European Infrastructure Finance Yearbook - Investing In Bonds ...

project economics and expected revenue
growth are known. Unless revenue and
EBITDA growth is at least equal to the
proportion of debt accretion, DSCRs will
narrow and the enterprise value of the
project will decline.
• Greater reliance on growth. Accreting debt
structures cause an overstatement of DSCRs
in the early years of a concession (by the
amount of the interest accrual or swap
inflow to the project). This allows early-year
cash flow deficiency to be managed (relative
to expected net revenue) while maintaining
dividend payments. Moreover, to the extent
the revenue, EBITDA, operating, and capital
cost and refinancing assumptions are
aggressive, as the accreting debt balance
amortizes in the medium-to-long term, longterm
DSCRs are at risk of not meeting base
case projections.
• Increased flexibility. Deferred-pay
mechanisms and non-amortizing structures
can inject flexibility into an infrastructure
financing structure, especially under more
aggressive revenue growth assumptions or
during the project’s start-up phase.
However, these deferability features
introduce additional credit risks for senior
lenders as debt increases.
• Allocation of risk/reward altered. Significant
dividend distributions remitted as a result of
the accreting structure’s deferral of senior
debt payments effectively puts equity ahead
of debt in the payment structure. This is a
reversal of the traditional role of capital
structure priority and funds flow
subordination, whereby equity acts as
patient capital and a buffer for senior debt
during periods of revenue ramp-up or
project cash flow weakness and is not seen
as earning a notable proportion of its
projected return ahead of senior debt.
Sponsors have advocated accreting debt
structures by highlighting lengthy concession
terms of many infrastructure transactions that
provide ample time in later years to repay higher
debt, although that same opportunity to earn cash
flow returns later in the concession also applies to
equity distributions. Nonetheless, combined with
solid business positions and inflation-linked
revenues streams, sponsors view the risk profile of
STANDARD & POOR’S EUROPEAN INFRASTRUCTURE FINANCE YEARBOOK
PROJECT FINANCE/PUBLIC-PRIVATE PARTNERSHIPS
these assets as low.
In many respects, long-term concessions can be
viewed as corporate transactions (perpetual
economic ownership of an asset). Generally,
corporate entities debt-finance and refinance on
an ongoing basis. For projects, we assume that
finite debt is issued and repaid along the
depreciating asset life. Also, the benefit of
covenants in rating corporate type structures is
less so than for projects. While the sponsor
argument of more corporate style financing of
very long-term concessions is reasonable, the
rating challenge is that transaction participants
cannot have both the benefit of undertaking a
corporate-style financing but calling it a project
financing by adding structural features that have
less value in a corporate finance rating approach.
To the extent that a good portion of equity
returns in the early years of a concession is
derived from excess cash flow that accreting debt
or swap structures produce, rather than
outperformance by the project, there are clear
benefits and incentives for sponsors to promote
financing structures that use accreting debt.
Standard & Poor’s has observed financial models
for infrastructure transactions in which aggressive
growth assumptions for revenue, together with
the cash flow benefits of using accreting debt (or
accreting swaps), results in the original paid-in
equity capital being returned to sponsors before
any debt repayment occurs. This has appeal to
project sponsors but a fundamental credit issue is
how the shift in risk to long-term lenders and
the enhanced returns to equity sponsors affect
credit quality.
Equity risk premiums (the difference between a
project’s cost of debt and its expected equity
return) can provide a quantitative proxy for the
relative risk of an entity. The equity risk
premiums observed for accreting debt structures
in infrastructure financings have been as high as
8%-12% (800-1,200 basis points). This reflects
only pretax cash equity yields and excludes
additional equity return benefit that might be
earned by sponsors through tax deductibility of
interest expense and amortization items (capital
cost allowance deductions or amortization of
goodwill) should economic ownership and tax
benefits be conferred to the concessionaire due to
the concession’s lengthy term. In contrast,
regulated utilities, which we rate slightly higher
than low investment-grade infrastructure projects
NOVEMBER 2007 ■ 109