the inevitable happens: Blue City's highest rated bonds downgraded to Junk

News just breaking that, surprise surprise, Blue City's bonds have been downgraded by the Fitch Rating agency.

The commentary seems pretty balanced and, well, true. Blue City have been slow, and that slowness cost them big time as it meant they didn't have stuff to sell in the hey-days of real estate in the GCC. Now, it's a little late.

Plus they have missed by a huge margin the covenants they made on sales. Collections (ie, the cash they've taken in from people via pre-construction sales) at the last interest payment date on 7 November 2008 were just $35 million, versus the original target of $165m. Cash take even failed Blue City management's re-revised target of $49m.

Ratings are deliberately obscure: BBB and above is investment grade, which means pension funds and banks can hold them. As usual, Blue City's borrowing was split into tranches will different claim on the assets and income, thus allowing BC to have a subset (just less than 30% of the $925 million they borrowed) of their bonds classify as investment grade 'BBB' by being entitled to first call on the cash. Even when issued, the remaining 70% of the borrowed money was junk. Now it all is.

More critically, if Blue City fail to raise $455 million in sales by 7 November this year, they are obliged to repay all the debt. Ooops. Sounds like insolvency looming to me.

As a result of this Blue City are desperately trying to renegotiate the terms of the loans. Meanwhile, Bank of New York Mellon - who I think hold the cash in escrow - have (I'm told by my sources within BCC1) not released any money to Blue City for the last 2 months. So no contractors are being paid, Bovis (the project manager) have walked out in disgust (previously reported here), the shareholders are still in court, and no-one in their right mind is buying property off plan in the GCC...

Perhaps a friendly Bulgarian Bank could be convinced to throw a big loan to Blue City's well connected Cyclone shareholders?

At least the construction of the hotel has started. But it won't help the way Omani bonds are seen in the market, especially if they miss payments.

Meanwhile, Al Sawadi Investments and Blue City management continue to be very well paid even though they seem to have a policy of stiffing their contractors.

So that's alright then.

BTW, Fitch's ratings are as follows:
Investment grade
* AAA : the best quality companies, reliable and stable
* AA : quality companies, a bit higher risk than AAA
* A : economic situation can affect finance
* BBB : medium class companies, which are satisfactory at the moment

Non-investment grade (also known as junk bonds)
* BB : more prone to changes in the economy
* B : financial situation varies noticeably
* CCC : currently vulnerable and dependent on favorable economic conditions to meet its commitments
* CC : highly vulnerable, very speculative bonds
* C : highly vulnerable, perhaps in bankruptcy or in arrears but still continuing to pay out on obligations
* D : has defaulted on obligations and Fitch believes that it will generally default on most or all obligations

PRESS RELEASE: Fitch Downgrades Blue City Invest 1 Ltd Notes
Thursday January 29th, 2009 / 13h22
Fitch Ratings-London-29 January 2009:

Fitch Ratings has today downgraded the A3, B1, C and D class notes of Blue City Investments 1 Ltd (BCC1) as detailed below. All the classes remain on Rating Watch Negative (RWN).USD262.5m class A3 (XS0267260346): downgraded to 'B+' from 'BBB-' (BBB minus); RWN USD143m class B1 (XS0259701018): downgraded to 'B-' (B minus) from 'BB'; RWN USD50.5m class C (XS0272445726): downgraded to 'B-' (B minus) from 'BB'; RWN USD70m class D (XS0273296243): downgraded to 'B-' (B minus) from 'BB'; RWN

The transaction is a securitisation of a USD925m financing package for the development of an upmarket residential, hotel and leisure resort on the Indian Ocean coast at Al Sawadi, located 90km to the west of Muscat, the capital of The Sultanate of Oman.
Fitch initially placed the notes on RWN on 4th July 2008 on the basis of poor sales performance and due to concerns relating to a legal dispute between the development's shareholders. While BCC1's new management successfully implemented operational and organisational improvements and introduced a more clearly focused marketing and sales strategy, the transaction continues to under-perform and the shareholder dispute remains unresolved. The project will also be challenged by the highly uncertain near term outlook for Oman's integrated tourism resort (ITR) market because of the global economic slowdown and the recent and rapid softening of the economy within the Gulf Cooperation Council (GCC) region.

The project has failed all of the documentation's Residential Sales Tests tested to date. Collections at the last interest payment date (IPD) on 7 November 2008 stood at USD35.0m versus the Residential Sales Test 1's target collection level of USD165.0m. Collections also fell substantially short of BCC1's revised forecast of USD49.0m.

The shortfall between actual collections and target collections as per the documentation's sales tests is largely attributable to three reasons: first, sales commenced significantly later than initially envisaged, and construction progress also suffered delays, due to changes to the master plan following the transaction's closing in November 2006; second, the actual payment plan for purchase price instalments under the project's residential sales contracts is linked to construction progress milestones, whereas the payment plan structure assumed by the documentation is linked only to a time schedule that was determined at closing and did not anticipate delays in the commencement of sales or construction; third, the Al Murjan section, which was forecast to generate sales of 800 units during 2008, proved unmarketable due to shortcomings in its design concept, forcing BCC1 to redesign this section and leaving it without any new product to sell for most of 2008.

As a result of the delayed launch of units to the market and slow sales progress to date, the project missed out on a period of strong growth in the GCC's real estate sector that the development was intended to take full advantage of. The GCC real estate boom came to an end in late 2008 and while the decline in prices and transaction volumes in Oman's ITR market is, due to its small size, more difficult to assess and quantify compared with the more transparent markets of Dubai and Abu Dhabi, the near-term outlook is negative and uncertain, undermining the confidence of both purchasers and developers. The agency understands that all the ITRs within the greater Muscat area on which construction has not commenced were temporarily put on hold by developers in late 2008.

Even if sales progress over the next two quarters is in line with BCC1's current expectations, the transaction will fail Residential Sales Test 5 on the 7 November 2009 IPD, which calls for USD455.0m of aggregate collections, triggering the immediate acceleration and mandatory repayment of all outstanding debt.

The agency understands that BCC1 is seeking to restructure the transaction via far-reaching amendments to the documents and will shortly be submitting its proposal to the issuer note and security trustee, The Bank of New York Mellon ('AA-'((AA minus))/'F1+'). BCC1 has informed the agency on an informal basis that the proposal will likely include changes to the Residential Sales Tests and Capex Tests, the launch and construction schedule of the project's different sub-sections, the payment schedule under the construction contract and the final legal maturity date of the notes in an attempt to avoid an acceleration of the debt and provide the borrower with a greater level of flexibility to respond to the changed market environment. Fitch intends to resolve its Rating Watch as more information about the proposed restructuring becomes available.

Regardless of the scope and effect of any amendments to the documentation, the agency nonetheless believes that BCC1 may face liquidity constraints and require an equity injection in the future, depending on future sales and collections volumes and the extent to which payments under the construction contract can be further back-loaded.

Following initial delays after the re-design of the masterplan, the laying of foundations of the first hotel began on 20 January 2009 and foundation works are scheduled to begin on the Al Naman apartment section on 15 February. The workers camp, with capacity for 9,000 workers, was completed in November 2008, and further enabling works on the site are ongoing.

Fitch will continue to closely monitor the performance of the transaction. Updated surveillance information and the new issue report can be found on the agency's subscription website, www.fitchratings.com.