Global Infrastructure Investment

CreditWeek ® The Global Authority On Credit Quality | January 21, 2015

SPECIAL REPORT GLOBAL INFRASTRUCTURE INVESTMENT

Timing Is Everything (p. 12)

How Europe Plans To Spend The State Of Global Project Global Toll Road Operators The U.K.’s Infrastructure €315 Billion In Three Years Finance Bank Lending Have Turned A Corner Investment Deficit CONTENTS January 21, 2015 | Volume 35, No. 3

SPECIAL REPORT 12 Global Infrastructure Investment: Timing Is Everything (And Now Is The Time) By Beth Ann Bovino, New York With global infrastructure investment needs now in the tens of trillions of dollars—figures that are essentially incomprehensible to most of us—it’s easy to see the problem as insurmountable. The result is that too often, we forget that even a relatively small increase in spending on infrastructure can yield outsized returns—especially if

COVER IMAGE: E.D. TORIAL / ALAMY TORIAL E.D. IMAGE: COVER investments are executed in a wise, targeted way.

23 Lessons Learned From 20 Years Of Rating 35 Are Rumors For Global Project Finance Bank Global Project Finance Debt Lending’s Demise Greatly Exaggerated? By Ben L. Macdonald, CFA, San Francisco By Michael Wilkins, London It has often been said that those who fail to learn from Bank lending to the global history are doomed to repeat it. Standard & Poor’s has project finance sector is again seen the global project finance sector absorb the on the upswing, following a lessons from the past by enhancing transaction long decline since 2011. structures, mitigating construction risks, reducing Banks remain attracted to counterparty exposure, and enacting many other project finance mainly credit-protective features to become one of the most because of the sector’s robust and stable sectors today. profitability relative to corporate lending and higher recovery rates. For the main lenders 29 Europe’s Investment Plan: How To Spend to the sector, this activity does not represent in our €315 Billion In Three Years view a major concentration risk, and it still garners a By Michael Wilkins, London relatively favorable treatment under Basel III. As part of an ambitious plan to rejuvenate the eurozone’s faltering economy through greater 41 Global Toll Road Operators Have Turned A Corner, infrastructure spending, the European Commission has identified a pipeline of With Credit Quality Likely To Improve In 2015 By Peter V. Murphy, New York 2,000 projects worth an estimated €1.3 trillion. These It’s the light at the end of the tunnel. With very few projects will be financed exceptions, Standard & Poor’s believes toll road primarily through the operators around the world have finally shown overall capital markets. With growth in 2014, after years of recession and the goal of creating postrecession sluggishness. The sector did remain jobs and boosting stable during the past few years, but we are now growth, the plan aims seeing toll road operators’ credit quality actually to inject €315 billion improve. In fact, we downgraded only one toll road in into the European economy over the next three years. 2014 and had 20 upgrades during the period.

2 www.creditweek.com 50 Can The G20-Sponsored Global Infrastructure Hub Kick-Start Private Investment In Asia-Pacific? By Thomas Jacquot, Sydney When the G20 countries met in Brisbane, Australia, in November 2014, the representative members agreed to create a Global Infrastructure Hub. In broad terms, the mandate of the hub will be to coordinate the infrastructure plans of participating governments; enhance governments’ knowledge of how their public sectors work, what they need, and how they are developing their funding practices; and standardize procurement processes.

55 Building For Growth: Can The U.K. Close Its Infrastructure Investment Deficit? By Aurelie Hariton-Fardad, London Although the U.K. was one of the pioneers of infrastructure development, in recent decades its investment has lagged behind that of other countries in the Organisation for Economic Co- operation and Development. This has put the country’s infrastructure under strain: the World Economic Forum cites inadequate supply of infrastructure as an obstacle to doing business in the U.K. We estimate the U.K.’s infrastructure investment deficit exceeds £60 billion.

Standard & Poor’s Ratings Services CreditWeek | January 21, 2015 3 FEATURES SPECIAL REPORT

12 www.creditweek.com Global Infrastructure Investment Timing Is Everything (And Now Is The Time)

Overview

● Standard & Poor’s sees clear economic benefits to G20 countries’ increased public spending on infrastructure—with the so-called “multiplier effect” of an increase in spending of 1% of real GDP running as high as 2.5 in a three-year period. ● The multiplier effect is generally greater in developing economies than for more developed countries; for example, China, India, and Brazil would all enjoy a boost to GDP of at least double the increase in investment. ● For Europe, it’s clear that a concerted effort across the region would have a greater effect than country-specific increases in spending. ● For developed nations, the increase would boost employment substantially— adding more than 700,000 jobs in the U.S. and about a million in the EU.

ith global infrastructure investment needs now in the tens of trillions of dollars—figures that are Wessentially incomprehensible to most of us—it’s easy to see the problem as insurmountable. The result is that too often, we forget that even a relatively small increase in spending on infrastructure can yield outsized returns—especially if investments are executed in a wise, targeted way.

Standard & Poor’s Ratings Services CreditWeek | January 21, 2015 13 FEATURES SPECIAL REPORT

And these returns aren’t just for lenders, generally benefit from the so-called In addition to the short-term boost to who often enjoy lower default rates and “multiplier effect” when they promote jobs and aggregate demand, infrastructure higher yields for infrastructure projects such investments, with each dollar of investment often yields long-term benefits than they might reap from similarly spending (again, when deployed judi- by enhancing efficiency, for instance by rated corporate debt—especially in ciously) translating into much greater allowing goods and services to be trans- developed markets. Economies will also gains in terms of GDP. ported more quickly and at lower costs. There’s no shortage of examples around Chart 1 | Investment In The EU the world in which a large infrastructure project has had a transformative effect. The Total (left scale) Private (left scale) Public (right scale) 48-mile-long Panama Canal—which is in

(% of GDP) (% of GDP) the final stages of a massive expansion, a century after its opening—instantly facili- 22 3.9 tated international maritime trade. Similarly, 21 3.7 the Channel Tunnel connecting France and 20 3.5 19 the U.K., which opened in 1994, now ushers 3.3 18 an estimated 20 million passengers (and 3.1 17 almost that many tons of freight) each year 16 2.9 between the two countries. 15 2.7 However, while a clear correlation 14 2.5 exists between the size of a project 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 and the ensuing economic benefits, Sources: European Commission, OECD, and Standard & Poor’s estimates. increased spending on projects © Standard & Poor’s 2015. doesn’t always lead to commensurate effects, according to a 2011 study of Chart 2 | Public Investment: Germany Versus The EU U.S. infrastructure investment by the Economic Development Research Germany EU (28 countries) Group. Additionally, a 2013 study by (% of GDP) management consultant McKinsey & 4.0 Co. suggested that if a given country’s

3.5 infrastructure projects are evaluated, planned, and executed more carefully, 3.0 they could generally be completed at two-thirds of current costs—a signifi- 2.5 cant savings, especially as govern- 2.0 ments around the globe look to maxi- mize their returns on investment. 1.5 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Some governments, notably in the Sources: Eurostat, OECD, and Standard & Poor’s estimates. U.K. and Australia, have extensive expe- © Standard & Poor’s 2015. rience using public-private partnerships (P3s) to finance infrastructure projects. Chart 3 | Total Investment: Germany Versus The EU Private-sector participation can allow governments to tap into design and Germany EU (28 countries) engineering expertise, better manage (% of GDP) construction timelines, reduce costs, 22 and improve the delivery of services to 21 the public. The track records for the 20 U.K. and Australia suggest P3 projects generally suffer fewer construction 19 delays and smaller cost overruns. 18 However, these results can vary, and 17 savings may not accrue to smaller proj- 16 ects where economies of scale can’t be 15 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 achieved. Nonetheless, we see P3s as an appealing alternative to relying Source: Eurostat. © Standard & Poor’s 2015. solely on public spending.

14 www.creditweek.com At any rate, the causal link between networks, and social infrastructure, such existing infrastructure. We believe that prudent infrastructure spending, whether as schools, courthouses, and hospitals. focusing on projects with the most public or private, and the benefits to an Clearly, infrastructure needs vary advantageous returns is critical. economy is undeniable, in our view. In greatly from country to country, Along these lines, in a research paper large part, this is especially true for trans- depending, among other things, on where published in December, Emil H. Frankel, portation projects, which can boost an an economy is on its developmental a senior fellow at the nonpartisan think economy in many ways, including adding timeline. In more developed economies, tank the Eno Center for Transportation jobs (and not just during a project’s con- where transportation systems are some- and former assistant secretary for struction), increasing income, and raising times more than a century old, refurbish- Transportation Policy under President property values. But “infrastructure” ment and replacement will eat up a George W. Bush, suggests that it’s essential entails much more than a country’s trans- larger share of necessary financing. In for any investment in U.S. transportation portation system. In addition to roads and developing nations such as China and infrastructure to go toward projects that bridges—as well as other transport- India, systems and networks must be offer the highest economic returns. Toward related projects such as rail systems, built from scratch to keep pace with pop- this end, increased leadership at the federal ports, and airports—we consider a ulation growth and enhance economic level is crucial, Mr. Frankel says, adding country’s essential infrastructure to expansion. Given that the U.N. projects that Congress could substantially improve include water and waste management the global population to rise to 9 billion this process by requiring the agencies facilities, power grids, telecommunications by 2050—with most of that in the devel- responsible for projects and programs to oping world, where the population could conduct transparent economic analyses as surge by almost one-half, to 7.8 billion— part of state and regional transportation Table 1 | The Effects Of An Increase there’s a clear need for substantial invest- improvement plans. Additionally, the In Spending Of 1% Of GDP ment in new infrastructure in the areas of Transportation Department should have energy, water, transportation, telecom- the authority to reject plans that don’t (Ranked by multiplier effect, highest to lowest) munications, and social facilities. follow this path, he says. Projected job Meanwhile, in an October report, the Multiplier effect gains (maximum Country (2015 to 2017) above baseline) Getting It Right International Monetary Fund (IMF) said U.K. 2.5 343,000 Standard & Poor’s believes private that increased infrastructure investment investors around the world have an could provide a much-needed boost to Brazil 2.5 418,000 opportunity to fill some of the giant gap demand in advanced economies—and China 2.2 2,400,000 created by public-funding shortfalls (see called it “one of the few remaining policy India 2.0 1,360,000 “Global Infrastructure: How To Fill A $500 levers available to support growth, given Argentina 1.8 68,000 Billion Hole,” published Jan. 16, 2014, on already accommodative monetary policy.” U.S. 1.7 730,000 RatingsDirect). This is especially true as In developing regions, such investment Japan 1.5 211,000 regulatory requirements limit banks’ could help alleviate existing and nascent long-term lending, and governments face infrastructure bottlenecks. And for all Canada 1.4 61,000 budgetary constraints. Infrastructure economies, it would boost productive Italy 1.4 136,000 deals can be attractive to nontraditional capacity and medium-term output. France 1.3 109,000 lenders such as insurers and pension G20 finance ministers and central bank Mexico 1.3 193,000 funds, which need to match long-term governors themselves have said that South Korea 1.3 95,400 assets and liabilities. Additionally, such raising infrastructure investment is crucial Germany 1.2 157,000 projects generally offer higher yields than to promoting growth in the global lenders might get from more traditional economy. As the IMF report pointed out, Indonesia 1.0 320,000 assets such as investment-grade sover- while increased public investment raises Australia 1.0 38,680 eign and corporate debt. output in both the short and long terms, the Eurozone 1.4 627,000 Whether the money comes from effects vary with a number of factors, Note: Most of the results in this table are from our public coffers or private interests, it’s including the degree of slack in an simulations for an increase in infrastructure investment of 1% of GDP in year one, using Oxford crucial that spending is managed reason- economy and the efficiency of investment. Economics’ Global Economic Model. However, for ably. Too often the primary criteria for a Not surprisingly, if the selection and execu- projected job gains in emerging regions, we used the empirically based rule known as Okun’s Law, which project’s approval are political support tion of a project are poor—and only a frac- states that unemployment falls by 1% when GDP and visibility, rather than more prudent tion of the money spent is converted into rises by 3%. Specifically, we used this for Asia-Pacific (Australia, China, India, Indonesia, Japan, cost-benefit analyses. Planners around productive public capital stock—long-term and South Korea) and Latin America (Argentina, the world and at all levels tend to try to output gains would be limited. Increasing Brazil, and Mexico) since the structure of the labor markets in these regions typically differs significantly address congestion and bottlenecks by investment efficiency is key to mitigating and renders most general equilibrium modeling pushing through new construction the potential trade-off between higher techniques less useful. instead of considering upgrades to output and the increase in public debt.

Standard & Poor’s Ratings Services CreditWeek | January 21, 2015 15 FEATURES SPECIAL REPORT

The Multiplier Effect ects as a percentage of GDP has recent debt crisis have significantly con- Although the figures vary considerably, dropped to a two-decade low of about strained spending on infrastructure governments generally have spent less, 1.7%, according to the Federal Reserve development and repair. as a percentage of GDP, on infrastruc- Bank of St. Louis. In the eurozone, the By contrast, government allocation is ture in recent years. In the U.S., for austerity measures that many govern- notably higher in the developing example, government spending on proj- ments implemented in response to the economies of Asia. China, for example, is now the world’s largest investor in infrastructure, with the government ear- Chart 4 | Public Investment: France Versus The EU marking roughly 8.5% of GDP for projects (a large chunk of which, it should be France EU (28 countries) noted, is outside its borders). India, (% of GDP) meanwhile, has been allocating roughly 4.5 4.7% of GDP in recent years. And not 4.0 only are these countries spending more than developed nations, but their 3.5 already-fast-growing economies stand to 3.0 benefit comparatively more if spending 2.5 were to rise, according to our estimates 2.0 of the multiplier effects for the majority of G20 countries. 1.5 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 In our analysis, Standard & Poor’s Sources: Eurostat, OECD, and Standard & Poor’s estimates. economists estimated the benefit to var- © Standard & Poor’s 2015. ious economies over a three-year period (2015-2017) of an increase in infrastruc- Chart 5 | Total Investment: France Versus The EU ture spending of 1% of real GDP in the first year. Because disaggregated meas- France EU (28 countries) ures of infrastructure investment aren’t (% of GDP) widely available, our analysis looked at 22 total public-sector investment as a proxy. 21 This may include investment in non- 20 infrastructure items, but to the extent 19 that infrastructure investments are gen- 18 erally found to have greater productivity- enhancing effects than other kinds of 17 public investment, our multiplier esti- 16 mates are conservative. 15 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Generally speaking, we found the mul- Source: Eurostat. tiplier effect to be greater in developing © Standard & Poor’s 2015. economies than for more developed countries (with the notable exception of Chart 6 | Public Investment: Italy Versus The EU the U.K., which we determined to have the highest potential multiplier effect of Italy EU (28 countries) the countries we looked at, for reasons (% of GDP) detailed below). China, India, and Brazil 4.0 would all enjoy a boost to GDP of at least double the increase in investment, 3.5 while the multiplier effect for countries 3.0 such as Australia, Germany, and Canada would be far smaller (see table 1). 2.5

2.0 The U.S. For the U.S., we estimate that an increase 1.5 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 in spending of 1% of real GDP—or about $160 billion, spread out over four quar- Sources: Eurostat, OECD, and Standard & Poor’s estimates. © Standard & Poor’s 2015. ters—would boost economic output by

16 www.creditweek.com $270 billion over the three-year period. In markets is high. Therefore, many of the utilization of existing infrastructure. In other words, for each additional $1 allo- jobs that an infrastructure project cre- particular, Mr. Leduc and Mr. Wilson cated for public-sector investment in ates and supports would be in those looked at whether highway spending 2015, about $1.70 would be added to real areas. However, the economy’s produc- would have more beneficial effects in GDP over the three years. tive capacity and output would also states that are growing fast—and thus This jibes with our estimate in May, likely increase once the infrastructure is more likely to suffer transportation con- when we found that $1.3 billion of public- built—and so the investment would gestion—than in slower-growing states sector investment would boost real GDP likely result in even more jobs long after where road capacity is underutilized. an additional $2 billion in 2015. On top of the project ended. In other words, the Their findings broadly support the notion that, such an increase would add 29,000 bump in employment comes from the that transportation infrastructure jobs to the U.S. construction sector, and creation of direct jobs (in construction improvements have more beneficial even more to the broader economy when and immediate construction supporting effects in regions that are already growing we counted positions in infrastructure- sectors) and indirect jobs, following rapidly—which implies that, in general, related industries. This is in line with esti- stronger demand and enhanced compet- infrastructure spending may be more mates from the Federal Highway itiveness in the area. effective, at least in the short run, as a Administration, which has determined Additionally, a 2012 report from trade facilitator of strong economic growth that a $1.25 billion highway capital group Associated Equipment Distributors rather than as a boost to weak growth. expenditure supports 34,779 jobs related found that every dollar invested in high- At any rate, highlighting the beneficial to the project. (See “U.S. Infrastructure ways and streets returns about $0.35 in economic effects of increased public- Investment: A Chance To Reap More Than tax revenue to government coffers (with sector spending on projects in the U.S. is We Sow,” published May 5, 2014.) $0.23 of that going to the federal govern- especially important given that the In our latest analysis, we estimate ment). And U.S. states stand to benefit country’s infrastructure is in desperate that an increase in spending of 1% of from infrastructure spending—typically need of repair. In its most recent report real GDP could add as many as 730,000 much more than through other govern- card in 2013, trade group the American jobs to the U.S. economy in 2015. Put ment expenditures. In a study of the Society of Civil Engineers (ASCE) gave differently, it would provide average effects of revisions to infrastructure the U.S. a grade of D+, which marked monthly job gains of 61,000—pushing grants on gross state products (GSPs) the first improvement (from D) since the overall monthly payroll gains to from 1990 to 2010, San Francisco Fed group began grading the condition of 272,000 (compared with our baseline economists Sylvain Leduc and Daniel U.S. infrastructure in 1998. According to forecast of 211,000). Wilson found that, on average, each ASCE estimates, investment of $3.6 tril- To be sure, time and place play key dollar of federal highway grants trans- lion would be needed by 2020 to rectify roles in how many jobs a project actually lated into an increase to a state’s GSP of the situation, and the group added that creates. During recessions or weak at least twice that. unless things change, the backlog of recoveries, private construction activity The study also suggests that the effects projects and deferred maintenance could is soft and unemployment in related job of increased spending may depend on the Table 3 | EU Simulation: 1% Increase In Public Table 2 | Perceived Quality Of Infrastructure, The Global Competitiveness Investment In 2015 Report, 2014 To 2015 Maximum gain Quality of Quality Quality of Quality of Quality of Quality of Country Multiplier in employment overall of railroad port air transport electricity Country infrastructure roads infrastructure infrastructure infrastructure supply Germany 1.2 157,000 Austria 7 3 11 60 33 7 France 1.3 109,000 Belgium 17 27 14 6 15 16 Italy 1.4 136,000 France 10 4 6 32 17 14 Spain 2.0 107,000 Germany 11 13 8 14 13 33 Eurozone 1.4 627,000 Ireland 36 25 31 29 23 17 Netherlands 1.8 34,000 Italy 56 57 29 55 70 35 Austria 1.3 18,000 Netherlands 6 5 9 1 4 9 Belgium 1.1 24,000 Spain 13 11 4 9 10 21 Ireland 1.6 12,000 Sweden 18 20 19 18 21 22 U.K. 2.5 343,000 U.K. 27 30 16 16 28 12 Sweden 1.1 20,000 Source: World Economic Forum. EU 1,068,000

Standard & Poor’s Ratings Services CreditWeek | January 21, 2015 17 FEATURES SPECIAL REPORT cost each American family $3,100 a year ture is in sorry shape, the World ranked it 25th in the world (out of 144). in personal disposable income. If more Economic Forum (WEF), in its Global The country’s roads came in at No. 20. evidence is needed that U.S. infrastruc- Competitiveness Report for 2012-2013, Canada Chart 7 | Total Investment: Italy Versus The EU For Canada (which came in slightly higher in the WEF report, with an overall Italy EU (28 countries) infrastructure ranking of 15th), we esti- (% of GDP) mate that each additional C$1 spent by 22 Canadian governments in 2015 would 21 increase real GDP by C$1.40 by 2017. With a government spending increase of 20 1% of real GDP totaling C$17.3 billion 19 (US$14.8 billion), this would add C$25 18 billion to GDP. On top of that, we 17 assume governments would use P3s for 16 a portion of the increase, lifting busi- 15 nesses’ fixed investment in the three 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 years and adding to the multiplier effect Source: Eurostat. © Standard & Poor’s 2015. on real GDP. Most of the increase (0.6%) would come in 2015. Chart 8 | Asia-Pacific: Real GDP Impact Of A 1% Increase In In this scenario, Canada’s real GDP Public Investment growth for 2015-2017 would average 2.7% annually, versus 2.5% in our base 2015 2016 2017 case, and the cumulative increase in real (% deviation from baseline) GDP would be C$141.6 billion. 1.2 At the same time, the increase in investment would lift employment by 1.0 an additional 45,000 jobs, beyond the 0.8 575,000 increase we expect for the 0.6 Canadian economy over the years, and 0.4 hourly wages would increase 3%, on 0.2 average, versus 2.7% in our baseline 0.0 scenario—not a significant improve- (0.2) ment to consumers’ ability to pay off Australia China India Indonesia Japan South Korea their debt. Source: Standard & Poor’s. © Standard & Poor’s 2015. Notably, because Canadian governments were relatively early adopters of Chart 9 | Total Spending On Infrastructure: Cross-Country Comparison outsourcing investment in infrastructure through P3s, increased government Public Private investment in infrastructure also mobi- (% of GDP) lizes private spending—obviously, an 6 important aspect of economic expansion. As it stands, Canada’s three levels of 5 government—federal, provincial, and 4 municipal—share responsibilities for 3 maintaining the country’s public infrastructure. After a period of elevated 2 investment in public projects in the 1 1950s and 1960s, governments reduced 0 their spending, and it wasn’t until recently, in the wake of the 2008 to 2009 1980s 1990s 2000s 1980s 1990s 2000s 1980s 1990s 2000s 1980s 1990s 2000s 1980s 1990s 2000s 1980s 1990s 2000s recession, that they again focused on Argentina Brazil Chile Colombia Mexico Peru infrastructure funding. While govern- Sources: Standard & Poor's calculations based on data from World Bank and ECLAC (UN’s Economic Commission for Latin America and the Caribbean). ment investment in infrastructure is © Standard & Poor’s 2015. again close to 3% of GDP (from a low of

18 www.creditweek.com 1.4% in 2000), decades of underinvest- financing gap for broadband networks in a whole has suffered two recessions ment have opened up a funding gap that the area of €30 billion a year until 2020. since 2008. There are, however, differ- the Canadian Centre for Policy Low investment has been a major ences across countries with respect to Alternatives estimated to be as much as cause for the slow recovery in the EU their positions in the cycle. Of all euro- C$145 billion in 2011. Other estimates economy. Moreover, chronically weak zone countries, Germany is closest to full of the gap, for example from the capital spending endangers future employment, and we estimate its output Federation of Canadian Municipalities, growth. To address this, EC President gap to be about 1.2 percentage points of include the cost of repairs that extend Jean-Claude Juncker in November out- GDP, compared with 3.8 percentage the service life of existing infrastructure lined the European Investment Plan that points for the eurozone as a whole. plus new spending to keep up with pro- would increase spending by €315 billion Another important dimension to keep jected population growth—according to from 2015 to 2017. in mind is the strong trade links between these measures, Canada will need to The commission has identified about EU countries. On average, 60% of invest more than C$200 billion in the 2,000 projects, with a potential invest- European exports/imports remain country’s public infrastructure in the ment of €1.3 trillion, that would help reju- within the union. Our research has coming decade. venate the eurozone’s faltering economy shown that boosting spending in one through infrastructure spending, financed country would have few effects on its Europe primarily by the capital markets. We think own growth and on that of its neighbors. In Europe, fixed investment has failed to the key to raising the €315 billion is the (See “A Stimulus Package From Germany recover fully from the declines during newly created European Fund for Alone Would Have Little Effect On The Rest the global economic and financial crisis. Strategic Investments, which will have Of The Eurozone,” published Oct. 21, In fact, total fixed investment as a share €21 billion of capital at its disposal—€8 2014.) This is because the leakage of the region’s GDP is now four per- billion of new EU cash, €8 billion of through imports reduces the direct centage points below its pre-crisis peak existing EU budget funds, and €5 billion impact on Germany’s GDP but is diluted (see chart 1). Private investment fell from the EIB. across its major trading partners. sharply during the crisis, which was par- tially offset by the spike in public investment as part of the stimulus measures implemented by the EU governments. In Europe, fixed investment has failed to recover Public investment has since been declining rapidly as governments consol- fully from the declines during the global economic idate their budgets. Still, a sizable chunk of government and financial crisis. spending—about one-third on average— is earmarked for infrastructure in the EU, according to estimates by economists at Economic research shows that infra- In this light, it makes more sense to the European Investment Bank (EIB). structure spending boosts output look at the region as a whole. For our However, in the majority of the region’s growth through demand in the short model, we assumed that public invest- countries, investment (both public and term and supply in the long term. The ment (coordinated across the EU) private) in transportation infrastructure demand-driven effect depends on where would increase by 1% of GDP in 2015. as a percentage of GDP is lower than a an economy stands in its economic We also assumed that monetary policy decade ago. Meanwhile, the perceived cycle; it’s stronger at the low point in a in Europe would remain accommoda- quality of overall infrastructure in some cycle. For instance, during the depres- tive, with neither the Bank of England, EU countries, such as Italy, is low. And sions of 1837-1842 and 1931-1935, the European Central Bank, nor others, including Germany, have lost investments in transportation infrastruc- Sweden’s Riksbank raising benchmark their previously high competitive posi- ture played a major role in lifting interest rates above what we assume in tion (see table 2). Europe’s economies out of the trough. our baseline scenario. The results we EU infrastructure investment needs At the same time, the supply-driven got were in sharp contrast to those from are approaching €1 trillion (US$1.2 tril- effects depend on how productive our “boost in a single country” simula- lion) in the next three years, according to investments are, which, in turn, could be tion. In fact, for the eurozone as a European Commission (EC) estimates, linked to how they’re financed. whole, the multiplier effect is quite including annual spending of more than Most economies in the region are at or strong: Each additional euro spent on €200 billion to meet agreed energy near low points in their cycles, as shown infrastructure would add €1.4 to real objectives. The EC also estimates that by each country’s output gap—the dif- GDP over three years (see table 3). €1.5 trillion is required for transportation ference between potential and actual At the same time, such an increase infrastructure through 2030, with the GDP—and the fact that the eurozone as would add an estimated 627,000 jobs in

Standard & Poor’s Ratings Services CreditWeek | January 21, 2015 19 FEATURES SPECIAL REPORT the eurozone, and more than 1 million tiplier effect for the U.K. of 2.5 over three GDP over the past decade despite fiscal in the EU (with the U.K. accounting for years. This is a higher effect compared with consolidation constraints (see charts 4 and 5). 343,000). All told, a concerted plan the boost to spending in the U.K. alone, However, a reduction in state transfers to encompassing the EU as a whole which we estimated at 1.9. The main reason local and regional governments, which would, in our view, have a much more is the additional boost to U.K. GDP due to account for the bulk of public investments, meaningful effect on growth and increased demand from its European trade could soon curb infrastructure spending. employment than would isolated, partners. We also project that such invest- The country, with the region’s second- country-specific increases. ment would add more than 300,000 jobs in largest economy, ranks fourth and sixth in the same year as the increase occurred. the quality of its roads and railways infra- The U.K. structure, respectively, in the WEF’s Inadequate investment in infrastructure Germany assessment—when investing 0.9% of GDP has become a significant obstacle to In Germany, the region’s biggest in transportation infrastructure, in line with doing business in the U.K., and the national economy, total capital the Organisation for Economic Co-opera- WEF’s Global Competitiveness Report spending has been low, by interna- tion and Development (OECD) average. ranks the quality of the country’s overall tional comparison, and has decreased However, demographic changes in some infrastructure 27th in the world. Output over time—plummeting to just above metropolitan areas, Paris in particular, per hour in the U.K. is below the average 17% of GDP in 2013, from 21.5% in have made the existing public transport for the rest of the G7 industrialized 2000. Public investment has slipped network inadequate to meet the growing economies; last year, one hour of work below 3% of GDP (see charts 2 and 3). needs of mobility. Meanwhile, the high- in the U.S. produced 40% more than one In fact, public investment in the speed broadband coverage rate was only hour of work in Britain. In our view, country has continuously been 1 per- 41% in France in 2013, compared with insufficient investment in infrastructure centage point lower than the EU 62% across Europe. To reach 100% cov- has been one of the key factors average for the past decade, and this erage, the country may need to spend an explaining weak productivity perform- trend continued even as numerous estimated €20 billion through 2022. ance in the U.K. European countries trimmed public At any rate, we estimate that an Road congestion is a fact of life in the spending amid fiscal consolidation. increase in public spending in one year U.K., hurting the economy and the environ- Underinvestment in Germany’s trans- of 1% of GDP (coordinated across the ment, and diminishing Britons’ quality of portation infrastructure investment EU) would result in a multiplier effect of life. According to INRIX, a road traffic and alone has led to an accumulated shortfall 1.3 for France over three years. driver services company, the U.K. is the of €60 billion since 2004, according to third-most-congested country among our calculations. The deteriorating Italy major developed economies in Europe and quality of German roads is reflected in Similarly, an increase in public spending North America. The average U.K. driver the WEF’s rankings: Germany ranked in one year of 1% of GDP across the EU spends approximately 30 hours a year in 13th in those terms in 2014, down from would result in a multiplier of 1.4 for traffic jams—and that figure rises to 84 fourth in 2008. neighboring Italy. This is especially note- hours in the London commuting area. To Meanwhile, investments are needed worthy, given that the country’s infra- address this, Prime Minister David in renewable energy systems for elec- structure is regarded as poor by interna- Cameron has announced that the govern- tricity and heat supply, and for power tional standards, ranking 56th in the ment will earmark £15 billion in the next 10 grids. Significant funding is also quality of overall infrastructure, years to improve the country’s major roads. needed to improve energy efficiency— according to the WEF. At the same time, we expect spending to to insulate buildings, for instance. This Italy’s public investment averaged 3% increase in the next decade, which will energy transition will require €31 bil- in the decade preceding the global eco- create significant opportunities for private lion to €38 billion per year until 2020, nomic and financial crisis. After a tempo- capital investment in the sector. In our according to the Deutsches Institut für rary boost as part of stimulus measures view, this could boost the country’s eco- Wirtschaftsforschung (the German during the crisis, public investment has nomic growth, both in the short term and institute for economic research). been trending down, and was just 2.4% over time. (See “Building For Growth: Can On the bright side, we estimate that an of GDP in 2013 (see charts 6 and 7). The U.K. Close Its Infrastructure Investment increase in public spending in one year At the same time, transportation-infra- Deficit?” on p. 55.) of 1% of GDP (coordinated across the structure spending amounted to an With an accumulated infrastructure EU) would result in a multiplier effect of average of 1.3% of GDP annually from investment deficit of more than £60 billion 1.2 for Germany over three years. 2004 to 2008 (above the OECD average of (US$95 billion), a clear opportunity exists. 0.9%) and dropped to 0.5% in 2010, We estimate that an increase in public France according to the International Transport spending in one year of 1% of GDP (coordi- In France, public investment has been com- Forum. Meanwhile, the perceived quality nated across the EU) would result in a mul- paratively high, remaining constant at 4% of of Italy’s transportation infrastructure is

20 www.creditweek.com poor, with rankings of 57th for the quality mental global GDP growth of 2.1% over These intraregional differences are of roads, 29th for rail, 55th for ports, and the next five years, and leaders said likely the result of the fact that Chile 70th for air transport, according to the increased investment in infrastructure had already invested more aggres- WEF report. And Italy is the fourth-most- was one of the ways to deliver on that. sively than its neighbors before 2008, congested country among major devel- Toward this end, G20 members agreed to and its infrastructure needs were oped economies in Europe and North create a global infrastructure hub in therefore lower, while the opposite sit- America (after Belgium, the U.K., and the Sydney, recognizing the need for greater uation existed in Peru. Another reason Netherlands), according to INRIX. coordination and simplification. In other may be that Chile uses better criteria words, paramount to achieving this goal to evaluate projects and invests more Asia-Pacific is making private investment in infra- efficiently than its peers. The six G20 countries in the Asia-Pacific structure more attractive. According to To catch up to countries such as region offer a mixed bag in terms of the the group’s estimate, an additional US$2 South Korea and China, Latin America multiplier effect that we estimate would trillion of private money could find its would need to earmark 6% of GDP for result from an increase in infrastructure way into infrastructure in the next 15 infrastructure in the next 20 years, spending of 1% of GDP. For those countries years. With Asia becoming the global eco- according to studies by the World Bank whose economies are running at close to nomic growth engine but suffering from a and the Economic Commission for potential GDP—i.e., Australia and material deficit in infrastructure, the Latin America and the Caribbean. But Indonesia—the increased spending region could capture a significant part of while more investment is needed, per- wouldn’t generate additional output since it that additional investment, in our view. haps a better way to close the infra- would crowd out other investment and spur inflation. On the other side of the coin, the fast-growing economies of China and India have a lot of upside in terms of investment …infrastructure investment is a hot topic in opportunities (although China’s capacity for credit financing is now more binding), Asia-Pacific, given the immense funding needs and which explains their multipliers of 2.2 and 2.0, respectively. Japan and South Korea— with investors showing a great deal of interest. with respective multipliers of 1.5 and 1.3— fall somewhere in the middle (see chart 8). In many ways, developing economies Broadly speaking, the mandate of the structure gap is to improve efficiency. are at an advantage since crumbling hub is to help coordinate participating To be sure, public infrastructure is noto- legacy systems and structures aren’t the governments’ infrastructure plans, to riously wasteful and inefficient not only burden they sometimes are in more develop public knowledge and expertise, in Latin America, but in other regions, developed areas, and these countries can and to standardize project-procurement including Asia-Pacific. As per the capitalize on technological advancements processes. By precisely quantifying the McKinsey study that suggested that to build from scratch. A prime example risks that private investors can expect, projects currently under way could be can be seen in India, where the estimated this would allow all countries to establish built at two-thirds the cost if evaluated, 1 billion mobile phones is approximately a common contractual framework for planned, and executed more carefully, 30x the number of landlines in use—and projects. We see this as key to drawing this means that Latin America could growing fast, with service providers free any significant amount of private money close the gap between actual and of the need to run cable to rural areas, to infrastructure. needed infrastructure at the same speed where just one-third of the population either by simply doubling investment to now has telephone service, according to Latin America 6% of GDP or by hiking investment mobile provider Telecom India. (Still, we As a share of GDP, infrastructure from 3% to 4% and adopting “best prac- note that India ranks 116th out of 144 investment in Latin America is below tices.” Certainly, the second alternative countries with regard to per capita the global average of 3.8% (see chart 9). is better, and more fiscally realistic, mobile-phone subscriptions; the U.S., for From 2008 to 2012, the region as a since it reduces undesirable income comparison, ranks 72nd.) whole allocated 3% of GDP for proj- transfers and deadweight losses. In this light, infrastructure investment ects—or about $150 billion per year, Using this criterion, we estimate the is a hot topic in Asia-Pacific, given the given that GDP averaged $5 trillion infrastructure gap for Latin America and immense funding needs and with during the five-year period. Broken out six of its seven largest economies investors showing a great deal of interest. by country, spending was close to the (excluding Venezuela due to data con- As part of the recent G20 meeting in average in Argentina, Brazil, Colombia, straints) at 1% of GDP—or about $336 Brisbane, Australia, members expressed and Mexico, while lower in Chile (2% billion over five years. In calculating the their commitment to achieving incre- of GDP), and higher in Peru (4%). effect that a regional investment

Standard & Poor’s Ratings Services CreditWeek | January 21, 2015 21 FEATURES SPECIAL REPORT increase of this magnitude would have on countries’ real GDP by 2017, we …the composition of infrastructure investment in Latin found multipliers ranging from 1.3 in Mexico to 2.5 in Brazil. America, with regard to public and private spending, has It’s important to note that these results capture only the boost to GDP from an been changing dramatically in the past three decades. increase in effective demand, and not the supply-side effects that would accrue more slowly as the stock of infrastructure capital increases. That said, the to its falling out of favor. But in This is especially important given that effect on aggregate demand is critical to Argentina, the quantity and quality of governments are spending a much a region suffering not only a likely infrastructure services improved in all smaller portion of their budgets on infra- decline in potential growth due to the sectors in which the private sector structure—particularly in the West. In external factors, but also a negative and participated. This was true for power the U.S., government spending on proj- expanding output gap, which has generation, transmission, and distribu- ects as a percentage of GDP has tum- resulted in a virtual halt in job creation in tion; natural gas transportation and dis- bled to the lowest in more than 20 years, some areas. To measure the effect that tribution; water and sanitation; and even and in the eurozone, governments’ aus- higher infrastructure spending would road building and maintenance. In all of terity measures have significantly eaten have on the labor markets, we combined these sectors, service was adequate, tar- into spending on infrastructure develop- our GDP multipliers with Okun’s law iffs affordable, and investment commitment and repair. (which attempts to quantify the relation- ments honored. Yet during the financial To be sure, while there’s a demon- ship between employment and eco- crisis in 2002, the Argentinian govern- strable relationship between a pro- nomic output) and found that an ment intervened in many of these mar- ject’s size and the resultant boost to increase in infrastructure spending kets, freezing tariffs and revising or an economy, more spending doesn’t equivalent to 1% of GDP in the region revoking contracts. The result was the always make for commensurate bene- would generate 900,000 jobs in Brazil retrenchment of the private sector from fits. In this light, it’s crucial that coun- and 250,000 in Mexico over the three- infrastructure investment. tries more carefully evaluate, plan, year period. Outside of Mexico and Argentina, pri- and execute their infrastructure proj- Meanwhile, the composition of infra- vate-sector participation is alive and well ects. This would result in significant structure investment in Latin America, in Latin America. For example, in Brazil, cost savings on the front end, and with regard to public and private the region’s biggest economy, the share bigger boosts to the economy down spending, has been changing dramati- of private participation in total infra- the road. CW cally in the past three decades. In the structure investment doubled to about Writer: Joe Maguire 1980s, most, if not all, infrastructure was 60% since the 1990s. In other words, built, financed, and maintained using more than half of public infrastructure in For more articles on this topic search RatingsDirect with keyword: public funds. In the 1990s, private-sector Brazil is currently being run by private Infrastructure Investment participation grew significantly through interests. The role of the private sector is privatization and concessions—and not growing in Colombia, too, where one of Analytical Contacts: just in telecommunications, but in sec- every three dollars spent on infrastruc- Beth Ann Bovino New York (1) 212-438-1652 tors such as power generation, trans- ture comes from private direct invest- Joaquin Cottani mission, and distribution, especially in ment. Meanwhile, in Chile and Peru, the New York (1) 212-438-0603 Chile and Argentina. Concessions (or share has stayed more or less constant at Paul F. Gruenwald P3s) occurred in water and transporta- about 50%. Singapore (65) 6216-1084 tion services, including roads, ports, Robert Palombi and airports. Keys To Success Toronto (1) 416-507-2529 Contrary to a common view, private- Standard & Poor’s believes it’s vitally impor- Jean-Michel Six sector involvement in infrastructure— tant for countries to improve the quality of Paris (33) 1-4420-6705 both P3 and privatization—continued their infrastructure investments in addition Vincent R. Conti through the 2000s, except in Mexico and to simply increasing spending—regardless Singapore (65) 6216-1188 Argentina. In the former, problems of where economies stand in their develop- Tatiana Lysenko related to the privatization of Telmex and ment. Among other things, this could entail Paris (33) 1-4420-6748 road concessions, in which poor planning better project appraisal and selection, per- Satyam Panday and execution on the part of the govern- haps through independent assessment, New York (1) 212-438-6009 ment resulted in the public having to pay comprehensive cost-benefit analyses, and Sophie Tahiri more for mediocre services, contributed improved project execution. Paris (33) 1-4420-6788

22 www.creditweek.com Lessons Learned From 20 Years Of Rating Global Project Finance Debt

t has often been said that those who fail to learn from history are doomed to repeat it. The global project finance sector can Overview perhaps be included among those who have learned from ● Many projects that fail experience I problems in more than one area. experience. The sector learned some hard lessons in its ● The causes of default can be pioneering days, such as how to counter market exposure risk— grouped broadly into technology or operations, market exposure, parent the biggest cause of default—and how to strengthen a project’s structure and counterparties, and structure to provide the necessary resilience to withstand regulation. ● We believe differentiating risk external shocks and counterparty risk. Based on Standard & factors under our revised criteria Poor’s Ratings Services’ experience over two decades with more will provide better insight into potential weaknesses in future than 500 projects—encompassing nearly 600 project debt project financings. issues—we have often seen the sector absorb lessons from the ● We expect to continue rating projects from the ‘A’ category, for past by enhancing transaction structures, mitigating construction some availability projects, down risks, reducing counterparty exposure, and enacting many other to the ‘BB’ or ‘B’ category, for credit-protective features to become one of the most robust and more speculative projects with contractual exposures. stable sectors today.

Standard & Poor’s Ratings Services CreditWeek | January 21, 2015 23 FEATURES SPECIAL REPORT

A Retrospective Look At total project debt worldwide, so the potential weaknesses in future project Rated Project Finance rated debt may not accurately represent financings. For example, a common Twenty years ago, some industry the larger set of all project financings. characteristic among defaults is having a observers were skeptical about whether Institutional investors have tradition- parent that is not completely separate, or nonrecourse debt supported by a single ally had little financial capacity for spec- a counterparty that cannot be replaced. asset could be robust enough to garner ulative-grade debt in their portfolios and Our revised criteria describe in more an investment-grade rating. Projects can have tended to invest in projects that detail some of the risks common in be as diverse as power generation, were already operational rather than single-asset, limited-purpose entities, refining or industrial plants, transporta- those just commencing construction. and we have placed a new emphasis on tion infrastructure, lodging, entertain- However, we have seen an increase in transaction structure. ment venues, and mining. We have seen both low-rated projects and bonds Standard & Poor’s has rated 513 proj- that a properly structured and economi- issued prior to construction, indicating ects in the past 20 years, covering more cally well-conceived project can achieve that the market for project finance debt than 573 separate debt issues (some long-term rating stability when the has broadened over the years. projects have both senior and subordi- project is aligned with sound, credit- nate debt). Of these 573 issuances, 39 worthy counterparties and operates Why Projects Fail have defaulted. In the context of our under predictable legal environments Projects can fail for reasons ranging from revised criteria, we have examined the and stable sovereign jurisdictions. simple and easily identifiable to varied causes and what they may mean for the Historically, project finance debt has and complex. Standard & Poor’s recently future of project finance credit quality. often been structured to earn a low- redesigned its methodology for ana- The causes of defaults can be broken investment-grade rating (‘BBB’ or lyzing project finance debt (see “Project down into the following broad groupings ‘BBB-’). However, the number of proj- Finance Framework Methodology,” pub- (see table 1): ects rated below investment grade has lished Sept. 16, 2014, on RatingsDirect) by ● Technology or design problems during grown to about 33% of all currently dividing the criteria into five distinct construction and initial ramp-up; rated project debt and includes tranches areas: construction, operations, transac- ● Ongoing operational underperfor- initially rated as low as ‘B’ or even tion structure, counterparty risk, and the mance; ‘CCC’. Project debt originally rated spec- overarching framework that ties them all ● Exposure to market prices or lack of ulative grade has an aggregate default together. Many of the projects that failed raw materials or project output; rate of 13.4%, while project debt initially experienced problems in one or two of ● Failure of a parent company; rated investment grade has about a 3.6% these areas, and we believe differenti- ● Counterparty problems; and aggregate default rate. Rated project ating the risk factors under the revised ● Imposition of new regulations. finance debt covers at most 5% of the criteria will provide better insight into Technology or design problems Problems during construction or opera- How A Project Financing Qualifies For A Rating tional ramp-up related to technology (at some power plants and a wastewater or us to assign a project finance rating, an entity must have a minimum facility) or cost overruns (a number of Fnumber of attributes. These are defined in paragraph 15 of the revised criteria transportation projects and a mining (see “Project Finance Framework Methodology,” published Sept. 16, 2014, on project in Western Australia) would seem RatingsDirect). But in summary, the project must be structured as follows: inherent to a single-asset project. But it ● As a limited-purpose entity with relevant covenants to limit project activities, a is interesting that only about 20% of cash management waterfall, and a perfected security interest on assets; defaults resulted primarily from tech- ● With limited or no recourse to sponsors or shareholders of the project, and full nology or operational failure. Projects recourse to project cash flow and assets; that we rate are usually well-structured ● With both revenue and operating risks, so future debt service is dependent on and commonly try to mitigate this type cash flows generated by project operations; of risk by using proven technologies and ● With a limited asset life; experienced construction firms. ● With a minimum set of covenants and controls applicable to senior debt; and The EnerTech Environmental Cali - ● With clear allocation of risks and responsibilities between the project entity and fornia LLC biosolids processing plant is counterparties through the project’s life. an example of technology failure. The If an entity does not meet this minimum set of attributes, we would not rate it facility simply did not scale up as under our project finance criteria. So for example, we would rate a company with a planned and was unable to achieve single power station asset but no limitations on activities or future debt issuances expected volumes in testing or declare as a corporate entity, not as a project financing. operational status before running out of funds. Another example of technology

24 www.creditweek.com failure is Bulong Operations Pty. Ltd., a then opened to traffic volumes substan- projected, or plant availability is not nickel and cobalt mine in Western tially below projections. meeting targets. Australia. It relied on cash flow from The construction section of our LSP Batesville Funding Corp. de - operations to meet debt service costs revised criteria seeks to clearly define faulted in January 2012 because of during start-up. Initial problems with the types of risks in such situations. In chronic operational issues that caused design changes, increased construction particular, we assign assessments for the the plant to underperform and eventu- costs, and difficulties with commis- degree to which the technology is ally use up project liquidity. Choctaw sioning delayed revenues andquickly proven, the extent of design completion, Generation L.P. defaulted at the end of depleted available reserves. A financially the difficulty of the schedule, the avail- 2012 after underperforming for an weak parent was unable to inject more ability of cash set aside for contingen- extended period because of a turbine equity, so the project was forced to raise cies, and the experience of the construc- design flaw and a series of equipment more debt, increasing the burden on tion management team. Although the failures. The project did not achieve its subsequent cash flow and leading to a collapse in the Lane Cove Tunnel was contracted heat rate, and extended out- downward spiral. hard to foresee, our new criteria high- ages hurt revenues. Cost overruns were the downfall for light some of the other common risk fac- In the operational section of the several transportation projects. Metronet tors. Similarly, the Metronet and revised criteria, we spend a lot of time Rail BCV and SSL Finance PLC, conces- Eurotunnel projects would receive a identifying the potential volatility of cash sions for the London Underground, had higher assessment for construction diffi- flows (described as an operating period a complex construction schedule cov- culty under the new criteria. And business assessment, or OPBA). Key fac- ering line upgrades and station improve- Bulong’s reliance on operating revenues tors include project technology, leverage, ments to several primary underground would have been more apparent in our contract terms, raw material prices, and lines, along with new rolling stock. The calculation of the certainty of funding output market prices. Minimum debt schedule was tight and had to work sources during construction. Although service coverage under an expected around continued full operation of the we discussed these risks under our pre- base case and a reasonably stressful network. The project defaulted after sub- vious criteria, the revised criteria provide (“once in 20 years”) downside scenario stantial cost overruns and delays that consistent assessments for each of these then lead to an operating period stand- reduced revenues. Eurotunnel S.A. is types of risk. alone credit profile. In a project like another example of construction cost Batesville or Choctaw that uses market- overruns, which led to extreme leverage Operational underperformance proven technology, it is unlikely that we at the end of construction. The project Three power projects in the U.S. could identify the ultimate cause of failed because low passenger and freight defaulted because of extended opera- default up front. But, as we conduct sur- volumes during operation could not tional problems. Although such prob- veillance on a project, our projections make up for the additional debt. lems are often related to technology incorporate actual performance history, The Lane Cove Tunnel project in and design, we consider this type of and once a poor performance history Sydney, Australia defaulted after a prob- default as different from those directly starts to build, the project’s vulnera- lematic construction effort went way related to construction. For example, a bility would be more apparent. over budget, mainly because a collapse power station could underperform if Although we have not changed this in a ventilation tunnel damaged build- its heat rate remains consistently high, philosophical tack, our revised criteria ings and the highway above. The project maintenance costs are higher than define a consistent approach for the downside scenarios that aids in com- Table 1 | Breakdown Of Project Finance Issue Defaults parisons between projects.

No. of % of % of debt issues defaults Aggregates defaults Hedging/commodity price exposure A number of projects failed primarily Technology or design (during 7 20.59 Technology and operations 29.41 construction/ramp-up) because of changes in raw material or Operational (underperformance, resource prices or volumes. Renewable higher capital expenditures, etc.) 3 8.82 projects usually have volume risk, i.e., Hedging/commodity exposure 2 5.88 Market for input or output 32.35 water volumes at hydro plants, and wind or solar resources at other plants Market exposure (price or volume) 9 26.47 (although we usually have sufficient Structural weakness at the parent 6 17.65 Structure/counterparties 35.30 information about the latter and run Counterparty failure 6 17.65 base-case scenarios at a very high confidence level, so lower resources than we Regulation 1 2.94 Regulation 2.94 expect may lead to a downgrade but not Total 34 100.00 100.00 usually a default).

Standard & Poor’s Ratings Services CreditWeek | January 21, 2015 25 FEATURES SPECIAL REPORT

The other type of risk in this cate- resulting in a large increase in cost Market exposure gory is the input price, including the when the hedge expires. Sometimes Some projects sell their output through cost of transportation to the project projects are limited in the types of fixed-price contracts at known volumes, site. Many power or industrial projects hedging that are even available to them. but many are exposed to volume risk pass on the risk of fuel supply to their The Northampton Generating Co. L.P. (such as traffic volumes on toll roads) or offtaker, but some projects are respon- waste coal plant is a classic example of price risk (for example, a merchant sible for their own fuel supply. Some are this. Fuel prices were higher than power plant selling electricity at local poorly hedged or not hedged at all. project expectations and were particu- hub prices). Problems arise from fuel hedge mis- larly affected by rising diesel costs for A number of volume-based road matches (using fuel oil and hedging transporting waste coal from sur- projects in Australia, Argentina, and through a more liquid derivative that rounding areas. China defaulted for this reason (Lane referenced natural gas) and hedges that In the new operational section in our Cove Tunnel, Autopistas del Sol S.A., do not last through the debt term, criteria, a project that is vulnerable to and Greater Beijing First Expressways raw material risk would have a higher Ltd., discussed below); others in Table 2 | Number Of Defaults And OPBA than an otherwise similar project Portugal and Spain had reductions in Non-Defaults By Issuer and would, therefore, require higher debt volumes and were downgraded (BRISA And Issue service coverage for a given rating. Auto-Estradas de Portugal S.A. and Again, the intention behind the revised Abertis Infraestructuras S.A. were two Issuer Issue criteria is to better highlight such risks parent companies with exposure to Total defaults 34 39 through our more detailed scoring multiple toll roads across the Iberian Non-defaults 479 534 approach and identify potential vulnera- peninsula that faced the possibility of Total ratings 513 573 bilities among otherwise similar projects. downgrades but remained low investment grade). Although we attributed the defaults at the Eurotunnel and the Table 3 | Issue Defaults By Initial Rating Lane Cove Tunnel projects to con-

Initial rating Number % of total Defaults % of defaults % chance of default struction problems, low traffic volumes were also to blame. AAA 0 0.00 0 0.00 0.00 The collapse in natural gas prices and AA 1 0.17 0 0.00 0.00 reduced energy demand after the 2007 A 51 8.90 1 2.56 1.96 economic downturn caused problems at BBB 334 58.29 13 33.33 3.89 many power projects and led to several BB 114 19.90 14 35.90 12.28 defaults. Bicent Power LLC had a small B 63 10.99 10 25.64 15.87 portfolio of projects, high leverage, and an interest rate hedge that locked the CCC/C 10 1.75 1 2.56 10.00 company into high fixed debt service, Category making the project vulnerable. Low Investment grade 386 67.36 14 35.90 3.63 market prices for its output and a court Speculative grade 187 32.64 25 64.10 13.37 judgment against the construction sub- Total 573 100.00 39 100.00 6.81 sidiary led to a default. Bicent suffered from a number of problems and had a questionable hedging strategy, but the Table 4 | Project Finance Rating Changes By Category primary cause of the default was lower energy prices than forecasted. Original rating Upgrades Downgrades Unchanged Defaults AES Eastern Energy L.P., an operator AA 0 1 0 0 of four coal plants in western New York, A 1 15 34 1 sold 100% of its energy at spot prices and BBB 16 75 230 13 had hedged most energy and capacity BB 12 21 68 14 sales on a three-year rolling basis. B764010Management reduced its hedging when forward prices began to fall and derivative CCC/C 3 0 5 1 market liquidity contracted. The project’s Category increased exposure to falling wholesale Investment grade 17 91 264 14 power prices was due in part to record Speculative grade 22 27 113 25 low natural gas prices. With leverage of Total 39 118 377 39 $500 per kilowatt, the project could not

26 www.creditweek.com meet its debt service requirements and parent York Research Corp. hurt York debt service coverage below 1x for an defaulted in January 2012. Power Funding Ltd., a project financing extended period. The initial project rating Astoria Generating Co. Acquisitions that included four power stations in (‘BB-’) was based partly on a guarantee LLC had a shortage of liquidity and Texas, New York, and Trinidad & from the local government if required. tripped its leverage covenants. Its liq- Tobago. And the default of unrated However, when the Village of Lombard uidity crisis stemmed from reduced Calpine Rumford Inc. took down was called on to support the project, it power demand and regulatory changes RockGen Energy LLC, Tiverton Power chose not to. Consequently, we lowered in the New York capacity market, Associates L.P., and Broad River the ratings on both the project and the vil- which together led to a collapse in Energy LLC with it. lage to ‘CCC-’ and ‘B’, respectively. capacity prices. AES Drax Energy Ltd. owned the largest power station in the U.K., producing 10% of the country’s electricity. Projects face regulatory and legal risks, and we have But it defaulted in 2003 after struggling to cope with a collapse in wholesale seen projects get into financial distress after tariff or electricity prices. The killing blow was the bankruptcy of its largest offtaker. regulatory changes. Market exposure is not limited to power projects. Murrin Murrin Holdings Pty. Ltd. and part-owner Glencore Nickel Pty. Ltd. both defaulted primarily The revised criteria delineate the The Greater Beijing First Expressways because of low prices for their output extent of separation from parents and Ltd. failed after the local government did products. Windsor Petroleum Transport sponsors in greater detail. not support the project because traffic Corp. is another interesting—and volumes were below expectations. recent—default (it entered restructuring Counterparty problems Our revised criteria include a rating this year). The project operates four Counterparty problems are more assessment of all economically mean- large crude carriers and defaulted common than some projects expect. ingful counterparties and a section on because of a glut of tankers (leading to Some projects cannot replace their how we view counterparties throughout the worst shipping rates since 1999) and counterparties, such as a sewage plant a project’s life. With new tables for a drop in oil exports from OPEC due to that is unable to find a new concession assessing liquidity and replaceability, we decreased demand in the U.S. provider if the local government water are able to provide more transparency utility terminates its contract with the regarding the risk created by individual Failure of a parent company project. In other cases, a project could counterparties. Although the default of a or counterparty find an alternative offtaker but may not counterparty is often hard to forecast, We see quite a few projects that are not be able to get a new contract that makes our goal is to provide transparency on completely bankruptcy-remote from economic sense. An example would be a how such a default could affect a project. their parent companies. Usually, a project that could sell at spot prices but parent’s bankruptcy would encompass would not be able to cover operating Regulation the project, but failure of the project costs and debt service at those prices. Projects face regulatory and legal risks, and would not necessarily hurt the parent. A few examples include the Mobile we have seen projects get into financial dis- The entities have some link, such as Energy Services Co. LLC, which lost rev- tress after tariff or regulatory changes. parent control of the project entity enue after its offtaker entered bankruptcy. Examples of regulatory risks include a board, or parent funding of reserves. The offtaker for the TermoEmcali Funding local government not approving expected Companies rated higher than the project Corp. power project in Colombia defaulted tariff increases, and the recent regulations rating may have structures like this. on its power purchase agreement (PPA) in the U.S. covering particulates, mercury, Generally, this is not a problem—unless obligations, resulting in that project’s default sulfur, and planned carbon emissions, all of the parent gets into distress. as well. AES Drax Holdings Ltd. also faced which led to additional capital expenditures A good example of this was the the bankruptcy of its largest customer, TXU for the affected projects. The Panda Global failure of Enron Corp. and the domino Europe, which provided partial credit sup- Energy Co. project failed after disagree- effect that had on a number of Enron- port to counter its merchant risk exposure. ment with the local government in China sponsored subsidiary power project A similar problem is when local govern- about tariff rates. Homer City Funding LLC financings such as Teesside Power ment entities do not support projects as owned a 1.8-gigawatt coal-fired power sta- Financing Ltd. in the U.K., which relied expected. The Lombard Public Facilities tion near Homer City, Pa. New regulations on Enron as the main revenue counter- Corp. project, in Illinois, has not yet forced the plant to make large capital party. Similarly, the default of unrated defaulted, but it has been operating with expenditures to install required pollution-

Standard & Poor’s Ratings Services CreditWeek | January 21, 2015 27 FEATURES SPECIAL REPORT control equipment. That, combined with leverage in most projects suggests that if ings, meaning we excluded several hun- lower-than-expected cash flow from low a project performs as forecasted when dred credit estimates (preliminary energy prices, resulted in a default. the rating is assigned, few opportunities studies done for issuers considering a full will exist for upgrades. (The exceptions rating) and rating estimates completed Overall Project Finance could include when we raise the rating for structured finance collateralized debt Performance on a counterparty or host country.) obligations that included project debt in Of the 513 different projects we have Third, the rating reflects our expectation their portfolios. The data do include a rated in the past 20 years, 34 issuers (or that the project will generally not issue small number of projects that suffered 6.8%) have defaulted (see table 2). additional debt, merge with or acquire from multiple failures—projects that As of September 2014, we had active other businesses, or materially change— defaulted on their initial debt, went ratings on 277 distinct issuances, and all factors that frequently contribute to through a refinancing or restructuring, another 296 ratings had been withdrawn, rating changes to corporate debt. Not and defaulted again. We also excluded either at the issuer’s request, upon matu- surprisingly, project finance ratings corporate ratings, including those on rity of the debt, after refinancing and exhibit more downgrade potential than project developers. In projects that have early payment in full, or upon default of upgrade potential (see table 4). issued more than one series of debt, we the project. In general, a downgrade is just over aggregated debt that is pari passu into a About two-thirds of project debt twice as likely as an upgrade, and we single tranche. So a project with two tranches were rated investment grade ini- changed the ratings on just less than half tranches of senior debt and additional tially, most were low-investment-grade, the project debt tranches (see table 5). subordinate debt has two distinct but they accounted for one-third of the We also segregated initial ratings into issuances in our data. project defaults (see table 3). A growing investment grade and speculative grade portion is rated in the ‘BB’ category. and counted the number of crossover The Future Of Project One of the guiding principles of debt issuances. Almost 75% of debt ini- Finance Ratings Standard & Poor’s analysis of project tially rated investment grade retained We expect to continue rating projects debt risk is that the initial rating should that rating level; 22% moved to specula- from the ‘A’ category, for some availability assess default risk through the debt’s tive grade, and the remaining 3% projects, down to the ‘BB’ or ‘B’ category, maturity, rather than the more limited defaulted (see table 6). Of the debt ini- for more speculative projects with con- timeframe for typical corporate entities. tially rated speculative grade, 6% moved tractual exposures. However, structures There are a number of reasons for this. to investment grade, 80% remained will continue to evolve. For example, we First, transaction structures and speculative grade, and 13% defaulted. expect most future U.S. power projects to covenants ensure that management is include pass-through provisions or com- typically restricted from making changes Methodology pensation for future carbon costs. And it to the nature or scope of the project, This article compares the initial debt rat- is likely that some project financings will financing structure, and even counter- ings with the last available rating. If the still fail. Structuring a default-free project parties or ownership. Second, the combi- debt has a current active rating, we use would require uneconomical contracts or nation of long-term contracts and high that one; if the debt rating has been levels of liquidity. withdrawn, we list the last rating prior to Our goal with the revised criteria is to withdrawal. This provides more informa- add transparency by isolating the weak Table 5 | Rating Changes tion about debt that has been retired points in projects. Some events, such as By Direction both for positive and negative reasons. changes in natural gas prices, are hard to Up Down Unchanged A number of projects were structured forecast, but our new, more detailed assess- Investment grade 50 127 209 with multiple tranches of debt, so the ment methodology attempts to show number of distinct tranches was 573. exactly which changes could put a project Speculative grade 29 65 93 This data include both public and confi- in distress. By applying our own downside Total 79 192 302 dential ratings but covers only “full” rat- analysis, we aim to make it clear how resilient a project is to what we believe is the most likely stress scenario. CW Table 6 | Crossovers By Rating Category For more articles on this topic search RatingsDirect with keyword: Original Currently Currently issue rating investment grade speculative grade Defaults* Project Finance Investment grade 386 289 83 14 Analytical Contacts: Speculative grade 187 12 150 25 Ben L. Macdonald, CFA San Francisco (1) 415-371-5005 Total 573 301 233 39 Michael Wilkins *Last rating prior to withdrawal. London (44) 20-7176-3528

28 www.creditweek.com Europe’s Investment Plan How To Spend €315 Billion In Three Years

Overview

● The European Commission’s Juncker Plan aims to deliver €315 billion of investment over the next three years, mostly from capital markets, to boost Europe’s economy and create jobs. ● We believe the plan, mainly for long-term strategic project investment but with a sizable portion ring- fenced for investment at SMEs and mid-market companies, is ambitious but achievable. ● Our analysis shows that increased investment in infrastructure can stimulate economic growth and create jobs as long as projects have a clearly targeted rationale and viable structure. ● However, we consider the plan’s greatest challenge will be to open up the capital markets sufficiently in a relatively short three-year timeframe, given its aim to attract private-sector investors at a multiplier of 15x the EU’s and EIB’s investment both for projects and SMEs. ● To succeed, we believe the plan will have to attract substantial crowding- in of the private sector through scaled-up capital market funding with support and incentives from Europe’s multilateral institutions, politicians, and policymakers.

s part of an ambitious plan to rejuvenate the eurozone’s faltering Aeconomy through greater infrastructure spending, the European Commission (EC) has identified a pipeline of 2,000 projects worth an estimated €1.3 trillion. These projects will be financed primarily through the capital markets. The projects are the backbone of the so-called Juncker Plan, named after the new EC president, Jean-Claude Juncker.

Standard & Poor’s Ratings Services CreditWeek | January 21, 2015 29 FEATURES SPECIAL REPORT

The EC formally adopted the plan on Jan. initial examination, the EC’s project list motivate this kind of step change in pri- 13, 2015, following its endorsement by EU resembles more of a wish list than a fully vate-sector funding (see chart 1). leaders at their year-end summit on Dec. worked-through pipeline of prioritized The main proposal of the plan is to set 18, 2014 (1). With the goal of creating jobs infrastructure projects. up the EFSI, a managed account on the and boosting growth, the plan aims to More transparency and detail are EIB balance sheet that will benefit from inject €315 billion into the European required to prioritize the projects and first-loss guarantees by the EU. The EFSI economy over the next three years. make them attractive and viable invest- will invest in riskier projects—or in more Under the plan, the EC will establish a ment propositions. In this respect, the junior positions in low-risk projects—to European Fund for Strategic Investment U.K.’s and the Netherlands’ work devel- help attract further private capital. (EFSI) with an initial size of €21 billion— oping their own infrastructure pipelines Such credit-enhancing initiatives are most of it for long-term project invest- could serve as useful templates. not new, and have had some success ments, while nearly a quarter will be ring- To implement the plan, the EC has lately in helping stimulate capital market fenced to fund investment at small and recognized that better regulation and activity in infrastructure. Such is the case midsize enterprises (SMEs) and mid- deeper capital markets are essential for of the EC project bond initiative, which, market companies. Of the facility’s initial investment (2). To this end, it proposes since August 2013, has been successful amount, the EU will provide €16 billion to develop long-term investment plans in leveraging €3 billion of bond in the form of guarantees, and the and an EU-level website linked to financing into five projects by providing European Investment Bank (EIB) will member states’ project pipelines. It also just under €500 million in contingent liq- provide €5 billion. The EFSI will invest in intends to provide technical assistance uidity support. riskier projects—or in more junior posi- through an EU investment advisory hub Nevertheless, scaling-up these early tions in low-risk projects—to help attract and procedural standardization, such as successes to the level envisaged under further private capital 15x greater than for public-private partnerships (PPPs). the Juncker Plan will, in our view, the initial EU and EIB €21 billion input. It also wants to introduce value-for- require more radical policy changes. Despite the plan’s laudable aims, money assessments to identify the most For example, on Dec. 3, 2014, the U.K. market observers have expressed many efficient project-structuring solutions announced a withholding tax exemp- concerns about its feasibility, applica- and propose new financial instruments tion for private placements in infra- tion, and ultimate ability to attract the to advance viable projects that are not structure, which prompted six invest- necessary level of institutional capital. yet financed. ment companies to immediately We believe the biggest hurdle to be commit £9 billion to the sector. Allianz Key Roadblocks And How overcome is opening up the capital mar- Global Investors alone announced it They Might Be Overcome kets to finance the plan, especially in the would allocate upward of £3 billion We see three key challenges for the relatively short time frame of three years. over the next three to five years. Juncker Plan: Although we believe there is significant Replicated on a regional scale, and ● Attracting sufficient long-term institu- and growing institutional appetite for complemented by other support mech- tional capital within a relatively short infrastructure investment—both debt and anisms, policy changes such as these time frame; equity—more intervention is required to could be the shot in the arm that is ● Convincing the public that infrastructure investment will rekindle EU economic growth; and Chart 1 | EU Member States’ Perceived Barriers To Infrastructure Investments ● Converting a €1.3 trillion project wish list into a credible and investable Administrative capacity pipeline. Project size gaps In our view, these challenges are not insurmountable. We believe there is a Project complexity strong case for increased investment in Regulatory framework infrastructure—if properly targeted— High financing costs acting as a stimulator for economic Financial regulation & capital markets growth and job creation. However, a Mid-caps & SMEs’ access to finance clear economic rationale that justifies each investment is also important Financing constraints because a project’s long-term viability Macroeconomic uncertainty will ultimately depend on it. 0 5 10 15 20 25 Market participants have been calling (No. of EU member state respondents) for a credible and comprehensive Source: European Commission. pipeline of projects across the EU. Upon © Standard & Poor’s 2015.

30 www.creditweek.com required to turn an EC wish list into an increase in spending of 1% of real EU reality. GDP in the first year. In the eurozone as a whole, we estimate the multiplier effect Building A Case: The Need For to be 1.4x, with Germany and France Infrastructure Investment coming out slightly lower at 1.2x and Does infrastructure investment always 1.3x, respectively, while Ireland and lead to economic growth? This premise Spain would benefit the most at 1.4x and has been challenged by CEPS, a Brussels- 2x, respectively. For the U.K., the EU based think tank, which has argued that simulation produces a multiplier of 2.5x. investment across the EU was probably The main reason for the additional boost above sustainable levels prior to the to U.K. GDP is increased demand from financial crisis due to the pre-2007 credit its European trade partners. We also boom. It argues that infrastructure project that such investment would add investment might only be justified as a more than 300,000 jobs in the same year growth stimulator in countries that have as the increase occurred. high levels of efficiency (3). Although we estimate the 20-year However, our own economic analysis accumulated investment deficit in the shows that infrastructure spending boosts U.K. to be about £64 billion (3.7% of output growth through demand in the short 2013 GDP), Bruegel—another Brussels- term and supply in the long term (see “Global Infrastructure Investment: Timing Is Chart 2 | Anticipated Investments By Sector Everything [And Now Is The Time],” on p. 12). 2015 To 2017 The demand-driven effect depends on where an economy stands in its economic Transport (29%) cycle; it’s stronger at the low point in a cycle. At the same time, the supply-driven Energy union (29%) effects depend on how productive invest- Knowledge, innovation, ments are, which, in turn, could be linked and the digital to how they’re financed. economy (18%) We believe that without growth, compli- Social ance with the EU’s fiscal rules by the infrastructure (15%) majority of its 28 member states will be almost impossible to achieve. Standard & Resources and environment (9%) Poor’s Ratings Services has stressed that Source: European Commission. the macroeconomic environment across © Standard & Poor’s 2015. the eurozone remains stubbornly weak, with faltering growth and deepening dis- Chart 3 | Identified Projects By Country inflation (see “Credit Conditions: The Eurozone Crawls Into 2015 With Weak Transport Knowledge innovation digital Resources & environment Momentum,” published Dec. 4, 2014, Energy Social infrastructure and health education on RatingsDirect). (Mil. €) Our economic simulations show that 70,000 each additional £1 spent on infrastruc- 60,000 ture in the U.K. alone in one year would 50,000 increase real GDP by £1.9 over a three- 40,000 year period. We also project that addi- 30,000 tional spending of 1% of GDP in the 20,000 U.K. would add more than 200,000 jobs (see “Building For Growth: Can The U.K. 10,000 . 0 l s a a a a a a a a a g y n Close Its Infrastructure Investment n i i i i ly i p m rk ry ce e ti ri ki ga a n n rus d and and a and tvi iu a an l U.K. p It an and a g ga Deficit?” on p. 55). Re u Spa man ol n nga bour man L h nma we el h Fr ul P Greece Irel Cy ortu Austri lov love Cro erl Esto Fi m S B B S P S h Hu e Other simulations by Standard & Ro Ger De Lit x Czec

Poor’s economists have estimated the Net Lu benefit to various eurozone economies Source: European Commission. over a three-year period (2015-2017) of © Standard & Poor’s 2015.

Standard & Poor’s Ratings Services CreditWeek | January 21, 2015 31 FEATURES SPECIAL REPORT based think tank—has estimated the most in the financial crisis. It remains sufficient to attract a further €70 billion equivalent deficit across the EU-15 to be unclear, however, which SME and mid- of investments to achieve the overall about €260 billion since 2006 (4). Even market companies specifically will ben- total amount the plan targets. this could be an underestimate, efit from this cheaper source of capital. High-risk start-up companies typically according to other sources. The current “ring-fencing” of the €5 bil- require a high equity cushion of approxi- In November 2014, the EC and EIB lion just covers SMEs and mid-market mately 40% or more. As a consequence, the commissioned a special task force that companies in general. From an eco- overall capital raised might be lower than identified that EU investment in 2013 nomic perspective, the EU money would the intended €75 billion. Furthermore, was 15% (€430 billion) below its pre- probably best be put to work by sup- given the current economic climate, the crisis peak in real terms (2). In some EU porting companies that create the issue might be less that companies lack member states, the range was said to be highest degree of innovation and the access to funding than that macroeconomic between 25% and 60%. most jobs as they grow, and those that and fiscal uncertainties encourage them not At this stage, there is insufficient infor- currently are cut off from external to invest. In such an environment, compa- mation from the list of 2,000 projects to financing to realize their plans. This nies might be unwilling to fully utilize the identify which would be viable from the would most likely be start-ups, younger benefits of the additional EU funding. perspective of raising large-scale invest- firms, and established SMEs with a However, if the EIB and EIF can suc- ment-grade debt. The projects are not growth focus. Should any of this EU cessfully address these potential weak- prioritized, and there are scant details on money be allocated to companies that nesses, we believe that the SME and procurement or financing methods. do not fit this business profile and that mid-market carve-out of the Juncker Nonetheless, the list contains a have access to external capital—either Plan offers a viable route to support number of projects in sectors that have directly through extension of capital by growth and employment in Europe. proved successful in attracting private the EIB or indirectly through EIB pack- investment, such as regulated power ages provided to commercial banks—the Financing The Plan transmission grids and PPP road proj- intended social benefits of the program Key to raising the total €315 billion for ects. However, there are others—such as might be reduced, in our view. The EU all initiatives is the crowding-in of pri- offshore wind power and high-speed rail money would then simply become an vate investors into projects funded by projects—that could prove problematic additional pool of competitive funds for the newly created EFSI. The facility size given their risk profiles and relatively already plentiful funding liquidity by will initially be €21 billion. Of this short operating histories. European commercial banks. amount, the EU is to provide €16 billion We also see some potential that com- in the form of guarantees, and the EIB The Fund Will Also Support SMEs mercial banks could be incentivized to will provide €5 billion. And Mid-Market Companies use the EIB financing to support their Out of the €16 billion of guarantees The bulk of the EFSI will support infra- own existing lower-risk clients instead of from the EU, we expect a large portion structure debt investments, but a extending credit to high-risk start-up will guarantee investments by the EIB. meaningful portion will be dedicated to companies. Should the EU funds indeed The remainder will likely be allocated to small and midsize enterprises (SMEs) flow into higher-risk start-up companies, cover equity or equity-like investments and mid-market companies. In partic- the question would still remain whether as well as SME investments through the ular, we expect that the EIB and the EU €5 billion provided via the EIF would be EIF (for €2.5 billion). will provide €5 billion in the form of equity-type investments and loan guarantee facilities via the European Table 1 | Selected EU Infrastructure Projects & Corporates Rated In 2014 Investment Fund (EIF). This aims to Rating date Companies or projects New rating/outlook generate a total of €75 billion of funds Jan. 2014 Scot Roads Partnership Finance Ltd. A-/Stable over the period 2015-2017 for SMEs Feb. 2014 EMPARK Aparcamientos y Servicios S.A. BB-/Stable/— and mid-market companies through a 15x multiplier or through raising addi- April 2014 Solutions 4 North Tyneside (Finance) PLC BBB- (SPUR)/Stable tional private capital on top of the €5 Aug. 2014 2i Rete Gas BBB/Stable/A-2 billion of EU and EIB capital. Aug. 2014 V.Group B/Stable/— How the money will be distributed will Sept. 2014 Dee Valley Water PLC BBB/Stable/— be decided by an administrative council Oct. 2014 Domodedovo International Airport CJSC BB+/Stable/B jointly controlled by the EIB and the EC. Nov. 2014 Western Power Distribution Ltd. BBB/Watch Pos/A-2 Since the funds are supposed to support growth and the creation of new jobs, we Dec. 2014 Aberdeen Roads (Finance) PLC A- (prelim)/Stable expect that a higher percentage will be SPUR—Standard & Poor’s underlying rating. Ratings as of Jan. 15, 2015. Sources: EIB/InfraNews, Standard & Poor’s. allocated to countries that have suffered

32 www.creditweek.com But where will the rest of the money the EFSI. If we were to assess that the such as bonds and private place- come from? Converting €16 billion of additional risk taken significantly out- ments—the scale of institutional EU guarantees and equity investments weighs the protection offered by the EU funding that the Juncker Plan envisages from the EIB into €240 billion of real guarantees, this could put pressure on is still unprecedented. long-term investments over three years EIB’s capital adequacy. According to Preqin, a data provider, will be a challenge. We expect this 15x The EC points to €650 billion of infrastructure funds had raised about $27 multiplier to be achieved by a combina- existing sources of funding available billion globally through the third quarter tion of leverage and an element of (including co-financing from member of 2014, mainly for unlisted equity crowding-in (incentivizing co-invest- states) at the EU level through programs investments, with about 25% of these ment) from other funding sources. The such as the Connecting Europe Facility, funds focused on Europe (6). Assuming EIB could deliver new loans, supported which provides grants and financial global project bond issuance of about by a first-loss piece guarantee from the instruments. However, deployment of $37 billion as a proxy for institutional EU. These loans would then crowd in finance through such sources and instru- debt appetite, together with the €38 bil- other investors to achieve the overall ments has been slow to date. lion of institutional investor capital investment target. Over the past years, the EIB already raised via funds in 2014, total nontradi- EIB projects typically attract about 3x borrowed about €70 billion each year to tional sources of capital are still only a as much private investment as it finances support its lending initiatives (€72 billion quarter of what the plan requires on an through its loans for projects. However, in 2013). With the additional lending annual basis. the EIB believes it could significantly envisaged under the Juncker Plan, we Institutional appetite for infrastructure increase this multiplier by financing would expect funding volumes to remain project debt has so far focused on 1) higher-risk (and higher-yielding) projects in this range. operational availability-based projects or being more junior in the structure of The real aim of the fund is to attract where regulatory and political risks are the project financing, as these projects large-scale private investment, especially limited, and 2) social infrastructure (hos- will benefit from the first-loss piece guar- from institutional investors. According to pitals, schools, and housing). Projects antee from the EU. Linklaters, a law firm, approximately that are in construction, rely on demand The partial de-risking of transac- €800 billion could be available from pri- from users to generate revenues, or are tions could well attract larger-scale vate funds for investment in European exposed to general market risk have investments from nontraditional infrastructure until 2023, provided there been less well supported. This could sources of capital, such as pension are enough sound revenue-generating change over time as investors continue funds, insurers, and other institutional projects for investment (5). to hunt for yields typically found only in investors, and so a multiplier of 3x is Although institutional investment in riskier projects (see table 1). likely to be a lower bound. infrastructure across the region has The project bond credit enhancement We expect the EIB to prudently been growing rapidly over the past two (PBCE) instrument from the EIB—which manage its additional risk arising from years—especially in debt instruments, has closed five transactions since August

Table 2 | PBCE Transactions Closed Since August 2013

Project Description Bond SizeRatings PBCE Pricing Project Castor Offshore underground €1.4 bil., BBB/Stable (at issue) €200 mil. initially 5.7% to 100 bps over (Watercraft Capital S.A.), gas storage infrastructure publicly listed sovereign at issue Spain project in Spain Greater Gabbard Electricity transmission £305.1 mil., NR £45.8 mil. 125 bps over the OFTO, U.K. assets connecting wind publicly listed benchmark U.K. gilt turbines of the Greater rate, or 4.317% Gabbard offshore wind farm to the U.K. onshore grid A11 Belgium First greenfield €590 mil. NR €115 mil. 4.50% availability-based road transaction Axione Infrastructures First PBCE project in €190 mil., 11-year NR €38 mil. 2.622%, 95.7 bps over France the broadband sector amortizing bond 10-year 1.5% and first PBI project German bund in France A7 motorway Germany First PBCE project in €429 mil., 29-year NR €85 mil. 2.96% Germany and second amortizing bond greenfield project PBCE—Project bond credit enhancement. PBI—Project bond initiative. bps—Basis points. NR—Not rated. Sources: EIB/InfraNews, Standard & Poor’s.

Standard & Poor’s Ratings Services CreditWeek | January 21, 2015 33 FEATURES SPECIAL REPORT

2013—has demonstrated how contingent capital can be deployed to good The need for greater infrastructure spending and the effect in sectors such as gas storage, offshore transmission, and availability- positive impact such targeted investment can have based roads (see table 2). Still, so far the instrument has not been applied to on the economy is relatively well understood. riskier projects that are either in construction or are exposed to volume risk. We believe the EFSI—described by EU officials as “PBCE on steroids”— (GW) power link between Spain and example, has agreed EU funding but with clearer definition on how it will be France costing up to €1.9 billion and a could ultimately be redundant given two targeted as well as how it will be struc- €1 billion two-GW Europe-Asia intercon- other Alpine railway tunnel projects tured could well succeed in attracting nector between Greece, Cyprus, and already under way. The rationale for the other sources of private capital. The Israel. Spain alone is offering €12 billion Fehmarn Belt tunnel is also weak, while need for greater infrastructure of power grid projects. the expansion of Frankfurt airport could spending and the positive impact such The list includes offshore wind plans quite feasibly be funded by its private targeted investment can have on the in the Netherlands (€12 billion) and owner, Fraport. CW economy is relatively well understood. Germany (€6.5 billion)—the latter also For the plan to succeed, substantial submitted more than €5 billion of off- NOTES crowding-in of the private sector shore grid link projects. (1) An Investment Plan For Europe, through scaled-up capital market Liquefied natural gas (LNG) facilities European Commission, Nov. 26, 2014 funding will be essential and, we also feature prominently on the list as (http://eur-lex.europa.eu/legal- believe, ultimately achievable—as long countries seek to benefit from plunging content/EN/TXT/PDF/?uri=CELEX:5201 as Europe’s multilateral institutions, global LNG prices and also ease 4DC0903) politicians, and policymakers provide increasing concerns over the security of (2) Special Task Force (Member States, sufficient support and incentives. supply that stem from geopolitical ten- Commission, EIB) On Investment In The sions in Russia and the Ukraine. EU—Final Report, November 2014 A Viable Project Pipeline, Or An Outside energy, the focus is mainly (3) Investment as the key to recovery in Overambitious Wish List? on transport links, with large-scale road the euro area? Daniel Gros, CEPS, Nov. The commission has identified €1.3 tril- PPP programs proposed for Germany 18, 2014 lion of potential investments (about (€10 billion), the Netherlands (€8.3 bil- (4) Measuring Europe’s Investment 2,000 projects), of which €500 billion lion), and Italy (€12 billion). There are Problem, Gregory Glayes et al. Bruegel, could be spent over the next three years also a number of mega-projects, Nov. 24, 2014 (7). The list is based mostly on sugges- including the €6.2 billion Fehmarn Belt (5) Set to revive: Investing in Europe’s tions of national governments but also tunnel project in Denmark, the €3 bil- infrastructure, Linklaters, March 2014 on recommendations from regional lion expansion of Frankfurt airport, the (6) The Q3 2014 Preqin Quarterly Update: authorities, other public bodies, private €11.7 billion Turin-Lyon railway, the Infrastructure. November 2014 investors, and the EC itself. €12.2 billion Brenner railway tunnel in (7) Project List From European Transport and energy projects consti- Italy, and two motorway plans in Commission, November 2014 tute 60% of the total (see chart 2). Romania costing €6 billion each. Some Electricity and gas interconnectors fea- of these mega-projects have been on For more articles on this topic search RatingsDirect with keyword: ture prominently on the list, with proj- the drawing board for years and have Europe’s Infrastructure Investment ects connecting Western European already been allocated EU funding but Analytical Contacts: countries (such as France, Belgium, have not been started. The Romanian Michael Wilkins Spain, the U.K., and Ireland) but also motorway investment project is already London (44) 20-7176-3528 between Central and Eastern European well under way—the government plans Mark P. Waehrisch countries (such as the Czech Republic, to spend about €4 billion, with another Frankfurt (49) 69-3399-9162 Hungary, Slovakia, Romania, Bulgaria, €5 billion from the EU—so in our view Aurelie Hariton-Fardad and Greece) as well as between the this is largely a recycling of existing London (44) 20-7176-3677 Baltic countries (see chart 3). projects for which funding has already Elie Heriard Dubreuil The Europe-wide effort to integrate been identified. London (44) 20-7176-7302 national power grids into an intercon- Although being on the list could Jean-Michel Six nected electrical system is a strong force accelerate the process, there remain Paris (33) 1-4420-6705 behind the plan. The list includes large- doubts as to the need for some of these Tatiana Lysenko scale schemes, such as a five-gigawatt schemes. The Brenner tunnel, for Paris (33) 1-4420-6748

34 www.creditweek.com Are Rumors For Global

Project Finance Bank Overview

● Banks are finding the project Lending’s Demise finance sector attractive again, and lending is picking up. Greatly Exaggerated? ● Project finance exposures rarely weigh materially on our assessment of banks’ risk positions. ank lending to the global project finance sector is again on ● Increased bank lending could be the upswing, following a long decline since 2011. For seen as delaying further the development of an institutional B2014, total project lending stood at $321.3 billion, up 4% investor market for project finance, on the $309.5 billion signed in 2013 and the second-highest and this is a concern if banks suddenly pull back again. annual volume on record, behind 2011’s $331.1 billion.

Standard & Poor’s Ratings Services CreditWeek | January 21, 2015 35 FEATURES SPECIAL REPORT

Banks remain attracted to project bypassing the banks—in the project Credit Agricole, November 2014). finance mainly because of the sector’s finance industry? Are we on the verge Altogether, global project finance loan profitability relative to corporate of seeing major changes that could volume totaled $198 billion in the first lending and higher recovery rates. For increase bank funding availability and nine months of 2014, accounting for just the main lenders to the sector, this liquidity, or will the project finance over 6% of the syndicated loan market activity does not represent in our view lending market remain a niche and and up 15% on the $172 billion recorded a major concentration risk, with related entrenched sector for a small number of in the same 2013 period. For the full year exposures typically accounting for less largely European and Japanese banks 2014, syndicated loan market share for than 5% of a bank’s balance sheet— already active in the sector? project finance was 10%, up from 8% the and still garners a relatively favorable previous year (see charts 1 and 2). treatment under Basel III. In fact, Project Finance Lending: A changes in regulatory treatment during Noticeable Pickup Increasing Liquidity And 2014 were positive for certain project In the third quarter of 2014, global Decreasing Margins finance bank commitments. project finance loans moved ahead of Funding and liquidity costs for many What impact could this lending the rest of the loan market and grew to Western European banks continue to increase have on our assessment of $80 billion, up by 38% compared with decrease and are significantly below credit risk for those most exposed to the second quarter of the same year, those costs in 2011 and 2012. Although the sector? And what does this mean for making the the third busiest quarter over Japanese banks still enjoyed a potential the future of disintermediation— the past 10 years (according to “Review of funding cost advantage over Western increased capital markets activity Project Finance Loan Markets Q3 2014,” European banks of about 25 basis points

Project Finance And The Impact On Capital Adequacy And Risk Position

tandard Poor’s bases its overall opinion on a bank’s pro- investor base by issuing secured lending or linking to non- Sjected capital adequacy from its quantitative risk-adjusted bank participants, contributes to the bank assessment. In our capital model (RAC) for banks. We do not differentiate corpo- view, international funding and capital resources would rate risk from income-producing assets such as project remain scarce for narrow wholesale business models in finance. This means our capital model criteria do not define project finance, particularly when they focus on highly specific charges for project finance assets when computing cyclical financing activity. Although we believe that project our risk-weighted assets. Rather, we apply a risk charge to the finance activities can weigh on banks’ net funding require- exposure at default for a project loan that would be the same ments, the modest relative size of these activities for the as to a corporate credit exposure. Such risk charge increases largest lenders to the sector and their diversified funding pro- with the average economic scores derived from our Banking files mitigate the overall impact. We note that, as a large pro- Industry Country Risk Assessment economic scores and the portion of project finance projects are funded with U.S. dol- geographical distribution of the bank’s assets. lars, the activity increases foreign currency funding When assessing the risk position, we determine whether requirements for a number of the largest lenders to the sector. potential risks are not fully covered by the RAC ratio and Such mismatches have contributed to reduced French bank the risk weight applied. This could be the case, for example, activity in trade finance or export finance loans since 2012, due to concentration exposure, and possibly higher tail risk. when short-term wholesale capital market funding in U.S. dol- We look at an exposure to given industry sectors, geogra- lars for them suddenly dried up. phies, or obligors. We see higher risks in project loans Furthermore, project finance loans tend to be less liquid where there are, among other aspects, either large con- than other credit exposures, such as corporate leveraged struction risks or uncertainties around regulatory or polit- loans. They are not traded in the secondary markets. Where ical risks. The same is true for those with material refi- asset sales may have taken place they have not led to infor- nancing risk. Refinancing risk is the risk that an existing mation being made public. Also, the insurance capital market loan cannot be repaid from a new borrowing. As for other base for investing in projects that include construction risk is types of credit exposures when analyzing risks, we review more limited. current and future economics that support the bank credit Finally, how complex a project finance construction period exposure. We also review underwriting and origination, is can lead to project exposures remaining funded through a where we see these relaxing to anticipate increased risk of bank balance sheet for a longer time before an issuer can con- future credit losses. template a capital market exit. This is different from other Project finance and the impact on funding position. Banks’ asset types, such as leveraged loans again, where the “under- ability to source funding, including the capacity to broaden its writing to market” time can be much shorter.

36 www.creditweek.com (bps) at year-end 2014, the stronger reality, although the banking market is cover unexpected losses, as well as the European banks are slowly converging very strong. banks’ ability to source sufficient long- with those of the Japanese banks and Such deals included the A11 road in term funding—particularly in light of among themselves. Bank appetite for Belgium, the A7 motorway in Germany, generally long tenors in this sector—to long-term lending continues to grow. the Greater Gabbard offshore power grid support their overall funding and liq- Since 2012, margins for project in the U.K., and the L2 road and Axione uidity positions. finance deals have been trending down broadband projects in France. faster than for corporates, while sec- Project finance exposures rarely ondary loan market activity appears to How Project Finance weigh materially on our assessment be on the decline again, with short-term Investment Affects Our Bank of banks’ risk positions bank liquidity costs falling back close to Creditworthiness Assessment As part of the analysis of a bank’s risk pre-credit crunch levels. When assessing the possible impact of position, we analyze how exposures are In EMEA, project finance margins project finance lending on a bank’s cred- split among different segments, such as still carry a significant premium of itworthiness, one key consideration for governments, the financial sector, cor- 220 bps relative to investment-grade Standard & Poor’s is whether this leads porates, and households. For corpo- corporate margins. However, after to any material concentration in the rates, we also typically analyze whether European public-private partnership institution’s risk exposures. Other con- a bank is exposed to any concentration (PPP) pricing stabilized in 2012 and siderations include whether the returns on individual sectors and the possible 2013, it is now trending rapidly down. offered by these exposures enable the tail-risk or greater cyclicality that could Also, a decrease in market activity in banks to generate sufficient capital to result from this. the third quarter in EMEA led to further price competition as investor liq- Chart 1 | Global Project Finance Market Overview uidity continues to improve. Proceeds this market (left scale) Market share (right scale) Project Finance Loans Still Take Dominance, With Bonds (Mil. $) (%) Rising In EMEA 300,000 12 The project finance loan market in 250,000 10 EMEA rose slightly in the first half of 200,000 8 2014 to $51.8 billion, up from $46 billion 150,000 6 in the first half of 2013, a rise of 12.6%. Europe made up $36.7 billion of the 100,000 4 total, with the Middle East contributing 50,000 2 $9.4 billion and Africa $5.7 billion. The 0 0 Japanese banks remain a key funding 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 source, but French, U.K., Dutch, German, Note: Industry total $2,577,054,200. Total issues 7,878. Source: Thomson Reuters. and Spanish banks were represented too. © Standard & Poor’s 2015. However, European bankers still feel that deal flow is slow, amplified by the Chart 2 | Project Finance Loans By Quarter And Region fact that competition is now hot between banks and other types of debt-funders, Americas Asia-Pacific EMEA Total such as the institutional and bond (Mil. $) investors that are encouraged by the 70,000 Europe 2020 Project Bond Initiative that 60,000 is promoting debt capital markets as an additional source of financing for infra- 50,000 structure projects. 40,000 Project bond volumes in the region 30,000 reached $11.7 billion, up from $8 billion 20,000 this time last year, a 46% increase (see 10,000 table). All the bonds were in the 0 2004 2004 2005 2006 2007 2007 2008 2009 2010 2010 2011 2012 2013 2013 2014 European region, aside from the $2 bil- Q1 Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1 Q4 Q3 lion Tamar oil and gas deal in Israel. EMEA—Europe, Middle East, and Africa. Institutional financing led by project Source: Thomson Reuters. bonds and private placements is a © Standard & Poor’s 2015.

Standard & Poor’s Ratings Services CreditWeek | January 21, 2015 37 FEATURES SPECIAL REPORT

Project finance typically represents a change for higher levels of capitalization, by using a different credit conversion small proportion of banks’ overall credit as well as the quality of bank capitaliza- factor. This has been seen as a positive exposure. For instance, for some of the tion profiles. In response, banks have change for certain trade and project largest lenders to the sector, project been derisking balance sheets, delever- finance commitments (as opposed to finance represented less than 5% of the aging, and moving toward achieving drawn loans) in relation to letters of overall exposures to corporates. better matched funding. Banks have also credit that have a 50% instead of 100% Therefore, we rarely view project finance increased their liquidity buffers. credit conversion factor. activities as materially affecting banks’ However, banks have made material The Net Stable Funding Ratio (NSFR) overall corporate risk exposure. progress in the past few years in capital will require that a bank holds stable Another reason for this is that project ratios and strengthening their funding funding that matches the liquidity char- finance has demonstrated a strong and liquidity measures. Combined with acteristic of their assets, and therefore default and recovery record, and proved greater visibility now in terms of regula- caused concerns that it would be costly to remain resilient during the last global tory requirements and often protracted and difficult for banks to have project financial crisis. When compared with implementation horizons, we believe finance backed by long-dated deposits corporate default rates (although based that this could support some recovery in or funding. Nevertheless, the NSFR does on limited data), our rated project lending to project finance for a number not distinguish loans to corporates from finance transactions default rate has of entities, as capital build-up in some project finance as long as the maturity is averaged 1.5% since our first default in regions may have reached a turning beyond a year. It has given banks an 1998, close but slightly below the default point (see “The Top 100 Rated Banks: Will incentive to move away from short-term rate for corporate issuers over the same 2014 Mark A Turning Point In Capital wholesale funding and increase funding period (1.8%). Compared with corpo- Cushioning?” published Oct. 6, 2014). through deposits. Long-tenor assets rates, the post-default recovery rate is In 2014, the Basel committee pub- expose banks to the risk of having to roll higher, which can be explained by the lished a modification of the leverage over the funding requirement several strong collateral package of project debt ratio’s exposure, using a more granular times during the exposure’s term, if not (see “Default Study: Project Finance Default approach to off-balance-sheet exposures fully matched in maturity from day one. And Recovery: Shale Gas Fuels Rise In U.S. Defaults,” published Aug. 9, 2013). Chart 3 | Risk-Weighted Assets—Top 50 European Banks We believe, however, that some project subsectors, such as shipping or (Bil. €) aviation, can be more cyclical. In a few 11,400 cases, often with smaller banks, we 11,200 -6.5% believe that concentrations in more 11,000 cyclical sectors weigh on these entities’ 10,800 risk profiles. 10,600 -5% 10,400 10,200 Stricter Regulations Have 10,000 Affected Banks’ Lending 9,800 Capacity, Although Pressure 9,600 Is Alleviating 2011 2012 2013 Source: Standard & Poor’s. We believe that stricter bank regulations © Standard & Poor’s 2015. being implemented since the crisis for capital, funding, and liquidity require- Chart 4 | Risk-Weighted Assets—Top Five French Banks ments, have affected banks’ capacity to lend. Banks around the world have been (Bil. €) restructuring and rebalancing their busi- 2,250 nesses after the financial crisis, which 2,200 has brought about a new era of tighter 2,150 2,100 -12% rules and regulations for financial institu- 2,050 tions. In response, the largest banks have 2,000 been building their capital cushions. 1,950 0% Basel III introduced radical changes in 1,900 capital requirements leverage, and liq- 1,850 1,800 uidity and funding ratios. Authorities’ 2011 2012 2013 approaches to strengthening banks’ reg- Source: Standard & Poor’s. ulatory capital remain a key impetus for © Standard & Poor’s 2015.

38 www.creditweek.com Banks may also have to deal with dominant lenders, the shift would be governments, banking authorities, and attracting international deposits such as radical, contrary to the U.S., where cap- central banks have sent strong signals that dollar funding, relying instead on less ital markets have taken a bigger role. banks have a key role to play in support of stable wholesale funding from the cap- The most visible part of disintermedia- economic growth and job creation. ital markets. tion in Europe has been in the corpo- Top European banks reduced signifi- Overall, new regulations have con- rate sector, with some countries like the cantly their risk-weighted assets during strained banks’ ability by increasing U.K. and France being more advanced 2012 and 2013, through, among other their costs to take long-term illiquid than in the Eurozone overall. measures, limitation of new lending, a assets on their balance sheets. Banks shift in the composition of assets, and have been forced to rethink how they Is Deleveraging And Intensive deleveraging in particular in nondo- can best use their balance sheets to Capital Management Coming mestic markets (see chart 3). The pace generate return, shifting the emphasis To An End? of this reduction is not uniform for all from the traditional “book-and-hold” After years of steady improvement in European banks. Over the same approach to an “originate-to-distribute” banks’ capitalization, recent develop- period, the top five banks in France, business model. For European banks ments could signal a change in trends. In after having gone through a more that had in the past been less averse to mature markets, many banks are no severe double-digit reduction of risk- long-term funding and had become longer in deleveraging mode, because weighted assets in 2012, saw their risk- weighted assets reduction coming to an end by the end of 2013 (see chart 4). EMEA Bank Deals By Country 2014 They are now showing more appetite

Proceeds (mil. $) Market share (%) No. of issues for again increasing their risk-weighted assets, in specific assets segments. U.K. 16,537.9 23.5 40 Sluggish economic conditions in Turkey 8,580.2 12.2 12 European domestic markets have also France 6,835.7 9.7 61 pushed banks to deploy more capital Norway 5,896.9 8.4 11 into international banking activities Netherlands 5,332.3 7.6 8 such as project finance. Russian Federation 4,373.4 6.2 5 While banks become less risky and smaller, there is also a refocus on prof- Sweden 4,195.8 6.0 2 itability. With still higher margins than Germany 3,380.0 4.8 16 other categories and upfront commis- Italy 3,246.9 4.6 20 sions, appetite in project finance lending Finland 3,230.4 4.6 5 from EMEA banks increased, and they Spain 2,421.0 3.4 11 became more active during 2014. Hungary 1,771.6 2.5 1 Higher Margins For Project Ireland 1,410.3 2.0 5 Finance And Upfront Fees Poland 718.5 1.0 5 Help Profitability Romania 553.7 0.8 5 European banks are struggling to deliver Austria 403.2 0.6 6 top-line revenue growth. With current Denmark 297.3 0.4 1 low interest rates squeezing interest Greece 277.2 0.4 3 margins and sluggish economies, banks have been looking at targeting defined Belgium 240.5 0.3 2 customer segments that align with their Portugal 211.1 0.3 2 competitive advantage and offer revenue Czech Republic 139.3 0.2 1 growth, shifting to focusing on customer Guernsey 133.2 0.2 1 relationships. Lending to infrastructure Bulgaria 125.0 0.2 1 and a shift to renewable energy projects Georgia 80.0 0.1 1 reinforce business relationships with large corporate sponsors. Croatia 55.5 0.1 1 This can explain why certain banks Serbia 19.5 0.0 1 are returning to project finance, as they Industry total 70,466.4 100.0 227 optimize balance sheets by replacing EMEA—Europe, Middle East, and Africa. loans with higher margins. Project Source: Thomson Reuters. finance loans still enjoy higher margins

Standard & Poor’s Ratings Services CreditWeek | January 21, 2015 39 FEATURES SPECIAL REPORT

Increased bank lending could be seen as delaying further the development of an institutional investor market for project finance.

than investment-grade corporate loans, banks turn more and more to an “origi- but they are trending rapidly down as nate-and-distribute” model than other more banks compete for a limited forms of disintermediation? The past number of transactions. two years have seen a resurgence of the The repositioning of activities has European collateralized loan obligation come at the same time as stronger dis- (CLO) market, which had been dormant tribution capabilities. This includes since 2008. This has been possible cooperating with institutional investors thanks to evolving structures in response in channeling funds to infrastructure to changing market conditions and the projects and a reduction in businesses need for managers to meet equity that do not generate significant syner- investors’ return expectations (see gies for banks. Since the financial crisis “European CLO 2.0 Structures Evolve In reduced the number of clients banks Response To Changing Market Conditions,” can do business with, they are looking published June 5, 2014). Similar to lever- at opportunities to strengthen long- aged loans, could project finance CLOs term relationships with customers, be a way to fund infrastructure loans? including with project finance sponsors. There have in the past been only a lim- Underwriting project finance debt by ited number of project finance CLOs. banks can be an attractive business line Project finance loans are complex and because it allows banks to take larger only a few investors are sufficiently upfront commitments, which supports equipped to assess and monitor their their relationship with designated key risks. Another potential obstacle to using customers while lowering their ultimate securitization to fund project finance is exposure, at least as long as banks can whether the capital structure’s eco- sell their positions quickly in the nomics are in place, meeting the return market. Appetite from investors and expected by the different tranches of the market liquidity have benefited from capital structure. A CLO manager’s main recent attractive conditions, one note- motivation is to arbitrage the interest worthy example being the leveraged paid on the various liabilities of a CLO loans market. But past experience has by the interest/capital appreciation also demonstrated that conditions can earned on the assets side. As long as this change rapidly, which can restrict balance is not right, incentives to have banks’ ability to reduce as intended CLOs expanding to project finance loans their exposures. will remain limited. CW

What Does The Future Hold? For more articles on this topic search RatingsDirect with keyword: Increased bank lending could be seen as Project Finance delaying further the development of an Analytical Contacts: institutional investor market for project Michael Wilkins finance, and this is a concern if banks London (44) 20-7176-3528 suddenly pull back again. We expect Nicolas Malaterre more disintermediation over the longer Paris (33) 1-4420-7324 term, but in the short term banks will go Taron Wade for profitability. Assuming continuing London (44) 20-7176-3661 growth in demand and more stringent Alexandre Birry capital and regulatory requirements, will London (44) 20-7176-7108

40 www.creditweek.com Global Toll Road Operators Have Turned A Corner, With Credit Quality Likely To Improve In 2015

t’s the light at the end of the tunnel. With very few Overview exceptions, Standard & Poor’s Ratings Services believes ● We believe toll road operators Itoll road operators around the world finally showed globally are rebounding following years of sluggish growth. overall growth in 2014, after years of recession and ● Across the world, we upgraded 20 postrecession sluggishness. The sector did remain stable issuers and downgraded only one. ● We expect continued growth in during the past few years, but we are now seeing toll road 2015 for the toll road operators we rate. operators’ credit quality actually improve.

Standard & Poor’s Ratings Services CreditWeek | January 21, 2015 41 FEATURES SPECIAL REPORT

In fact, of all the toll roads we rate, we economy contracted 2.1% in the first a full-year rate of 6.2%, and a drop to downgraded only one in 2014, in quarter—but then the next two quar- 5.8% for 2015. Furthermore, for the Mexico. Conversely, we had 20 upgrades ters showed the strongest growth in a U.S. toll road sector, the continuing during the period. decade. Overall, we expect annual trend of declining oil and gasoline 2014 growth of 2.3%, and 3.1% growth prices bodes well for toll operators, not U.S. for 2015. Other economic barometers only from reduced driving costs but The U.S. economy is continuing its are equally encouraging. National also from the potential increase in dis- recent trend of starting the year soft unemployment at the end of the cretionary spending that can also raise but finishing strongly. In 2014, the quarter was 5.9%, leading us to expect overall miles driven.

Table 1 | U.S. Toll Facilities Ratings As Of Jan. 1, 2015

Issuer name Obligor/project name State Long-term rating Outlook Bay Area Toll Authority Bay Area Toll Authority CA AA Stable Bay Area Toll Authority Bay Area Toll Authority CA A+ (second lien) Stable Buffalo and Fort Erie Public Bridge Authority Buffalo & Fort Erie Public Bridge Authority NY A+ Stable Cameron County Cameron County TX A- Stable Central Florida Expressway Authority Orlando-Orange County Expressway FL A Stable Central Texas Regional Mobility Authority Central Texas Regional Mobility Authority TX BBB Stable Chesapeake Chesapeake Expressway VA BBB Stable Delaware River Port Authority Delaware River Port Authority PA A Stable Delaware River Port Authority Delaware River Port Authority PA BBB (second lien) Stable Delaware River and Bay Authority Delaware River and Bay Authority DE A Stable Delaware River Joint Toll Bridge Commission Delaware River Joint Toll Bridge Commission PA A Stable E-470 Public Highway Authority E-470 Public Highway Authority CO BBB Stable Eagle Pass Eagle Pass TX A Stable Florida Alligator Alley FL AA- Stable Florida Florida Turnpike Enterprise FL AA- Stable Florida Tampa-Hillsborough County Expressway Authority FL A Stable Foothill-Eastern Transportation Corridor Agency Foothill-Eastern Transportation Corridor Agency CA BBB- Stable Golden Gate Bridge Highway and Golden Gate Bridge Highway and CA AA- Stable Transportation District Transportation District Grand Parkway Transportation Corp. Grand Parkway TX BBB Stable Greater New Orleans Expressway Commission Greater New Orleans Expressway LA A Stable Harris County Harris County TX AA- Stable Indiana Finance Authority WVB East End Partners LLC (Ohio River Bridges) IN BBB Stable Illinois State Toll Highway Authority Illinois State Toll Highway Authority IL AA- Stable Kansas Turnpike Authority Kansas Turnpike KS AA- Stable Laredo Laredo Bridge TX A+ Stable Lee County Lee County FL A- Negative Maine Turnpike Authority Maine Turnpike ME AA- Stable Maine Turnpike Authority Maine Turnpike ME A (second lien) Stable Maryland Transportation Authority Maryland Transportation Authority MD AA- Stable Massachusetts Department of Transportation Metropolitan Highway System MA A+ Stable McAllen McAllen International Toll Bridge TX A Stable Metropolitan Washington Airports Authority Dulles Toll Road DC A Stable Metropolitan Washington Airports Authority Dulles Toll Road DC BBB+ (second lien) Stable Metropolitan Washington Airports Authority Dulles Toll Road DC BBB (third lien) Stable

42 www.creditweek.com Rating changes in the sector in 2014 bridges. Farther south, the Tampa- due to the additional capacity it now all five were upgrades (see tables 1 and Hillsborough County Expressway has in the corridor. We raised our 2). All of the upgrades were largely Authority operates in a region with rating on the San Joaquin Hills issuer-specific, relating to improved what we consider a deep and diverse Transportation Corridor Agency three financial profiles, or project improve- economy, and it has instituted a policy notches to ‘BBB-’, following a restruc- ments. Furthermore, we believe delivering predictable and automatic turing that significantly reduces peak Delaware River Joint Toll Bridge toll increases. In southern California, annual debt service while extending Commission benefits from its maturity we upgraded the Orange County maturities slightly. In Texas, we and system diversity as a network of Transportation Authority in California upgraded the Central Texas Regional

Table 1 | U.S. Toll Facilities Ratings As Of Jan. 1, 2015 (continued)

Issuer name Obligor/project name State Long-term rating Outlook Miami-Dade County Rickenbacker Causeway FL BBB+ Stable Miami-Dade County Expressway Authority Miami-Dade County Expressway FL A- Stable Mid-Bay Bridge Authority Mid-Bay Bridge FL BBB+ Stable Mid-Bay Bridge Authority Mid-Bay Bridge FL BBB- (second lien) Stable New Hampshire New Hampshire Turnpike NH A+ Stable New Jersey Turnpike Authority New Jersey Turnpike NJ A+ Stable New York State Bridge Authority New York State Bridge Authority NY AA- Stable New York State Thruway Authority New York State Thruway NY A Stable New York State Thruway Authority New York State Thruway NY A- (second lien) Stable Niagara Falls Bridge Commission Niagara Falls Bridges NY A+ Stable North Carolina Turnpike Authority Triangle Expressway NC BBB- Stable North Texas Tollway Authority North Texas Tollway TX A- Stable North Texas Tollway Authority North Texas Tollway TX BBB+ (second lien) Stable Ohio Turnpike and Infrastructure Commission Ohio Turnpike OH AA- Stable Ohio Turnpike and Infrastructure Commission Ohio Turnpike OH A+ Stable Oklahoma Turnpike Authority Oklahoma Turnpike OK AA- Stable Orange County Transportation Authority Orange County Transportation Authority (SR-91) CA AA- Stable Osceola County Osceola County FL BBB- Stable Pennsylvania Turnpike Commission Pennsylvania Turnpike PA A+ Stable Pennsylvania Turnpike Commission Pennsylvania Turnpike PA A- (second lien) Stable Rhode Island Turnpike and Bridge Authority Rhode Island Turnpike and Bridge Authority RI A- Negative Richmond Metropolitan Authority Richmond Metropolitan Authority VA A+ Stable Riverside County Transportation Commission Riverside County Transportation Commission (SR-91) CA BBB- Stable Route 460 Funding Corp. of Virginia Route 460 Funding Corp. of Virginia VA BBB- Negative San Joaquin Hills Transportation Corridor Agency San Joaquin Hills Transportation Corridor Agency CA BBB- Stable San Joaquin Hills Transportation Corridor Agency San Joaquin Hills Transportation Corridor Agency CA BB+ (junior lien) Stable South Jersey Transportation Authority South Jersey Transportation Authority NJ A- Stable South Jersey Transportation Authority South Jersey Transportation Authority NJ BBB (second lien) Stable Texas Turnpike Authority Central Texas Turnpike System TX A- Stable Toll Road Investors Partnership II L.P. Dulles Greenway VA BBB- Stable Triborough Bridge and Tunnel Authority Triborough Bridge and Tunnel Authority NY AA- Stable Triborough Bridge and Tunnel Authority Triborough Bridge and Tunnel Authority NY A+ (second lien) Stable Virginia Small Business Financing Authority Elizabeth River Crossings Opco LLC VA BBB- Stable Virginia Small Business Financing Authority 95 Express Lanes LLC VA BBB- Stable West Virginia Parkway Economic Development and Tourism Authority West Virginia Parkways WV AA- Stable

Standard & Poor’s Ratings Services CreditWeek | January 21, 2015 43 FEATURES SPECIAL REPORT

Mobility Authority a notch due to the on the Commission to negative in Latin America completion of a project on time and November 2014 to reflect our expecta- In our view, toll roads in Latin America within budget, and where initial traffic tion that its large capital funding have maintained sound credit quality results are greater than forecast. We requirements could materially weaken overall. Most of our rating actions within also had two outlook revisions on U.S. its debt metrics over the next two the past 12 months were upgrades (see toll roads during the period—both to years. We also kept a negative outlook tables 3 and 4), which we attribute to negative from stable. on Blue Water Bridge Canada in south- higher-than-expected traffic levels and western Ontario, in part because of better performance in general. Canada the effect that commercial traffic Mexican toll roads have shown a Canada’s gradually strengthening trends is having on its debt service traffic recovery trend in line with GDP economy has contributed to modestly coverage levels. growth (we expect 2.7% for 2014 and increasing traffic volumes for most toll We expect toll road operators’ per- 3.5% for 2015). Without considering road operators. We estimate the pace of formances to reflect Canada’s ramp-up periods in several of the toll the country’s real GDP growth quick- economy, in which we foresee real GDP roads we rate, we expect traffic to ened to about 2.3% in 2014, from 2.0% rising 2.3% to 2.8% yearly through increase an average of 3.2% annually, in 2013. Not only did this stimulate 2017. There remains little appetite as a result of the country’s GDP traffic demand, it enabled toll road oper- among governments for new volume- growth and (in some cases) also in line ators to pass along rate increases, which based toll road projects. Instead, we with local economic growth. In recent further supported their cash flows. expect governments to continue months, we have seen sponsors lever- Toronto-area toll road operator 407 procuring new road and bridge projects aging their toll road projects through International Inc. has enjoyed the through availability-style public-private subordinated issuances (such as Rio strongest traffic growth, at more than partnerships (P3s), in which govern- Verde and Lipsa project) to finance 3% in the first three quarters of 2014. ments retain market risk. Case in point, new projects. This largely reflected above-average we expect the federal government to Chilean toll roads continue under- economic conditions and heavy con- procure the Champlain Bridge replace- taking improvements and expansion gestion on alternative routes within its ment project in Quebec as an avail- works, mainly consisting of lane addi- service area. Traffic for the Halifax- ability-based P3. If this project pro- tions, new bridges and tunnels, con- Dartmouth Bridge Commission has ceeds, it will be one of the largest nection improvements, and new exits been considerably slower, given Nova infrastructure projects in North that tend to relieve traffic. We don’t Scotia’s muted economic growth and America, with an estimated capital cost think these investments will affect harsh winter. We revised our outlook of C$3 billion to C$5 billion. credit quality, given the Ministry of

Table 2 | U.S. Toll Facilities—Rating Actions*

Issuer Obligor To From Date

Upgrades Central Texas Regional Mobility Authority (senior lien) Central Texas Regional Mobility Authority BBB/Stable BBB-/Stable Oct. 14, 2014 San Joaquin Hills transportation Corridor Agency San Joaquin Hills transportation Corridor Agency BBB-/Stable BB-/Stable Oct. 8, 2014 Orange County Transportation Authority Orange County Transportation Authority AA-/Stable A/Stable Aug. 1, 2014 Delaware River Joint Toll Bridge Commision Delaware River Joint Toll Bridge Commision A/Stable A-/Stable May 1, 2014 Florida Tampa-Hillsborough County Expressway Authority A/Stable A-/Positive Feb. 3, 2014 Outlook revisions Rhode Island Turnpike and Bridge Authority Rhode Island Turnpike and Bridge Authority A-/Negative A-/Stable May 30, 2014 Route 460 Funding Corp of Virginia Route 460 Funding Corp of Virginia BBB-/Negative BBB-/Stable April 1, 2014 New ratings Texas Turnpike Authority Central Texas Turnpike System BBB+/Stable NR Dec. 19, 2014 Miami Dade County Rickenbacker Causeway BBB+/Stable NR July 15, 2014 New York State Thruway Authority (second lien) New York State Thruway Authority (second lien) A-/Stable NR June 26, 2014 Buffalo and Fort Erie Public Bridge Authority Buffalo & Fort Erie Public Bridge Authority A+/Stable NR May 13, 2014 Osceola County Osceola County BBB-/Stable NR March 18, 2014 *Rating actions listed cover calendar year 2014. NR—Not rated.

44 www.creditweek.com Public Works’ strong track record in In Brazil, tariff adjustments have Standard & Poor’s believes that this compensating the concessionaires’ shaped the credit story in 2014. On does not represent any change in the investments through tariff increases, July 1, 2014, the regulator raised São regulatory framework under which São concession term extensions, and direct Paulo state toll road tariffs slightly Paulo toll roads operate, as it aimed to cash payments. In addition, internally below the rate of inflation (6.37%). maintain the contracts’ internal rates generated cash has financed most of The concession contracts allow infla- of return (IRR). In 2013, the São Paolo these projects. tion-adjusted tariffs every year. state government, in an attempt to dif-

Table 3 | International Toll Facilities Ratings As Of Jan. 1, 2015

Issuer name Obligor/project name Country Rating Outlook Sun Group Finance Pty Ltd. Queensland Motorway Australia BBB+ Negative Transurban Finance Co. Pty Ltd. Australian toll road operator Australia A- Negative Autoban—Concessionaria do Sistema Anhanguera Bandeirantes S.A. Toll road Brazil brAAA Stable Arteris S.A. Brazilian toll road network operator Brazil brAAA Stable Atlantia Bertin Concessoes S.A. Brazilian toll road network operator Brazil brAAA Stable Autopista Planalto Sul S.A. Toll road Brazil brAAA Stable CCR S.A. Brazilian toll road network operator Brazil brAAA Stable Concessionaria Auto Raposo Tavares S.A. Toll road Brazil brAA- Stable Concessionaria da Rodovia Presidente Dutra S.A. Toll road Brazil brAAA Stable Concessionaria Ecovias dos Imigrantes S.A. Toll road Brazil brAAA Stable EcoRodovias Concessoes e Servicos S.A. Brazilian toll road network operator Brazil brAAA Stable RodoNorte Concessionaria de Rodovias Integradas S.A. Toll road Brazil brAAA Stable Rodovia das Colinas S.A. Toll road Brazil brAAA Stable Triangulo do Sol Auto-Estradas S.A. Toll road Brazil brAAA Stable 407 International Inc. 407 ETR Canada A Stable 407 International Inc. 407 ETR Canada A- (second lien) Stable 407 International Inc. 407 ETR Canada BBB (third lien) Stable Blue Water Bridge Canada Blue Water Bridge Canada BBB- Negative Halifax-Dartmouth Bridge Commission Macdonald and MacKay Bridges Canada AA- Negative Ruta del Bosque Sociedad Concesionaria S.A. Ruta del Bosque Chile BB+ Stable Ruta del Maipo Sociedad Concesionaria S.A. Autopistas del Maipo Chile BBB- Stable Ruta del Maule Sociedad Concesionaria S.A. Ruta del Maule Chile BBB- Stable Sociedad Concesionaria Autopista Central S.A. Sociedad Concesionaria Autopista Central S.A. Chile BBB+ Watch Pos Sociedad Concesionaria Costanera Norte S.A. Costanera Norte Chile A Stable Sociedad Concesionaria Rutas Del Pacifico S.A. Rutas del Pacífico Chile BBB (SPUR) Stable Sociedad Concesionaria Vespucio Norte Express S.A. Vespucio Norte Chile BB (SPUR) Positive Shenzhen International Holdings Ltd. China toll road network operator China BBB Stable Autoroutes du Sud de la France S.A. French toll road network operator France A- Stable Autoroutes Paris-Rhin-Rhone S.A. French toll road network operator France BBB+ Stable Cofiroute French toll road network operator France A- Stable Verdun Participation 2 S.A. Toll road France BBB- (SPUR) Stable VINCI S.A. VINCI S.A. France A- Stable Ellaktor S.A. Ellaktor S.A. Greece B+ Stable M6 Duna Autopalya Koncesszios Zartkoruen Mukodo Reszvenytarsasag* M6 Duna Hungary AA Stable DirectRoute (Limerick) Finance Ltd. DirectRoute (Limerick) Finance Ltd. Ireland BB- (SPUR) Stable

Standard & Poor’s Ratings Services CreditWeek | January 21, 2015 45 FEATURES SPECIAL REPORT fuse violent political protests, froze sionaries in the period, resulting in a Lastly, we expect traffic on Panamanian tolls and took measures to rebalance higher IRR. Compensating drivers for toll roads we rate to increase at 6% on the contract return, such as reducing this, the regulator approved lower-than- average for the next 12 months due to the variable granting fee and tolling inflation tariff hikes. We believe the the continuous growth of the trucks with suspended axles. adjustment’s impact should be marginal country’s economy (6% to 7%) in the According to the regulator, the rebal- on toll roads operators’ financial per- next couple of years but more impor- ancing measures benefited the conces- formance and our ratings. tantly as a result of toll roads pro-

Table 3 | International Toll Facilities Ratings As Of Jan. 1, 2015 (continued)

Issuer name Obligor/project name Country Rating Outlook Atlantia SpA Italian toll road network operator Italy BBB+ Stable Autostrade per I’Italia SpA Toll road Italy BBB+ Stable Ostregion Investmentgesellschaft Nr. 1 S.A. A5 Ypsilon Motorway Project Austria B+ (SPUR) Stable Fideicomiso 1784 (Autopista Rio Verde Libramiento La Piedad) Toll road Mexico mxAAA Stable Fideicomiso 1784 (Autopista Rio Verde y Libramiento La Piedad) Toll road Mexico mxAA Stable Fideicomiso 209635 (Matehuala) Libramiento de Matehuala Mexico BBB+ Stable Fideicomiso 2990 (Punta Diamante)§ Carretera Viaducto La Venta-Punta Diamante Mexico mxAA Stable Fideicomiso 464 (Plan del Rio)§ Libramiento Plan del Rio Mexico mxAAA Stable Fideicomiso 464 (Plan del Rio)§ Libramiento Plan del Rio Mexico mxBBB (second lien) Stable Fideicomiso 80425 (Monterrey-Cadereyta) Autopista Monterrey-Cadereyta Mexico BBB- (SPUR) Stable Fideicomiso 833 (Veracruz-Cardel)§ Autopista Veracruz-Cardel Mexico mxA+ Negative Fideicomiso CIB/2076 (Autopista Rio Verde mxAA- y Libramiento la Piedad) Toll road Mexico (subordinated) Stable Fideicomiso No. 2227 (Periferico del Area Metropolitana de Monterrey) Toll road Mexico mxAA- Stable OPI* Toll road Mexico mxAA+ Stable Periferico del Area Metropolitana de Monterrey Toll road Mexico mxAAA Stable Red de Carreteras de Occidente S.A.B. de C.V.§ Packaged concessionaire: 4 Toll Roads Mexico mxAAA Stable & 2 Availability Concesionaria Mexiquense S.A. de C.V. Conmex Mexico BBB Stable Fjellinjen AS Oslo Tollroad System Norway AA- Stable ENA Norte Trust Corredor Norte Panama BBB Stable ENA Sur Trust Corredor Sur Panama BBB Stable Granvia a.s. R1 Expressway Slovakia BBB+ Stable Korea Expressway Corp. Korean toll road network operator South Korea A+ Stable Abertis Infraestructuras S.A. Abertis Infraestructuras S.A. Spain BBB Stable Autovia de la Mancha, S.A. Autovia de la Mancha, S.A. (AUMANCHA) Spain B (SPUR) Negative Oresundsbro Konsortiet† Oresund Link Sweden/ AAA Stable Denmark Aberdeen Roads (Finance) PLC Aberdeen west peripheral route U.K. A- (prelim.) Stable Amey Lagan Roads Financial PLC Amey Lagan Roads Financial PLC U.K. BBB- (SPUR) Stable Autolink Concessionaires (M6) PLC M6 Motorway Project U.K. A- (SPUR) Stable Channel Link Enterprises Finance PLC Eurotunnel U.K./France BBB (SPUR) Stable CountyRoute (A130) PLC (senior debt) A130 U.K. B+ (SPUR) Stable Highway Management (City) Finance PLC M1/Westlink U.K. BBB (SPUR) Stable Road Management Consolidated PLC A1 (M) and A417/419 U.K. B (SPUR) Stable Scot Roads Partnership Finance Ltd. M8/M73/M74 Scotland U.K. A- Stable *Senior secured debt rating. §National scale rating. †Rating based on that of supporting government. SPUR—Standard & Poor’s underlying rating. N/A—Not applicable.

46 www.creditweek.com viding an efficient alternative to by Ostregion Investmentgesellschaft Nr. 1 actions incorporating traffic risk might Panama City gridlock. S.A. and DirectRoute (Limerick) Finance see a return during 2015, where the Ltd. to stable from negative because traffic route concerned can establish a track Europe performance improved for both projects. record, such as for a refinancing of Standard & Poor’s underlying ratings Median rating levels within the portfolio existing debt. (SPURs) on European P3 road projects rose after we assigned new issue ratings of European toll road network operator have demonstrated greater stability in the ‘A-’ and ‘BBB+’ to road projects in the U.K. (TRNO) traffic volume recovered above past year, as economic conditions have (two projects) and Slovakia. All three proj- GDP level in the first nine months of improved and projects have continued to ects incorporated availability-based rev- 2014, supporting moderate growth in mature. We raised our ratings on the senior enues in their contract structures and earnings and resilient cash flows. In 2015, debt issued by Amey Lagan Roads hence have no exposure to traffic risk. we expect that rating trends will remain Financial PLC in September 2014, and on All 12 SPURs in our portfolio have stable (for further information, see “Global that issued by Autolink Concessionaires stable outlooks. This reflects the more Rating Trends For Toll Road Network (M6) PLC in November. The former was positive outlook for GDP growth and Operators Will Remain Stable In 2015,” pub- due to a financial restructuring initiated by inflation across Europe for 2015 and lished Dec. 26, 2014, on RatingsDirect). the issuer, while the latter was due to the beyond, reflected in our forecasts for Our base-case credit scenario for 2015 completion of remedial works and the both traffic volumes and tolls. Although assumes traffic volumes in line with real improving financial profile of the project as all recently rated transactions have GDP, which we view as a key economic the concession approaches its end. We incorporated availability-based rev- driver for TRNO, and we now estimate also revised our outlook on the debt issued enues, we believe that interest in trans- that in 2015 it will:

Table 4 | International Toll Facilities—Rating Changes

Issuer Obligor To From Date

Upgrades Investimentos e Participacoes em Infraestrutura S.A. Brazil brAA-/Stable/— brA+/Stable/— Nov. 6, 2014 Concessionária Auto Raposo Tavares S.A. Brazil brAA-/Stable/— brA+/Stable/— Nov. 6, 2014 Triângulo do Sol Auto-Estradas S.A. Brazil brAAA/Stable/— brAA/Stable/— May 8, 2014 Rodovia das Colinas S.A. Brazil brAAA/Stable/— brAA/Stable/— April 8, 2014 Sociedad Concesionaria Costanera Norte S.A. Chile A/Stable/— A-/Watch Pos/— Nov. 21, 2014 Sociedad Concesionaria Autopista Central S.A. Chile BBB+/Watch Pos/— BBB/Stable/— Sept. 22, 2014 Sociedad Concesionaria Costanera Norte S.A. Chile A-/Stable/— BBB+/Stable/— Sept. 22, 2014 Autoroutes Paris-Rhin-Rhone S.A. France BBB+/Stable/— BBB/Positive/— Nov. 26, 2014 Autoroutes du Sud de la France S.A. France A-/Stable/— BBB+/Stable/— March 31, 2014 Cofiroute France A-/Stable/— BBB+/Stable/— March 31, 2014 VINCI S.A. France A-/Stable/— BBB+/Stable/— March 31, 2014 M6 Duna Autopalya Koncesszios Zartkoruen Mukodo Reszvenytarsasag* Hungary AA/Stable AA-/Stable March 18, 2014 Fideicomiso 209635 (Matehuala) Mexico BBB+/Stable/— BBB/Stable/— May 21, 2014 Autolink Concessionaires (M6) PLC U.K. A- (SPUR)/Stable/— BBB- (SPUR)/Watch Pos/— Nov. 18, 2014 Amey Lagan Roads Financial PLC U.K. BBB- (SPUR)/Stable/— BB (SPUR)/Watch Pos/— Sept. 10, 2014 Downgrades Fideicomiso 833 (Veracruz-Cardel)§ Mexico mxA+/Negative/— mxAA/Stable/— Feb. 19, 2014 Outlook revisions Sun Group Finance Pty Ltd. Australia BBB+/Negative/— BBB+/Stable/— Sept. 22, 2014 Transurban Finance Co. Pty Ltd. Australia A-/Stable/— A-/Negative/— Sept. 22, 2014 Ostregion Investmentgesellschaft Nr. 1 S.A. Austria B+ (SPUR)/Stable/— B+ (SPUR)/Negative/— Aug. 29, 2014 Halifax-Dartmouth Bridge Commission Canada AA-/Negative/— AA-/Stable/— Nov. 27, 2014 Sociedad Concesionaria Autopista Central S.A. Chile BBB+/Stable/— BBB+/Watch Pos/— Nov. 21, 2014 Sociedad Concesionaria Costanera Norte S.A. Chile A-/Watch Pos/— A-/Stable/— Sept. 22, 2014

Standard & Poor’s Ratings Services CreditWeek | January 21, 2015 47 FEATURES SPECIAL REPORT

● Increase 1.9% in Spain, where Abertis TRNOs, but it is more sensitive to weak issuer’s business risk profiles or financing Infraestructuras S.A. will generate economies. We also expect tariffs structures, which in turn could lead to about 40% of consolidated EBITDA. increasing in line with, or slightly more than, credit metric deterioration. Furthermore, We expect that the country’s unem- the previous 12 months’ inflation. We esti- there have been some discussions ployment will fall to 22.8% in 2015, mate that CPI inflation in 2015 will be 0.4% around changes in the French toll road compared with 24.6% in 2014 and in Spain, 0.5% in Italy, and 1.2% in France. concession model, more specifically to 26.1% in 2013; In our view, this should sustain low-single- cap—or even lower—tariffs. Toll road ● Increase 0.2% in Italy where digit revenue growth for 2015. We also concession formulas are linked to infla- Autostrade per l’Italia SpA, the main expect that the EBITDA margins of most tion and investment levels. We continue TRNO of Atlantia SpA, is based; and TRNOs will be stable, with those that have to expect significant changes to existing ● Increase by 0.7% in France, where introduced some cost containment meas- contracts to be difficult to implement Autoroutes Paris-Rhin-Rhone, and ures showing slight improvement. because of clauses in their contracts Vinci S.A., along with its subsidiaries Although we believe the sector’s per- compensating operators for changes to Autoroutes du Sud de la France S.A., formance will remain stable through the sector’s regulatory environment and Cofiroute, operate. 2015, merger and acquisition (M&A) protecting the economic balance of the Consequently, in 2015, we expect traffic activities and regulatory changes could concession contracts. However, a signifi- and revenues to increase modestly in Italy constrain the ratings. The degree to cant change in the regulatory regime and France and more significantly in Spain. which M&A affects ratings will depend could lead us to reassess the French Heavy traffic might be more profitable for on the effect of the integration on an TRNOs’ competitive position and cash

Table 4 | International Toll Facilities—Rating Changes (continued)

Issuer Obligor To From Date

Outlook revisions (continued) Sociedad Concesionaria Vespucio Norte Express S.A. Chile BB/Positive BB/Stable/— April 7, 2014 Shenzhen International Holdings Ltd. China BBB/Stable/— BBB/Negative/— May 5, 2014 DirectRoute (Limerick) Finance Ltd. Ireland BB- (SPUR)/Stable/— BB- (SPUR)/Negative/— Dec. 19, 2014 Atlantia SpA Italy BBB+/Stable/— BBB+/Negative/— May 13, 2014 Granvia a.s. Slovakia BBB+/Positive/— BBB+/Stable/— Nov. 18, 2014 Abertis Infraestructuras S.A. Spain BBB/Stable/— BBB/Negative/— Feb. 4, 2014 New ratings Sun Group Finance Australia BBB+/Stable/— NR June 24, 2014 Arteris S.A. Brazil brAAA/Stable/— NR Sept. 22, 2014 Autopista Planalto Sul S.A. Brazil brAAA/Stable/— NR Sept. 22, 2014 Atlantia Bertin Concessoes S.A. Brazil brAAA/Stable/— NR April 14, 2014 OPI* Mexico mxAA+/Stable NR Dec. 17, 2014 Fideicomiso No. 2227 (Periferico del Area Metropolitana de Monterrey) Mexico mxAA-/Stable/— NR Nov. 18, 2014 Fideicomiso CIB/2076 (Autopista Rio Verde Mexico mxAA- (2nd lien)/ NR Nov. 7, 2014 y Libramiento la Piedad) Stable/— Fideicomiso 1784 (Autopista Rio Verde y Libramiento la Piedad) Mexico mxAAA/Stable/— NR July 3, 2014 Fideicomiso 1784 (Autopista Rio Verde y Libramiento la Piedad) Mexico mxAA/Stable/— NR July 3, 2014 Periferico del Area Metropolitana de Monterrey Mexico mxAAA/Stable/— NR May 14, 2014 Ellaktor S.A. Greece B+/Stable/— NR Oct. 3, 2014 Aberdeen Roads (Finance) PLC U.K. A- (prelim.)/Stable/— NR Nov. 28, 2014 Scot Roads Partnership Finance Ltd. U.K. A-/Stable/— NR Feb. 20, 2014 Withdrawals Fideicomiso No 80481 (Mexico-Toluca) Mexico NR BBB+ (SPUR)/Stable/— Sept. 10, 2014 Note: Rating actions listed cover calendar year 2014. *Senior secured debt rating. §National scale rating. SPUR—Standard & Poor’s underlying rating. NR—Not rated.

48 www.creditweek.com In China, although economic growth has marginally softened in some areas, increases in car ownership continue to support traffic growth.

flows. Some French ministers of parlia- tinued reluctance of private investors to ment have supported a buy-back of take greenfield risks due to recent fail- some of the toll road concessions. We ures, Australian state governments have understand that if this were to happen, had to look at new structures to ensure which we don’t expect right now, it they could be privately funded. This would not take effect until 2017 and includes structuring the East West Link would give rise to financial compensa- tunnel in Melbourne as an availability- tion based on an estimation of the cash based project and the West Connect flows foregone by the concessionaires. project in Sydney, which is likely to be on The press has reported estimates in the the government’s balance sheets until range of €15 billion to €20 billion. traffic is established. In China, although economic growth has Asia-Pacific marginally softened in some areas, We expect performances for toll road increases in car ownership continue to sup- operators in the Asia-Pacific region to port traffic growth. After the implementa- be broadly stable, with continued tion of tariff concessions that affected some momentum for economic growth in the toll road operators, the regulatory land- region, some capital expansion projects scape has stabilized, and we expect this to completing and fueling incremental continue for now. Our expectation of stable earnings, and links between rate hikes performance also reflects our opinion that and inflation. Traffic growth typically M&A activity across the sector will remain closely correlates with GDP growth, limited, similar to 2014 but significantly which we expect to be 2.6% for Australia lower than in the years before that. in 2015 (compared with 3.2% for 2014), Given Korea Expressway’s broad net- For more articles on this topic search RatingsDirect with keyword: 7.1% for China (7.4% in 2014), and 4% in work, we believe its performance will Toll Roads Korea (3.6% in 2014). We forecast infla- remain closely linked to that of South tion in these countries to remain at 2% Korea’s economy. Investments will con- Analytical Contacts: to 2.5%, broadly in line with 2014 levels. tinue, but more to develop secondary Peter V. Murphy New York (1) 212-438-2065 In Australia, a Transurban Finance Co. road links and relieve congestion, rather Pty Ltd.-led consortium acquired than increase earnings. Aurelie Hariton-Fardad London (44) 20-7176-3677 Queensland Motorway, the main toll Juliana Gallo operator in Brisbane, resulting in Looking Ahead London (44) 20-7176-3612 Transurban having full or significant Across regions, we expect to see con- Robin M. Burnett ownership stakes in nearly every toll tinued growth in 2015 for the toll road London (44) 20-7176-7019 road in Australia’s three largest cities. operators we rate, mostly because of a Thomas Jacquot The remaining toll road operators are stronger global economy in 2014 and Sydney (61) 2-9255-9872 single-asset companies, and their respec- into next year. What might put growth at Paul Judson, CFA tive fortunes have been mixed, with the risk would be weaker economic perform- Toronto (1) 416-507-2523 Brisbane Airport Link and Cross City ance than our economists forecast, Candela Macchi Tunnel in Sydney going into administra- regionally or globally. To whatever Buenos Aires (54) 114-891-2110 tion and Transurban acquiring the latter. degree that were to occur, it could bring Anita Pancholy We expect significant investment to con- to a halt the positive momentum the Dallas (1) 214-871-1402 tinue across the country, with a combi- sector has gained in 2014. For now, how- Veronica Yanez nation of major road expansion in ever, we’re expecting modest growth to Mexico City (52) 55-5081-4485 Melbourne but also greenfield projects in continue for most toll road operators in Garrett Malise Sydney and Melbourne. Given the con- the year ahead. CW New York (1) 212-438-3513

Standard & Poor’s Ratings Services CreditWeek | January 21, 2015 49 FEATURES SPECIAL REPORT

50 www.creditweek.com Can The G20-Sponsored Global Infrastructure Hub Kick-Start Private Investment In Asia-Pacific?

Overview

● Asia-Pacific’s large investment requirements make it an attractive region for infrastructure investors. ● In practice, Australia captures the bulk of the region’s private investment, mainly through the combination of a real-deal pipeline and well understood institutional and legal frameworks. ● The creation of the Global Infrastructure Hub, in Sydney, should promote an environment that offers better investment opportunities across the rest of Asia, provided it is bold in its approach and does not seek to replicate what others are already doing. ● The success of this initiative will ultimately be inherently linked to the willingness of regional governments to promptly implement the Hub’s recommendations.

hen the G20 countries met in Brisbane, Australia, in November 2014, the representative members agreed Wto create a Global Infrastructure Hub (and to base it in the Australian city of Sydney). In broad terms, the mandate of the hub will be to coordinate the infrastructure plans of participating governments; enhance governments’ knowledge of how their public sectors work, what they need, and how they are developing their funding practices; and standardize procurement processes.

Standard & Poor’s Ratings Services CreditWeek | January 21, 2015 51 FEATURES SPECIAL REPORT

While there is a need for greater coor- the next 15 years. With Asia becoming with investors showing a great deal of dination and taking onboard lessons the global economic growth engine interest in the sector. This is because learnt from decades of private infra- but many of its countries suffering everyone realizes that the infrastruc- structure investment globally, will the from material deficits in infrastructure, ture requirement is immense. The Global Infrastructure Hub be bold the region’s goal should be to capture Asian Development Bank (ADB) and enough to make a meaningful differ- a significant part of that additional the Asian Development Bank Institute ence? Sticking to delivering investment investment through increased invest- estimated in their joint study in what is now the current way will ment in infrastructure. But how to go “Infrastructure for a Seamless Asia” achieve only one certainty: continued about that? The G20 recognized the that the region would require about stagnation of investment levels and an need for greater coordination and sim- US$9 trillion of investment between increase of the infrastructure deficit. plification (and this is particularly rele- 2010 and 2020, with about 70% of that Change is needed. vant for countries in Asia-Pacific)— earmarked for new projects, and the One of the key goals coming out of and thus the Global Infrastructure Hub remainder being allocated to mainte- the G20 meeting was the commitment was conceptualized. nance of existing infrastructure. The to achieving incremental global ADB estimated that more than 50% of growth of 2.1% over the next five Infrastructure Opportunities that amount would need to be allocated years. On the G20 estimate, achieving Abound Across Asia-Pacific to the energy sector, reflecting the sys- the 2.1% growth could release an addi- Infrastructure investment in Asia- temic electricity generation capacity tional US$2 trillion of investment over Pacific is a hot topic of conversation, deficit and rapid growth in energy demand. The road sector is estimated to require in excess of US$2 trillion Chart 1 | Infrastructure Quality Ranking Of Selected APAC Countries over the period. (Out Of 151) Evidence of this requirement for growing investment in infrastructure can (Ranking) also be found in the World Economic 100 Forum’s annual Global Competitiveness 90 Report 80 , which, among other things, 70 assesses the quality of infrastructure 60 across the globe. Chart 1 highlights the 50 ranking of several countries in the region 40 30 in terms of infrastructure quality, as 20 defined by the World Economic Forum. 10 Hong Kong (first in the ranking), 0 Australia China Hong KongIndia Indonesia Japan Malaysia Philippines Japan, and Australia all feature in the top APAC—Asia-Pacific. 15%, but opportunities for further invest- Source: World Economic Forum. ment in the rest of the region are clearly © Standard & Poor’s 2015. real. The fact is that actual private investment remains limited. This is Chart 2 | Enforcing Contracts, Dealing With Construction Permits because investors remain concerned about the institutional, legal, and regula- Dealing with construction permits Enforcing contracts tory frameworks in most countries. In its

Philippines “Doing Business” project, The World Bank Group has assessed a number of factors Malaysia for 189 countries, including dealing with Japan construction permits (capturing the ease Indonesia of obtaining all necessary consents and permits, as well as obtaining utility con- India nections) and enforcing contracts. Chart Hong Kong 2 shows for the same countries as chart China 1 the rankings in both categories. Australia 0 20 40 60 80 100 120 140 160 180 200 How To Ensure A Project’s Success (Ranking) Two factors (although not the only Source: Doing Business Project, World Bank Group. ones) are critical for the potential suc- © Standard & Poor’s 2015. cess of a project.

52 www.creditweek.com The first provides an insight as to the results of the study in Australia, India Will The Global Infrastructure Hub likelihood of a project’s construction and Indonesia. Be Effective In Allocating Risk? activities performing in line with In the enforcement of legal rights Clearly, the cost of a project encapsu- budget and program. under a contract, two areas are critical: lates not only the direct cost of building A typical greenfield project might ● How long until a decision is reached? and operating but also adequate contin- involve a number of steps before and gencies against known risks. As a result, building activities start, such as ● What are the costs? risk allocation between the public and obtaining required licenses and per- The duration is key from the point of private sector can have a significant mits (covering environmental consider- view of assessing for how long cash impact on the overall economics of a ations or building approvals). Then, a flows could be disrupted and, as a transaction, and could lead to materially project would require all necessary result, how to determine the required different outcomes. While the overar- approvals to operate. We view the liquidity that a project may need to ching concept of the risks needed to be “Dealing With Construction Permits” have. Based on the table, this would allocated to the party that is best as providing some evidence of how indicate liquidity requirements for proj- equipped to manage it is very well efficient (or otherwise) the bureau- ects in India that could be 3x higher accepted in the infrastructure finance cracy of a country is. This level of effi- than what they would be in Australia or sector, it is not, in our view, simply ciency adds to the certainty of the Indonesia (looking purely at the time to about the ability to manage a risk, but construction phase of a project. In its resolution). The cost of the procedures really about the ability to do so in a study, the World Bank Group deter- is also important in determining cost-efficient manner. mined that the average length of time required liquidity, as a project would This is where we believe the Global to obtain construction permits in need to have sufficient funds to cover Infrastructure Hub could play a signifi- Australia is 112 days, growing to 185 these costs. Again, this would have a cant role in determining the optimum days in India or 211 days in Indonesia. significant impact on liquidity, and this risk transfer that will deliver an economi- Such added duration not only leads to item would differentiate projects in cally efficient infrastructure that is increased costs (for a similar actual Australia and Indonesia. attractive to a wide range of private build phase, a project in Indonesia investors. Clearly, risk allocation should would take at least three months Example not be standardized across all countries longer than Australia, resulting in an Increased contingencies. Let’s assume three but tailored to each and every jurisdic- additional three months of interest on identical projects, with a capital cost of tion. While the risk allocation should not the financing). Also captured in this US$1 billion, 80% debt funded, located in be standardized, the search for unifor- measure is the cost of obtaining those Australia, India, and Indonesia. What mity across all countries could be the permits. According to the study, when would be the size of the required contin- underlying basis for it. expressed as a percentage of construc- gency funds necessary to absorb the Take the example of construction tion value, the figures came in at 0.5%, same level of stress linked to delay in permits, highlighted earlier. This risk is 28.2%, and 4.3% in Australia, India, obtaining consents? We assume here that generally accepted in a number of mar- and Indonesia, respectively. All else each project should be able to absorb a kets globally because of certainty being equal, this again would indicate 10% increase of budget and 10% increase around timeframe to obtain those. The more favorable conditions in Australia. in the time to obtain these permits. timeframe could be used as the bench- Taking the same project as above and mark that private investors are willing The second is certainty that the assuming the project located in to take the risk on, and therefore, this project will perform as expected Australia has sufficient liquidity to cover could be a set number of days for which under its contracts. potential disputes, we assess in table 3 a project in other jurisdictions would be While confidence that a project would the additional liquidity that would be at risk. Where the costs are unknown, perform as expected in the base case required for a similar project in India the risks would probably be retained by from an operational perspective is and Indonesia to provide the same the public sector—this is not about important, investors also focus on the buffer. For the purpose of this example, pushing risks back to a government, but ability to enforce contracts in case this we are assuming a claim equal to 10% of establishing the most economical way “operational” base case was experi- the construction price. to mitigate such risk. In the event a encing pressure. This is where we In both examples, to achieve a similar project was to establish large contin- believe the “Enforcing Contracts” position in terms of risk contingency and gencies against the risk but achieve the measure provides some good guidance. taking an Australian project as the bench- desired outcome in a cost- and time- In its study, the World Bank Group mark, the Indian project would require an efficient manner, the contingency would assessed the length of time, number of additional contingency of about 17% of the then flow as an equity distribution. procedures, and costs to solve a con- construction costs, whereas the Indonesian While risk and cost sharing could also tractual dispute. Table 1 looks at the project would need an additional 11%. be envisaged, simplicity is sometimes

Standard & Poor’s Ratings Services CreditWeek | January 21, 2015 53 FEATURES SPECIAL REPORT the most efficient structure when the principle above in an Indonesian con- Ultimately, it is such knowledge and range of outcomes is extremely wide. text, projects could transfer some land understanding of the overall risk allocation By establishing and precisely quanti- acquisition risks, although up to a set that attracts a lot of investors to Australia, fying the risks that private investors budget and for a set period of time, despite the country having seen its fair should be retaining, this would then allow beyond which the project would be share of project stresses. Very well-known all countries to establish a contractual fully compensated. In this particular examples can be found in the toll road framework that is common. The differ- case, though, a government might sector, where four of the most recently ence is that, unlike what is typically done decide to complete all land acquisi- completed projects have defaulted today, where governments seek to retain tions ahead of the project progressing. because of severe traffic shortfalls against a common set of risks irrespective of the forecasts. Projects have also come under protections that can be found in laws and Commitment To Expectations severe stress due to material construction regulations, this is about transferring a Keeps Australia Attractive cost overruns. Yet investors remained defined set of risks to the private sector. To Investors comfortable taking the risk with those proj- A typical example highlighting this While improving coordination and ects, mainly because contracts performed is the risk around land acquisitions: In standardization will always have a posi- in line with expectations. Obviously, a lot of countries, land acquisition is tive impact in the successful delivery of another key reason for the attractiveness transferred to the private sector a project, many private investors of Australia is the higher sovereign rating because there are very well defined remain reluctant to invest in certain compared with a lot of other countries—in and legislated procedures for compul- countries not because of a lack of the infrastructure sector, the sovereign sory acquisition, for which the costs coordination/standardization, but rating would typically act as a cap on a can be very well estimated. In prac- because they simply do not have suffi- project’s rating. A low sovereign rating tice, private investors are willing to cient comfort around the strength of would therefore result in a lower rating. take the risks because they are com- some legal and regulatory systems. That is, however, one area that investors fortable that the time will be no longer Such typical weaknesses introduce a can easily take a view on. A different story than a set number of days and that the level of uncertainty that is generally is managing risks that are undefined and costs have a high degree of certainty. not compatible with risks related to extremely challenging to deal with absent That is not the case in other countries, single-asset financing. For example, exorbitant contingencies. such as Indonesia, where time and facing the prospects of lengthy delays costs can vary materially. Applying the in the connection of a new power plant Change, So As To Grow to the electricity transmission grid The Global Infrastructure Hub should means that a project that would have act as a conduit to the fulfilment of Asia- Table 1 | Averages For Projects In otherwise performed adequately during Pacific’s infrastructure needs by taking Australia, India, Indonesia its construction is at risk of default the lead in driving standard risk profiles. simply because it cannot sell its elec- But, in reality, governments around the Duration Costs in days (% of claim) tricity output. We believe that until region will need to proactively and con- Australia 395 21.8 these weaknesses are addressed, sistently apply the Hub’s findings and Australia will continue to capture the recommendations, setting aside both India 1,420 39.6 lion’s share of private infrastructure national preference and personal ambi- Indonesia 471 115.7 investment earmarked for the region. tion. For that to happen, the Hub’s ideas must be acceptable to all parties while Table 2 | Required Contingency Funds remaining independent from politics and disengaged from the public/private tus- Debt interest cost to Contingency sles. That will be a challenge for the (Mil. US$) Permit costs Cost contingency cover additional time Total increase (as % of build cost) organization, but one that we regard as Australia 5.0 0.5 1.7 2.2 0.22% well worth taking on. CW India 282.0 28.2 3.2 31.4 3.14% Indonesia 43.0 4.3 2.8 7.1 0.71% For more articles on this topic search RatingsDirect with keyword: Global Infrastructure Hub

Table 3 | Additional Liquidity Required Analytical Contacts: Thomas Jacquot Debt interest cost Sydney (61) 2-9255-9872 Additional for additional time Additional cost Total increased Contingency time coverage coverage (mil. US$) contingency (mil. US$) liquidity (mil. US$) (as % of build cost) Gloria Lu, CFA, FRM Hong Kong (852) 2533-3596 India 1,025 days 157.3 17.8 175.1 17.5% Hiroki Shibata Indonesia 76 days 11.7 93.9 105.6 10.6% Tokyo (81) 3-4550-8437

54 www.creditweek.com Building For Growth Can The U.K. Close Its Infrastructure Investment Deficit?

lthough the U.K. was one of the pioneers of infrastructure Overview development, in recent decades its investment has ● The U.K.’s infrastructure investment Alagged behind that of several other countries in the deficit is at least £60 billion, and Organisation for Economic Co-operation and Development potentially much greater, according to Standard & Poor’s analysis. (OECD). This has put the country’s infrastructure under strain: In ● We estimate that each additional £1 2014-2015 Global Competitiveness Report the U.K. spends on infrastructure in the from the World one year would increase real GDP Economic Forum, inadequate supply of infrastructure stood out by £1.9 over a three-year period. ● We also project that additional as an obstacle to doing business in the U.K. We estimate that spending of 1% of GDP in the U.K. over the years, the U.K. has accumulated an infrastructure would add more than 200,000 jobs in the same year. investment deficit of more than £60 billion.

Standard & Poor’s Ratings Services CreditWeek | January 21, 2015 55 FEATURES SPECIAL REPORT

There is currently a broad consensus boost the country’s economic growth, struction output halving since the 1980s. among all main political parties in the both in the short term and over time. Road congestion is viewed as a significant U.K. about the need to invest more in problem in the U.K., generating costs to the infrastructure. And Standard & Poor’s The U.K.’s Infrastructure economy and the environment, as well as to Ratings Services estimates that each Investment Deficit the population’s quality of life. INRIX, a road additional £1 the U.K. spends on infra- Total investment in new U.K. infrastruc- traffic and driver services company, ranks structure in one year (in real terms) will ture has been trending down since the the U.K. as the third-most-congested increase real GDP by £1.9 over a three- mid-1980s, dropping from 1% of GDP in country among major developed year period. We also project that infra- 1980 to 0.6% in 2008, at the outset of the economies in Europe and North America. It structure investment would have a strong global crisis. Although the government’s estimates that over the past 12 months, the effect on job creation. Additional stimulus program and preparation for the average U.K. driver has spent some 30 hours spending of 1% of GDP in the U.K. would 2012 Olympic Games boosted infrastruc- in traffic jams, and that figure rises to 84 add more than 200,000 jobs in the same ture spending to 0.95% of GDP in 2011, hours in the London commuting area. The year, by our estimates. We expect that this increase was only temporary. government recognizes that its road net- investment will increase over the next Falling investment levels have hurt cer- work is under significant strain. To address decade, which will create significant tain sectors more than others (see chart 1). this, on Nov. 10, 2014, Prime Minister David opportunities for private capital invest- Roads have seen the most dramatic Cameron announced that the government ment in the sector. In our view, this could declines, with infrastructure-related con- plans to spend £15 billion over the next 10 years on improving its major roads. But just how large is the U.K.’s infra- Chart 1 | Infrastructure-Related Construction Output structure investment deficit? Our

1980 to 1995 1996 to 2010 2011 to 2012 2013 to 2014* analysis suggests that it is at least £60 billion—and potentially much greater. P (% of GD ) We used two approaches to estimate the 0.40 deficit. The first assessed the shortfall in 0.35 infrastructure spending by looking at the 0.30 U.K.’s historical levels of investment. 0.25 Applying the assumption that the U.K. 0.20 should have continued spending about 0.15 1% of GDP—the level in 1980—annually 0.10 on developing its infrastructure, we esti- 0.05 0.00 mate that the deficit in infrastructure Water and sewerageElectricity RoadsRail investment between 1994 and 2013 is *Data for 2014 refer to the first half of the year. Maintenance is not included. about £64 billion, or 3.7% of 2013 GDP. Sources: Office of National Statistics; Standard & Poor’s calculations. © Standard & Poor’s 2014. We also assessed the U.K.’s spending compared with that of other OECD countries, based on data from the International Chart 2 | Average Transportation Infrastructure Investment In 1995 To 2011 Transport Forum. From 1995 to 2011 (the latest data available), the U.K.’s invest- % of GDP OECD average ment in its transportation infrastructure (%) averaged 0.7% of GDP, compared with 1.8 0.9%, on average, for the OECD 1.6 1.4 economies (see chart 2). Applying the 1.2 assumption that the U.K. should have 1.0 0.8 invested in line with the OECD average 0.6 during that period, we estimate a deficit 0.4 0.2 of £58 billion, or 3.4% of 2013 GDP. 0.0 l The second estimate is, in our view, s a a y n n l i rk ce ay e li ga a a a d any and and and ium U.S. pa

l likely too low because it covers only one U.K. It an and apan g m S n J anada n Fr Greece ortu Irel Austri erl C Fi Swe

Norw of the infrastructure sectors. In addition, if Bel P h Austr Germ De we were to use the higher levels of invest- Switzerl

e Net ment in countries with the best infrastruc- h T ture as guidance for an optimal level of OECD—Organisation for Economic Co-operation and Development. investment, the estimated deficit would be Sources: International Transport Forum, Standard & Poor’s calculations. © Standard & Poor’s 2014. much higher. For instance, Switzerland,

56 www.creditweek.com which the World Economic Forum ranked first in terms of overall infrastructure Infrastructure investment generates both short- and quality in its 2014 global competitiveness report, invests 1.5% of GDP in transport long-term benefits, including job creation, increased infrastructure. Based on that level of investment, the deficit the U.K. has accu- demand, and improved productivity. mulated would exceed £200 billion.

Beyond The Cost Of Infrastructure taking these indirect and induced effects The debate on infrastructure often focuses into account, for each 1,000 jobs directly on cost. While this is an important part of created in infrastructure construction, the equation, we view the potential employment as a whole rises by 3,053 returns on infrastructure investment to be jobs (according to a joint report by the equally important. Infrastructure invest- Centre for Economics and Business ment generates both short- and long-term Research and Civil Engineering benefits, including job creation, increased Contractors Association titled “Securing demand, and improved productivity. As a our economy: The case for infrastructure”). result, each £1 billion spent on infrastruc- The short-term boost to output and ture may generate much more in terms of employment would be welcome, pro- total economic output—a phenomenon vided that there is still slack—or known as the “multiplier effect.” unused resources—in the economy, In the short term, infrastructure including in the labor market. But the investment boosts aggregate demand in benefits of infrastructure spending the economy. A construction company don’t stop there. Over the longer term, needs materials, goods, and services improving infrastructure can enhance (e.g., steel) from other industries, which the private sector’s productivity, for boosts demand in these categories. As instance, by reducing transport and hiring increases across various sectors communication costs. And the gains and the total wage bill rises, people can be significant: The December 2006 begin to spend some of their additional Eddington Transport Study shows that a income, thus increasing demand for con- 5% reduction in travel time for all busi- sumer goods and services. Businesses ness travel on roads could generate are also likely to spend more. And this around £2.5 billion of cost savings for spending cascade explains why each £1 companies, or 0.2% of 2006 GDP. billion invested in infrastructure may Reduced transport costs improve generate much more in terms of GDP. market access and enhance competi- The impact on employment alone can tion, which boosts productivity. be significant. Infrastructure spending The impact on the labor market can tends to first boost job creation in the also extend beyond the short term. construction industry—for example, to Better transport infrastructure can boost build roads. This is the direct effect of job creation by connecting people to infrastructure spending on employment. jobs. As an example, the U.K.’s Northern But it also generates employment in Hub project aims to stimulate economic related industries, such as manufac- growth by improving train services turing, while demand also increases for between the major cities of Northern the services of engineers and surveyors, England, thereby promoting job creation for example. This represents an indirect and improving access to employment, effect on employment. As people get according to the National Infrastructure paid and spend part of their income on Plan 2013. consumer goods and services, the addi- A number of empirical studies confirm tional spending may also create new that infrastructure has a positive effect on jobs in unrelated segments of the long-term economic growth, although economy—an induced effect of infra- the magnitude of the reported impact structure investment. Indeed, when varies widely and causality is difficult to

Standard & Poor’s Ratings Services CreditWeek | January 21, 2015 57 FEATURES SPECIAL REPORT establish (i.e., countries with higher in the construction sector in particular in our simulations, consumer price infla- output may be able to afford higher remains well below the pre-crisis tion remains below 2% until mid-2016 spending on infrastructure). A compre- peaks—by about 250,000 jobs. We and averages 2.3% in 2017. hensive 2009 study conducted by OECD believe that at a time when monetary Our simulations suggest that the mul- economists reports a positive impact of policy is ultra-loose and slack in the tiplier effect of infrastructure investment infrastructure spending on growth, based economy still persistent, an increase in for the U.K. economy is currently quite on historical data between 1960 and infrastructure spending can significantly strong. As we noted previously, each 2005. Specifically for the U.K., the find- boost demand. additional £1 spent on infrastructure in ings suggest that investment in roads, To quantify the impact of increased one year (in real terms) would lift real railways, and electricity generation infra- infrastructure spending on the economy, GDP by £1.9 over a three-year period, by structure was associated with higher Standard & Poor’s conducted simulations our estimates, and the effect on job cre- output levels over the study period. using Oxford Economics’ Global ation is also strong: Additional spending Economic Model. We assumed that on infrastructure of 1% of GDP in the Increasing Spending public investment—which we take as a U.K. would add more than 200,000 jobs Could Bring Big Returns proxy for infrastructure investment— in the same year. But what would be the effect of addi- increases by an additional 1% of GDP Our simulations focused on the short- tional infrastructure spending on today’s (or around £19 billion) above our base- term impact of infrastructure investment U.K. economy, in terms of output and line forecast. We also assumed that the through the lens of demand. Beyond the job creation? Bank of England keeps its policy rate at short-term effect on demand, we expect Despite the recovery gaining pace the level of our baseline scenario, gradu- that infrastructure investment would since the beginning of 2013, there is still ally rising to 1.9% by the end of 2016. boost the country’s productivity over slack in the U.K. economy. Employment We think it is a plausible assumption as, time, which should support a perma- nently higher level of potential output. This is consistent with findings pub- Chart 3 | GDP Per Hour Worked In G7 Countries In 2013 lished by the Civil Engineering Contractors Association in May 2013. They estimate (Index U.K. = 100) that in the U.K., £1 of infrastructure 150 spending boosts GDP by £1.3 in the short 140 term and £2.8 in the long term. 130 Furthermore, a report published by the 120 National Institute of Economic and Social 110 Research in April 2013 suggests that an 100 increase of infrastructure investment in 90 the amount of 1% of GDP can boost 80 potential GDP by 0.4% in the long term. Japan U.K. Italy Canada Germany France U.S. The long-term impact of increased Sources: Organisation for Economic Co-operation and Development, Standard & Poor’s calculations. © Standard & Poor’s 2014. infrastructure investment is relevant because, in our view, insufficient investment has been one of the key factors Chart 4 | Infrastructure-Related Construction Output By Type Of Financing explaining weak productivity perform- Public Private ance in the U.K. Output per hour in the U.K. was below the average for the rest (% of GDP) of the major G7 industrialized 1.4 economies in 2013 (see chart 3). And in 1.2 2013, one hour of work in the U.S. was 1.0 producing 40% more than one hour of 0.8 work in the U.K. 0.6 0.4 Productivity in the U.K. has remained 0.2 roughly unchanged from its level in the 0.0 pre-downturn year of 2007, and is cur- 5 5 3 5 3 3 3 rently some 18% below what it would have been if it had continued to grow at /1/2007 /1/2008 /1/2012 /1/201 /1/1997 /1/1998 /1/2002 /1/200 /1/1987 /1/1988 /1/1992 /1/199 /1/1982 /1/198 9/1/2004 3 6 9/1/2009 3 6 9/1/1994 3 6 9/1/1999 3 6 9/1/1984 3 6 9/1/1989 3 6 3 6 its long-term rate since 1991. One factor 12/1/200 12/1/2010 12/1/199 12/1/2000 12/1/198 12/1/1990 12/1/1980

Sources: Office of National Statistics, Standard & Poor’s calculations. has been strong employment growth © Standard & Poor’s 2014. accompanying the economic recovery,

58 www.creditweek.com reflected in a rising participation rate, licly fund only one-quarter of its infra- increasing numbers of self-employed, structure pipeline. Securing significant temporary, and part-time workers, and a private capital investments will, in our long period of falling real wages, which view, require good visibility on the have encouraged firms to expand timing of new projects, their terms, and employment further. the process for awarding them. We see Notwithstanding the impact of labor this as essential for the government to market developments, structural factors ensure that it has the tools to facilitate such as infrastructure bottlenecks may and deliver on these projects—and to help explain weak productivity perform- ensure that it addresses the historical ance in the U.K. The OECD has repeat- shortfall in infrastructure investment. edly identified insufficient infrastructure Investors have allocated significant as one of the factors holding back U.K. funds to finance new infrastructure productivity growth, and has called for projects. The range of investors an increased investment in infrastruc- includes infrastructure funds as well as ture—-both public and private. pension and sovereign funds, which have allocated part of their capital for The Financing Challenge infrastructure investment (see chart 4). The need for greater investment in the Participants also include infrastructure U.K.’s infrastructure prompts questions companies such as utilities, airports, about how to finance it at a time when and water companies, which will deliver government debt is rising and the some of the new investments. In addi- country’s budgetary deficit remains sig- tion, with regulatory requirements nificant. We anticipate that general gov- restricting banks’ long-term lending, ernment net debt will peak in 2016, at nontraditional lenders such as insurers just over 95% of GDP, before gradually and pension funds are poised to con- declining. The government has imple- tribute a larger share to the infrastruc- mented a fiscal consolidation program to ture investment pipeline (see “Investing In cut its deficit. In our view, this fiscal Infrastructure: Are Insurers Ready To Fill pressure is likely to constrain the gov- The Funding Gap?,” published July 7, 2014, ernment’s ability to finance new infra- on RatingsDirect). The government has structure projects. We therefore believe been making strides to encourage insti- that a significant portion of funding for tutional investment in infrastructure, infrastructure investment will come from which should help diversify funding the private sector. sources. For example, as part of the U.K. The government has supported signifi- Insurance Growth Action Plan, U.K. cant private sector investment in the insurers have agreed to work alongside past. It has done so, in part, by providing partners with the aim of delivering at a stable and transparent legal system, least £25 billion of investment in U.K. developing public-private funding infrastructure over the next five years. schemes, and fostering strong regulatory In our view, macroeconomic factors frameworks in industries such as airports, support an increase in private invest- water, and energy. However, private cap- ment in infrastructure. Real interest rates For more articles on this topic search RatingsDirect with keyword: ital investment in infrastructure has not remain at historical lows. Employment in Infrastructure Finance fully offset falling public investment. the U.K. construction sector remains well Analytical Contacts: The government has developed a below peak levels. Investing in infra- Aurelie Hariton-Fardad national infrastructure plan that lays out structure creates jobs, generates London (44) 20-7176-3677 its ambitions in terms of new invest- demand, and enhances productivity. Michael Wilkins ment. This plan includes a pipeline of While we expect real GDP to grow by London (44) 20-7176-3528 projects worth £383 billion, with most of 2% to 3% per year over the next several Jean-Michel Six the spending in the energy and transport years, we believe higher infrastructure Paris (33) 1-4420-6705 sectors. While the plan gives investors investments could lift growth further and Tatiana Lysenko an overview of the government’s goals, bolster the U.K.’s competitiveness. And Paris (33) 1-4420-6748 we believe it could benefit from more given the U.K.’s fiscal challenges, this Sophie Tahiri detail. The government expects to pub- couldn’t come at a better time. CW Paris (33) 1-4420-6788

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