The allocation and management of risks in PPP project finance transactions and general-purpose corporate lending differ. Because project finance lenders are dependent on project cash flows, and do not have recourse to the sponsor's balance sheets, their short-term exposure can put pressure on a project's early stages and increase the risk of default (Sorge and Gadanecz 2004). This contrasts with corporate finance lending. Here, shorter maturities are considered less risky, suggesting that the standard upward sloping relationship between credit risk and loan maturity may not apply to project finance. The construction and operation phases of infrastructure projects are each characterized by specific risks and mitigants. It is therefore likely that incrementally extending loan maturities after the scheduled time for a project to be operational might drive up ex ante risk premiums, but at a decreasing rate, based on the risk allocation mechanism and availability of mitigants, such as guarantees.
Governments can also use credit-enhancement tools to promote PPP bankability; for example, in a minimum payment guarantee to reduce demand risk where the contracting authority guarantees a minimum revenue. The minimum revenue guarantee is generally enough to cover debt servicing at some level of the debt service coverage ratio or to reach a minimum return. A guarantee that services the principal and interest in the case of default can also be used. This approach is widely used to mitigate default risk, and it reduces the need for lenders to make fresh exposures to stressed projects (Vecchi et al. 2017).3
Corielli, Gatti, and Steffanoni (2010) analyze nonfinancial contracts with third parties that reduce the credit risk to lenders and lower financing costs. These contracts include (i) purchasing agreements that guarantee raw material to SPVs at predefined quantities, quality, and prices (raw material cost and availability risk shifting); (ii) off-take agreements that enable SPVs to sell part or all of their output to parties who commit to buy at predetermined prices and for a given period (market risk shifting); and (iii) operation and maintenance agreements to provide SPVs with a level of maintenance that is compliant with predefined service agreements. The authors find evidence showing that, although nonfinancial contracts lower the risk profile of PPP projects, lenders may be unwilling to reduce rates if the sponsor is a contract counterparty.