Default rate on PFI loans lower than on general infrastructure, Moody's says

The agency's updated study (61-page / 937KB PDF – registration required), which builds on research originally published in 2010, also found that banks were more likely to recover the full amount of the outstanding debt in those PPP and PFI cases that did end in default.

Overall, the study highlighted the "robust and stable" nature of project finance debt despite an increasingly challenging climate as compared to 'vanilla' corporate loans, Moody's said.

Its analysis was based on the performance of more than half of all project finance loan transactions which closed over the period between 1983 and 2010. Only 278 of the 3,533 loans covered ended in default, it said.

Andrew Davison, senior vice president with the agency, said that loan defaults in the three years after a project closed were "marginal", but fell "significantly" further as a project headed towards ten years from completion.

"This characteristic of project finance bank loans is significantly different from the marginal annual default rates we have observed for corporate issuers, which are broadly stable," he said.

He added that banks had a high chance of recovering money where a project finance loan had defaulted. On average 79.9% of funds were recovered, but loans were fully restructured or repaid with no financial loss in 63.6% of defaults, the report said.

These figures were even higher for projects classed as PFI or PPP, where 87% of funds were recovered.

Although the agency urged caution due to the relatively low number of transactions identified as PFI or PPP in its study, it said that the 805 transactions analysed provided "some evidence to support the view held by many market participants that PFI/PPP is a discrete sub-sector lying at the low-risk end of the project finance spectrum".

Infrastructure law expert Barry Francis of Pinsent Masons, the law firm behind Out-Law.com, said that the results of the study were unsurprising.

"The close attention paid at the due diligence stage in such projects identifies risk and allocates it to the person best able to manage it, who then manages it in such a way that default through performance, volume or financial inadequacy is less likely than in many projects procured by other methods," he said.

The PFI model was introduced in the 1990s as a way of using private funding to pay for major public infrastructure projects such as roads, prisons and schools. In a PFI agreement, the private sector obtains finance to design, build and operate a facility for the benefit of the public. In return the public sector will grant its private sector partner a long-term contract to run the facility and will pay a monthly fee over the life of the project to repay the loan. PPP is a generic term used to describe partnerships which involve more flexible financing and operating contracts.

The report concluded that project finance loans were "a resilient class of specialised corporate lending" compared to standard corporate bank loans. This was because they were structured to be "highly robust" to a wide range of risks, and to minimise any economic loss in the event of a default.