Record Junk Sale Funds Fertilizer After Texas Blast: Muni Credit

An Iowa agency is set to offer the largest-ever U.S. municipal junk bond sale to finance a fertilizer plant two weeks after an explosion at a Texas distributor of crop nutrients killed 14 people.

The Iowa Finance Authority plans to issue $1.2 billion in tax-exempt debt this week to fund the building of a 320-acre nitrogen fertilizer plant by Orascom Construction Industries, Egypt’s biggest publicly traded company. Bond documents cite the hazards of ammonia, which may have contributed to the Texas blast, while saying that the facility won’t make solid ammonium nitrate, the most explosive type of nitrogen fertilizer.

Even with the risk, high-yield investors such as Bill Black at Invesco Ltd. and Dan Solender at Lord Abbett & Co. say they’ll consider the debt, ranked three steps below investment grade. They’re drawn by the deal’s scale and because the price of natural gas, a fertilizer ingredient, is below its five-year average. Lower-rated munis are rallying as buyers look for extra yield with interest rates near generational lows.

“It’s going to be attractive to a lot of people because its size should make it a bond people can trade,” said Black, who co-manages the $7.2 billion Invesco High Yield Municipal Fund from Oakbrook Terrace, Illinois. “If you’re right that this plant will succeed and perform, you should be rewarded with decent improvement in the rating and the pricing on the bonds.”

Yield Appeal

The Iowa borrowing, the biggest from an issuer in the state since at least 1974, is an example of tax-exempt bonds sold for industrial development, which have accounted for the most entities defaulting in the $3.7 trillion municipal market. Local agencies sell the securities for companies, hospitals and nonprofit organizations, whose credit backs the obligations.

Such securities also provide some of the highest yields.

Iowa’s sale may yield 1.8 percentage points more than AAA munis, said Chris Ryon, who helps oversee $9.3 billion in local debt at Thornburg Investment Management in Santa Fe, New Mexico.

Dan Toboja, vice president of muni trading at Ziegler Capital Markets in Chicago, said the deal may be priced similarly to a $295 million offer last week by an Ohio agency for Genesis HealthCare System. The 2022 maturity in the issue yielded 2.18 percentage points above AAAs.

That spread is more than double what investors demand to own munis with a BBB rating, two steps above junk. The gap touched 0.96 percentage point last month, the smallest since September 2008, Bloomberg data show.

Historic Sale

The Iowa offer will eclipse a $750 million deal in 2007 for West Penn Allegheny Health System in Pennsylvania. That was the largest tax-exempt junk deal since at least 1990, Bloomberg data show. An Indiana agency’s plan to issue $1.3 billion of similar fertilizer-project bonds for a Pakistani company has been derailed after the group’s products were linked by the U.S. Department of Defense to improvised explosive devices used against American troops in Afghanistan.

The nitrogen fertilizer industry is proposing about $20 billion of new plants and almost $2 billion of expansions across nine states and three Canadian provinces, according to Mark Gulley, a New York-based analyst at BGC Financial LP.

Among the planned projects is CF Industries Holdings Inc.’s proposed $1.7 billion expansion of a site in western Iowa. CF is the largest U.S. maker of nitrogen fertilizer. An ammonium nitrate blast at the same location in 1994, when it had different ownership, killed 4 workers.

Safety Standards

The new plant in southeast Iowa “will have state-of-the-art technology and the highest safety standards,” Omar Darwazah, Orascom’s investor relations manager in Cairo, said via e-mail. “Some safe, easy-to-handle and non-explosive alternatives are available that provide the same nutrients to the soil” as ammonium nitrate, and the facility will produce those instead, he said.

The venture will sell ammonia, granular urea, urea ammonium nitrate and diesel exhaust fluid, offering documents show. While authorities are still piecing together what happened in West, Texas, it’s possible ammonia played a role, said John Verkade, a chemistry professor at Iowa State University in Ames.

“Ammonia itself can be a mean customer” when stored in tanks, he said in an interview. “Part of that huge fireball might have been ammonia burning at quite a high temperature.”

One of the bondholder risks cited in offering documents is “Hazardous Nature of Ammonia,” which the statement warns “could cause severe damage or injury” and result in lawsuits, fines or regulatory enforcement.

‘Wrong Time’

For investors such as Nicholos Venditti at Thornburg, those risks, coupled with the narrowest high-yield spreads in more than four years, mean he won’t be purchasing the securities.

“It’s just the absolute wrong time to be buying that type of risk,” he said. “Credit spreads have compressed to as tight as they’ve ever been, and it doesn’t help the cause when you have something happen with multiple deaths.”

The April 17 Texas blast flattened 50 homes and injured 200. A nursing home, hospital and two schools are within a mile of the facility.

The closest residents to the planned Iowa plant live a quarter-mile away, said Gary Folluo, a member of the Lee County Board of Supervisors. The local fire department has had multiple meetings to discuss precautionary measures, he said by phone.

Job Producer

The plant will provide as many as 3,500 construction jobs for the county of 35,617, and 165 full-time jobs once the facility is operational, Folluo said. Lee County in February had a jobless rate of 9 percent, compared with 5 percent statewide, U.S. Labor Department data show.

Standard & Poor’s and Fitch Ratings both grade the project debt BB-, three levels below investment grade. S&P said in its report that construction “dominates credit risk” and that the rating could increase to as high as BB+, one level below investment grade, once the facility begins producing fertilizer. The bonds mature from 2019 to 2025.

The plant benefits from its location in Iowa, the biggest corn-producing state and the largest consumer of nitrogen-based fertilizer, while also bordering Illinois and Missouri, which will lower transportation costs, Folluo said.

“People are excited -- it could be the start of a new sector in high-yield,” said Toboja at Ziegler.

The Iowa sale will represent about 20 percent of the $6 billion of planned muni borrowings this week, in the smallest issuance wave since March, data compiled by Bloomberg show.

Ten-year benchmark munis yield 1.76 percent, close to the lowest since January. The tax-exempt bonds are still cheaper than similar-maturity Treasuries, which yield about 1.66 percent.

The yield ratio between the two securities is 106 percent, the highest in about three weeks. The greater the figure, the less expensive munis are compared with federal debt.

(For more credit-market news, click on TOP CM. For Municipal Credit Markets column alerts, see SALT MUNCREDIT.)
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