Understanding the Highway 2000 bond issue

Source: Financial Gleaner, June 14, 2002

This article addresses certain issues raised in various publications on Highway 2000 regarding the investment in the Real Return Convertible Bonds ('the Bonds'), issued by National Road Operating and Constructing Company (NROCC), to long term investors and certain information purported to be provided by PricewaterhouseCoopers.

In 1998 a study, by PricewaterhouseCoopers, on pension funds in Jamaica found that Jamaican-based pension portfolios were significantly leveraged towards short term fixed income securities with long-term investments, including equities, accounting for only 19 per cent of investments compared with 64 per cent and 75 per cent invested in this category by pension funds in the USA and the U.K. respectively.

The pension funds surveyed explained that the unavailability of long-term investments and the attractiveness of high interest rates on short term investments accounted for the leverage towards short term instruments, however the need for appropriate long term assets was clearly made.

Arising from the survey, it was concluded that Jamaican institutional investors primarily pension funds, would find long term investment instruments such as fixed income and equities attractive; this is no different from pension funds in other countries. In Chile, for example, it was estimated that a substantial part of that country's pension and life insurance companies' investment funds were invested in long-term investment instruments providing funding for infrastructure projects. The Infrastructure Bonds issued in Chile, with tenor of 17 years or more, proved popular with life insurance companies and pension funds in that they served as a hedge for their large pool of mismatched liabilities; this we found was no different from the situation in Jamaica prior to the NROCC Bond issue. Malaysia and Singapore institutions have also invested their long-term funds in Infrastructure Bonds.

As the local financial advisors to Highway 2000, PricewaterhouseCoopers worked with Dehring Bunting & Golding for over two years to structure the Real Return Convertible Bonds that were used to raise $3.552 billion for Phase 1 of Highway 2000. This process involved numerous meetings with and presentations to various long-term investors. The design of the Bonds had regard to their requirements and include the following features:

* Long term - 30 years to redemption

* Good real rate of return - Coupon rate of 4.5% paid semi-annually throughout the tenor and exempted from income tax

* Inflation proofing - Bond Principal indexed to inflation

* Guaranteed income - Interest and Principal payments guaranteed by the Government of Jamaica

* Liquidity - Bonds fully tradable and transferable

* Option kicker - To convert the Bonds into equity shares in NROCC at maturity at the discretion of the Bondholder

The Bonds are Jamaica's first 30 year long term debt instruments in modern times. They provide the long-term investors with the opportunity to match long-term liabilities with long-term assets. The coupon rate of 4.5 per cent provides an attractive real rate of return, with principal amount indexed to inflation and interest payments being tax-free. These features assist investors to manage the effects of inflation; traditionally one of the main factors responsible for eroding pensioners fixed income and also allows professionals to better price annuities.

The Government Guarantee insulates the investor from the project risks and improves the attractiveness of the Bonds by essentially providing the same level of security as that for Government instruments. This guarantee will only be invoked if the project revenues are insufficient to allow for payments to the Bondholders as they fall due.

In recognition of the potential cashflow constraints that may be faced by investors from time to time, the Bonds are fully tradable and it is anticipated that there will be a secondary market similar to that of the Government Eurobonds.

The convertibility feature provides the investor the opportunity to participate in the upside of the project through an equity participation in the project upon the maturity of the bond. This option is exercised at the sole discretion of the investor and may prove to be quite valuable if the projected revenues of the project are realised.

In discussions with long-term investors, the following analysis was presented showing the indicative levels of investment by selected institutions if they invested 10 per cent of their liquid assets (5 per cent of total assets) in the Bond instrument. It was assumed that the liquid assets managed by these institutions comprised of 50 per cent of their total assets.

National Insurance Fund ­ $900 M

Life of Jamaica Limited ­ $600 M

West Indies Trust Co. Ltd. ­ $700 M

Guardian Life Ltd. ­ $400 M

First Life Insurance Co. Ltd. ­ $200 M

The Bank of Nova
Scotia Ja. Ltd. ­ $500 M

Total ­ $3,300 M

These figures do not represent the actual subscription made by these institutions.

In December 2001, NROCC successfully raised J$3.552 billion by private placement of the first inflation-indexed 30-year bond to become available in Jamaica. Investors in the Bonds are mainly long-term institutions and the success of the issue demonstrates that the features are an attractive match of their risk profile.

The Government of Jamaica has raised long term Bonds before, but never with this level of index proofing. For example, a tranche of Variable Interest Bonds was raised in the mid- 1970s to build infrastructure at Portmore and Mona Road. Like other Government debt the loan was fully serviced and paid off at maturity in accordance with the terms of the issue.