This is the second in a series of blogs about infrastructure projects. You can access the first blog here: At the Crossroads of a Potential $15 Trillion Problem.
Infrastructure assets and projects face a bigger economic and financial test from the coronavirus pandemic than during the financial crisis of 2008-2009, when they proved to be fairly resilient.
Ultimately, all players involved, be it governments or private players, must satisfy a risk-return equation. This requires an evaluation of performance risk, which is the risk that an infrastructure project will not perform as initially intended, with one or more parties possibly breaking the contractual agreement. The objective of assessing performance risk is not to eliminate it, but to highlight potential areas of concern so they can be recognized and effectively managed. Given this, a performance risk framework should be employed by all parties involved in a project, not just those taking financial risks.
Major Risks for Infrastructure Projects
The risk assessment of a project should reflect its credit quality during its weakest period until the obligation is repaid through project cash flows. Separation of the construction and operation phases enables a risk assessment to identify if the weakest period is during one phase or the other. The S&P Global Ratings Project Finance credit rating methodology outlines a number of factors to consider. Examples of issues to review during the construction phase include:
- 1. Technology and design: Risk of costs being underestimated or design changes/enhancements requiring additional funding.
- 2. Construction: Risk of construction counterparties not performing due to the complexity of the design and delivery method.
- 3. Project management: Risk that management will not perform on its requirements (e.g., cash management, design approvals, permit retention, and dispute resolution).
- 4. Construction funding: Risk related to construction funding versus projected needs.
Examples of issues to review in the operations phase include:
- 1. Project operations: Risk that a project's predicted cash flows will not materialize due to the inability of it to provide products/services.
- 2. Resources and supply chains: Risk due to the possibility of a project experiencing a shortage in production or service provision because of supply chain disruptions, or the lack of availability of raw materials to satisfy baseline requirements.
- 3. Market exposure: Risk based on the potential impact of volatile prices, fluctuating demand, and a lack of competitive advantage relative to peer projects.
- 4. Country problems: Risk of a company being domiciled in a particular country with potential geopolitical problems.
- 5. Liquidity and refinancing: Risk associated with the existence and suitability of reserve accounts and refinancing debt under various scenarios.
Adding to these examples, decision-making processes for long-term investment strategies are increasingly being influenced by environmental, social, and governance (ESG) issues, such as climate change, waste management, and human rights. Access to financing is being made contingent on stringent ESG expectations in a growing number of instances. It is, therefore, important that ESG issues be considered along with those listed above.
When Projects Default
It is inevitable that some infrastructure projects, particularly those on a large scale, will run into problems, evidenced by the fact that default rates on projects are not zero. While average historical losses on defaulted projects evidence strong recoveries (or smaller losses) relative to corporate defaults, project-specific recoveries can vary widely from the average with near total losses through to complete recoveries. It will therefore be prudent for all parties to estimate potential losses in an event of default. The main, post-default factors to consider include:
- 1. Realistic net present value of future cash flows.
- 2. Expected volatility of expected cash flows.
- 3. Reasonable scenarios that may lead to default and the impact on future cash flows.
- 4.Liabilities payment waterfall (e.g., taxes, interest/principal payments, and environmental restoration costs).
- 5. Jurisdictional influences (e.g., enforceability of creditor rights).
- 6. Guarantees and insurance with respect to project financing.
Tools to Assess Project Finance Risks
Broad risk assessment factors can be captured in a model or scoring framework to support a consistent analysis across diverse projects. S&P Global Market Intelligence’s Project Finance suite of tools provides a framework for the analysis of Project Finance transactions, reflecting industry or sector and geographic-specific factors, with the use of well-established project finance debt rating criteria. The suite comprises Probability of Default (PD) and Loss Given Default (LGD) Scorecards that bring together statistically validated PD and LGD methodologies, quantitative and qualitative risk factors, and market benchmarks to build a single, robust assessment framework to identify and manage Project Finance credit risks.
 “Infrastructure Finance Outlook”, S&P Global Ratings, Issue 1, 2020, www.standardandpoors.com/pt_LA/delegate/getPDF;jsessionid=61F72E5543D1927A4EF179423E18E338?articleId=2425191&type=COMMENTS&subType=.
 “Rated Global Infrastructure Displays Strong Credit Quality And Low Risk”, S&P Global, April 2018.
For more information about Project Finance ScorecardsClick Here
Credit Risk and Infrastructure Issues: At the Crossroads of a Potential $15 Trillion Problem