European Infrastructure Finance Yearbook - Investing In Bonds ...

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PROJECT FINANCE/PUBLIC-PRIVATE PARTNERSHIPS 120 ■ NOVEMBER 2007 • The type of security enforcement scenario (liquidation versus selling the project as a going concern); • Senior debt’s ability to influence the recovery for its benefit; • Macroeconomic conditions and its impact on the value of any collateral; • The level of any break costs under a hedging or derivative instrument; • The insolvency or bankruptcy regime in a jurisdiction or country; • Third-party costs, such as legal and insolvency-related costs; • The time it takes to emerge from default; • The length and value of a project’s cashflow tail after the repayment of senior debt; • Any other equal-ranking obligations. As each of these factors can vary considerably from market to market across the globe, so too will the level of recovery for each project’s subordinated debt. Consequently, each project needs to be examined on a case-by-case basis. Why can subordinated debt issues be rated one or more notches below the senior debt rating? As each project’s business profile is unique, so too is its financial, contractual, and legal structures. Depending on the unique features of each project, our ratings on project subordinated debt issues have on average ranged up to three notches below the senior debt rating. However, there have been exceptions in both directions, depending on the project and specific structural elements, covenants, and security features. Some credit features that have led to subordinated debt being rated more than one notch below senior debt (and hence more equity-like treatment) have included: • Severe cash-flow encumbrances on subordinated debt servicing due to senior debt distribution lock-ups, the timeframe before cash is released from lock-up, and debt-service reserve maintenance; • No rights or remedies in the event of a default affecting senior debt; • No cross-acceleration or cross-default mechanisms; and • Low debt-service coverage ratios and stress buffers. STANDARD & POOR’S EUROPEAN INFRASTRUCTURE FINANCE YEARBOOK Conversely, some credit features that have led to subordinated debt being rated closer to the senior debt rating have included: • Contingent support from sponsors to mitigate cash-flow encumbrances on subordinated debt servicing; • Lower probability of reaching equity lockup, which could occur in a project due to simple services to be delivered, a benign payment mechanism, strong and/or highly rated service providers to whom cost and revenue deduction risk is passed, and considerable third-party support; • Subordinated debt liquidity support in the form of a dedicated debt-service reserve (up to six months), the ability to capitalize or defer interest, PIK notes, and contingent third-party support; • Sharing of collateral security enforcement rights with senior lenders; and • Strong debt-service cover ratios and stress buffers. There are also examples of subordinate debt being rated on par with senior lien obligations. These have occurred in situations where the senior lien debt amounts are very small in relation to the subordinate lien, when a senior lien may be closed, or when the project operates with significant financial margins. (For examples of our ratings and related research on project subordinated debt issues, see the following issuers on RatingsDirect: 407 International Inc., Express Pipeline L.P., Reliance Rail Finance Pty Ltd., San Joaquin Hills Transportation Corridor Agency, and Alameda Corridor Transportation Authority.) Where to from here for subordinated debt structures? As active competition for project and infrastructure asset continues to move prices higher, market participants will continue to explore subordinated debt funding options and product structures to increase leverage to meet this strong demand. So long as the economic cycle continues, market participants will continue to push boundaries in debt structuring; however, market participants should remember that debt structuring is not a way to obtain funds at no risk
and that project fundamentals rather than financial engineering are the key to investmentgrade structures. So where to from here? Given the long-term nature of project and infrastructure assets, and the competitive nature of debt arrangers and the risk appetite of investors for long-term assets, the landscape for project subordinated debt will continue to evolve. Standard & Poor’s expects to see variations in subordinated debt products for project and infrastructure transactions. While cash flows from projects will continue to be carved up to create subordinated debt instruments, at the end of the day there is no “free lunch”, and the key credit consideration will remain--what will cause a rated tranche of subordinated debt to default and how will a particular subordinated debt instrument affect the default or recovery of any senior-ranking debt? ■ STANDARD & POOR’S EUROPEAN INFRASTRUCTURE FINANCE YEARBOOK PROJECT FINANCE/PUBLIC-PRIVATE PARTNERSHIPS NOVEMBER 2007 ■ 121
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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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ject Finance Rating Distribution: I
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COMMENTARY Publication Date: Sept.
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(Bil. ) 140 120 100 80 60 40 20 0 F
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UTILITIES EUROPEAN UTILITIES Once a
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UTILITIES approach to ownership unb
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UTILITIES 16 ■ NOVEMBER 2007 tran
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UTILITIES 18 ■ NOVEMBER 2007 Limi
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Publication Date: osenergoatom (sta
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UTILITIES 24 ■ NOVEMBER 2007 Tabl
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UTILITIES Publication Date: Aug. 29
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UTILITIES Publication Date: Nov. 12
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UTILITIES Publication Date: Sept. 3
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UTILITIES Publication Date: Aug. 17
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UTILITIES Publication Date: Sept. 3
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UTILITIES 50 ■ NOVEMBER 2007 stro
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TRANSPORTATION INFRASTRUCTURE 54
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Page 152 and 153: CONTACTS KEY ANALYTICAL CONTACTS Fr
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