| CREDIT RISK | GUEST ARTICLE |
Infrastructure investment analyst Robert Bain suggests it might be time to re-assess the credit quality of UK public-private partnerships - a mature, resilient sector characterised by low volatility, essentiality, strong government support under successive political regimes and few defaults
ANALYSIS OF THE Treasury's Private Finance Initiative (PFI) Signed Projects Listi shows that the average maturity of PPP projects in the UK - taken from the date of financial close - is now over 8 years (see Table 1); this is past midway between the 5- and 10-year horizons employed by rating agencies when publishing cumulative default rates. The majority of rated PPPs sit clustered in the low investment-grade neighbourhood. This is no surprise. The transactions were specifically structured with this rating target in sight for economic reasons, including possible credit substitution by the (once thriving) monoline insurance industry. On a standalone basis, few break through the 'BBB' ceiling into 'A' territory (and none above it).
Only a small proportion of UK PPPs are publicly ratedii - around 5 percent (see Rating agencies and UK PPP projects panel p40) - and it is reasonable to assume that those that are presented to rating agencies are structured less aggressively and generally have stronger credit quality attributes. This assumption is supported by my analysis of PPP projects that sit in some bank portfolios (and have credit characteristics upon which rating analysts would frankly frown) - but let's keep the argument simple. Let's assume that all PPPs are of a similar credit quality and that 'BBB' is the correct rating.
The 5-year cumulative default rate for a 'BBB' issuer is fractionally above 2 percent, while the 10-year rate lies just above 5 percentiii. At 8 years, the default rate should be around 3.75 percent (see Figure 3, p41). The Treasury's List provides details of 667 UK PPP projects; the majority of which use similar project finance structures. Applying 3.75 percent to that portfolio infers that, by now, 25 PPP projects in the UK should have defaulted. That number would of course be higher if we accept that a proportion of bank-financed projects have weaker credit profiles, but let's run with the simple argument for now.
Getting details on defaulted PPP projects is not easy but, despite extensive research and many discussions with experienced project finance bankers, the number I calculate - using a broad definition of 'default' - falls a long way short of 25. In correspondence with the Treasury, they identified 6iv; 8 if you consider Metronet BCV and SSL to have defaulted (which S&P does, but Moody's does not). Other than the Metronet transactions, which some argue were defaults on an agreement but not on debtv, there have been no defaults at all in the rated PPP universe to date. Given the sector's credit history, set against published expectations for 'BBB' loan performance, and the critical mass of project exposure and financier experience accumulated over nearly 20 years, is it perhaps time to revisit PPP credit ratings?