How is Infrastructure different from other asset classes? Natixis European Infrastructure Day - Paris, 17 October 2013 ANDREW DAVISON, SENIOR VICE PRESIDENT
Contents 1. What is Infrastructure? 2. Risk characteristics of Infrastructure Debt 3. Risk characteristics of Project Finance bank loans 2
1 What is Infrastructure? 3
Characteristics of Infrastructure Debt» Debt issued by both public and private issuers that provide large, capital-intensive, critical assets to an economy For example, to finance power, gas, water and transport systems and other fundamental facilities serving a country» Infrastructure credits tend to exhibit the following characteristics: Long-term importance of their underlying business Asset-heavy capital-intensive nature Generally low-to-manageable operating risk Ability to support long-term debt, often at higher levels of gearing than is typical for similarly-rated nonfinancial corporates» Many infrastructure issuers have either a special relationship with their sovereign or local government or are regulated as monopolies The necessity of investments in Infrastructure can reduce business and operating risk relative to corporate industrial issuers 4
Infrastructure includes a wide range of enterprises» Risks borne by providers of risk capital and debt can differ significantly based on the relevant procurement approach, regulatory regime, financial structure and industry. Procurement Approach for Infrastructure Assets Procured or guaranteed directly by sovereign or sub-sovereign entities Risk characteristics Risks are often borne largely by the governmental entity Examples Transport for London (Aa2, stable) Regie Autonome Des Transports Parisiens (Aa1, negative) Procured by regulated Business risk substantially reflects the risk Terna - Rete Elettrica Nazionale utilities or regulated allocation embedded in the relevant regulatory S.p.A. (Baa1, negative) businesses framework National Grid Gas Plc (A3, stable) Procured by unregulated Unregulated businesses can be exposed Iberdrola S.A. (Baa1, negative) businesses Procured using project finance to significant ifi market or competition risks. Credit strength is typically strongly correlated with the size and relative market position of the business Risk exposure of senior debt substantially reflects the contractual arrangements and the structural features of the project Generally constrained by the credit strength of key counterparties Societe des Autoroutes t Paris-Rhin- Rhone (Baa3, stable) AES Corporation (Ba3, stable) The Hospital Company (Dartford) Issuer plc (A1, stable) Autovia del Camino (Ba1, negative) No generally accepted definition of Infrastructure amongst market participants p 5
2 Risk characteristics of Moody's s-rated Infrastructure Debt 6
Default and Recovery Study - Infrastructure Debt» In December 2012, Moody's published its inaugural study of the historical performance of rated infrastructure debt over the 30 year period 1983-2012H1» The Study reflects Moody s definition of infrastructure» Moody's infrastructure portfolio comprises over $3.2 trillion of rated debt: $2.4 trillion debt issued by over 1,000 corporate infrastructure and project finance entities $0.8 trillion debt issued by over 2,100 US municipal infrastructure issuers The Study focuses on the comparison of corporate infrastructure (i.e. excluding municipal infrastructure) t vs non-financial i corporates 7
Profile of Moody s-rated Infrastructure Debt Rating Distribution, Average 1983-2012H1» The majority of corporate infrastructure rated debt has been issued in developed countries» Regional distribution by value: 38% North America (ex US Muni) 43% Europe 15% Asia Pacific» Regional distribution by number of debts: 59% North America (ex US Muni) 19% Europe 10% Asia Pacific» The majority of corporate infrastructure debt is investment grade and with ratings concentrated in the A and Baa-range In contrast, for non-financial corporates, half of the population is rated investment grade and half is rated speculative grade 8
Cumulative Default Rates ("CDRs")» CDRs for investment-grade corporate infrastructure debts and non-financial corporate debts are very similar for horizons up to 4 years Lower CDRs beyond 4 years illustrate the greater stability of infrastructure debts As discussed below in relation to Credit Loss Rates, it is not generally possible to match the entire multiple-year term structure of credit risk» CDRs for Ba-rated corporate infrastructure debts are lower than for Ba-rated non-financial corporates But this finding should be interpreted with caution given the small sample of Barated infrastructure debts Historical default rates show that Moody s ratings rank-order default risk 9
Recovery Rates for Defaulted Corporate Infra Debts» Average recovery rates for each of the sectors referenced within the study (regulated utilities, unregulated utilities and other corporate infrastructure debts), are higher than non-financial corporates These higher observed recoveries are consistent with corporate infrastructure credits sometimes combining somewhat higher PD with somewhat higher recovery in order to achieve the same rating On average, corporate infrastructure debts have higher recovery rates than non-financial i corporate issuers 10
Credit Loss Rates» Corporate infrastructure and non-financial corporate ratings imply similar credit loss rates for horizons up to about 4 years.» Beyond 4 years or so, the greater stability of infrastructure credit results in lower loss rates than for like-rated non-financial corporates» Generally it is not possible to match the entire multiple-year term structure of credit risk If non-financial corporate and corporate infrastructure ratings are calibrated to achieve similar credit loss over short- or medium-term horizons, then they cannot simultaneously match at longer horizons.» Credit loss rates for Baa-rated debts are approximately 30% lower than those of non-financial corporates, altho in absolute terms they are of the same order of magnitude indicating overall comparability of performance» Credit loss rates for Ba-rated corporate infrastructure debts are lower than similarly rated non-financial corporate issuers But, given the small sample of Ba-rated corporate infrastructure debts, this finding should be interpreted with caution 11
Summary of risk characteristics of Corporate Infra Debt» Compared with like-rated non-financial corporate issuers, corporate infrastructure debts have broadly similar credit loss rates by like-rating category Credit loss rates for Baa-rated debts have been approximately 30% lower than those of non-financial corporates, although in absolute terms they are of the same order of magnitude indicating overall comparability of performance For Ba-rated debts (representing a small proportion of corporate infrastructure debts), credit loss and default rates are lower than for non-financial corporates» Corporate infrastructure and non-financial corporate ratings imply similar credit loss rates for horizons up to about four years» Beyond that, the greater stability of infrastructure credits results in lower loss rates than observed for like-rated non-financial corporates BUT» Credit characteristics of different types of infrastructure debts can be quite different» Infrastructure credits may be subject to sudden and somewhat unpredictable shifts in credit quality (event risk) Infrastructure includes a wide range of issuers 12
On-going research efforts and other developments» We are working on an updated version of our Infrastructure Default Study» Request for Comment published in September 2013: We are seeking market feedback on a number of refinements that we propose to make to our Regulated Electric and Gas Utilities Rating Methodology We are also seeking market commentary on our evolving view of the credit supportiveness of the US utility regulatory framework 13
3 Risk characteristics of Project Finance bank loans 14
Characteristics of Project Finance» Often used to fund the development of energy, natural resource and social infrastructure assets, and the provision of associated public services. Can be an efficient way to fund capital intensive and strategically important assets Aims to match long tenor asset life with long tenor funding Second Severn River Crossing, UK» Typical features: Project undertaken by an SPV that can only engage in the business of the project Project scope is defined in contractual arrangements SPV raises project finance debt (often highly leveraged) to finance upfront construction works Principal and interest payments are made solely from cash flows generated by the project SPV Security taken over SPV s assets, but limited recourse to project sponsors' other assets Structural features enhance creditworthiness Single asset risk transactions, but typically structured to be highly resilient to severe macroeconomic and performance stresses 15
Default and Recovery Study - Project Finance bank loans» Moody's published a new study of the historical performance of unrated project finance bank loans (the "Study") in February 2013» Includes 4,067 projects representing 53.6% of all project finance transactions originated worldwide over 28 year period 1 Jan 1983 to 31 Dec 2011» The Study is based on confidential data provided by a consortium of banks (the "Bank Group")» The Study is freely available to non-subscribers: http://www.moodys.com/pages/pfsplashpage.aspx The Study provides strategic insight into the credit characteristics of project finance bank debt 16
Marginal Default Rates STUDY EXHIBIT 12.2 Chart of Marginal Default Rates (BII)» A marginal default rate reflects the likelihood that a performing loan at the start of a specific year defaults in that year Marginal default rates (BII) average 1.7% pa during an initial 3 year period Marginal default rates fall significantly thereafter, trending towards levels consistent with single A ratings by year 10 from financial close» Marginal default rates during construction are higher than those associated with mature operations Fundamental difference in evolution of marginal default rates for PF vs corporate issuers 17
Average Recovery Rates STUDY EXHIBIT 24 Distribution of Recovery Rates» Bi-modal distribution of Ultimate Recoveries (most likely recovery rate is 100%) Almost two thirds of Ultimate Recoveries experience no economic loss» Average recovery rate for Ultimate Recoveries (MDY) is slightly lower than that for Ultimate Recoveries (BII) Recovery rates for work outs are substantially greater than for distressed sale exits 18
Summary - Risk characteristics of PF bank loans Key findings include:» Cumulative default rates are consistent with ratings in the Baa/Ba rating categories;» Marginal default rates trend towards levels consistent with single-a ratings by year 10 from financial close;» Average ultimate recovery rates are high» Most likely ultimate recovery rate was 100%, with two thirds of ultimate recoveries exhibiting no economic loss» Average recovery rates for work outs exceed those for distressed sale exits» Ultimate recovery rates appear to be substantially independent of economic cycle;» Projects face significant incremental risk during the construction phase Project finance credit exposures exhibit risk characteristics which differ from general corporates 19
On-going research efforts and other developments» We anticipate publishing an addendum to the Study in the near future providing additional granular information about the performance of infrastructure projects: Based on a broad definition of infrastructure For infrastructure t projects with availability-based b revenues, and For PFI/PPP infrastructure projects.» We are also working on an updated version of the Study based on an updated and expanded data set 20
Summary 21
Summary: How is Infrastructure different from other asset classes?» What is Infrastructure? t The necessity of investments in Infrastructure can reduce business and operating risk relative to corporate industrial issuers No generally accepted definition of Infrastructure amongst market participants» Risk characteristics of Infrastructure Debt Compared with like-rated non-financial corporate issuers, corporate infrastructure debts have broadly similar credit loss rates by like-rating category for horizons up to about 4 years Beyond that, the greater stability of infrastructure credits results in lower loss rates than observed for like-rated non-financial corporates Infrastructure includes a wide range of issuers for which credit characteristics can be quite different» Risk characteristics ti of project finance bank loans Marginal default rates trend towards levels consistent with single-a ratings by year 10 from financial close; Average ultimate recovery rates are high Thank you for your attention 22
Andrew Davison Senior Vice President, Infrastructure Finance Group Direct: +44 20 7772 5552 Email: andrew.davison@moodys.com 23
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