Standing tall

A comprehensive study by Moody’s surveying the performance of project finance loans over a 25-year period shows ultimate recovery rates on par with corporate bank loans.

Project finance lenders – providers of the non-recourse debt that’s been the main source of financing for infrastructure and energy projects over the last two decades – have reason to feel proud following a study published this week by ratings agency Moody’s.

The good news, abundantly highlighted in the study, is that the fundamentals of project finance loans are strong and the risk mitigating mechanisms put in place to support them stand the test of time.

Moody’s analysed the performance of more than 2,500 project finance loans underpinning projects across the globe from 1983 to 2008. The sample came from what the agency described as a “consortium of leading sector lenders” and accounted for almost 45 percent of all projects financed since 1983.

The ratings agency found that this sub-set of corporate loans is remarkably resilient, with consistently high recovery rates averaging 76.4 percent. A recovery rate measures how much of its investment a lender is able to salvage in the event of a default situation.

Moody’s also concluded that recovery rates on project finance loans are “broadly similar to ultimate recovery rates for corporate bank loans, despite features such as high gearing and long tenor that are typical for project finance loans”.

In fact, ultimate recovery rates are “broadly consistent” for projects located in highly developed economies as well as developing economies, according to Moody’s. Even places traditionally perceived as risky, such as Africa, emerge well, with only one project out of 92 on the continent having defaulted.

Power projects are by far the most prone to defaulting, accounting for almost half of total defaults. But their recovery rate still stands at 88 percent.

The ratings agency also found that lenders who chose to cut their losses by selling defaulted loans posted a substantially lower recovery rate (47.8 percent) on their investment than those who decided to stick through the work-out process (76.4 percent).

The problem is that project finance loans’ strong performance still has to contend with two formidable challenges. First, there’s the ongoing liquidity crisis which is constraining long-term bank lending. And secondly, there’s a regulatory climate (read: Basel III) that is threatening to make the long-term, illiquid loans that are the staple of project finance even more expensive than they currently are.

Challenges notwithstanding, project lenders have reason to stand tall.