IN THE BEGINNING

So why do PPP projects attract low investment-grade ratings? History may offer an explanation. Back in the early years of the PFI, UK credit analysts - faced with these new, highly leveraged, single asset project-financed transactions supporting long-dated, non-recourse debt - had limited experience on which to call and few comparators to use. Our American cousins, however, had witnessed such structures before; being employed as risk mitigants in the energy and utility sectors. This established the rules of the game, including setting the 'appropriate' credit metrics and benchmarks. Debt service coverage ratios (DSCRs) above 1.35x, for example, were typical basic requirements for investment-grade ratings; along with 12-month reserve accounts.

Today - with the benefit of hindsight - we understand that PPPs are very different from project-financed credits in the energy and utility sectors - such as US power plant assets (with much more operational risk and weaker off-takers than PFI projects). That was not understood back in the mid-1990s. This, together with inherently conservative views about the unknown (and untested) suggested that, if investment-grade at all, low investment grade was probably the right call.

Then came that most powerful of cognitive biases; anchoring. Having rated some early PPP projects as 'BBB', it would be counterintuitive to have (and awkward to defend) different ratings on frankly similar deals. Inconsistency is not the friend of rating agencies. But the deals were not similar. The investment bankers' game was to push the envelope with each successive project, squeezing the financials yet still achieving investment-grade ratings. Gearing increased; coverage and lock-up ratios fell; reserves shrank; construction risk mitigants thinned. Despite increasing comfort with the asset class, the continual stripping away of lender protection is a credit landscape against which ratings were unlikely to trend upwards.

TABLE 1: MATURITY OF PFI PROJECTS

Support for the anchoring theory comes from outside the UK and explains a number of apparent rating discrepancies commented on by othersvi. Some later PPP projects, particularly in Australia and Canada, were assigned higher ratings - yet look not dissimilar in terms of credit quality to their UK counterparts (in some cases weaker). Local analysts focusing on local markets and an investor appetite for 'A'-rated paper were less constrained by earlier rating actions from across the globe and benefitted from the experience which comes with the passing of time.

In write-ups, greater emphasis appeared to be placed on the public-sector off-takers, their credit standing (typically 'AAA') and the incentives on them to ensure project success through adequate support. In terms of analytical approach, this moves PPPs away from standalone projects towards the 'government-related entity' (GREvii) end of the credit universe. GRE credit ratings are notched up from standalone project ratings to reflect their important public policy roles, typically in the delivery of social services. In most cases PPPs are exactly that; state-initiated public policy instruments delivering essential social services.