European Infrastructure Finance Yearbook - Investing In Bonds ...

PROJECT FINANCE/PUBLIC-PRIVATE PARTNERSHIPS
118 ■ NOVEMBER 2007
and maintenance accounts, which are there to
support the senior debt rating. Likewise, collateral
security interests or claims upon liquidation
granted to subordinate lenders should rank after
senior debt.
The maturity profile of subordinated debt
should be longer dated than senior debt,
otherwise it is not truly subordinated.
The voting rights of debt participants.
These rights should be limited solely to senior
debt participants; subordinated debt should have
no rights while senior debt is outstanding.
Nonpetition language.
This needs to be considered to ensure that no
winding-up provisions are allowed while senior
debt is outstanding either permanently or for a
specified period. Typically, the objective is to
ensure that subordinated debt has no right to
challenge any enforcement rights or validity in the
priority of payments of senior debt holders.
The events of default and termination events
of any interest-rate swaps used to hedge
subordinated debt.
These need to be closely examined. Although the
majority of subordinated debt is fixed-rate debt, if
variable subordinated debt is used and overlaid
and mitigated with a interest-rate hedge, the
events of default and termination events of the
swap would need to be limited so as not to
accelerate or cross-default senior debt.
Subordinated debt rights or remedies in a
restructuring, insolvency, or
bankruptcy proceeding.
Deeply subordinated debt should not have any
such rights or remedies. For beneficial equity
treatment, project subordinated debt should only
be able to enforce its security and creditor rights
unless, and until, senior debt has done so.
What is the analytical framework for project
subordinated debt?
Some market participants think of the analytical
assessment behind rating subordinated debt as
one of simply solving a target debt-service cover
ratio (DSCR) or simply notching off the senior
debt issue rating. But our approach is more
sophisticated. No two projects are the same from
STANDARD & POOR’S EUROPEAN INFRASTRUCTURE FINANCE YEARBOOK
a business, industry, market, operational,
structural, or legal perspective. Certainly, it is fair
to say that a senior debt issue rating provides
some starting point for the subordinated debt
rating. However, in order to make a proper
assessment, we assess a project’s cash flows to
understand where the credit stress points may be
relative to the payment structure under the
subordinated debt instrument and its exposure
horizon. In assessing the ability and willingness of
a project’s subordinated debt to pay its
obligations in full and on time, our analytical
framework reviews and measures a number of
elements that influence the level of potential
default and rating of a subordinated debt tranche:
The underlying business and industry risk of
a project.
This examines the key business and industry
economic fundamentals that influence the
underlying volatility of a project’s operating cash
flow.
A project’s financial ratios (for example, DSCR
on a total debt basis {senior and subordinated
debt} and segregated subordinated debt basis after
{senior debt}). It is important to note that the
DSCR should not be viewed in isolation. This is
particularly true when a project includes accreting
debt structures that can overstate a transaction’s
DSCR, while also deferring senior debt
amortization. (see “Accreting Debt Obligations
And The Road To Investment Grade For
Infrastructure Concessions” on page 105). As a
result, we closely examine all financial ratios,
particularly revenue growth assumptions and the
components of the coverage ratios that are can be
overstated by such financing instruments.
Senior debt cash lock-up triggers, sweep triggers,
and reserve limits (for example, senior debtservice
reserve and maintenance reserves).
Understanding these triggers and reserves is a
critical part of the analytical framework for
subordinated debt, as such lock-up triggers and
reserves are for the protection of senior lenders
only, and may result in subordinated debt being
more susceptible to default, particularly if
subordinated debt does not have its own
dedicated debt-service or liquidity reserve.