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13. Project and Infrastructure Debt as an Asset Class

© New York University/Stern School of Business, CC BY 4.0

The credit rating agencies, notably Standard & Poor’s, have been active in analyzing project and infrastructure-based bond debt from the perspective of default risk.1 Figure 5 shows project and infrastructure finance ratings from 1982 to 2004.

Figure 5. Historical Project Finance Ratings Outstanding, 1992–2014 (Source: © Standard & Poor, 2015)

As of the end of 2015, there were about 250 S&P-rated infrastructure issues, the majority of which are rated BBB, the lowest investment grade, and therefore acceptable in key institutional portfolios. Issues rated as A presumably are backed by highly rated sponsors and therefore do not qualify as non-recourse project financing. The remaining infrastructure bond issues are non-investment “speculative” grade. Figure 6 shows the distribution by geography and rating, and Figure 7 shows the distribution by sector and rating.

Note the dominance of investment-grade ratings in the OECD countries, with a significant Latin American representation. Infrastructure among the rated sectorial projects is dominated by power, transportation, and public finance/real estate. Note the marginal role of telecommunications among project-based rated debt issues. The power sector, in turn, is highly sensitive to risk-shifting contracts such as offtake contracts with strong counterparties and significant liquidity providers in place.

Figure 6. Project Finance Ratings by Region (Source: © Standard & Poor, 2015)

Figure 7. Historical Project Finance Ratings by Industry (Source: © Standard & Poor, 2015)

Figure 8. Annual Project Finance Ratings Actions (Source: © Standard & Poor, 2015)

How stable are the ratings? Figure 8 shows ratings upgrades and downgrades of investment-grade and speculative issues, respectively, in the project finance arena, evidently with significant re-rating activity during the 1982–1994 period. It shows a higher share of upgrades toward the end of the period, notably in the power sector. Re-ratings are reflected in transition matrixes, showing ratings migration over periods from one to five years after issue. As expected, ratings migration is highest in the lower investment-grade and speculative-grade project and infrastructure securities.

Table 6 shows cumulative default rates for infrastructure issues, by rating, for different time periods since issue. For BBB issues the cumulative default rate was 4.3% over 15 years, and for speculative issues it was 20.1% for the same period.2 Overall, 5.8% of the S&P project population defaulted, and 68% of these had an initial speculative-grade rating with a median rating of BB.

Table 6. Cumulative Average Default Rates (%) for Project Finance Issues (Source: © Standard & Poor, 2015)

Evidence from the rated project finance market relies on a small share of the thousands of project financings done every year, so these data do not represent the market as a whole. Moreover, the dataset breakdown has some bond tranches too small to permit meaningful conclusions. Nevertheless, if the future of infrastructure finance is to tap the world’s large fiduciary asset pools, it must demonstrate a growing trend toward investment-grade issues, which the data currently indicate. There are also interregional differences — for example, speculative-grade project finance captures 46% of the activity in North America but only 24% in Europe.

Finally, in recent years financing mechanisms and funds invested in sustainable infrastructure have grown exponentially.

Green bonds, for example, have grown from $10 billion in 2013 to $45 billion in 2015. At the international level, global commitments by governments toward a low-carbon future, in conjunction with the UN SDGs, have led to multilateral banks such as the World Bank and the Asia Development Bank working to de-risk private-sector investment in sustainable infrastructure by leveraging their AAA rating to issue social impact bonds. A Green Climate Fund has been set up to assist with the climate commitments, and governments around the world have committed $100 billion to stimulate the transition to a low-carbon economy.

At the national, state, and municipal level, PPPs are emerging to tackle water infrastructure issues, among other needs. In the US, Connecticut and New York have set up “green banks” focused on catalyzing investment in renewable energy and water quality infrastructure.

The US EPA launched its Water Infrastructure and Resiliency Finance Center in January 2015, which incorporates a Clean Water State Revolving Fund and a Drinking Water State Revolving Fund aimed at financing resilient water infrastructure as well as storm-water and green infrastructure programs. The funds do not depend on Congressional appropriations. They make loans, purchase debt obligations, securitize financing, provide guarantees, and carry an AAA rating. Annual new issues have been around $2 billion, with the projected need rising to $3 billion to $4 billion annually.

The Chinese government has set up a formal process for infrastructure PPPs as part of its goal to bring more private-sector financing to address environmental challenges, many of which are infrastructure related.

One apparent trend is growing demand from institutional investors and smaller “impact investors” for fixed-income, long-term investments that create social benefit. Securitization of green infrastructure, such as energy-efficiency loans and solar power, are beginning to create a more liquid secondary market for infrastructure improvements.

1 2014 Project Finance Default Study and Rating Transitions, Standard & Poor’s Ratings Direct, 23 February 2016.

2 Ibid.