co., the unit behind the project, have gained about 5 percent in the past year, including dividends, while the Karachi Stock Exchange 100 Index has earned about 43 percent, data compiled by Bloomberg show.

Halting the project would further crimp supply of high-yield muni debt.

Localities sold just $552 million of non-investment grade local bonds last year, the least since 2009, according to Moody’s Investors Service data compiled by Bank of America Merrill Lynch. Demand for lower-rated debt is its highest since September as the bonds outperform the broader market.

“A $1.3 billion deal is going to cause us to assign an analyst, send somebody out there and talk to people,” said Paris at Invesco, which oversees about $23 billion in local debt. “It’s a chance to get bonds.”

‘Great Opportunities’

He co-manages the $7.2 billion Invesco High Yield Municipal Fund, which the company closed to new investors in September because demand for the debt was outpacing investment opportunities.

“It would be unfortunate if this project gets postponed or taken off,” Paris said. “People get a little nervous, but if you do your homework on these projects and what they’re for, they’re really great opportunities.”

Investors have added $1.3 billion to high-yield muni mutual funds this year, according to Lipper US Fund Flows data. The funds added assets for seven consecutive weeks through Feb. 27, the longest stretch since September.

The project drew scrutiny from Representative Duncan Hunter, a California Republican who served in the Marines in Afghanistan and Iraq, and Senator Bob Casey, a Pennsylvania Democrat.

“Indiana did the right thing by putting the deal on hold,” Hunter said in an e-mailed statement. He spoke with Pence in January about the project. “The company’s track record and susceptibility to influence raised some real concerns.”

Ausaf Qureshi, head of investor relations for Fatima Fertilizer, declined in an e-mail to say whether the company would seek to build a plant elsewhere in the U.S. if the Indiana project were halted.

Barbero said in his most recent statement that he appreciates Fatima’s work on a new product to make calcium ammonium nitrate less explosive.

It would be a “true scientific breakthrough,” he said.

Market Update

In trading yesterday, yields on 30-year benchmark munis were little changed at about 3.07 percent, the highest since August, according to Bloomberg Valuation data.

Munis trailed gains in Treasuries as California began selling about $2.6 billion of general-obligation debt.

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