European Infrastructure Finance Yearbook - Investing In Bonds ...

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PROJECT FINANCE/PUBLIC-PRIVATE PARTNERSHIPS 110 ■ NOVEMBER 2007 with accreting debt, see equity risk premiums above their cost of debt of 300-400 basis points. A traditional risk-reward relationship between equity and debt capital providers includes equity capital taking more of a project’s cash flow risks (such as later-period uncertainty) than senior creditors given the significant risk premium that the project sponsors can earn. The expectation of higher equity returns than fixed-rate debt should incorporate the achievement of base case financial projections and reflect higher risk incurrence by sponsors, thus providing incentive for equity to take a longer view and keep “skin-in-the-game.” As noted earlier, to the extent a large proportion of the value is derived in the early years of the concession through accreting instruments, such incentives might be reduced and the interests of equity or sponsors and lenders are not as closely aligned. Question 7: How do we analyze peak debt accretion and subsequent amortization guidelines for long-term concessions? In analyzing transaction structures for mature assets that have used accreting debt or swaps, Standard & Poor’s has set out broad principles as to how far into the concession debt can rise; when we would expect a certain proportion of the maximum accreted debt balance to paid down; and when we would expect final maturity (100% paydown of the maximum accreted debt balance). This amortization principle has varied depending upon the concession’s length, the asset’s business risk profile, and offsetting structural features that might provide support to the credit risks of debt accretion. We are likely to view shorter term concessions (e.g. 20-35 year terms) with short-to-no tail or concessions with significant construction risk, for example, as more speculative unless their debt burden and accretion proportion is considerably lower than an asset with a longer concession term, all else being equal. In many cases, a shortterm concession is not likely to exhibit the characteristics that allow for accreting debt and still achieve investment grade. We have not previously commented on the magnitude of maximum debt accretion relative to the original debt at transaction inception. This will be a function of different asset classes, business profiles, structural protections, and STANDARD & POOR’S EUROPEAN INFRASTRUCTURE FINANCE YEARBOOK desired rating levels. Our credit analysis also focuses on the physical and economically useful life of an infrastructure asset to which to link amortization and the final maturity of debt (particularly if the asset risks physical or economic obsolescence, substitution, or increasing competition). For this reason, there are no fixed standards for acceptable investment-grade leverage levels, credit ratios, or debt accretion and subsequent amortization guidelines. We assess each credit independently on all these factors, although broad business risk profile distinctions reflect the strength of certain asset classes and the ability to support relative accreting debt burdens. For example, a long-term airport concession, all else being equal, would likely be considered to have a stronger business position than a parking facility concession, which is likely to have greater competition and substitution risks. (x) 2.5 2.0 1.5 1.0 0.5 0 2005 2010 2015 © Standard & Poor’s 2007. 2020 Debt Structure And Deferred Pay 25-year amortizing debt Moderate accreting debt Significantly accreting debt 2025 2030 2035 Principal Outstanding The chart above illustrates project debt accretion proportion and subsequent principal amortization under three different payment profiles. The lines in the graph do not represent any specific project that Standard & Poor’s rates, but illustrates the potentially different risk profile of varying debt and maturity structures, as well as the impact the concession term length might have on credit quality. • The curve at the bottom of the table represents a traditional 25-year amortizing debt instrument common in the U.S. public 2040 2045 2050 2055 2060 2065 2070
finance market that has a predominately interest-only payment profile in the first few years of the concession with full amortization occurring thereafter. This amortization schedule may be used to produce level annual debt service costs or, in concert with a capitalized interest period, to manage construction of an asset--for which there could be no revenue receipt until completion. Such a structure might have a modest (to no) equity tail based on a shorter concession. • The middle curve represents a long-term concession (a term of at least 50 years if there is no equity tail but up to 75 years if there is a 25-year tail). In this senior debt repayment profile, debt accretes to about 25% higher than the original par issuance at or about year 20 and amortizes to zero in the next 30 years. • The top curve represents a concession that is likely at least 75 years in term, as the senior debt accretes to more than 2x (100%) relative to original par issuance in the first 40 years of the concession and then amortizes rapidly in the next 15-20 years. Assuming the same asset and business risk profiles and debt-to-capital ratio at transaction inception, with the notable potential differences being variations in concession term, covenants, legal provisions, and debt and maturity structure, Standard & Poor’s would likely view the first curve (colored light green) as the most conservative financial risk profile and the third (red) as the most aggressive. This is the case given the absence of accretion and the proportion of debt repayment early in the concession for the first scenario and the very high proportion of accretion and the back-ended nature of the repayment profile for the third scenario, which would also likely imply high dividends payable to sponsors during the period of considerable accretion. Standard & Poor’s would not view the third scenario as investment-grade regardless of how strong the business risk profile or underlying asset quality. The second curve (dark green) could be investment grade if it had a solid business risk profile, supportive covenants and legal provisions, and a lengthier equity tail--although how close this scenario could get to the credit quality of the STANDARD & POOR’S EUROPEAN INFRASTRUCTURE FINANCE YEARBOOK PROJECT FINANCE/PUBLIC-PRIVATE PARTNERSHIPS first one would be determined by the relative differences of these factors. In summary, our ratings will incorporate the maximum accretion relative to original par debt issuance, the proportion of back-ended principal repayments and the share of paid-in equity capital returned in the form of dividends referenced in Questions 5 and 6 into our analysis with less aggressive structures generally associated with higher rated concessions. Question 8: How would Standard & Poor’s analyze the accretion characteristics and subsequent amortization guidelines for public infrastructure owners and debt issuers? These transactions will be evaluated on a case-bycase basis. In the U.S. public finance market, capital appreciation bonds have been employed for many years, often in the start-up toll road sector. Although these structures provide cushion and flexibility during the initial years of toll projects when revenues are still growing, they in fact result in a higher debt burden in later years. This can be problematic for a start-up facility, especially during a restructuring, if net toll revenues fall short of projections and debt service requirements. All things being equal, the ability of a public sector entity to assume accreting debt structures is comparatively better than for projects for several reasons including the ability to pledge revenues from a variety of assets (not just a single project), the lack of a concession term, its long-term interests as the permanent asset owner and the lack of dividend payouts which presumably allows for better liquidity and capital expenditures that improve asset quality and enhance revenues. As such, adherence to our amortization guidelines is not necessary for consideration of investment grade structures. However, on a relative basis, the financial risk profile of a public sector debt issuer would be viewed as more aggressive and highly leveraged and a weaker credit compared to traditional amortizing debt structures. Additionally, the same fundamental credit concerns regarding shifting long-term risks to lenders exist, although they can be mitigated through the mechanisms discussed in this FAQ including cash sweeps and debt reduction under scenarios when revenue projections fall short of forecasts. NOVEMBER 2007 ■ 111
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November 2007 Infrastructure Financ
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CONTENTS Introduction STANDARD & PO
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INTRODUCTION 2007: New Challenges A
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COMMENTARY Publication Date: Sept.
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UTILITIES EUROPEAN UTILITIES Once a
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