WASHINGTON — An analysis of rating actions on bonds issued for projects involving public-private partnerships reveals that P3s are vulnerable to credit risk following downgrades of participants even if the projects are going well, according to a Moody’s Investors Service report released Thursday.
P3s are gaining popularity in the United States, where more states are enacting, or seeking to enact, laws authorizing such arrangements. Government and industry leaders like Transportation Secretary Ray LaHood and the American Association of State Highway and Transportation officials are actively promoting the potential of the P3 finance method.
However, these arrangements leave projects exposed to risk from downgrades of governments, banks and construction companies, said Moody’s senior credit officer Catherine Deluz. The debt of P3 projects can be downgraded if proper safeguards aren’t in place.
Deluz said that since Moody’s began rating P3s about 10 years ago, more than half of downgrades, reassignments to negative outlooks, or reviews for downgrade have been at least partially connected to a downgrade of one or more of the project’s participating parties.
Project participants represent key risk factors during different phases of a project, the report demonstrates. A downgrade of the firm constructing the project is potentially most damaging early on, but becomes less so as the project nears completion and begins operating, Deluz said.
The report points out some common characteristics of P3s that make them sensitive to participant risk.
“They usually do not keep a large amount of cash apart from the minimum required to be kept in various reserves,” the report states. “That limits their ability to meet unexpected material cash requirements.”
Additionally, Deluz wrote, many types of P3s don’t have a means of increasing revenue or liquidating assets to meet sudden cash needs. Some types of P3s, such as toll roads, do have that flexibility.
To protect against the possibility of one party’s weakened credit damaging the entire project, most P3 arrangements include a mechanism that “de-links” the participants’ credit with that of the project. The mechanism can take the form of an obligation to replace one company with another if the risk reaches a certain level, according to the report.
“However, even when de-linkage of the framework is strong, it is not bullet-proof,” the report said. “Unexpected events often shine a light on management’s approach to risk mitigation, and where an issuer fails to take prudent measures to mitigate an emerging risk, e.g. by contracting with weaker counterparties while stronger alternatives remain available, this in itself will likely weigh on its ratings.”
Deluz stressed that the context of the participant downgrade has to be taken into account when determining its potential effect on a public-private partnership, since poor operational performance could exacerbate a partner’s downgrade and not all participants are equally influential at each stage of a given project.
Therefore, she said, Moody’s will continues to examine each potential downgrade in detail.
“We are going to take it on a case-by-case basis,” Deluz said.