securities & exchange commission infrastructure round table

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Securities & Exchange Commission Infrastructure Round Table Lagos, August 5 & 6, 2013 Konrad Reuss Regional Manager Sub-Sahara Africa Standard & Poor’s [email protected]

2.

Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s.

Agenda

•  Rating Agencies – Background Information

•  Infrastructure Financing and Ratings

•  Project Finance Talking Points

3.


The Credit Rating Agency Landscape

•  The global players: Standard & Poor’s Ratings Services (S&P), Fitch Ratings, Moody’s Corporation

•  Other globally active CRAs: AM Best (US), Egan Jones (US), Kroll Bond Rating Agency (US), Morningstar (US), Dominion Bond Rating Service (Canada), Japan Credit Rating Agency (Japan), Rating & Investment Information (Japan), Dagong Global (China)

•  National Credit Rating Agencies: e.g. GCR Global Credit Ratings (South Africa), Agusto (Nigeria)

4.


Standard & Poor’s Credit Ratings

A Credit rating is: •  A forward-looking opinion of relative creditworthiness

•  A key component in pricing debt

–  Typically: higher rating = lower default risk = lower cost of capital

–  Rating scale runs from “AAA” (highest) to “D” (lowest; indicates default)

A Credit rating is not: •  A recommendation to purchase, sell or hold a particular security

•  A comment on the liquidity of the instrument or any other element affecting the suitability of the investment for an investor, including interest rate, currency and prepayment risk

•  An audit of the obligor’s financials or operations

5.


Rating Scales: Investment Grade & Speculative Grade Debt

6.


Short-term Rating Scale & Scale Correspondence

•  Debt with a maturity of one-year or less such as commercial paper. •  Only the A-1 category is modified by a plus sign to distinguish additional strength.

A-1+ A-1 A-2 A-3 B

AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- BB+ BB BB-

Short-term

Long - term

7.


How Financial Markets Work

8.


How to borrow –and from whom…?

Manufacturing

& Project Co

From public debt markets…

$

$

Short Term

Notes

Bonds

From financial institutions

(banks and insurance companies)…

$ Loan

contract

9.


What Ratings provide to financial market participants

Ø A reliable source of information

Ø An understandable scale for comparison

Ø Clearly described method of measurement

10.


How Do Credit Ratings Add Value?

•  Can “benchmark” credit against other issues •  Supplements in-house credit resources

Intermediaries (Bankers) Issuers (Borrowers)

Investors (Lenders)

•  Facilitates pricing against other benchmark deals

•  Third-party opinion of the credit of their client

•  Acceptance in many debt markets •  Can estimate cost of debt

•  Expands potential investor universe

•  Compare to others

11.


Impact on Corporate Borrowing Costs

Source: Standard & Poor's Global Fixed Income Research

Average corporate bond spreads from January 2003 through April 2011.

0100200300400500600700800900

1,000Ba

sis

Poin

ts

AA A BBB BB B CCCand

below

Average Five-Year Option-Adjusted Spread for Different Rating Categories

AA A BBB BB B CCC and below

12.


Project Finance

13.


Infrastructure Spending – The Starting Point

• Via Budget

• Government debt

• Tax payer ultimately pays

• Public sector managed

• Off-budget

• Project finance structure

• User pays (entirely/partially)

• Private sector managed

14.


S&P Global Project Finance

15.



16.



17.



18.


Main rating drivers for project finance

•  Solid economic rationale, supported by opinionated reports

•  Experienced contractors and operators

•  Reasonable leverage mitigating volume risk and uncertainties

Legal

Structure

Counterparty Risk

Contractual Structure

Competitive Market

Exposure

Technology, Construction

and Operations

FinancialStrength

Project Level Risks

19.


Appendix: Main rating drivers for project finance

–  Project level risks: §  Contractual framework §  Technology §  Operations §  Construction §  Market position §  Counterparty risk §  Legal structure §  Financial strength

–  Sovereign risk –  Institutional risks –  Force majeure risk –  Credit enhancements

Credit Enhancements

Force Majeure

Institutional Risk

Sovereign Risk

Project level risks

“If a project cannot reasonably forecast commercially ongoing operations, other concerns such as the viability of guarantees

or credit enhancements will count for little.”

20.


Project Finance Talking Points

•  Construction Risk

•  Political and regulatory risk, macroeconomic risk

•  Transfer and convertibility risk

•  Suitability of investor

•  Pooling of projects

•  Credit enhancement/risk mitigation

•  Ensure regular project flow

21.


Key Issues in Financing Structures – the “5 Ps”

•  The 5 Ps of project finance financial structure have, in general, been the key drivers of ratings differentiation (purely from a financial perspective):

Protective transaction structure Security, Covenants and Controls

Predictable project cashflow and regulation

Cashflow volatility, not just DSCR

Profile of amortization which does not build-in risk

Smooth, no back ending of risks

Providing better liquidity than comparative projects

To bridge cashflow disruption

Passing operational and financial project risks to those who can best manage it

Creates a counterparty exposure

22.


Latest developments

23.


The Funding Challenge – Who is Bridging the Gap?

•  The world faces enormous infrastructure investments. An estimated EUR 1.5 trillion to EUR 2 trillion are needed to meet the policy goals of the Europe 2020 Strategy for smart, sustainable and inclusive growth.

•  … traditional lenders are under severe economic pressure and market is struggling to find a structure that meets both equity investors’ requirement and investors’ demand for lower-risk bond.

•  So who may bridge the funding gap:

–  The rise of alternative financing in infrastructure - New investors are emerging ( e.g. Blackrock) or stated their interest

– Capital Market Issuance: various initiatives have been put in place (EIB project bond initiative, UK Guarantee scheme, etc.) to support senior debt to meet investors’ rating preferences.

24.


The Rise of Alternative Financing

•  Just under $100 billion was raised in the global project finance loan market in 2012 – down from $159 billion in 2011

–  Traditional lenders (banks, governments) are under severe economic pressure.

–  New investors have entered the marketplace (Blackrock etc.)

–  Experienced participants have set more ambitious fundraising targets

•  In the U.S., a quarter of all project lending last year came directly from alternative sources - with MENA and Asia Pacific, following a similar pattern.

•  In 2012 over $20 billion in infra debt involved alternative funding sources (Shadow Banking)

•  Should this trend continue, we anticipate more than $25 billion of project finance debt will sourced from the shadow banking sector in 2013.

25.


Global Project Finance Funding Environment: 2012-2013

Top Participants Aviva 14 BMO Capital Markets 8 Bank of Tokyo-Mitsubishi UFJ 6 CIBC 5 RBC Capital Markets 5 Scotiabank 5 Barclays 5 National Bank Financial 5 Bank of America 4 ING Bank 4 Macquarie 4 SMBC 4 TD Bank Financial Group 4 Union Bank 4 Other 108

Source: IJ and InfraNews

26.


Investors seek low risk, high yield

•  Certain infrastructure projects complement the long-term liability needs of insurance companies and pension funds, e.g. PFI.

–  Stable fixed-rate and inflation-linked cash flows

–  Relatively manageable credit risk (if well done and not overleveraged)

–  High observed and projected recovery rates in case of default

–  Typically provides a higher yield than government bonds

•  But still lack of confidence…

–  Potential institutional investors continue to be wary of being caught in a repeat of 2007 asset bubble.

–  Perceived heightened level of risk compared to sovereign bonds

–  Lack of information about more challenging projects (e.g. offshore wind)

27.


PBCE to stimulate the European Infrastructure Project Bond Market •  EIB to provide subordinated debt instruments (PBCEs) to enhance the

credit quality of senior debt issued by project finance issuers.

–  EC contributing €230 million in capital for the pilot phase

–  At least €4.6 billion of senior debt could be made available

–  EIB effectively acting as subordinated lender

•  If inserted properly within the transaction structure PBCE may reduce the likelihood of default on senior debt

•  However, PBCE in itself would not be sufficient to improve the credit quality of a project with weak fundamentals, eg:

–  Weak business profile

–  Exposure to weak, irreplaceable, counterparty

–  Transaction structure that doesn’t protect creditors

28.


•  Market sentiment suggests that construction risk in particular remains a specific source of anxiety (as compared to Operations risk)

–  Typical problems encountered by projects during construction include the underestimation of costs, design changes, granting of permits, adverse weather, and force majeure events

–  Estimating the required amount of credit support to complete a project is therefore a complex task in itself

•  Many of these issues can be resolved by changing the project structure or covered via insurance, given sufficient expertise and experience on behalf of investors.

•  Operations contracts are not without risks of their own.

Example: Construction Risk

29.


Criteria Update

30.


Key Elements of Project Finance Criteria Being Reviewed

•  We are reviewing our criteria for rating project finance transactions

–  The review is designed to deliver greater transparency

–  Will result in refinements to some of our assumptions and methodologies

–  Possibly leading to modest adjustments to some project finance issue ratings

•  The broad criteria areas the review intends to cover are:

–  Construction and operations counterparty risks (see Project Finance Construction And Operations Counterparty Methodology, Dec. 21, 2011);

–  Construction and operations phases (see Request For Comment: Global Project Finance Methodology--Construction Phase, Jan.28, 2013);

–  Transaction structure; and

–  Criteria framework

31.


Example: Construction Risk

32.


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