In this paper, we extend the structural credit risk model of illiquid debt developed by Blanc-Brude and Hasan (2016) (BBH) to incorporate the step-in option of senior creditors in PF and model its impact on the valuation and risk profile of senior unsecured project debt, taking into account the bargaining power of creditors and borrowers in investment projects that are relationship specific. Step-in options can also be understood as trading-off credit risk and duration, depending on creditor risk preferences.
Large infrastructure projects are often financed through limited-recourse project finance (PF) vehicles with a high proportion of senior debt. PF is a unique form of corporate governance that creates extensive creditor rights when certain covenants are broken, most notably the option to ”step-in” upon a credit event, and to restructure the firm to maximise either expected recovery or expected payoff, depending on the nature of the credit event. These options significantly impact the outcome of credit events, and credit rating agencies report anecdotal evidence of very high recovery rates in project finance debt compared to comparable corporate debt.
However, data paucity forbids robust reduced-form modelling of expected recovery rates. In this paper, we extend the structural credit risk model of illiquid debt developed by Blanc-Brude and Hasan (2016) (BBH) to incorporate the step-in option of senior creditors in PF and model its impact on the valuation and risk profile of senior unsecured project debt, taking into account the bargaining power of creditors and borrowers in investment projects that are relationship specific. Step-in options can also be understood as trading-off credit risk and duration, depending on creditor risk preferences.
In this paper, we describe the objectives, roadmap and recent progress of academic research with respect to benchmarking the financial performance of privately-held infrastructure debt or equity investment, with a focus on the recent development of a new framework to collect data and evaluate such assets.
To determine a way forward, we take the following approach: we start from the reasons why infrastructure investment benchmarks are in demand and list the key questions that such benchmarks should be expected to answer. Unfortunately, they remain very difficult to answer today, for lack of the relevant information.
Hence, we propose a roadmap to develop a definition, valuation, data collection and portfolio construction framework of privately-held infrastructure debt and equity cash flows designed to answer these important questions.
Using new data, we show that construction risk in infrastructure project finance is well- managed and that project sponsors face very little construction risk compared to the well-documented, systematic and very large costs overruns found in traditional infrastructure project procurement.
We know from the project management literature that construction risk is significant in public infrastructure projects delivered through traditional procurement methods. We also know that, when similar projects are procured using project financing, construction risk is passed on through date-certain, fixed price contracts. However, there is, to our knowledge, no available empirical research on the significance of construction risk once it has been passed on.