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COMMENTS

How We Assess The Credit Strengths Of European Corporate Securitization, Project Finance, And Structurally Enhanced Debt


How We Assess The Credit Strengths Of European Corporate Securitization, Project Finance, And Structurally Enhanced Debt

Many investors hold debt that S&P Global Ratings rates under its criteria for project finance (PF), structurally enhanced debt (SED), or corporate securitization (whole business securitization [WBS]), each an asset class. The scope of each criteria falls somewhere along a spectrum of credit risks that largely reflects the nature of the assets and creditor protections, which include the operating and financial covenants, security, and the strength of the regulation, if any.

This article discusses the key differences in the assets and creditor protections, and presents the building blocks of our ratings within each asset class and ratings distributions for senior secured debt issued by European issuers. Our data show that our ratings assigned on SED and WBS transactions fall within a fairly limited range, while our ratings on PF transactions are more disperse.

In broad strokes, the characteristics that distinguish each asset class from the others are:

  • PF relates to the financing of an asset in its construction and/or operations phase where there is a finite life related to a contract or a concession. Cash flows are exposed to operating risks, although protected by a degree of risk transfer and allocation among participants.
  • SED is backed by transportation infrastructure and regulated utilities that we view as shielded from competition and creditor protections that include a stand-still period.
  • WBS credits are neither regulated nor have a finite life. They are backed by a company's operating cash flows and a security package that affords the creditors control over any borrower insolvency. All of the WBS that we currently rate in Europe are U.K.-based. The assets remain on the balance sheet of the operating company (balance-sheet corporate securitizations).

Our issue ratings reflect the transaction's asset quality and creditor protections with consideration given for the borrower's underlying creditworthiness, through a stand-alone credit profile (SACP) in the case of PF and SED. Our ratings approach to WBS reflects the business risk profile (BRP) and an anchor and any notching for our assessment of a transaction's relative credit characteristics and performance in aggregate, both in absolute terms and relative to peers. Table 1 presents a summary of the assets and creditor protections that we typically see in the transactions in each asset class. Our ratings reflect the balance achieved between the two factors. For example, we generally see a regulated utility backing an SED transaction as stronger than a corporate borrower in a WBS. However, the creditor protections provided in the latter often tip the scale and result in greater uplift (see table 6 for the potential uplift) from the underlying creditworthiness of the corporate borrower, whereby we view the credit risks associated with the senior debt similarly, with both achieving investment-grade ratings within the 'BBB' or low 'A' rating categories.

Table 1

Summary Of Typical Assets And Creditor Protections
Asset class   Assets   Creditor protections
Project finance Sectors that commonly use project finance structures include transportation infrastructure (e.g., toll roads, bridges, and tunnels), social projects (e.g., barracks, hospitals, schools, accommodation, and detention centers), energy and water infrastructure (e.g., power generation and transmission, gas transmission, liquefied natural gas terminals, and water treatment plants), and commodity-based projects such as oil and gas and mining projects backed by reserves. - A project financing has a finite economic life, and project documents constrain the level of permitted asset and business expansions.

- Project risks are allocated equitably between all participants in the transaction, with the scope of limiting risks.

- Security interest over the project's assets, protects the project and its property from third-party claims and the primary instrument of intervention for lenders.

- Operating and financial covenants binding the project company.

Structurally enhanced debt A regulated utility or regulated transportation infrastructure company that provides an essential or near-essential infrastructure product or service with little or no practical substitute. - Security may be over the company's assets or in the form of shares in the holding and operating companies if regulation or legislation does not allow for the granting over the assets directly, which we generally view as a relative weakness in our analysis.

- The common terms agreement documentation provides for a credit remedy period (sometimes referred to as a standstill period) of at least 12 months, during which all creditors suspend their enforcement claims, except for the right to sell the shares of the operating company coupled with dedicated liquidity facilities that can be drawn during the credit remedy period.

- Covenants, prudent risk management, and the ability to affect a recovery through the sale of shares of the operating subsidiary while they may still hold significant value.

Whole business securitization A corporate entity, no finite life, a going concern. - Both operating and financial covenants that seek to control business risks and allow for the secured creditors to seek remedies ahead of insolvency and avoid a court-led proceedings through the appointment of an administrative receiver, or the equivalent.

- The borrower retains operational control, but grants security (fixed and floating charges) over its assets, to secure undertakings under the loan. The secured creditors (namely, the noteholders) rely on borrower-level performance triggers to empower the trustee to appoint an administrative receiver ahead of a potential insolvency of the borrower, or default on the secured loan. Appointment of an administrative receiver will block court-led administration and allow the receiver to manage the assets in the best interests of the noteholders.

- Both operating and financial covenants that seek to control business risks and allow for the secured creditors to seek remedies ahead of insolvency and avoid a court-led proceedings through the appointment of an administrative receiver, or the equivalent.

- The borrower retains operational control, but grants security (fixed and floating charges) over its assets, to secure undertakings under the loan. The secured creditors (namely, the noteholders) rely on borrower-level performance triggers to empower the trustee to appoint an administrative receiver ahead of a potential insolvency of the borrower, or default on the secured loan. Appointment of an administrative receiver will block court-led administration and allow the receiver to manage the assets in the best interests of the noteholders.

We form our credit opinions for each asset class based on the methodologies that we apply in our ratings analysis. However, all three asset types share a common theme. We first assess the operating company's operating strength, which provides a good proxy for earnings and cash flow volatility and comprises the risk and return potential for a company in the markets in which it participates. Second, we evaluate the financial risk, which reflects the relationship of the cash flows the company can achieve, given its operating strength, to the company's financial obligations. For structurally enhanced debt we apply a cash flow/leverage analysis to determine a corporate issuer's financial risk profile, while PF and WBS we perform a debt service coverage ratio (DSCR) analysis to assess whether cash flows will be sufficient to service debt through the related transaction's life. A borrower's overall creditworthiness reflects a combination of its operating strength and financial risk.

The information in this article is presented on an aggregate basis and may not capture all potential rating outcomes, as the nature of the underlying assets may have idiosyncratic risks that may not be fully mitigated by structural enhancements. All ratings are a committee decision and we may consider the specific credit characteristics and structural enhancements on a stand-alone and comparative basis, the result of which may affect our view of a transaction's operating or financial strength, which may in turn result in rating outcomes that differ from those implied by the aggregate data.

Table 2

Credit Measures
Asset class Operating strength measure Financial risk measure Borrower creditworthiness measure
Project finance Operations phase business assessment* DSCR analysis* Preliminary operations phase stand-alone credit profile*
Structurally enhanced debt Business risk profile§ Financial risk profile§ Stand-alone credit profile†
Whole business securitization Business risk profile§ DSCR analysis† Anchor‡
*Assessed based on "Project Finance Operations Methodology," published on Sept. 16, 2014. §Assessed based on "Corporate Methodology," published on Nov. 19, 2013. †Assessed based on "Stand-Alone Credit Profiles: One Component Of A Rating," published on Oct. 1, 2010. ‡Assessed based on "Global Methodology And Assumptions For Corporate Securitizations," published on June 22, 2017. DSCR--Debt service coverage ratio.

Operating Strength

For both SED and WBS transactions we capture an underlying company's operating strength by our assessment of its BRP which focuses on the competitive climate within those markets (its industry risk), the country risks within those markets, and the competitive advantages and disadvantages the company has within those markets (its competitive position). For PF, the analogous measure is a project's preliminary operations phase business assessment (OPBA). The main factors to determine the OPBA are:

  • Performance risk assessment: We determine this by analyzing asset class operations stability and then adjusting for several factors, including project-specific contractual terms and risk attributes, performance standards, and resource and raw material risk.
  • Market risk assessment: Market risk only applies when a project's cash flow available for debt service (CFADS) has the potential to decline by more than 5% from our base case to our downside case due to market risk. In such cases, we then assess the project's market exposure (an assessment of its CFADS volatility due to market forces) and its competitive position.
  • Country risk.

OPBAs are assigned on a scale (1=best to 12=worst). Within each asset class, the OPBA and BRP represent a relative scale for the strength of the underlying credit, but this does not imply any relationship between the two measures. For example, a project is by its nature a single asset and our project finance criteria treat the single-asset risk as inherent to the asset class while our corporate ratings criteria impose certain restrictions to our view of the credit strength of a single asset corporate issuer. That said, the OPBA or BRP, as the case may be, is used in combination with a DSCR analysis to establish an anchor in the case of WBS transactions or a SACP in the case of PF and SED transactions.

Owing to the nature of the assets that fall within the scope of each criteria (see Appendix), those assets backing SED transactions, near essential and regulated, carry either an excellent or a strong BRP. We generally assess BRPs for WBS--which are backed by operating companies that are more susceptible to competitive and economic pressures--as ranging from strong to fair, largely driven by the competitive position and industry (see chart 1 for aggregate information and tables 3 and 4 for deal-level details).

For PF, the results are a bit more mixed. We have assessed European power projects an average OPBA between 5 and 6, largely due to one power project (CRC Breeze Finance S.A.) that carries an OPBA of 7 and represents 20% of the total number of European project finance issuers of debt that we rate within Europe's power industry. By contrast, social, accommodation, and entertainment projects have an average OPBA of between 2 and 3, with two outliers being issuers backed by football media and sponsorship rights that carry OPBAs of 11, but those outliers only represent approximately 5% of the total number of issuers within that industry.

Chart 1

image

Table 3

Structurally Enhanced Debt
Issuer BRP Industry*
Affinity Water Programme Finance Ltd Excellent Regulated Utilities
Anglian Water Services Financing PLC Excellent Regulated Utilities
Dwr Cymru (Financing) Ltd. Excellent Regulated Utilities
Elenia Finance Oyj Excellent Regulated Utilities
Ellevio AB Excellent Regulated Utilities
Southern Water Services (Finance) Ltd. Excellent Regulated Utilities
South East Water (Finance) Ltd. Excellent Regulated Utilities
Thames Water Utilities Cayman Finance Ltd. Excellent Regulated Utilities
Wales & West Utilities Finance PLC Excellent Regulated Utilities
Gatwick Funding Ltd. Strong Transportation Infrastructure (Reg.)§
Heathrow Funding Ltd. Excellent Transportation Infrastructure (Reg.)§
Yorkshire Water Services Ltd. Excellent Regulated Utilities
*Industry as determined by our key credit factors. §We apply our rating-to-principles approach to Heathrow Funding Ltd. (HFL) and Gatwick Funding Ltd. (GFL), using our criteria "Rating Structurally Enhanced Debt Issued By Regulated Utilities And Transportation Infrastructure Businesses," published on Feb. 24, 2016 (the SED criteria). Neither HFL nor GFL are in scope of the SED criteria due primarily to higher risk of competition and the absence of a credit remedy period during which creditors take control of the business and either stabilize its credit quality or sell the company's shares. However, HFL and GFL benefit from the majority of the structural enhancements listed in the SED criteria, and has additional risk mitigating factors such as the right for creditors to step in and appoint an administrative receiver while the business may still retain significant value. The combination of these factors leads, in our view, to a marginal reduction in the default risk of HFL and GFL, similar to the marginal default risk reduction that SED senior bondholders can benefit from. BRP--Business risk profile.

Table 4

Whole Business Securitization
Issuer Borrower* BRP Industry§
AA Bond Co. Ltd. AA Intermediate Co Ltd. Satisfactory Business Services
Arqiva Financing PLC and Arqiva PP Financing PLC Arqiva Group Parent Ltd. Strong Telecom & Satellite
Arsenal Securities PLC Arsenal Holdings PLC Fair Retail and Leisure†
CPUK Finance Ltd. Center Parcs (Holdings 1) Ltd. Fair Retail and Leisure‡
Dignity Finance PLC Dignity Holdings No.2 Ltd. Fair Business Services**
Greene King Finance PLC Greene King Retail Parent Ltd. Fair Retail and Leisure
Marston's Issuer PLC Marston's Pubs Ltd. Fair Retail and Leisure‡
Mitchells & Butlers Finance PLC Mitchells & Butlers Retail Holdings Ltd. Satisfactory Retail and Leisure‡
RAC Bond Co. PLC RAC Bidco Ltd. Satisfactory Business Services
Spirit Issuer PLC Spirit Pub Company (Managed) Ltd. and Spirit Pub Company (Leased) Ltd. Fair Retail and Leisure‡
THPA Finance Ltd. Pd Portco Ltd. Fair Transportation (Unreg.)
Unique Pub Finance Co. PLC (The) Unique Pub Properties Ltd. Fair Retail and Leisure
*The top-most obligor within the ring-fenced corporate structure and the entity assessed the BRP §Industry as determined by our key credit factors. †Sports and Leisure. ‡Restaurants and Retail. **Consumer and Business Services. BRP--Business risk profile.

Financial Strength

A company's operating strength affects the amount of financial risk that it can bear at a given level of creditworthiness and constitutes the foundation for a company's expected economic success. As mentioned above, for SED we apply a cash flow/leverage analysis to determine a corporate issuer's financial risk profile that we base on our corporate criteria, while for PF and WBS, we perform a DSCR analysis to assess whether cash flows will be sufficient to service debt through the related transaction's life (see "Corporate Methodology," published on Nov. 19, 2013). In either case, our analysis considers the minimum DSCR produced under our base-case projection. We consider that, in order to achieve a given level of creditworthiness (either a preliminary operations phase SACP or anchor), a stronger business with more stable cash flows will require a lower DSCR than a weaker business with more volatile cash flows.

Table 5 shows the average minimum DSCRs for the senior debt within each asset class and industry, and further stratified by operating strength. Given that PF issuers typically issue only senior debt, the information presented from this point forward, whether it be financial ratios or ratings, is limited to the senior debt. Weaker businesses generally have higher average DSCRs, with a few exceptions that we highlight below. For example, for the social, accommodation, and entertainment issuers that have OPBAs of 11, their average minimum DSCR is 3.30x, while those with an OPBA of three or four have an average minimum DSCR of 1.25x.

Table 5

Average Minimum DSCRs By Industry And Operating Strength
Asset class Industry Operating strength (OPBR)
1-2 3-4 5-6 7-8 9-10 11-12
Project Finance Power 1.25x 1.53x 0.90x*
Social, Accomm. & Ent. 1.18x 1.26x 3.30x
Road, Bridge and Tunnels 1.16x 1.29x 1.20x§
Operating strength (BRP)
Excellent Strong Satisfactory Fair Weak Vulnerable
Whole Business Securitization Telecom & Satellite 1.54x
Business Services 1.80x 3.01x
Retail and Leisure 1.67x 1.92x
Infrastructure (Port) 1.92x
*Reflects CRC Breeze Finance S.A. §Excludes Road Management Consolidated PLC, whose preliminary stand-alone credit profile is overridden by the results of our downside analysis, largely due to the presence of robust liquidity is such that we would expect the project to persevere through our downside scenario, regardless of our base-case average DSCRs, in view of only three years remaining until final repayment. The average DSCR is adversely affected by issuers (e.g., CountyRoute A130 PLC) for which we forecast the minimum DSCR dips below 1x but where the debt service is supported by liquidity reserves. DSCR--Debt service coverage ratio.

Borrower Creditworthiness

Beyond an assessment of the operational strength, we reflect our view of the borrower's creditworthiness in either an SACP for SED and PF transactions, or an anchor for WBS transactions. Each measure reflects a borrower's ability to service its debts. We assess the issuer's SACP for SED transactions using our corporate criteria and the "Key Credit Factors For The Transportation Infrastructure Industry" or the "Key Credit Factors For The Regulated Utilities Industry" (see chart 2). We derive the SACP from the borrower's BRP and the consolidated financing group's financial risk profile, which includes the analysis of the financing group's credit metrics. In the case of WBS and PF, we establish an anchor or SACP through a DSCR analysis, respectively. In this report, a PF borrower's SACP is its preliminary operations phase SACPs as determined under our operations phase project finance methodology (see "Project Finance Operations Methodology," published on Sept. 16, 2014).

Similar to the trend shown for relative operating strengths, the SACPs for SED transactions are, on average, two notches higher than the SACPs assigned to PF issuers and the analogous anchors assigned to the borrowers in WBS transactions. Each measure shown in chart 2 is before any credit given for structural enhancements or other modifiers are applied. For PF we compare the preliminary operations phase SACP to the base-case anchor for WBS and to the SACP for SED transactions. Within the PF transactions' social, accommodation, and entertainment industry (two issuers backed by football media and sponsorship rights) the counterbalancing effect of the higher average base-case DSCR for the issuers whose OPBA is 11 or 12 has lifted their preliminary operations phase SACPs to the 'bb' category.

Chart 2

image

Issue Ratings

Our issue ratings for senior debt generally address the timely payment of interest and the ultimate payment of principal. In cases where the notes have the benefit of a promise to pay scheduled amortization--largely limited to both PF debt and WBS notes backed by either public houses (pubs) in the U.K., Dignity Finance (funeral services), THPA Finance (port operations on the northeast coast of England), or Arsenal Securities, our ratings address the timely payment of both interest and principal. Table 6 highlights the general relationship between our issue ratings and the borrower's creditworthiness, and indicates when we would assign recovery ratings alongside our long-term issuer ratings. For SED, the relationship is clear, with a one-notch uplift between the issue ratings and the SACP, reflecting the strength of the structural enhancements in mitigating default risk beyond what we reflect in our credit metrics. For PF and WBS, the relationship is not as cleanly defined and there are a number of qualitative adjustments that may be warranted based on modifiers and comparable analysis. These adjustments generally have a downward bias given that they, on balance, are meant to address weaknesses rather than strengths.

Table 6

Relationship Between Our Issue Ratings And The Creditworthiness Of The Borrower
Asset class Ratings* Recovery ratings
Project finance The lower of the operations phase SACP and the construction phase SACP with further notching, generally down, due to any parental linkage and structural weaknesses. Separate recovery ratings may be assigned for speculative grade issues (see "Recovery Rating Criteria For Speculative-Grade Corporate Issuers," published on Dec. 7, 2016). The recovery rating does not affect the project finance issue credit rating.
Structurally enhanced debt SACP plus one notch. Separate recovery ratings may be assigned for speculative grade issues (see "Recovery Rating Criteria For Speculative-Grade Corporate Issuers," published on Dec. 7, 2016). The recovery rating does not affect the project finance issue credit rating.
Whole business securitization A debt service coverage ratio based anchor plus up to three notches before any negative adjustments under our modifiers and comparable rating analysis. In rare cases, a fourth upward notch may be granted under our comparable rating analysis. Recovery ratings are not assigned as our ratings look through the insolvency of the borrower rather than repayment from the disposal of any asset sales.
*Our ratings on senior secured debt in the case of project finance and structurally enhanced debt, although we may also assign ratings to subordinated debt. SACP--Stand-alone credit profile.

Chart 3 clearly shows the relationship, with the senior notes in SED transactions (light blue) having issue ratings that are, on average, one notch higher than their corresponding SACPs, while PF ratings (dark blue) show modest uplift from their SACPs after giving consideration for our downside analysis, the debt structure, liquidity, refinance risk, and our comparable rating analysis. For WBS (yellow), the results are more disburse, with the issue ratings for most industries reflecting the uplift resulting from our downside analysis (a maximum of three notches), net of any modifiers or comparable rating analysis adjustments. In the case of the telecommunications and satellite industry, the issue ratings are lower than the anchor due to a few factors, but largely due to the presence of liquidity at the borrower, which benefits the anchor itself rather than providing uplift from it in our downside analysis and the impact of higher leverage in the face of a strong BRP, which further limits any uplift in our downside analysis (see "Ratings Affirmed On Arqiva Financing And Arqiva PP Financing's Corporate Securitization Notes Under Revised Criteria," published on Nov. 29, 2017).

Chart 3

image

The data show the interplay between asset quality and our view of the relative strength of the structural enhancements. The asset quality for SED transactions tends to be consistent, largely owing to the leveling effects of regulation in our assessment of their SACPs, which has direct implications on the potential ratings outcomes. By contrast, the preliminary operations phase SACPs for PF transactions displays greater variability since the asset class encompasses sectors of varying credit strengths but equivalent structural enhancements, which results in the largest variation in rating outcomes among the three asset classes. For WBS, the story is one of a variety in both asset quality and structural enhancements. Here, liquidity support and subordination result in senior ratings that are generally within the 'BBB' category, with one exception (Spirit Issuer PLC).

For any transaction, we will determine whether it is SED, PF, or WBS based on the nature of the assets, regulation being a key consideration for SED, and the structural enhancements available to the noteholders, with the nature and strength of the security package and other credit protections being our primary considerations along with liquidity support. We will make this determination case-by-case in light of the scope of our applicable criteria and after considering a transaction's unique credit characteristics.

Related Criteria

Whole Business Securitization (WBS)
  • Methodology And Assumptions For Corporate Securitizations, June 22, 2017
Project finance (PF)
  • Project Finance Framework Methodology, Sept. 16, 2014
  • Project Finance Transaction Structure Methodology, Sept. 16, 2014
  • Project Finance Operations Methodology, Sept. 16, 2014
  • Key Credit Factors For Road, Bridge, And Tunnel Project Financings, Sept. 16, 2014
  • Key Credit Factors For Social Infrastructure, Accommodation, And Entertainment Project Financings, Sept. 16, 2014
  • Key Credit Factors For Oil And Gas Project Financings, Sept. 16, 2014
  • Key Credit Factors For Power Project Financings, Sept. 16, 2014
  • Project Finance Construction Methodology, Nov. 15, 2013
  • Project Finance Construction And Operations Counterparty Methodology, Dec. 20, 2011
Structurally enhanced debt (SED)
  • Rating Structurally Enhanced Debt Issued By Regulated Utilities And Transportation Infrastructure Businesses, Feb. 24, 2016
  • Corporate Methodology, Nov. 19, 2013
  • Stand-Alone Credit Profiles: One Component Of A Rating, Oct. 1, 2010
  • Key Credit Factors For The Regulated Utilities Industry, Nov. 19, 2013
  • Key Credit Factors For The Transportation Infrastructure Industry, Nov. 19, 2013

Related Research

Whole Business Securitization (WBS)
  • Guidance: Methodology And Assumptions For Corporate Securitizations, May 23, 2018

Appendix A
Item   Whole business securitization (WBS)   Structurally enhanced debt (SED)   Project finance (PF)
Issuer The issuer is a special-purpose entity (SPE) that is compliant with our SPE criteria (see "Structured Finance: Asset Isolation And Special-Purpose Entity Methodology," published on March 29, 2017). A limited-purpose entity (LPE) (or group of entities) that is independent and separate from the parent. An LPE (or group of entities) that forms a project where the limited purpose entity is building and operating the project that is independent and separate from the parent and where lenders' risk of repayment is restricted to the project's success or failure.
Scope (assets) - The criteria mostly discuss jurisdictional application in the context of either the U.S. or the U.K. However, the criteria could be applied in other developed jurisdictions with similar insolvency laws, or equivalent creditor protection mechanisms.

- On a going concern basis (no finite life).

- For balance sheet transactions, the assets remain on the balance sheet of the operating company. Noteholders achieve control over the obligor's assets via a secured loan structure between the issuer, a bankruptcy-remote SPE as the issuer of the debt, and the relevant obligor as borrower.

- Securitized cash flows are from a range of sectors where we can establish reasonable confidence in sustainable, long-term cash flow projections. We may form the view that certain industries or product offerings are not compatible with longer-term ratings due to risks of structural changes in the industry or obsolescence. Further, the risk of a fundamental change in the business's operating model can also challenge the visibility of long-term performance.

- Typically a mature company that has a history of stable cash flow generation and is in an industry that is not exposed to technological or other disruptive factors.

- Generally not acquisitive nor has exposure to obsolescence risk.

- A financing group that includes an operating company which derives almost all of its earnings from regulated utility activities or regulated transportation infrastructure activities, although there are some differences in the companies' operational performance, size, and business mix.

- A regulated utility or regulated transportation infrastructure company is defined as a corporation that offers an essential or near-essential infrastructure product or service with little or no practical substitute (such as electricity, water, and gas, airports, and toll roads), has a business model that is shielded from competition (naturally, by law, shadow regulation, or by government policies and oversight), and is subject to comprehensive regulation by a regulatory body or implicit oversight of its rates (sometimes referred to as tariffs), service quality, and terms of service.

- Furthermore, the regulated businesses must operate in a jurisdiction where rates are high enough for the operating company to recover prudently incurred costs, including all debt costs and a fair return on its capital.

- Project finance is used to finance a variety of capital-intensive Greenfield and brownfield assets.

- Sectors that commonly use project finance structures include transportation infrastructure (e.g., toll roads, parking facilities, airports, and ports), social projects (e.g., barracks, hospitals, and schools), energy and water infrastructure (e.g., power generation, gas transmission, liquefied natural gas terminals, and water treatment plants), and commodity-based projects such as oil and gas and mining projects backed by reserves.

- A limited asset life with restricted activities: A project financing has a finite economic life, and project documents constrain the level of permitted asset and business expansions.

- An LPE or group of entities that form(s) a project where the limited purpose entity is building and operating the project that is independent and separate from the parent and where lenders' risk of repayment is restricted to the project's success or failure. We believe that this element, if present, may help lower the LPE's risk of insolvency by reducing the likelihood of claims against the project stemming from activities unrelated to the project's permitted activities.

Key Structural Features - We view the financing groups as sufficiently delinked from their parent companies, under our analysis of parent/subsidiary links as defined in "Group Rating Methodology," published on Nov. 19, 2013.

- Dedicated liquidity support at the issuer level, or at the borrower level and available to the issuer following the insolvency of the borrower.

- May have multiple classes (senior, mezzanine, and junior, including high-yield debt).

- Governed by a common terms agreement (CTA) that applies to all existing, and nearly all future, creditors.

- Fixed and floating security over the obligor group's assets

- The lender's investment is protected by key structural elements, including the security structure, legal framework, payment structure, cash flow mechanics, reserve accounts, and credit enhancements. As a result, lenders rely on the borrowing group's cash flow available for debt service for the servicing its debts.

We define SED as debt that:

- Is issued by a financing group that is delinked from its parent company; and

- Includes structural enhancements designed to reduce the likelihood that the financing group (including the related operating company) may default.

 

More specifically:

- For an operating company that experiences a moderate degree of underperformance, the enhancements provide a set credit remedy period (see glossary of terms) during which the company can take steps to stabilize its credit quality, or creditors can sell the company's shares while it retains significant value;

- SED structures lack post-insolvency protections found in balance sheet corporate securitizations, due to regulatory or legislative restrictions on the granting of security of the assets to the secured creditors (see security above);

- The structural features that underpin the ratings on regulated utilities' SED transactions are largely homogeneous. They are distinguished mainly by the presence or absence of subordinated debt and the degree of prudence in treasury and hedging policies;

- The automatic credit remedy period after breaching a debt restriction covenant (commonly called an event of default), during which creditors can take control of the group and either aim for operational recovery or sell the shares in the operating and holding company;

- Dedicated liquidity facilities that enable the issuer to pay interest charges for at least the first 12 months of any credit remedy period. This allows the creditors to focus on strengthening the credit quality of the regulated business or selling its shares while they retain significant value;

- They are governed by common terms documentation (CTA and STID) that applies to all existing, and nearly all future, creditors;

- The CTA documentation provides for a credit remedy period (sometimes referred to as a standstill period) of at least 12 months, during which all creditors suspend their enforcement claims, except for the right to sell the shares of the operating company; and

- We view the financing groups as sufficiently delinked from their parent companies, under our analysis of parent/subsidiary links as defined in "Project Finance Transaction Structure Methodology," published on Sept. 16, 2014. One of the supporting features for our analysis of delinking is our understanding that for entities incorporated in England and Wales, the risk of substantive consolidation in parent insolvency proceedings under the governing law is remote.

In order for a debt issue or debt-like obligation to be assigned an issue credit rating under our project finance criteria, the project and transaction structure must have all of the following characteristics:

- A project finance transaction structure: A project must have a transaction structure that meets certain minimum requirements. That is, the project is structured as an LPE; provides senior lenders a senior secured ranking through a security package to the key project assets; contains covenants to limit the project's range of permitted actions, including future financings; and includes cash management covenants and establishes a cash management system that prioritizes the payment of senior debt service ahead of other project obligations;

- Limited recourse or nonrecourse to the sponsors or shareholders of a project, but full recourse to the project's cash flows and assets: In a project finance transaction, the project finance lenders typically only have recourse to the project's assets, cash flows, and contractual agreements. The lender's investment is protected by key structural elements, including the security structure, legal framework, payment structure, cash flow mechanics, reserve accounts, and credit enhancements. As a result, lenders rely on the project's cash flow available for debt service and collateral for the servicing, repayment, refinancing, and security of project debt or debt-like obligations;

- Both revenue and operating risk: A project's ability to service, repay, or refinance a project finance debt issue or bank loan is dependent on the future cash flows generated by the operations of the asset once constructed and fully operational; and

- Specified responsibilities and risk allocation over the life of project: Project finance transactions have established and specified responsibilities that limit risk through contracts and transaction documents over the project life. A project financing comprises a mix of integrated contracts that are in place over the life of a project.

Covenants Both operating and financial covenants that seek to control business risks and allow for the secured creditors to seek remedies ahead of insolvency and avoid a court-led proceedings.

 

Restriction on the underlying business:

- The business activities the borrower can engage in;

- The ability to acquire or dispose of assets while prohibiting the incurrence of additional indebtedness;

- The issue of additional shares, an engagement in a consolidation or merger; and

- The creation or permission of any security or security interests over any charged assets, undertakings or revenues

 

Financial covenants (EBITDA DSCR, FCF DSCR or FCF ICR):

- 1st level of covenants usually limits the cash flow outflows from the securitization; and

- The 2nd level, at which the company is still able to service the debt, triggers the appointment of an administrative receiver (U.K.) or a restructuring agent (U.S.), allowing the noteholders to take control ahead of a possible insolvency.

Most transactions operate with little headroom within their covenants and close to their rating triggers, but a few have committed to reduce leverage by adjusting their financial policy. We recognize this in these transactions' stand-alone credit profiles (SACPs).

 

Dividend restriction covenants:

- Debt to regulatory capital value (RCV) based on senior debt;

- Debt to RCV based on total debt; and

- Interest coverage ratio based on senior debt.

 

Debt restriction covenants:

- Adjusted interest coverage ratio based on senior debt; and

- Debt to RCV based on total debt.

- A covenant package that establishes limits on additional debt, additional security, and asset sales; minimum insurance requirements.

- Limits on amendments to the structure, including mergers and acquisitions. This covenant package should extend over the debt term.

 

Covenants and controls for senior secured debt in the structure:

- Project finance transactions are structured to issue senior secured debt, which is typically the majority of the project's capital structure. This is backed by covenants and forms of security for the benefit and credit protection of senior secured lenders in a project finance transaction;

- A cash management covenant package that includes a mechanism that establishes priority of cash payments to holders of senior debt after maintaining ongoing operations as well as liquidity mechanisms that ration and preserve cash in a project in support of the senior debt credit;

Security - Share pledge over the TopCo's shares in the Holdco/Borrowing Group for the benefit of the class B noteholders.

- Fixed and floating charges over the company's assets.

- Bankruptcy-remote SPE has security over the assets of the borrower in a secured loan structure (see "Global Methodology And Assumptions For Corporate Securitizations," published on May 23, 2018).

- Security may be over the company's assets or in the form of shares in the holding and operating companies if regulation or legislation does not allow for the granting over the assets directly, which we generally view as a relative weakness in our analysis.

- In particular, a feature of transactions involving the assets of U.K. regulated utilities involves the regulated company's ability to grant security over its assets, the enforcement of which is restricted by the provisions of the Water Industry Act, the Energy Act, and the utility's operating license. This affects the U.K. regulated utility's ability to pledge as security tangible property, which is subject to a special administration regime in case of insolvency.

- Share pledge over the TopCo's shares in the Holdco/Borrowing Group;

- A senior secured ranking through a security package that limits the disposal of key assets or reduces the incentive for third parties (including parents) to attempt to file the project into insolvency or seize the business's key assets after insolvency; and

- The security package should include first-ranking security over substantially all of the assets and undertaking of the business for the benefit of project finance debtholders.

Ratings* A DSCR based anchor plus up to 3 notches before and, in rare cases, in a fourth notch under our comparable ratings analysis. SACP plus one notch. The lower of the operations phase SACP and the construction phase SACP with further notching, generally down, due to any parental linkage and structural weaknesses.
Ratings Address - Issue Ratings;

- Do not address refinancing risk, which must be fully mitigated;

- Rate through insolvency of the borrower or obligor group; and

- Issue credit ratings do not reflect our expectations for recovery after a payment default.

- Issue ratings;

- May address refinancing risk; and

- Rate to insolvency--issue credit ratings do not reflect our expectations for recovery after a payment default.

- Issue ratings;

- May address refinancing risk;

- Limited to two tranches (senior and junior); and

- Rate to insolvency--issue credit ratings do not reflect our expectations for recovery after a payment default.

Outlooks Not Provided Outlooks are generally assigned, where appropriate, to corporate and government entities and to some structured finance ratings. However, they are not, in our view, appropriate for our ratings on the notes issued by an issuer in a corporate securitization, given that our ratings approach assumes that we can rate through the insolvency of the borrower. Provided Provided
Recovery Ratings Recovery ratings are not assigned as our ratings look through the insolvency of the borrower. Separate recovery ratings may be assigned for speculative grade issues (see "Recovery Rating Criteria For Speculative-Grade Corporate Issuers," published on Dec. 7, 2016). Separate recovery ratings may be assigned for speculative grade issues (see "Recovery Rating Criteria For Speculative-Grade Corporate Issuers," published on Dec. 7, 2016).
*Our ratings on senior secured debt in the case of project finance and structurally enhanced debt, although we may also assign ratings to subordinated debt. DSCR--Debt service coverage ratio.

Appendix B: Definitions

For the purpose of this article, our industry definitions are limited to European issuers and include:

Utilities:  Water, sewerage, gas, and electric businesses, many of which are regulated;

Oil and gas:  Midstream companies that derive the majority of their revenues from transporting, processing, storing, and marketing commodities (such as natural gas and oil);

Social:  Education, accommodation, and entertainment assets, such as sports facilities, hospitals, prisons, or public housing;

Power:  Retail, unregulated/merchant generation, and transmission/distribution of electricity;

Transportation:  Commercial operations of airports, marine ports, toll road networks, railways and other transportation infrastructure assets; and

Other:  Other infrastructure like assets not included in any of the above sectors, such as mining, telecom networks, desalinization plants, or industrial projects.

This report does not constitute a rating action.

Analytical Contact:Greg M Koniowka, London (44) 20-7176-1209;
greg.koniowka@spglobal.com
Research Contributor:Alex Roig, London + 44 20 7176 8599;
Alex.Roig@spglobal.com

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