1. Eduardo Alves
Associate Director,
Credit Solutions
S&P Capital IQ
Infrastructure Investment in Latin America:
Confidently Measuring Risks
Governments around the world continue to struggle with tighter budgets and increasing
infrastructure needs. As the traditional source for infrastructure investment, not only in Latin
America, public coffers can no longer sustain the level of capital required to maximize long-
term infrastructure development. This widening funding shortfall can only be bridged by
attracting more private sector participation. Further to short-term gains in the labor market
and aggregate demand, infrastructure investment creates long-term benefits through a
“multiplier effect” whereas investment expenditure results in a disproportionally larger
increase in GDP. However, simply increasing investment amounts alone does not translate
into large long-term gains. The multiplier effect is conditional on many country-specific
factors, including efficiency of investments and project selection. (Standard and Poor's
Ratings Services, 2015) Banks and nontraditional lenders, like insurance companies and
pension funds, are well positioned to capitalize on this opportunity. To do so in a risk prudent
matter, they must adopt a robust risk assessment tool that aligns with proven project finance
methodologies.
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2. INFRASTRUCTURE INVESTMENT IN LATIN AMERICA
$336 Billion Needed Over 5 Years
Infrastructure investment in Latin America from 2008 to 2012 stood at 3% of regional GDP,
trailing the 3.8% global average. The World Bank and the Economic Commission for Latin
America and the Caribbean (ECLAC) estimate that Latin America must double infrastructure
investment from 3% to 6% of regional GDP, maintaining this level over 20 years, to eliminate
the current infrastructure gap to countries like South Korea and China. There is a strong
need to address shortfalls in infrastructure in Latin America in the areas of energy, water,
transportation, telecommunications, and social facilities. (Standard and Poor's Ratings
Services, 2015)
Consultants at McKinsey estimate that projects already in progress could save up to a third
of total costs by adopting “best practices” in projects’ evaluation, planning, and execution.
These best practices would allow Latin America to eliminate the gap between actual and
needed infrastructure by increasing infrastructure investments from 3% to 4% of regional
GDP, as opposed to 6%. The report concludes that, over the next five years, the
infrastructure gap in Latin America is 1% of regional GDP, roughly $336 billion. (Standard
and Poor's Ratings Services, 2015)
Opportunities, Lower Defaults, and Higher Recoveries
Public infrastructure investment is chronically wasteful, not only in Latin America. Increased
private sector participation brings enhanced expertise and efficiency. During the 1980’s,
infrastructure investment was all but completely funded by governments. However, the
proportion of public to private investment in Latin America changed drastically since those
years. Starting in the 1990’s, private sector participation through privatizations and public-
private partnerships (3Ps or PPP), have played a much larger role. Brazil and Colombia are
fitting examples. In Brazil more than 60% of public infrastructure investment is now privately
funded. While in Colombia, it reached one-third of all infrastructure spending. (Standard and
Poor's Ratings Services, 2015) This trend is promising but the pace of change falls short of
what is needed – aggravated by a retreat of private capital during the 2008 financial crisis.
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3. INFRASTRUCTURE INVESTMENT IN LATIN AMERICA
As a result of regulations implemented since the crisis, banks are much better capitalized
and are now looking for ways to increase returns. Infrastructure project lenders benefit from
lower default rates and higher recoveries when compared to similarly rated corporate bonds.
(Standard and Poor's Ratings Services, 2015) Latin American governments should support
structural reforms that attract private sector funds and reduce risk to investors.
Assessing the Risks in Project Finance Deals
Adopting a project assessment tool that looks at project specific risks but also provides a
basis for cross-project comparison increases the efficiency of project selection and
investment. S&P Capital IQ leveraged the ratings framework below to develop a scorecard
used to analyze project finance deals in a comprehensive, consistent, and fully documented
method.
Identify the Project Finance Transaction
To start, it is necessary to determine whether the transaction is in fact a project finance deal.
Thought a seemingly elementary question, it is not always a straightforward one. A limited
purpose entity (LPE) must be established, providing a security package to senior lenders
and abiding by covenants that restrict the projects’ actions and cash management. The
project must have limited or no recourse to sponsors and shareholders but full recourse to
the project’s cash flow and assets. Throughout the limited project life, risks and
responsibilities must be clearly allocated between the project and counterparties.
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4. INFRASTRUCTURE INVESTMENT IN LATIN AMERICA
Determine the Project’s Stand-Alone Credit Profile (SACP)
An assessment of the project during the construction phase and the operations phase is
necessary because of inherent risks associated with each stage. The SACP reflects the
phase with the highest risk.
Construction Phase Analysis
The construction phase starts when the project’s financing documents are executed and all
conditions for drawdown are satisfied. The focus is on assessing whether the project is
adequately funded to be fully built on time and without cost overruns. Important factors
included in this analysis are the technological requirements of the project, applicability of
these technologies, the project’s complexity and management, construction timeline,
contingency reserve, and ability of contractors to deliver on commitments. It is challenging to
forecast the default of counterparties but measuring counterparty risk is essential.
Operations Phase Analysis
The operations phase starts at the end of the construction phase and lasts for the duration
of the project’s life or until the full repayment of the project’s debt. Focus is on analyzing
cash flow volatility as a function of performance risk, market risk, and country risk. Careful
scrutiny of contract specifications is needed to establish the project’s ability to deliver
products and services reliably. Some projects, power projects in particular, could be
vulnerable to volume risk and price risk. Country-specific factors like economic risk, political
risk, financial system risk, rule of law, and payment culture should receive a pragmatic
evaluation. As in the construction phase, assessing counterparty risk is also a critical
component of the assessment. Debt-service coverage projections under a baseline and a
stressful downside scenario are used to complement the analysis.
Determine the Project’s Final Score
As observed by S&P, many projects are not fully protected from the bankruptcy of a parent
company. (Standard and Poor's Ratings Services, 2014) Thus, linkage to parent company is
a significant risk factor. The legal and regulatory environment and relations with local
governments could have a material impact on a project’s viability.
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5. INFRASTRUCTURE INVESTMENT IN LATIN AMERICA
Works Cited
Standard and Poor's Ratings Services. (2013, November 15). Project Finance Construction
Methodology. RatingsDirect.
Standard and Poor's Ratings Services. (2014, September 16). Key Credit Factors For Road,
Bridge, And Tunnel Project Financings. RatingsDirect.
Standard and Poor's Ratings Services. (2014). Lessons Learned From 20 Years Of Rating
Global Project Finance Debt. RatingsDirect.
Standard and Poor's Ratings Services. (2014, September 16). Project Finance Framework
Methodology. RatingsDirect.
Standard and Poor's Ratings Services. (2014, September 16). Project Finance Operations
Methodology. RatingsDirect.
Standard and Poor's Ratings Services. (2015, January 14). Are Rumors For Global Project
Finance Bank Lending's Demise Greatly Exaggerated? RatingsDirect.
Standard and Poor's Ratings Services. (2015, January 21). Global Infrastructure Investment:
Timing is Everything (And Now Is The Time). CreditWeek, pp. 12-22.
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6. INFRASTRUCTURE INVESTMENT IN LATIN AMERICA
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