In this alert we focus on infrastructure and energy projects, further exploring the financing issues raised in our earlier alert and how they are likely to affect borrowers and others in this sector.
Mature Infrastructure Assets
The different liquidity approaches referred to in our earlier alert (including drawing down undrawn commitments, amend and extend transactions and bridge facilities) are expected to apply generally to mature infrastructure assets, at least at the higher end of the credit spectrum. Certain assets can be expected to avoid material direct business impacts from the crisis (such as energy transmission / distribution networks). However, others may already be feeling the pinch (such as transport infrastructure tied to discretionary passenger traffic, noting questions may arise as to the long-term impacts).
In the case of completed PPPs, outside sectors which may be more directly affected by COVID-19, similar considerations should apply, at least to the extent their primary revenue line remains a strong Government-backed credit. Pass through, risk allocation and abatement in certain sectors may come under closer scrutiny - for example road projects reliant on patronage (which will fall in the event of a forced shutdown). Hospitals will of course be under intense pressure - whilst clinical services generally remain a State responsibility, soft FM contractors will no doubt be tested as well (although the risk of nationalisation, recently seen in Spain, remains remote). Similarly whilst schools are receiving heavy media attention, COVID-19 risks should not present a particular or immediate threat to those which are PPP-financed. Courts, prisons and entertainment infrastructure projects will encounter COVID-19 risks in different forms again. However, given the nature of the Australian contractor market, it would not be unprecedented for a 'perfect storm' of issues on unrelated projects to fall ultimately on a single contractor.
In the Australian market there are similarities between debt financing arrangements for mature infrastructure borrowers and those of strong investment-grade corporates - a key difference being the regulated nature of core assets (e.g RAB for network assets, long-term concession-style leases for privatised ports etc). In the absence of major regulatory upheaval this can be expected to continue. Those infrastructure borrowers who have issued in the capital markets may see some increase in trading on their registers, but in other respects similar considerations to those in our previous note should apply.
Once market volatility settles, CFOs and financial advisers will no doubt once again turn their minds to opportunities to lock in refinancing gains if record low interest rates are here to stay.
Privately Sponsored Projects
Completed projects with fully contracted offtakes should generally be shielded from immediate or direct COVID-19 impacts, assuming their offtakers and other contractors remain sound. Financings linked to a minimum credit rating of the offtaker could be challenged over the coming months (leading to increases in margins/review events) and the impact on credit quality of security posted by contractors may also come under scrutiny (eg PCGs with minimum credit rating requirements for EPC and O&M contractors). In the renewable energy sector, some counterparties in the recent wave of corporate PPAs may come under financial pressure (the university sector being a particular example where commentary is already beginning to ask solvency questions, given the heavy reliance on foreign student income). If such pressures continue, the benefits of a portfolio approach to corporate PPAs may soon be borne out.
Projects Under Construction
Much commentary has already been produced on the effects of supply chain issues and force majeure in construction delays. In the case of project financed assets, delays will have particular consequences under the finance documents - the general considerations noted in our earlier alert will be relevant here (MAE, specific representations / warranties / events of default), and further considerations will also apply (such as calls on bonding by financiers directly, and drawing upon reserve accounts / facilities).
Whilst the current uncertainty and volatility is not conducive to easy procurement or smooth execution of debt financing for new projects, to the extent that COVID-19 is currently a medical and economic crisis more than a financial crisis, new projects with sound economics should remain bankable in the medium term. It has also been suggested that infrastructure spending may be one of the tools deployed by governments to further support an ailing economy - this is likely to present opportunities for contractors most immediately, where the Government initially prefers shovel-ready Government funded projects.. At present, mainstream commercial banks remain better placed to continue lending than they were during the GFC - this should reduce or remove the need for multilaterals and ECAs to step up to fill gaps as they did in the period following 2008.
New projects can expect to see heightened focus from financiers on certain terms - for example risk sharing between offtakers and borrowers on change-in-law and uninsurable FM.
Infrastructure assets are unlikely to be early candidates for 'fire sale' scenarios, given their inherent illiquidity and long lead times. Inevitably, however, there will be certain infrastructure investors and sponsors whose financial circumstances may compel them to realise assets through sale, (for example, where the changes to the superannuation early withdrawal regime trigger a significant short-term need for cash), and others looking for well-priced opportunities to deploy capital. In particular, certain funds may need to offload infrastructure or energy assets to maintain their allocations, where as a consequence of the listed markets' recent performance those funds are overweight in alternatives, including infrastructure (although some funds have already moved to revalue infrastructure assets, which should insulate them from this risk). Some listed infrastructure companies' ability to raise funds for new projects / acquisitions (e.g to participate in auctions) may also be constrained as capital markets tighten (as outlined in our earlier alert).
Existing Financing Considerations
As noted in our earlier alert, borrowers should be actively reviewing their existing financing arrangements to assess the existing and potential impact of COVID-19, and infrastructure / project finance borrowers are no different in this respect.
In projects with relatively fixed contracted offtake revenues, DSCRs are less likely to come under pressure than businesses with market-facing leverage/EBITDA-based covenants.
However, the other side of this coin is the very limited scope for fully contracted projects to flex either side of the equation (particularly in highly geared PPP-style financings) - any material impact on costs or revenue which is not insured or passed through to a viable third party can therefore lead to solvency concerns more quickly.
In the current circumstances, forward looking (versus backward looking) ratio testing may also deliver quite different results for patronage assets (e.g., airports).
Solvency Considerations: Safe Harbour Measures
As outlined in our previous note, the "safe harbour" from insolvent trading represents a potentially very valuable form of evasive action for borrowers in this sector who are experiencing difficulties and looking to trade through this period. The additional temporary measures regarding creditors' claims and directors' liability announced on 22 March will give further comfort in this regard.
The Global Angle
This alert provides further information on how COVID-19 is impacting finance transactions globally.
Other Considerations for Borrowers
For further information on how COVID-19 is impacting Australian Business, listen to a podcast from a team of Baker McKenzie experts who assess the implications on a number of subject areas.