Australian PPP Market 2010 Outlook

Global Infrastructure & Project Finance

www.fitchratings.com 3March 2010

Australia Special Report

Australian Infrastructure & Project Finance Outlook 2010: An Expanding State of Play Stable Outlook Following Economic Slowdown The outlook for Fitch Ratings’ Australian infrastructure and project finance ratings in 2010 is stable. The infrastructure and project debt in Australia that Fitch rates predominantly consists of mature public‐private partnerships (PPPs) in the transport sector. The investment‐grade ratings reflect low credit risks. These projects typically have strong cash flows and very sound coverage ratios (current interest coverage and expected debt service coverage, as well as loan life and project life cover).

The economic downturn in 2009 was relatively short‐lived in Australia. The country avoided a recession even though economic activity slowed overall. In 2010, the Australian economy is expected to show positive growth. This bodes well for the usage and revenue growth of operating projects and supports a positive outlook for the performance of operating projects. This does not necessarily translate into a positive ratings outlook due to the currently high cost of capital, as well as remaining refinancing risks and associated uncertainties with respect to the introduction of amortising debt structures for mature projects.

Off the back of this expected uplift in economic growth, and the continuing backlog of planned infrastructure projects, Fitch anticipates that the volume of new projects coming to Australia’s debt markets in 2010 will exceed the markets’ funding capacity, including for both prospective government and PPP issuers. In 2010, many of the new projects to be offered to the market are expected to use PPP frameworks, although the structures are likely to migrate toward the availability‐based payment model and away from the more established user‐based payment model. Fitch expects to see a greater uptake of availability‐based projects in the social infrastructure sectors (for example, hospitals, schools, prisons, government buildings) and transport sectors (for example, un‐tolled roads and light rail projects).

Projects using the availability‐based model may have less construction and revenue risks where clear performance targets are defined and contracted, and more stable cash flow, which will help ratings. However, they may also have more aggressive financial structures and lower debt service coverage, which may constrain ratings. User pay projects may have greater construction and ramp‐up revenue risks, and cash flows that strengthen over time, which will initially constrain ratings. However, they may also have less aggressive financial structures and higher debt service coverage early on, which may augment ratings.

Fitch expects the proportion of Australian projects financed through bond issuance to slowly increase once the current market turbulence subsides, especially for mature projects seeking to begin amortisation, and large new projects whose debt requirements cannot be accommodated solely through traditional bank financing. This is expected to be the result of continuing liquidity constraints in the bank market in conjunction with likely bank requirements for much stronger security and covenant packages; both of these will reduce the relative benefits (in terms of flexibility and pricing) to sponsors opting for bank financing. It will also be an opportunity to test the willingness of equity sponsors to make more visible their commitment to the long term by sharing the return in the early years with debt investors in a more balanced way than has been done in the past. Together with the implementation of the availability‐based model for certain projects, these changes

Analysts Robert Zivcic +61 2 8256 0304 [email protected]

William Streeter +65 6796 7224 [email protected]

Related Research • Rating Criteria for Infrastructure and

Project Finance (September 2009)

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Australian Infrastructure & Project Finance Outlook 2010: An Expanding State of Play March 2010 2

could expand the number of infrastructure projects being financed as well as the types of financing solutions for these projects, resulting in an expanded “state of play” for infrastructure finance in Australia.

Top credit considerations in 2010 for Australian infrastructure and project finance ratings include the pace and direction of the following factors:

• The economic recovery, and whether it extends across all sectors and proves sustainable, or whether it stalls, should the global economic recovery stall.

• The interest rates, and whether nominal rates continue to rise, margin spreads remain wide and liquidity remains tight. While interest rate management by the Reserve Bank of Australia will be a factor, so will Australia’s access to foreign capital.

• The liquidity in Australia’s financial markets, and whether bank lending will remain adequate, bond markets begin to thaw, and longer‐term maturities can be reintroduced.

• The introduction of amortising debt structures for mature projects with strong and sustainable cash flows.

Key Rating Drivers for the 2010 Outlook Implications of an Improving Economic Environment In 2009, Australia was among the few developed countries to avoid a recession even though economic activity slowed overall. In 2010, the Australian economy is expected to show positive growth, although it remains to be seen if this recovery is sustainable, and if it will expand across all sectors or whether it will stall should the global economic recovery stall. Australian states tend to have different economic and industrial bases. The states that have a predominantly resources and energy based economy, namely Western Australia and Queensland and to a lesser extent New South Wales, fared slightly better in 2009 than those states with a more diversified industrial and services economy.

Economic growth, however modest, bodes well for the usage and revenue growth of operating projects and supports a positive outlook for the performance of operating projects. However, what remains common to all Australian states is the ongoing need for new infrastructure to meet demand generated by economic and population growth, and the refurbishment and maintenance of existing but aging infrastructure to sustain current and future economic activity. The current needs in Australia cover the full gamut of urban and regional transport (road, rail, airport, sea ports), social (health, education, public housing, prisons) and utility (power, water, telecommunication) infrastructure. In the resources and energy sectors, the needs lean more towards supply chain infrastructure, primarily in transport and distribution, to support export capability, including rail, sea ports, power and pipelines.

Constraints to Infrastructure Finance A key issue for project sponsors, and in particular Australian governments, is that the quantum of infrastructure projects identified for delivery to maintain economic growth exceeds the available funding capacity of Australian capital markets, as well as the underlying budget and borrowing capacity of Australia’s governmental sector. Other restraining factors to infrastructure development include the limited pool of contractors, consultants and skilled labour that is available to deliver projects. These issues may potentially have an adverse cost impact on project procurement and delivery. Such costs coupled with high expected borrowing costs are likely to have a constraining effect on new project debt ratings.

Commercial Bank Responses to this Changing Environment In early 2009, the principal source of funding for infrastructure debt was short‐term bank loans (up to three year). Margin spreads were wide by historical standards and



availability was limited. In the second half of 2009, the tenor had increased up to five years and margin spreads had started to tighten. The other response by commercial banks was in the form of tighter covenants. In a number of bullet refinancings rated by Fitch, the equity lock‐up provisions were made more restrictive, which is a positive rating consideration, and in some cases, de‐gearing exercises were a feature in refinancing bullet maturities.

Commercial banks showed a preference in 2009 to refinance debt of existing projects with established operating cash flow over the financing of greenfield projects with untested user‐pay risk. The projects whose debt is rated by Fitch typically have strong cash flows and very sound coverage ratios (current interest coverage and expected debt service coverage, as well as loan life and project life cover). Therefore, the higher cost of capital has had no impact on existing ratings and outlooks. Nevertheless, the currently high cost of capital limits the potential for ratings upgrades, and remains a constraint for the economic financing of greenfield projects.

The Potential Re‐Emergence of the Bond Market Throughout most of 2009, bond markets were not an available alternative although signs of activity started to emerge towards the end of 2009. In 2010, Fitch expects to see a trend toward longer‐term, amortising debt funding in the Australian infrastructure sector. In normal markets, long‐term financing is more oriented towards capital markets rather than to the bank loan market.

Fitch expects the proportion of transactions financed through bond issuance to slowly increase once the current market turbulence subsides, especially for the longer‐maturity transactions. This will be the result of continuing liquidity constraints in the bank market in conjunction with the likely requirement among bank lenders for much stronger security and covenant packages, which will reduce the relative benefits (in terms of flexibility and pricing) available to sponsors opting for bank financing. It will also be an opportunity to test the willingness of equity sponsors to make more visible their commitment to the long term by sharing the return in the early years with debt investors in a more balanced way than has been done in the past.

In 2010, many of the new projects to be offered to the market are expected to use PPP frameworks, although the structures are likely to migrate toward the availability‐based payment model and away from the more established user‐based payment model. Hybrid financings may emerge with partial bank and partial bond funding solutions. Projects using the availability‐based model may have less construction and revenue risks where clear performance targets are defined and contracted, and more stable cash flow, which will help ratings. However, they may also have more aggressive financial structures and lower debt service coverage, which may constrain ratings. User‐pay projects may have greater construction and ramp‐up revenue risks, and cash flows that strengthen over time, which will initially constrain ratings. However, they may also have less aggressive financial structures and higher debt service coverage early on, which may augment ratings.

Sponsor Responses to This Changing Environment As a result of wider interest spreads for project risk — and the significant project refinancing and interest swap resetting requirements over coming years — infrastructure project re‐gearing exercises have been tempered for the foreseeable future. An important rating consideration is the sponsor’s business model (both policy and practice) toward debt re‐gearing for the purpose of advancing equity distributions.

Prior to the global financial crisis, re‐gearing behaviour resulted less in ratings volatility and more as a ratings constraint, contributing to lower ratings than the economic profile of certain projects would have otherwise suggested. For greenfield



projects with heavy capital costs and speculative economic underpinnings, initial aggressive gearing has often resulted in costly debt restructurings.

Another important response by some sponsor companies to the global financial crisis has been the raising of additional equity. In some cases, this equity was raised to mitigate debt issuance in advance of scheduled capital improvements or expansions. In other cases, the equity raisings in 2009 served to de‐gear project balance sheets. Some of these equity raising exercises were due to changes in sponsor policies and some were at the encouragement of commercial bank lenders at the time of debt refinancing.

Finally, the introduction of amortising debt structures for mature projects with strong and sustainable cash flows could also have positive credit implications. While the number of mature and financially robust projects is small in number, their collective debt load represents a sizable proportion of outstanding infrastructure debt. The current ratings carry varying expectations about when this amortisation will begin and at what pace debt will be amortised. Some projects could actually begin amortising debt as early as next year. The re‐emergence of the bond markets in Australia will be instrumental to this process.

Transport Sector Rating Outlooks for 2010 Currently, Fitch infrastructure debt ratings in Australia are concentrated in the transportation sector, including toll roads and an airport. The portfolio of rated project debt is for mature or maturing projects, with either a strategic regional or national role in the services they provide, as well as established customer bases and strong project cash flows (see Appendix 2 for a list of infrastructure and project debt ratings in Australia). The ratings also benefit from the Commonwealth’s supportive economic, legal and regulatory environments. The major ratings constraints include the standalone non‐recourse nature of the projects, and cash flow susceptibility to refinancing risk.

Toll Roads: Ratings Outlook Stable Current toll road debt ratings are stable as the economic downturn was short‐lived in Australia. Most operating toll roads saw little to no decline in traffic and no decline in revenue. Debt service coverage levels were robust going into the downturn, and easily offset any economically induced slowdown in revenue growth, or wider interest spreads from debt refinancings. In 2010, interest spreads are expected to narrow marginally, but the cost of capital will likely remain high. The biggest risk for scheduled refinancings is shorter tenors, not credit exposure to interest rates. In Sydney, the Roads and Traffic Authority of New South Wales seems to be working cooperatively with concessionaires on proposed road upgrade projects. In spite of the sector being buoyed by the favourable economic backdrop, heightened public interest in regional transportation projects, and a more stable (yet still expensive) cost of capital, the latter is expected to make it harder to finance new standalone toll road projects.

What to Watch 1. Tenor and margin spreads for upcoming refinancings or expansion project debt.

2. Interest by Australian pension funds in re‐entering the market for infrastructure investments, especially for mature operating assets.

3. The introduction of amortising debt structures for mature operating toll roads.

Airports: Ratings Outlook Stable The ongoing economic recovery in Australia, and the strategic nature of the major Australian airports, including the absence of regional competition (as is present in parts of the US or Europe), contribute to a continuation of the stable outlook for both ratings and the sector. Major international airports saw some dip in international travel early in 2009, related to the economy and the outbreak of the



H1N1 virus, but traffic began to rebound later in the year. None of this passenger volatility had a material effect on the credit metrics for projects with a Fitch rating, and 2010 is expected to be a good year for Australian airport activity.

What to Watch 1. Continued diversification of the international carrier base at major hub

airports.

2. The pace and direction of potential changes to Commonwealth airport regulations, and the effect of these changes on planned capital investments.

3. The pace of debt accumulation at Australia’s major airports.

Conclusion The Australian project finance market has been characterised by non‐amortising short‐ to medium‐term bullet financing provided by the bank market. For typical project financings this creates refinancing risk. However, given the nature of the Australian capital markets, this has not been an impediment to financing with most issuers typically commencing refinance campaigns up to 12 months before scheduled maturity. This proactive approach coupled with solid project cash flow performance may support a particular rating level. In the case of PPPs or projects where the financing is principally a bullet or a series of bullets but where there is a long concession life, Fitch will also consider, in addition to the refinance risk, cash flows, coverage ratios, structural supports, the amortisation profile and the concession tail in arriving at ratings. The fact that a project is funded by a series of bullets will not necessarily preclude an investment‐grade rating being assigned.

The outlook for infrastructure and project finance debt ratings in Fitch’s Australian portfolio for 2010 is stable. The projects are predominantly mature investment‐ grade PPPs in the transport sector. The projects have strong cash flows and very sound coverage ratios, which is reflected in the low credit risk associated with these particular projects.



Appendix 1: Primer on the Australian Infrastructure Market The Australian financial market has been characterised by non‐amortising short‐ to medium‐term bullet financing provided by the bank market. For typical corporate as well as project financings, this creates refinancing risk. However, given the nature of the Australian capital market, this has not been an impediment to financing, with most issuers typically commencing refinance campaigns up to 12 months before scheduled maturity. This active market approach coupled with the solid cash flow performance of Fitch‐rated infrastructure projects supports their investment‐grade ratings.

In the case of PPPs or projects where the financing is principally a bullet or a series of bullets but where there is a long concession life, rating considerations include the strength and sustainability of project cash flow and projected coverage ratios in addition to refinancing risk. Other ratings considerations include structural supports such as reserves and equity lock‐up provisions, the expected debt amortisation profile and concession tail. These and other factors are addressed in more detail in Fitch’s updated “Rating Criteria for Infrastructure and Project Finance” that was published on 29 September 2009. This criteria report is available on Fitch’s website at www.fitchratings.com.

The fact that a project is funded by a series of bullets will not necessarily preclude an investment‐grade rating from being assigned if the economic capacity to retire debt is strong, and if sponsor behaviour suggests sufficiently constrained appetite for debt re‐gearing.

In a few cases (none currently rated by Fitch), certain project loans, particularly for tolled tunnel projects with heavy leveraging, have faced problems at the time of refinancing. Fitch expects to see negotiated debt restructurings rather than a high number of defaults leading to a termination of the concession agreements. Credit considerations for these restructured projects include the economic capacity of the project cash flows to repay debt, and the extent to which those cash flows are leveraged after the restructuring. Projects that are able to de‐gear are likely to fare better through this process of debt restructuring.

Over the past two to three decades, Australian governments have demonstrated a growing reluctance to take onboard construction and patronage risk for infrastructure projects. In part, this has occurred where governments have lacked the fiscal capacity to fund infrastructure. In such cases, PPPs and private finance initiatives (PFI) have provided governments with a means to avoid using their own balance sheets to finance and operate infrastructure facilities, allowing them instead to focus on the provision of services.

The now familiar structures applied to infrastructure and project finance include build‐own‐operate‐transfer (BOOT), build‐lease‐transfer (BLT), build‐own‐operate (BOO) and design‐build‐finance‐operate (DBFO). These and other structures have resulted in an increase in the use of project finance as a means of financing infrastructure in Australia.

These types of projects were typically financed with a combination of equity, internally generated cash flows and debt. The capital markets have been used in a supplementary capacity to raise debt for infrastructure projects with varying degrees of success. In Australia, credit enhancement of capital market debt instruments by monoline insurers enabled the raising of longer dated debt, particularly for PPP projects. However, with the global financial crisis, their capacity to effectively participate in the infrastructure sector is now greatly diminished.



Appendix 2

Fitch Infrastructure & Project Finance Ratings in Australia

Issuer Fitch Long‐Term Rating (local and foreign currencies as noted) Outlook

AMT Management Limited (Airport Motorway Group) Tranche A : AUD195m senior secured bank facility due 31 Jul 2012 A‐ Stable Tranche B: AUD260m senior secured bank facility due 31 Jul 2014 A‐ Stable Tranche C : AUD60m senior secured bank facility due 31 Jul 2016 A‐ Stable

Interlink Roads Pty Limited AUD13m standby facility due 23 Dec 2012 A Stable AUD510m term facility due 23 Dec 2012 A Stable

Southern Cross Airports AUD40m 10‐year fixed‐rate credit‐wrapped notes due 11 Oct 2012 BBB Stable AUD240m 10‐year floating‐rate credit‐wrapped notes due 11 Oct 2012 BBB Stable

Sydney Airport Finance Company Pty Limited (Sydney Airport) AUD111m bank facilities due 8 Dec 2011 BBB Stable AUD218m bank facilities tranche H due Dec 2012 BBB Stable AUD25m bank facilities tranche G due Sep 2011 BBB Stable AUD30m bank facilities tranche K due Dec 2013 BBB Stable AUD348m bank credit facility due 10 Sep 2011 BBB Stable AUD376m bank facilities tranche F due Sep 2011 BBB Stable AUD43m bank facilities due 1 Dec 2011 BBB Stable AUD43m bank facilities due 1 Dec 2012 BBB Stable AUD50m bank facilities tranche I due Dec 2013 BBB Stable AUD77m bank facilities tranche J due Dec 2012 BBB Stable AUD150m floating‐rate wrapped facilities due 21 Nov 2011 BBB Stable AUD200m floating‐rate wrapped facilities due 20 Nov 2021 BBB Stable AUD217m floating‐rate callable wrapped facilities due 20 Nov 2013 BBB Stable AUD250m 6.25% wrapped facilities due 21 Nov 2011 BBB Stable AUD300m floating‐rate wrapped facilities due 20 Nov 2015 BBB Stable AUD308m 3.12% wrapped facilities due 20 Nov 2030 BBB Stable AUD586m 3.76% wrapped facilities due 20 Nov 2020 BBB Stable AUD659m floating‐rate wrapped facilities due 11 Oct 2027 BBB Stable AUD700m floating‐rate wrapped facilities due 20 Nov 2014 BBB Stable AUD750m floating‐rate wrapped facilities due 11 Oct 2022 BBB Stable

Transurban Finance Company Pty Ltd (toll road concession) AUD100m bank credit facility due 17 Aug 2014 A‐ Stable AUD125m bank credit facility due 17 Aug 2017 A‐ Stable AUD375m bank credit facility due 17 Aug 2012 A‐ Stable AUD195m working capital facility due Jun 2010 A‐ Stable AUD150m working capital facility due Feb 2011 A‐ Stable AUD85m working capital facility due Feb 2011 A‐ Stable AUD85m working capital facility due Feb 2011 A‐ Stable AUD100m floating‐rate medium‐term tranche B notes due 15 Sep 2011 A‐ Stable AUD200m 6.5% medium‐term tranche A notes due 15 Sep 2011 A‐ Stable AUD300m floating‐rate notes due 30 Nov 2015 A‐ Stable AUD300m floating‐rate notes due 30 Nov 2017 A‐ Stable USD100m notes ‐ tranche A due 31 Dec 2014 ser 144A A‐ Stable USD108.6m notes ‐ tranche C due 31 Dec 2019 ser 144A A‐ Stable USD140.1m notes tranche C ‐ due 14 Nov 2021 A‐ Stable USD125.5m senior notes ‐ tranche B due 10 Aug 2017 ser 144A A‐ Stable USD157.1m notes tranche B ‐ due 14 Nov 2018 A‐ Stable USD156.5m senior notes ‐tranche C due 10 Aug 2020 ser 144A A‐ Stable USD38.9m notes ‐ tranche B due 31 Dec 2016 ser 144A A‐ Stable USD49.5m notes tranche A ‐ due 14 Nov 2016 A‐ Stable USD58m notes tranche D ‐ due 14 Nov 2026 A‐ Stable AUD72m notes ‐ tranche D due 31 Dec 2019 ser 144A A‐ Stable USD98m senior notes ‐ tranche A due 10 Aug 2015 ser 144A A‐ Stable

Source: Fitch



Fitch Infrastructure & Project Finance Ratings in Australia (continued)

Issuer Fitch Long‐Term Rating (local and foreign currencies as noted) Outlook

WSO Finance Pty Limited ‐ WestLink Group (toll road concession) senior secured bank facility Tranche A: AUD500m maturity date 21 Dec 2010 BBB+ Stable Tranche B: AUD500m maturity date 21 Dec 2012 BBB+ Stable Tranche C: AUD250m maturity date 21 Dec 2015 BBB+ Stable

Hospital Car Parking Limited (parking concession) NZD10m notes due 30 Jun 2011 A‐ Stable

Source: Fitch



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Australian PPP Market 2010 Outlook

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