The term ‘Infrastructure’ typically refers to the technical structures that support a society, such as Roads & Bridges, Energy (Power, Oil & Gas), Utilities including water supply, Transportation (Rail, Road & Sea), Social Infrastructure (Municipalities and Local bodies) Telecommunications, Mining, Ports – Air & Sea and so forth.
The drivers for rating companies that are engaged in Infrastructure business are quite different from rating drivers of other categories. It may be observed that companies engaged in the infrastructure companies could be:
- Belonging to private sector or Government related entities
- Already engaged in the successful operations of the implemented projects or may be in the process of implementing or the combination of both.
- The revenue streams are normally for a longer-term as compared to other companies as some infrastructure projects normally take a longer period for implementation.
Brickwork considers certain other unique factors while rating infrastructure companies and hence has developed a separate Criteria Framework for Rating Infrastructure companies.
The general description of criteria for Infrastructure companies for assigning both public and private ratings to a variety of debt instruments in the transportation, energy, water, social infrastructure sectors, etc... are covered in this document.
Pricing
It may be observed that the pricing of goods & services in the infrastructure sector are quite often regulated by government commissions in the form of tariffs.
However, within the infrastructure sector, different segments adopt different practices. The highly regulated tariff regimes could be witnessed in the areas of Oil & Natural Gas, Aviation, Water Sewerage services, etc…
Brickwork considers such government interventions as both positive and negative. On the one hand, it is positive because regulators determine financial returns favourably for infrastructure companies in order to balance the interest of consumer and the company. On the other hand, it is negative as the absence of pricing flexibility will be a disincentive for efficiently run firms.
Government Policy
Brickwork classifies the Infrastructure companies in three broad categories:
- Public-policy-based institutions, which play a central role in meeting political and economic objectives
- Commercial enterprises, which play a smaller or no public policy role
- Commercial enterprises that include corporate or financial institution that are likely to receive extraordinary government assistance.
The assessment of an entity is a function of the level of influences of the government policies for the independent functioning of the entity. The government influences come in the form of direct & indirect taxes, funding support, providing government guarantees, etc…
Demand and Supply position
Unlike other sectors, the infrastructure sector has a favourable demand and supply positions. In other words, the demand outstrips the supply in most of the cases. Brickwork considers this phenomenon as favourable in the short to medium terms.
Impact of monopoly on profitability
In India, we could observe, government has created companies in the infrastructure sector and allowed them the advantage of being a monopoly player. The monopoly position helps companies to generate more profits and at the same time the government interventions by way of having social, political and economic objectives will make entities inefficient.
Contractual foundation:
The contractual foundation covers the whole range of relevant Project Agreements (which exclude the finance agreements and other documents that set out the financial structure). The primary objective is to determine the level of protection from market and operating conditions that each agreement provides. The secondary objective is to determine whether the obligations created by each contract address the project’s risk characteristics and separate adequately the ownership of the project from the management by defining and limiting correctly the operational flexibility.
Competitive market exposure:
An evaluation of how a project would perform when faced with competitive market exposure is important for all projects, not only those that currently face market risks. However, for projects exposed to market risks, the competitive market exposure evaluation will be even more critical. Overall demand for a project’s output and its competitive position relative to its peer group are principal determinants of credit quality. The competitive fundamentals of a project need to be considered over the life of the project.
The analysis of a project’s competitive market position focuses on the following factors:
- Industry fundamentals
- Commodity price risk
- Supply and cost risk
- Foreign exchange exposure
- Project’s source of competitive advantage
- Potential for new entrants, disruptive technologies, or exiters
Counterparty exposure
Assessment of the soundness and legality of the contractual framework needs to be supplemented by an assessment of the ability and the willingness of the contracting parties to fulfil their obligations. The willingness of counterparties to perform might stem from economic incentives, business relationships, market position, reputation, ownership, and relationship with government, rather than from contractual arrangements.
Technology, Construction and operations
The choice of technology and construction risk present significant concerns to project finance financiers / investors. The remedies available to financiers / investors are unlikely to offer adequate protection if the project fails due to the choice of technology, construction difficulties or inefficiency in operations. Disputes and litigations, even if they result in favorable claims, can delay timely payment to financiers / investors. Brickwork places a great importance on the technical and operational evaluation of project finance transactions. The related risks falls into two categories: namely; pre-construction risks and post-construction risks.
Financial Strength
One of the most visible and quantifiable measures of project risk is the sufficiency of cash flow to cover obligations. The companies must generate adequate revenues to cover principal and interest payments after meeting mandatory charges such as operations and maintenance expenses, nonrecurring items, capital replacement expenditures, and taxes. The company cash flows must be able to contend with risks such as interest rate fluctuations, inflation risk, liquidity risk, and in some cases funding risks and foreign exchange fluctuations. Fundamentally, the key financial issue is a company’s ability to generate adequate cash flow to cover its debt obligations.
A project’s leverage is a secondary consideration. Sponsors will typically try to leverage a project to its greatest possible extent to limit their paid-in equity cash commitment. The quality of the cash flow will be the key determinant. For example, a start-up toll road facing uncertain traffic demand would need to have a lower gearing ratio to deliver the same degree of credit risk as an existing toll road with proven operating experience.
A project’s debt amortization schedule may have a significant impact on credit quality. A front-end loaded amortization schedule that takes advantage of near-term cash flow certainty may suit some projects such as power projects with near-term certainty on power purchases and better-known plant operating and fuel costs. Other projects, such as toll roads, may benefit from delayed amortization of debt, allowing cash flow generation ability to build up as toll road usage grows. Bullet maturities and short-term financing will significantly increase credit risk for all projects. Uncertainty about the status of the project or the status of the financial markets when funds are required increases the risk of bullet maturities, short-term bridge financing, and commercial paper.
Legal Risk
Because of the non-recourse, single-asset nature of project financing, the legal structure of the project needs to provide comfort to the financiers / investors that:
- The project company is legally restricted in its scope, isolated from other businesses, and importantly, insulated from the insolvency of the sponsors
- The financiers / investors have the legal right to enforce their collateral rights first and fully
- The project lending agreements define the rights of the financiers / investors fully in relation to the project and to the management
- Financiers / investors have the ability to gather adequate information on the project on an ongoing basis.
|
