By Cynthia Howells CFA- Director, Global Infrastructure and Project Finance Group, Fitch Ratings

Financing infrastructure projects through capital markets have not yet materialised in Sri Lanka, but it is a fairly common currency in many developed markets. Fitch Ratings has evaluated hundreds of infrastructure debt financings globally using commercial bank loans and capital market bonds, which are the standard financing models in the so called “Developed World.”

In 2007, Fitch formed the “Global Infrastructure and Project Finance Group” or GIG, in order to consolidate the many and various infrastructure analyses being done at Fitch under one consistent methodology. Given the infrastructure requirements and recent financings worldwide, GIG has been very busy indeed over the last five years.

With the end of the war and the growth of tourism and trade, there is more demand for updated infrastructure in Sri Lanka than perhaps ever before in its modern history. Examples of current infrastructure needs include: easing the shortages of electricity; expanding road networks and bridges outside the capital of Colombo; demand for a growing railway to crisscross the island and for additional airports and port capacity. As a developing nation, Sri Lanka also needs to build more schools, hospitals and other social infrastructure. According to the Central Bank of Sri Lanka, the Government has in fact identified the aviation, maritime, energy, knowledge, commerce and tourism sectors as hubs for ongoing development.
Nearly all, if not most of the proposed infrastructure projects in Sri Lanka are financed through foreign government loans, international aid, and some foreign grants. On a smaller scale, selected privately-run local commercial banks have come forward to lend to develop rural roads in Sri Lanka.

The questions I’d like to pose to investors, financiers, bankers, civil servants, regulators, and others in Sri Lanka are: Why is private, corporate, and local bank capital not entering the infrastructure market in Sri Lanka? Can the Sri Lankan business and financial sector apply the financing structures, which are being successfully used in the rest of the world, to attract capital for needed infrastructure?

Impossible dream?

From what I have read, heard, and understood, there is little reason why this is not possible. So, what are the advantages of involving non-government banks and private investors in infrastructure financing?
Broadly speaking, there are many benefits to be reaped by transitioning to a private sector debt financing model in Sri Lanka. The latter provides an attractive investment opportunity in the country that could retain local and foreign capital, as well as talent, in the country. It strengthens the local economy by fostering common goods that are the foundation of future growth — roads, bridges, airports, power plants, etc. It paves the way to accelerate infrastructure development across multiple projects, if many entities support different infrastructure projects at the same time.

Through the experience in the United States, for example, it is clear that even the U.S. government can’t complete all the infrastructure projects that are needed by itself. Providing a role for private capital in a project allows a government to shift its focus to the most difficult projects. As a result, the more straight forward, but still important projects, can be financed by the private sector.

However, there are some disadvantages that could surface during this transition too. Higher financial risk accompanies financings that are not backed by sovereign credits. In addition, greater financial expertise is needed to evaluate and mitigate the extra financial and project risks for the investor. Some level of independent, or third-party, evaluation from the equity and debt providers is required to assess the strengths and weakness of various projects for new investors.

Based on Fitch’s track-record of rating capital market financings, I will outline: how Fitch defines infrastructure projects; what Fitch has seen are typical terms for infrastructure financings; the key rating drivers of Fitch’s infrastructure analysis, and what criteria Fitch has published for the capital markets on infrastructure assets.

I will also illustrate my points through two examples of existing infrastructure projects that Fitch has rated that are not dependent on government aid. One is a power generation project in the U.S., and the other is a toll road in Australia. However, please note that Fitch is not an advisor and Fitch does not structure financings. What I can tell you is how Fitch looks at the market, and how Fitch has rated structures that were presented to us.

How does Fitch define an infrastructure project?

The defining characteristic of an infrastructure project is the nature of the expected cashflows to repay the debt. Debt repayment depends on cashflows of a stand-alone project or infrastructure facility. Projects are independent entities structured to repay the debt financing used to construct them, and earn a return for their equity sponsors.

Cashflows are typically generated from operations of the stand-alone project, which can encompass several project assets in different locations or simply in one location.Use of a project vehicle is required to permit segregation of project cashflows – examples include an enterprise fund within a governmental entity or a single-purpose, bankruptcy-remote corporate structure.

Typical infrastructure terms Fitch has observed

In Fitch’s global experience evaluating infrastructure projects, a project financing is typically 80 percent debt – either loans or bonds –and 20 percent equity, but these factors vary.

Debt investors are typically institutional investors like government pension funds; corporate pension funds; insurance companies; large infrastructure asset funds; forward looking corporates such as information technology (IT) companies, and the like. Debt investors can also be traditional lenders; international or local commercial banks; international and local investment banks; other financial institutions.

The project sponsor, the entity that provides the equity for the project, is typically only relevant to the infrastructure project prior to closing of the financing. The reason is, after the equity capital is paid, an infrastructure project is usually independent (or non-recourse) to the sponsor.

The debt term is typically for the life of the project – between 20 to 30-years – depending on the asset. This means investors look at the long-term prospects for debt repayment, not just the short-term market dynamics. The debt is typically fully amortizing over the debt term, however Fitch has also rated many other amortisation structures. Interest rates are typically fixed, given the higher risk of the long tenure of the debt and single asset nature of the cash flows.

Through this, you must keep in mind that Fitch rates the individual debt instruments and NOT the project itself. Each debt tranche with unique rate, tenor, and amortisation characteristics will be rated as a separate debt issue to be serviced by the project, not the other way around.

Fitch also rates the “likelihood of default” on infrastructure debt, based on the applicable criteria and key rating drivers. Fitch infrastructure ratings do not incorporate recovery prospects, again only the likelihood of a default.

Fitch Infrastructure Criteria

GIG’s Master Criteria, which I have been discussing up to this point, is the general roadmap for evaluating the infrastructure sector and is applicable globally. The Master Criteria is published on the Fitch website (www.fitchratings.com), and is widely available to the global marketplace.

GlG also publishes many Sector Criteria on various asset classes that provide specific guidelines tailored to that industry. GIG’s suite of criteria include: airports; ports; toll roads, bridges and tunnels; thermal power projects; onshore wind projects; solar power projects; sports stadiums (U.S. only); and availability-based projects (revenue streams paid by government authorities based on availability) including schools, hospitals, public housing, libraries, mass transit, etc.

Conclusions

As you can see, corporates and banks already play a key role in developed markets by financing a diverse group of infrastructure projects. Similarly, the corporate and banking sectors in Sri Lanka have a role to play in the development of local infrastructure to provide public goods in their own country.
The Sri Lankan Government is likely to retain control over the terms of the concessions, including terms of repayment of debt and loans provided by corporations and banks in Sri Lanka. Yet, the roadmap for the successful funding and structure for non-government sponsored infrastructure projects already exists, and is relatively easy to copy.

Credit rating agencies such as Fitch, and its competitors, have well developed methodologies for analysing and evaluating the risks of investing infrastructure asset debt. Credit rating agencies have experience rating large numbers of infrastructure asset classes across the globe, which involve both the private and government sectors.

Together with the financial and banking sector, rating agencies may have a role to play in evaluating the added risks of private infrastructure financing for the Sri Lankan market.

Cynthia Howells, CFA, is a Director at Fitch Ratings who focuses on Energy and Industrials in the Global Infrastructure and Project Finance Group. Prior to joining Fitch three years ago, she spent close to 11 years as corporate utility lender at a major U.S. bank. She lives in New York with her two children and Sri Lankan husband.