Companies with noncontrolling equity interests (NCEIs) are typically holding companies that own a minority interest in another asset or company (referred to as an investee company). These NCEI entities often issue secured debt that is nonrecourse to the investee company. Given the lack of material assets, the NCEI debt at the holding-company level is serviced with distributions from the investee company, and as a result, its credit quality is dependent on that cash-flow stream.

The majority of rated NCEIs have assets in the Americas and are in the infrastructure sector. However, there has been significant global interest in this structure as companies review how to apportion their capital and rationalize assets. We expect the NCEI structure to be used when companies would prefer to retain control of key assets but choose to partner with a strategic investor or financial partner.

Below we answer some questions on the NCEI structure and how we rate such companies.

What type of corporation does S&P Global Ratings view as an NCEI?

We define NCEIs as entities whose only significant assets consist of one or two material noncontrolling equity interests in other financial and nonfinancial corporations--with a stake of at least 10% but typically not more than 50%. This would also include holding companies that own an equity stake of more than 50% in an investee company but don't have control.

Typically, investee companies are structured as joint ventures with a financial sponsor--a private equity or an asset management firm. The investee company might or might not have debt on its balance sheet, and it distributes all of its cash flows--after maintenance capex and debt service--to its owners. The NCEI's debt is collateralized by the equity ownership in the investee company. If cash flows generated by the investee are insufficient to cover the NCEI's debt service, a default of the latter will not have an impact on the investee company or its owners. In many cases, the waterfall structure allows for excess cash to be redirected as a dividend from the NCEI to its owner.

The NCEI structure is commonly used in the U.S. energy infrastructure sector, where significant growth in crude oil and natural gas production over the past few years spurred sizable investments in both gathering and processing systems and transportation pipelines. In many cases, these cash flows are supported by highly contracted cash flows, and so financial sponsors have been actively investing in this sector.

Which NCEIs does S&P Global Ratings rate?

We currently rate seven companies under our NCEI methodology (see Table 1). Although this number is small, there has been growing global investor interest in this form of financing structure.

The majority of rated NCEIs are in the U.S. and have a 30%-50% interest in energy infrastructure assets. These assets include long-haul natural gas pipelines (BCP Renaissance and Traverse Midstream), natural gas gathering and processing systems (FR BR Holdings), and liquefied natural gas facilities (Blackstone CQP). Outside of the U.S., Candelaria Spain holds a noncontrolling interest in OCENSA (a Colombian crude oil pipeline), and Matador Bidco has a stake in Spanish oil company CEPSA. Most rated North American NCEIs use the term loan B market as the single source of financing, while the European and Latin American NCEIs use either secured notes or term loans.

We've withdrawn our ratings on five other NCEIs--EMG Utica LLC, Bronco Midstream Funding LLC, IFM (U.S.) Colonial Pipeline II LLC Corp, Samchuly Midstream Fund 3, and Sociedad de Inversiones Pampa Calichera--because their debt was repaid or refinanced.

Table 1

How does S&P Global ratings treat NCEIs in its credit analysis?

When we analyze an NCEI, we start with the credit quality of its investee company or companies. To determine how many notches lower the NCEI rating will be than the rating on the investee companies, we consider four major factors:

• The investee company's cash-flow stability;
• The investee company's corporate governance and financial policy;
• The NCEI's financial ratios; and;
• The NCEI's ability to liquidate its investments.

We assess these factors as either positive, neutral, or negative. We've assessed cash-flow stability as positive for the majority of the NCEIs we rate in the energy sector. This is because we expect them to receive stable or growing distributions, supported by the investees' strong contract profiles that, in certain cases, have minimum revenue levels, including take-or-pay contracts or minimum volume commitments. Conversely, we've assessed most of our rated NCEIs' financial ratios and ability to liquidate investments as negative. We did so because investee companies are often privately held by financial sponsors, which tend to operate their portfolio companies with elevated leverage.

Table 2

What structural features make NCEIs different from companies rated under S&P Global Ratings' corporate methodology?

Rated NCEIs lack directly owned tangible assets. As a result, they benefit from certain structural features to improve liquidity, including a six-month, forward-looking debt-service reserve account. In certain cases, they also benefit from an excess cash-flow sweep, which--in addition to the mandatory amortization--targets improving leverage over time. This tends to reduce the amount of debt outstanding as the debt approaches its maturity. Many of the currently rated NCEIs in the U.S. are covenant-lite, with a debt service coverage ratio that ranges from 1.05x to 1.4x.

What key credit risks are NCEIs subject to?

Besides asset-level risk, such as operational issues that could reduce distributions to the holding company, the lack of control subjects the NCEI to changes in the dividend policy. Although some sponsors can block or veto changes to the dividend policy, it is unlikely they would exercise these rights if the investee company is experiencing operational challenges. Rather, they would likely focus on preserving the investee company's credit quality.

Meaningful capex initiatives or cost overruns could also result in lower-than-anticipated dividends to the NCEI. If those distributions are lower than the NCEI's fixed charges, this could trigger liquidity stress at the NCEI. The investee company might also consider debt offerings, which could weigh on the NCEIs credit quality.

Why are all of the current NCEI ratings speculative-grade?

It's possible for an NCEI to have an investment-grade rating, but none currently do. In fact, more than 80% are rated in the 'B' category or lower (see Table 1). Among the currently rated NCEIs, in most cases the credit quality of the investee company is no better than the 'BBB' category. The rating on an NCEI is generally three notches below the credit quality of the investee company, which results in a starting point in the 'BB' category.

NCEIs also rely on discretionary dividend payments from an investee company that the NCEI doesn't control. This makes the NCEI subject to greater cash-flow volatility than is typical among investment-grade entities. However, because NCEI debt is typically senior secured, under our recovery ratings methodology the debt could benefit from a ratings uplift into the investment-grade category.

How have NCEIs performed?

Most rated NCEIs ended 2019 with higher leverage but stronger coverage levels than originally forecasted (see Charts 1 and 2). Both EMG Utica LLC and IFM (U.S) Colonial Pipeline II LLC performed well through maturity, with 2019 leverage ratios of 2x and 2.6x, respectively. We stopped rating these NCEIs when their debt was refinanced.

Blackstone CQP Holdco LP (BXCQP) is one of the largest NCEIs that we rate by market value, and it has benefited from growing dividend receipts over the last few years. It receives a stable minimum quarterly distribution from Cheniere Energy Partners (CQP). CQP owns liquefied natural gas assets backed by long-term, highly contracted cash flows with investment-grade customers. Our expectation is that in 2020 and 2021, Blackstone will continue to enjoy stable distributions, further reducing its leverage to below 5x, while maintaining EBITDA interest coverage ratio above 3.5x. Due to its growing dividends, Blackstone has been able to pursue a number of dividend recapitalizations without any meaningful deterioration in its credit quality. In September, Blackstone sold its interest in BXCQP to its affiliate, Blackstone Infrastructure Partners, and Brookfield Infrastructure Group.

Our original expectation for FR BR Holdings L.L.C. was that its leverage ratio would improve to the low to mid 4x area by year-end 2019 from about 6x pro forma at the close of First Reserve's acquisition of a 50% interest in Blue Racer Midstream LLC in late 2018. This expectation stemmed from forecasted distribution growth, the mandatory term loan amortization, and the excess cash flow sweep. However, because Blue Racer's 2019 volumes and revenues were lower than we anticipated, its distributions to FRBR amounted to about 60% of our projected figures. As natural gas prices improve, we expect FRBR will maintain a leverage ratio below 6x and an EBITDA interest coverage of approximately 2x.

Both Traverse Midstream Partners LLC and BCP Renaissance Parent L.L.C. benefit from stable distributions from Rover Pipeline LLC, which resulted in leverage metrics of about 8.5x-9.5x at year-end 2019. In early 2019, Rover announced additional capital costs that would be covered by two of Rover's owners: Traverse Midstream Partners LLC and Energy Transfer LP. Blackstone, through its ownership of BCP, was not required to fund these costs due to certain structural agreements when it originally made its investment in Rover. We now expect that in 2020 and 2021, BCP and Traverse will maintain their respective leverage ratios at 8x or above and 8.5x-9x, making them some of the highest leveraged NCEIs.

The impact of the social unrest in Chile and the economic shock from the COVID-19 pandemic have pressured Corp Group Banking S.A's capacity to meet interest payments on a timely basis. As a result, it recently defaulted. We forecast the sole operating company, Itau CorpBanca, is unlikely to pay a dividend through 2021.

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Why did S&P Global Ratings rate LoneStar Stonepeak under its corporate criteria rather than its NCEI criteria?

Lonestar is 100%-owned by an affiliate of Stonepeak Infrastructure Partners, which we consider to be an infrastructure fund. Lonestar has interests in three development-company (DevCo) joint ventures (JVs) that have equity interests in the following assets:

• Frac Train 6: 107 million barrels/day (MBbl/d) fractionation facility (net 80% ownership);
• Grand Prix: 300 MBbl/d (expandable to 550 MBbl/d) pipeline from the Permian Basin to Mont Belvieu on the Gulf Coast (net 19% ownership); and
• Gulf Coast Express: 1.98 billion cubic ft. per day pipeline running from the Permian Basin to Agua Dulce on the Gulf Coast (net 20% ownership).

Although Stonepeak has a noncontrolling interest in both the Grand Prix and Gulf Coast pipelines, we view it as having controlling ownership interest in Frac Train 6. As a result, we assess its credit quality on a consolidated basis under our corporate methodology framework. That said, through third-quarter 2023, Targa Resources has the option to buy out Lonestar's equity stake in the DevCo JVs at a predetermined price or in increments of $100 million. We believe Targa will exercise this option. We rated LoneStar 'BB-' (stable outlook), one notch below our 'BB' rating (positive outlook) on Targa at the time. If LoneStar relinquishes control of Frac Train 6, this could result in our revising our approach to analyzing LoneStar.