European Infrastructure Finance Yearbook - SP

Infrastructure Finance Ratings
European Infrastructure Finance Yearbook 2007/08
November 2007
20 Canada Square Canary Wharf London E14 5LH www.standardandpoors.com
CONTENTS
CONTENTS
Introduction
2007: New Challenges And Threats, But Sector Remains Robust Michael Wilkins 3
Infrastructure Commentaries
How Infrastructure Assets Have Weathered A Decade Of Storms Lidia Polakovic, Michael Wilkins, Jonathan Manley, and Peter Kernan The Changing Face Of Infrastructure Finance: Beware The Acquisition Hybrid Michael Wilkins and Taron Wade 4
European Utilities
Credit FAQ: Assessing The Credit Implications Of EC Legislative Proposals For The Internal Energy Market Peter Kernan and Beatrice de Taisne Nuclear Power In The EU: The Sleeping Giant Is Only Gradually Waking Up Hugues de la Presle and Peter Kernan Volts And Jolts: What To Expect As Russia Restructures Its Power Markets Eugene Korovin and Peter Kernan Combating Climate Change In The EU: Risks And Rewards For European Utilities Peter Kernan, Michael Wilkins, Mark Schindele, and Hugues de la Presle
12 13
17
22
33
Summary analyses
Electricite de France S.A. Endesa S.A. Enel SpA E.ON AG Gaz de France S.A. Iberdrola S.A. RWE AG Scottish and Southern Energy PLC Suez S.A. Vattenfall AB 40 41 42 43 44 45 46 47 48 49 51 52
Transportation Infrastructure
Skies Remain Clear For European Airports, Governance Increasingly Important Alexandre de Lestrange and Lidia Polakovic BAA Ltd. Alexandre de Lestrange and Michael Wilkins Channel Link Enterprises Finance PLC Alexandre de Lestrange, Michela Bariletti, and Michael Wilkins
56
67
STANDARD & POORS EUROPEAN INFRASTRUCTURE FINANCE YEARBOOK
NOVEMBER 2007 1
CONTENTS
CONTENTS CONTD.
Summary analyses
Copenhagen Airports A/S Deutsche Bahn AG DP World Ltd. Sanef VINCI S.A. 85 86 87 89 90 92 93
Project Finance and Public-Private Partnerships

Updated Project Finance Summary Debt Rating Criteria Terry A Pratt, Ian Greer, Arthur F Simonson, and Lidia Polakovic Credit FAQ: Accreting Debt Obligations And The Road To Investment Grade For Infrastructure Concessions Paul B Calder, Kurt Forsgren, Ian Greer, and Lidia Polakovic Credit FAQ: The Evolving Landscape For Subordinated Debt In Project Finance Andrew Palmer, Kurt Forsgren, Terry A Pratt, Paul B Calder, Lidia Polakovic, and Santiago Carniado Credit FAQ: Recently Upgraded Nakilat Provides Case Study For Credit Analysis Of LNG Shipping Projects Karim Nassif, Terry A Pratt, and Michael Wilkins Standard & Poors Methodology For Setting The Capital Charge On Project Finance Transactions Lidia Polakovic, Parvathy Iyer, Arthur F Simonson, Dick P Smith, and David Veno Sweden Moves Closer To PPP Model As Alternative Financing For Infrastructure Assets Lidia Polakovic, Karin Erlander, and Michael Wilkins
105
116
122
126
129
Summary analyses
Abu Dhabi National Energy Company PJSC Autoroutes Paris-Rhin-Rhone Metronet Rail BCV Finance PLC/Metronet Rail SSL Finance PLC Peterborough (Progress Health) PLC Transform Schools (North Lanarkshire) Funding PLC 132 133 136 138 142 144 149
Ratings List Key Analytical Contacts
2 NOVEMBER 2007
INTRODUCTION
INTRODUCTION 2007: New Challenges And Threats, But Sector Remains Robust
he year 2007 marks Standard & Poors Infrastructure Finance Ratings groups 10th anniversary. I am therefore delighted to introduce this years European Infrastructure Finance Yearbook, in which we discuss the continuing evolution of the asset class and highlight the years key transactions, sectors, and trends. In addition we set out the latest developments in our ratings criteria and methodology. We have also taken the opportunity to look back over the decade and examine the phenomenal growth the asset class has experienced as well as the challenges it has faced. In accordance with the past few years, throughout 2007 infrastructure has remained a highly sought after asset class in the financial markets, continuing to attract new investors with its reputation for low volatility and high stability. Yet, with this sustained growth in appetite has come a simultaneous push on the boundaries of infrastructure finance--with investors eager to pay higher acquisition multiples and employ novel financing techniques to purchase infrastructure assets. Consequently, the level of credit risk across the sector has escalated, as debt multiples have continued to creep upward. In particular, Standard & Poors has witnessed an increasing number of infrastructure assets being purchased using a new form of acquisition financing in the debt markets. When acquiring both traditional assets, such as water and toll roads, and nontraditional assets, for example motorway service stations, participants are increasingly combining project finance structuring techniques with covenants prevalent in corporate-style leveraged finance facilities. Standard & Poors believes such structuring techniques can involve significantly more credit risk than is usual among previous infrastructure finance transactions, as favorable debt terms are often coming at the expense of necessary protections. Consequently, we have warned market participants that, as credit markets become increasingly tight-as has been the case in the second half of 2007--some of these more loosely structured and highly leveraged acquisition loans may find it hard to attract lender and investor interest. Nevertheless, we have also been keen to highlight that for well-structured infrastructure finance transactions funding traditional infrastructure assets--such as the Thames Water refinancing transaction--investor appetite looks set to remain, due to the assets strong credit quality. For this reason, such transactions are likely to show significant resilience in the face of the current market volatility. Indeed, such stability has been the case for infrastructure assets throughout the past decade, despite substantial market shocks. Notably, Standard & Poors has analyzed the project, utility, and transportation sectors through numerous difficult environments--such as the Asian crisis that threatened many credits across the region in 1997, as well as the California power crisis, Enron Corp. bankruptcy, Brazilian energy crisis, and events of Sept. 11, 2001, all of which placed ratings under downward pressure in later years. Despite such pressures, on the whole, project and infrastructure credits have remained robust in the longer term, and the credit trends of the past decade illustrate the strength of the infrastructure sector. Unsurprising, therefore, that the market has continued to expand--with the booming global economy driving demand for supporting infrastructure. Consequently, the demand for Standard & Poors ratings has similarly grown in the sector, with the number of global project finance ratings alone reaching 304 in total at the beginning of this year, a dramatic increase from the 93 we rated in 1997. The articles within this years European Infrastructure Finance Yearbook reflect this continued development of the infrastructure market. We discuss the growth in project, utility, and transportation finance transactions in new jurisdictions--such as Russia and Eastern Europe--as well as our approach to rating increasingly complex structuring techniques. Importantly, Standard & Poors continues to closely follow the trends across the infrastructure sector, extending and revising our criteria to enable the appropriate assessment of risk originating from the new markets, new structures, and new avenues of infrastructure ownership. I therefore hope you find this 2007 European Infrastructure Finance Yearbook of considerable use and we look forward to receiving any feedback or questions you may have on this publication.
Michael Wilkins Managing Director and Head of Infrastructure Finance Ratings

STANDARD & POORS EUROPEAN INFRASTRUCTURE FINANCE YEARBOOK NOVEMBER 2007 3
COMMENTARY
HOW INFRASTRUCTURE ASSETS HAVE WEATHERED A DECADE OF STORMS

Publication Date:
Oct. 31, 2007 Primary Credit Analysts: Lidia Polakovic, London, (44) 20-7176-3985 Michael Wilkins, London, (44) 20-7176-3528 Secondary Credit Analysts: Arthur F Simonson, New York, (1) 212-438-2094 Ian Greer, Melbourne, (61) 3-9631-2032 Peter Rigby, New York, (1) 212-438-2085 Other Secondary Credit Analysts: Jonathan Manley, London, (44) 20-7176-3952 Peter Kernan, London, (44) 20-7176-3618 Paul B Calder, CFA, Toronto, (1) 416-507-2523
ver the past decade, Standard & Poors Ratings Services has witnessed phenomenal growth in demand for infrastructure assets. A highly sought after asset class in the financial markets, infrastructure benefits from its reputation for stability and flexibility to respond to changing investor needs. The sector is evolving, with assets becoming more varied and the financial structures that support their financings increasingly sophisticated, making risk analysis more complex than ever. This year marks Standard & Poors Infrastructure Finance Ratings groups 10th anniversary. It therefore seems appropriate to review the highs and lows of the past decade, and to consider how infrastructure has matured as an asset class. In 1997, infrastructure finance faced a difficult environment. The Asian crisis was unfolding, threatening many project and infrastructure credits rated by Standard & Poors across the region. In many cases the crisis derailed projects at all stages of the pipeline--from many in development infancy to a handful ready to close on their financings. Market shocks have followed. Notably, the California power crisis, Enron Corp. bankruptcy, Brazilian energy crisis, and events of Sept. 11, 2001, caused widespread disruption in the project, utility, and transportation sectors. Through it all, though, infrastructure assets have shown resilience, and the market continues to grow. This should surprise few. As the global economy has boomed, the need for supporting infrastructure has exploded, which has also resulted in a significant rise in the number of Standard & Poors ratings in the sector. Project
finance ratings alone rose to 304 at the beginning of 2007, from 93 in 1997. Project finance transactions have also spread globally to markets such as Latin America, the Middle East, and-more recently--Eastern Europe. New forms of project finance have gained popularity, with the U.K. public-private partnership (PPP) market growing in importance over the decade. This market continues to expand, with several countries developing their own PPP models-including Canada, Australia, and most recently the U.S.--as a means of delivering public sector services using private sector expertise. Increasingly more diverse assets are being presented to us as infrastructure (see charts 1 and 2 below), and infrastructure finance now includes wind and solar power projects, as well as more unusual asset types such as stadiums and car parks. The Infrastructure Finance Ratings team has followed the cycles of infrastructure finance of the past decade and studied their causes and effects. Here are some of the decisive moments in the development of the infrastructure asset class.
Power Projects Hit By Falling Commodity Prices

After the Asian financial crisis in 1997-1998, the majority of infrastructure assets enjoyed rating stability. This all changed in 2002, when rated project credit quality precipitously fell. Collapsing commodity prices drove many of the negative credit trends. Most of the project finance downgrades occurred in the U.S. power sector, affecting projects exposed to contracts with weakening power offtakers in particular. Notably, a number of rated AES Corp. projects that sold
Chart 1 Breakdown Of Projects By Sector, December 1997
Chart 2 Breakdown Of Projects By Sector, May 2007
4 NOVEMBER 2007
ject Finance Rating Distribution: Investment Grade Versus Speculative Gr

Investment grade Speculative grade
100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Standard & Poor's 2007.
COMMENTARY
The ever present demand for infrastructure assets across the globe ensures that the drivers of infrastructure are set to remain. As the sector matures, so too will the Infrastructure Finance teams credit risk analysis methodology and analytical approach.
Note
Additional research by Deepti Hemnani, Archana Sharma, Ganesh Iyer, and Kaustubh Shrotriya, and by Caroline Hyde of Moorgate Group.
NOVEMBER 2007 7
COMMENTARY
THE CHANGING FACE OF INFRASTRUCTURE FINANCE: BEWARE THE ACQUISITION HYBRID

Publication Date:
Sept. 7, 2007 Primary Credit Analyst: Michael Wilkins, London, (44) 20-7176-3528 Leveraged Finance & Recovery: Taron Wade, London, (44) 20-7176-3661
ank lenders and institutional investors have traded favorable debt terms against the management of credit risk during the infrastructure finance boom of the past 18 months. Now, with the cycle turning in the global credit markets, loosely structured and highly leveraged acquisition loans are looking far less attractive. As a result, it is estimated that up to $34 billion of leveraged infrastructure loans may be left paralyzed under current market conditions. Cheap debt with relatively generous terms has been the order of the day among infrastructure sponsors. To meet market demand, banks have combined project finance structuring techniques with covenants prevalent in leveraged finance facilities--allowing sponsors to acquire infrastructure assets at record-breaking debt multiples. Despite the advantages for borrowers, Standard & Poors Ratings Services believes that this new form of acquisition hybrid poses a significant credit risk to the infrastructure sector. Many assets recently purchased for eye-watering acquisition multiples have failed to boast the operating and cash flow strengths assumed typical of infrastructure assets. Such risks are likely to be exacerbated as credit markets become increasingly volatile and investor confidence fragile. With $332 billion in leveraged loans currently sitting on banks balance sheets globally, bankers are unlikely to be keen to lend to infrastructure assets in the current climate without comfort that credit risks are well mitigated. Investors and lenders alike therefore need to examine the risks associated with each individual transaction, and if necessary seek more credit protection than is currently being provided within the hybrid structure to ensure that the level of debt can be supported by the underlying asset. This is particularly pertinent as new assets are brought under the infrastructure umbrella--with car parks, motorway service stations, and motor vehicle certificates now claiming to be strong infrastructure assets.
investors marrying together structuring techniques from both financing classes to acquire infrastructure assets. Crucially, the high debt multiples usually associated with project finance transactions have been adopted in conjunction with the relatively flexible controls, hurried due diligence, and weak security packages more common in LBOs. As a result, increased debt multiples are often coming at the expense of necessary risk mitigants. Since 2006 a phenomenal appetite for infrastructure assets has spread worldwide. This, in turn, has fuelled a surge in the number of acquisitions within the sector, making it a significant area of growth for the syndicated loan market. Landmark deals include the purchase of U.K.-based airport operator BAA Ltd. (BBB+/Watch Neg/NR) by a consortium led by Grupo Ferrovial S.A. in February 2006 for $30.2 billion, the acquisition of the Indiana Toll Road for $3.8 billion by Macquarie Infrastructure Group and Cintra Concesiones de Infraestructuras de Transporte, and Goldman Sachs Admiral Acquisitions consortiums 2.8 billion acquisition of Associated British Ports (ABP).
Fusion Of Project Finance And Leveraged Finance

As for the financing of greenfield infrastructure assets, investors have turned toward project finance to raise funds when acquiring mature infrastructure assets--securing high leverage multiples due to the stable cash flows and monopolistic environment. They have then incorporated leveraged finance structuring techniques instead of carrying out an LBO of the asset as would traditionally have been the case for the acquisition of mature infrastructure assets (see table on next page for the various structuring techniques typically associated with leveraged finance transactions and project finance transactions, respectively). Of key concern for Standard & Poors is that, in combining techniques, investors have been trading favorable debt terms against the management of risk. Often we are seeing new infrastructure acquisition financing structures employing structural features, such as short shareholder lock-in periods, that are weaker than those of traditional transactions, coupled with a very aggressive financial structure. ABP, for example, was purchased for 2.8 billion with an enterprise value (EV)-to-EBITDA ratio of 16.6x.
Breaking New Boundaries: Hunger For Infrastructure Drives Development

Over the past few years the boundaries of infrastructure finance have been increasingly pushed, with investors hungry for new types of assets and financing techniques. Consequently, the lines between project finance and leveraged finance have become evermore blurred, with
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COMMENTARY
Leveraged Finance And Project Finance Structuring Techniques

Leveraged finance Corporate entity in competitive environment Debt capacity dictated by market-driven multiples Medium-term maturity, lower leverage, bullet repayment Standardized due diligence Key ratio: debt to EBITDA Flexible financial undertakings Capital expenditure lines accounted for, but not mandatory future capital expenditure Standardized security interest charges Project finance Asset with stable cash flows over the long-term, monopolistic environment Debt capacity dictated by discounted cash flows Long-term maturity, higher leverage, amortizing repayment, lower margins Detailed due diligence Key ratio: loan to project life coverage Fixed financing structure, monitored/ updated Future expenditure (i.e., restoration of assets) accounted for Ring-fencing security and "cash waterfall" controls
Despite the assets strong monopolistic position and stable cash flows, these terms are unlikely to fully mitigate risk arising from the high level of debt. Nor are they likely to mitigate market risks such as the increasing environmental and regulatory hurdles limiting ABPs ability to expand capacity in the future.
Infrastructure--An Ever Expanding Asset Class?

For the past 18 months, sponsors have also been using the hybrid structure to acquire assets not traditionally considered as infrastructure. These assets do not benefit from the significant track record of other sectors such as ports and airports and therefore may not be suitable to support high debt multiples, lacking the necessary long-term stable cash flows or a strong monopoly position in the market. The recent refinancing of Autobahn Tank & Rast Holding GmbH, a German motorway service area operator, is a clear example of the market opening up to new assets and financing acquisitions that would not previously have been recognized as infrastructure-style deals. Indeed, the initial acquisition of Tank & Rast by privateequity investor Terra Firma for 1.1 billion in November 2004 involved traditional leveraged finance techniques. The acquisition was financed using an all-senior debt facility, with a debt multiple of 6x debt to EBITDA. As little as two years later, in June 2006, Terra Firma was able to refinance the debt, obtaining greater leverage at a cheaper price. The refinancing transaction involved a 1.2 billion seven-year senior loan with a cash sweep, and
leverage was about 8x. Significantly thinner margins were attained via the refinancing--with pricing falling to a range of 125 basis points (bps) to 150 bps in 2006, from a range of 212.5 bps to 262.5 bps in 2004. Importantly, the arrangers of the refinancing--Royal Bank of Scotland, Barclays Capital, Socit Gnrale, and West LB--marketed the transaction as infrastructure play, highlighting the assets 90% market share and stable, predictable cash flows. Investors and lenders need to be aware of the credit risk of applying significant leverage to a new asset type. The experience of U.K. motorway service operator Welcome Break Group demonstrates the pitfalls of assuming that this asset class can support significant levels of debt. Standard & Poors believes that applying infrastructure-style financing techniques to less mature asset types could serve to undermine the sectors reputation for strong, long-term revenue flows if appropriate risk mitigants are not employed.
The Origins Of The Acquisition Hybrid

Hybrid acquisition financing structures are fairly new to the infrastructure sector, with the South East Water deal in 2003 heralding the first transaction of this kind on a large scale. It was the subsequent flurry of French toll road deals in 2005 and 2006 that brought infrastructure acquisition transactions into the mainstream--with Eiffaries purchase of Autoroutes Paris-RhinRhone (APRR) providing a template for future transactions. Techniques from both leveraged finance and project finance were evident in the APRR
NOVEMBER 2007 9
First quarter Fourth quarter
Second quarter Transaction count*
Third quarter
(Bil. )
140 120 100 80
(No. of transactions)
320 280 240 200 160
60 120 40 20 0 1999 2000 2001 2002 2003 2004 2005 2006 2007 80 40 0
*Transaction count takes first- and second-lien portions of a single transaction as one event and excludes any amendments. For the first half of 2007, the transaction count was 214. Standard & Poor's 2007.
COMMENTARY
Contractual terms have also been weakening elsewhere in the loan markets, with the introduction of covenant-lite LBOs further reducing lenders control over borrowers performance. Furthermore, Standard & Poors has recorded that the level of senior debt amortizing within European LBOs has dropped steeply, to 15% at the beginning of 2007 from 50% in 2001. With risk mitigants deteriorating in this fashion across the loan market in general, Standard & Poors does not believe that the infrastructure asset class can withstand a continued deterioration in underwriting quality. Hybrid acquisitions must therefore be restricted to infrastructure assets operating within monopolistic environments with stable cash flows over the long term. Moreover, high leverage should be accompanied by the necessary structural package and creditor protections.
Notes
Additional data provided by Thomson Financial. Additional research by Caroline Hyde of Moorgate Group.
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EUROPEAN UTILITIES
nce again, while the European utility sector continues to exhibit generally strong credit characteristics, credit quality has come under pressure--with increased debt-financed M&A activity and heightened levels of regulatory risk the principal drivers of this pressure. Favorable operating conditions have, however, continued for many utilities--particularly among generators and vertically integrated power companies in the deregulated markets, where high power prices and strong free operating cash flows have remained a source of credit strength. M&A activity has continued at a high level since 2006, and has resulted in several downgrades--at E.ON, EDP, Enel, and Iberdrola for example--and a number of CreditWatch listings across the sector. Crucially, these negative rating actions have been catalyzed by a weakening of companies financial profiles following debt-financed acquisitions, as exemplified by Enels downgrade to A from A+, with all ratings remaining on CreditWatch with negative implications, following its acquisition of Endesa. We believe that the consolidation trend will continue and is likely to keep ratings under pressure. Of the top 20 European utilities, five companies are on CreditWatch negative as a result of M&A activity (Enel, Iberdrola, Endesa, Scottish Power, and Gaz de France) and a further four companies have negative outlooks. Meanwhile, the European Commissions ongoing scrutiny of European utilities, together with the recently announced legislative proposals to further liberalize the internal energy markets, has highlighted the regulatory and political risk many companies remain exposed to. In particular, of the measures proposed, any forced ownership unbundling of transmission grids would have the greatest impact on credit quality, affecting vertically integrated utilities in Germany (such as E.ON and RWE), France, (EDF and GDF), and Greece (Public Power Corp.). At this stage, we do not factor in any assumption that those companies that currently own and operate transmission networks will be forced to sell their networks. We believe there continues to be significant uncertainty about both the final form of any legislative package and whether ownership unbundling will be required, as there is no unanimity between the EC and the member states about whether unbundling is necessary. The future direction of climate change policies adds a further layer of uncertainty and risk to the utility sector. Phase 2 of the EUs Emission Trading Scheme comes into force from Jan. 1, 2008. Given the high level of uncertainty over future climate policy initiatives and long-term carbon pricing, this issue will remain a significant challenge for generators, especially when taking long-term investment decisions. Nevertheless, it is clear that the outlook for both renewable and nuclear energy investment has improved and will continue to do so due to the heightened global focus on environmental issues, while that of coal--the most CO2-intensive fuel--has weakened. The need for technological developments to reduce the CO2 intensity of coal will be key to the future of coal-fired generation. Accordingly, the articles included here provide an important insight into the current environment European utilities face, as well as detailed analyses of the resulting credit issues. Based in London, Paris, Frankfurt, Madrid, Milan, Moscow, and Stockholm, our regional utilities infrastructure analysts welcome your feedback; their contact details are listed at the end of this book. Please do not hesitate to contact me, or any of the analysts, if you require further information.
Peter Kernan Managing Director and Team Leader European Utilities Team
12 NOVEMBER 2007
UTILITIES
CREDIT FAQ: ASSESSING THE CREDIT IMPLICATIONS OF EC LEGISLATIVE PROPOSALS FOR THE INTERNAL ENERGY MARKET
Publication Date:
Sept. 21, 2007 Primary Credit Analysts: Peter Kernan, London, (44) 20-7176-3618 Beatrice de Taisne, London, (44) 20-7176-3938
n Sept. 19, 2007, the European Commission (EC) published a package of legislative proposals for the internal energy market. One of the ECs principal goals is to correct what it sees as structural failings in some EU electricity and gas markets. According to the EC, the current rules on the separation of network activities from supply and production of energy do not ensure proper market functioning. The EC recommends that this be remedied either through ownership unbundling, so that a single company could no longer own transmission and generation or supply activities, or by implementing an independent system operator (ISO) model that would make it possible for existing vertically integrated companies to retain network ownership, provided that the assets are operated completely independently from the generation and supply operations. To highlight the potential implications of the ECs findings for the credit quality of European utilities, Standard & Poors Ratings Services addresses below some of the most frequent questions we have been receiving.
some of the proposals--specifically to take out one or both of the proposals for the ownership and operation of transmission networks. Which member states would be most affected? A number of member states, including the U.K., Sweden, Portugal, Italy, and Spain, have already implemented ownership unbundling of transmission networks. For these countries, a legal requirement to unbundle would have no impact on domestic energy markets. Some member states, however, such as France, Germany, and Greece do not currently require ownership unbundling of transmission networks. The domestic energy markets of these countries could therefore be significantly affected by any obligation to implement ownership unbundling. When would the member states have to implement the legislative package? The earliest member states would have to implement the unbundling and/or ISO requirements is likely to be around 2012 on the basis of a normal legislative procedure and assuming that the current text is the one that is finally adopted. The text could change during the course of the legislative debate, however, and implementation could be delayed beyond 2012, as it is the member states who determine the timing of their domestic legislative programs. What assumption do the ratings on affected companies make about the likely outcome of the legislative process? At this stage, we do not factor in any assumption that those companies that currently own and operate transmission networks will be forced to sell their networks or will pre-empt a potential legislative requirement by unilaterally deciding to sell their networks. We believe that there continues to be significant uncertainty about both the final form of any legislative package and whether ownership unbundling will be required, as there is no unanimity between the EC and the member states about whether unbundling is necessary. For example, there is significant opposition to forced ownership unbundling in France and Germany, two of the largest and most influential member states, which, if sustained, increases the likelihood that an alternative
Frequently Asked Questions

What are the key potential credit stress points in the draft legislative package? The measure that could have the most marked effect on credit ratings would be the unbundling of network assets by vertically integrated utilities. The ECs current proposals include unbundling as the default option, with the possibility for member states to apply for a derogation and use the ISO model. What is the next stage in the process? The ECs proposal now has to go through the normal codecision process with the European Parliament and European Council, whereby both institutions can amend the current text in the course of two readings. A third reading allows for formal negotiations between the two institutions if they cannot agree. Standard & Poors understands that there are some strongly divergent views within and between the member states on the proposals, and specifically on the subject of ownership unbundling. As such, we believe that some member states and EU parliamentarians could work to alter or remove
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UTILITIES
approach to ownership unbundling--such as the ISO model or some other proposal--will be included in the final legislation. In addition, even if ownership unbundling were required it is possible that the affected companies could mitigate the impact on credit ratings by using any received proceeds to reduce debt. Why does the vertically integrated model support credit quality and credit ratings? From a rating perspective, the European utility sector has favorable credit characteristics, as reflected in the relatively strong credit ratings on many of the largest companies in the sector. One of the key factors underpinning this credit strength is that many of the rated utilities own monopoly transmission and/or distribution networks whose cash flow and earnings are relatively stable and low risk. These favorable credit characteristics provide strong support for debt capacity and credit ratings. Stand-alone EU transmission and distribution companies are typically rated in either the AA or A categories, depending on financial risk factors such as balance sheet leverage, dividend policy, and acquisition appetite. National Grid PLC, for example, is rated A-, while the smaller Danish national energy transmission company Energinet.dk SOV is rated AA+. On the other hand, the EU electricity generation and supply markets are open and competitive (albeit that there are significantly different levels of competition within different member states), and are therefore characterized by actual or potential earnings volatility. Wholesale and retail prices are largely determined by the market (although some member states continue to set regulated supply tariffs), and generation and supply businesses face price and volume volatility and lack revenue and earnings predictability. Accordingly, generation and supply businesses are inherently riskier from a credit perspective than transmission and distribution businesses. The vertical integration model bears lower credit risk than generation only and generation and supply models, as the ownership of a network business provides a relatively stable, and predictable, regulated earnings base, underpinning cash flows and borrowing capacity. The integration of generation with supply operations (providing a customer base to which power can be sold), and generation and supply operations
with network operations, provides a strong competitive advantage for many market participants. How common is the vertically integrated model? The predominant business model in the EU electricity market is that of vertical integration, which combines generation and supply operations with distribution and/or transmission networks. Of the top 20 rated European utilities (see table on next page), 15 are vertically integrated companies, for which network earnings account for a significant share of consolidated earnings and represent a key credit strength. Of the 15 vertically integrated utilities, six own distribution networks only and nine own distribution and transmission networks, of which seven also operate transmission networks. The seven utilities that own and operate transmission networks are E.ON AG (A/Stable/A-1), RWE AG (A+/Negative/A-1), EnBW Energie BadenWuerttemberg AG (A-/Stable/A-2), and Vattenfall AB (A-/Stable/A-2) (who all own and operate regional electricity transmission networks in Germany), Electricite de France S.A. (EDF; AA/Stable/A-1+) and Gaz de France S.A. (AA-/Watch Neg/A-1+) (who respectively own and operate the electricity and gas transmission networks in France), and Public Power Corp. S.A. (BBB+/Stable/--) (which owns and operates the electricity transmission network in Greece). Scottish Power PLC (A-/Watch Neg/A-2) and Scottish and Southern Energy PLC (A+/Stable/ A-1) own transmission networks in Scotland, but these networks are operated by National Grid PLC (A-/Stable/A-2), which provides an example of a functioning ISO model. Would ownership unbundling of transmission networks threaten the ratings of affected companies? Yes. Ownership unbundling would increase the overall risk and volatility of the consolidated business model. As such, if the impact of unbundling were not offset by--for example-either a reduction in overall debt and materially stronger forward cash flow credit protection measures, or the adoption of compensating strategic measures (such as the use of proceeds from unbundling to acquire other low-risk earnings streams), ratings would be threatened.
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Would ownership unbundling automatically result in lower ratings? No. While ownership unbundling of transmission networks would increase consolidated business risk by reducing the share of earnings and cash flow generated from monopoly operations, and increasing the proportion of earnings generated from more volatile and competitively exposed generation and supply operations, this could be compensated for by lowering the overall leverage and financial risk of the group. In other words, it is possible that the credit impact of any unbundling could be negated through a sustainable reduction of total debt and overall financial risk and/or a counterbalancing change in strategy that would lower business risk. Furthermore, the lower the proportionate contribution of transmission networks to the consolidated cash flow of the group, the lower the overall impact of any unbundling. For example,
there was no impact on the ratings on Enel SpA (A/Watch Neg/A-1) when it sold down a minority stake in Italian power transmission grid owner Terna SpA (AA-/Stable/A-1+) in 2005, as Terna contributed only 5%-6% of Enels then consolidated operating income. The degree of headroom in a companys ratings could also have a bearing on the impact of unbundling if, for instance, there is significant capacity within the ratings for a weakening of the consolidated financial and business risk profile. Are competitively exposed utilities always rated lower than network companies? No. For example, of the rated nonvertically integrated European utilities, Centrica PLC (A/Negative/A-1), which owns and operates generation and supply businesses, is rated higher than National Grid PLC (A-/Stable/A-2), which owns and operates the electricity and gas
Top 20 Rated European Utilities

Company Centrica PLC E.ON AG EDP - Energias de Portugal, S.A. Electricite de France S.A. EnBW Energie Baden-Wuerttemberg AG Endesa S.A. Enel SpA Fortum Oyj Gaz de France S.A. Iberdrola S.A. National Grid PLC Public Power Corp. S.A. RWE AG Scottish and Southern Energy PLC Scottish Power PLC Suez S.A. Union Fenosa S.A. United Utilities PLC Vattenfall AB Veolia Environnement S.A.
*At Sept. 21, 2007.
Country U.K. Germany Portugal France Germany Spain Italy Finland France Spain U.K. Greece Germany U.K. U.K. France Spain U.K. Sweden France
Business Model Generation and supply Vertically integrated Vertically integrated Vertically integrated Vertically integrated Vertically integrated Vertically integrated Vertically integrated Vertically integrated Vertically integrated Transmission and distribution Vertically integrated Vertically integrated Vertically integrated Vertically integrated Diversified Vertically integrated Combination utility Vertically integrated Water
Transmission Assets No Yes No Yes Yes No No No Yes No Yes Yes Yes Yes Yes No No No Yes No
Corporate Credit Rating* A/Negative/A-1 A/Stable/A-1 A-/Negative/A-2 AA-/Stable/A-1+ A-/Stable/A-2 A/Watch Neg/A-1 A/Watch Neg/A-1 A-/Stable/A-2 AA-/Watch Neg/A-1+ A/Watch Neg/A-1 A-/Stable/A-2 BBB+/Stable/-A+/Negative/A-1 A+/Stable/A-1 A-/Watch Neg/A-2 A-/Watch Pos/A-2 BBB+/Stable/A-2 A/Watch Neg/A-1 A-/Stable/A-2 BBB+/Stable/A-2
NOVEMBER 2007 15
UTILITIES
transmission grids in England and Wales (as well as some U.S. network assets). While Centrica has a higher level of business risk than National Grid because its earnings are competitively exposed and are more volatile, this is compensated by Centricas significantly lower leverage. Following National Grids recent acquisition of U.S.-based KeySpan Corp. (A-/Stable/A-2), unadjusted net debt will increase to approximately 19.5 billion by 2009, from 11.8 billion in 2007, with consolidated funds from operations (FFO) interest coverage of about 3.5x and FFO to total debt of about 15%. By comparison, in the 12 months to June 2007, Centricas FFO coverage of adjusted net debt was very strong at about 97%. Why would an ISO model have less of an impact on credit quality than unbundling? An ISO model in which the operational management and investment plans of transmission networks would be controlled and determined by parties independent of the owners has been presented as an alternative--and potentially less politically divisive--option than ownership unbundling. The impact of such a move on the ratings in the sector would in principle be significantly less than that of unbundling, because the network owners would not be forced to divest and would retain access to the relatively solid, stable, and predictable network earnings (compared with, for example, volatile power generation earnings). An ISO model would mean that the vertically integrated utilities--such as E.ON, RWE, EDF, EnBW, and Vattenfall--that own transmission networks and whose credit quality benefits from such ownership, would continue to own the network and consolidate their earnings. Rating risk under an ISO model would, therefore, be limited compared with the significant rating risk presented by ownership unbundling. The ultimate effect of such a move would depend, however, on factors such as whether the networks would continue to be fully consolidated. In addition, current transmission network owners could decide to unilaterally sell networks if an ISO system were introduced, thereby redeploying capital from what would be a passive low-risk investment into a fully controlled and managed investment such as high-risk power generation.
What was the impact on Scottish Power and Scottish and Southern Energy when the operation of their transmission networks moved to an ISO model? None. National Grid has operated the transmission networks of Scottish Power and Scottish and Southern Energy since 2005. Both companies continue to consolidate their transmission networks, and their consolidated credit quality continues to benefit from the relatively stable earnings of the transmission networks.
16 NOVEMBER 2007
Publication Date:
Carbon Emissions By Type Of Power Generation

(Tons of 2 equivalent gigawatthours)
1,000 900 800 700 600 500 400 300 200 100 0 oal Source il Natural as ydroelectric Nuclear orld conomic ouncil, 2004.
The EU's Main Providers Of Uranium, 2006
thers (23 )
anada (24 )
South frica (Nami ia) (5 ) ustralia (14 ) Niger (16 )

Source uratom. Standard & Poor's 2007.
ussia (19 )
UTILITIES
Limited Nuclear Revival In The EU Nevertheless...

Following the commissioning in September 2007 of the Cernavoda 2 reactor in Romania, 146 reactors are currently in operation in the EU providing 30% of the regions electricity. Only four plants are currently being built and another four are planned (see table 1). This compares with 33 plants being currently built worldwide and 94 planned. A number of additional nuclear plants are being considered in other EU countries, especially the Czech Republic and Finland as well as Lithuania and Romania, but with no firm commitment so far.
Table 1 - Nuclear Power Plants In the EU

Nuclear reactors Operational France Germany Spain Sweden United Kingdom Finland Bulgaria Romania 59 17 8 10 19 4 2 2 5 20 146 Under construction 1 0 0 0 0 1 0 0 2 0 4 Planned 0 0 0 0 0 0 2 2 0 0 4
...Given Relatively Limited Political And Public Support So Far...

Although the EU is generally supportive of the development of nuclear power, support at state level is more mixed. Recognizing the right of each member state to decide on its energy mix, in March 2007 the EU Council underlined nuclear powers place within the regions carbon-reduction strategy, and its contribution to addressing growing concerns about security of supply. However, the council also highlighted nuclear powers drawbacks in terms of safety, decommissioning, and waste management. Within the EU, some countries are clearly supportive of nuclear power, especially France, Finland, and a number of Eastern European countries. In The Netherlands, the government
Slovakia Others Total
Source: World Nuclear Association, October 2007.
signed the Borssele covenant in June 2006, under which the operating life of the countrys only nuclear power station in Borssele has been extended until 2033 at the latest, as long as it remains in the top quartile of the safest power stations of its kind within the EU, the U.S., and Canada. In its May 2007 energy white paper, the British government also clearly reiterated its support for new nuclear power stations, the costs of which, including for decommissioning and waste disposal, must, however, be entirely borne by the private sector.
Table 2 - Nuclear Power Phase Out Policies In Europe Country

Belgium
Existing nuclear phase out legislation/policy

A 2003 law imposes the closure of nuclear plants after 40 years of operation--with exceptions possible for security of supply concerns--and prohibits the building of new nuclear plants. Gradual phase out planned to be completed in 2030, with first plant closure to occur in 2015. Based on the "Atomausstiegsgesetz" law, government and nuclear operators agreed in 2001 to limit the average life of nuclear plants to 32 years based on production quotas. The building of new nuclear plants is also prohibited. Policy is to phase out nuclear power but no schedule or specific strategy set. The "Nuclear Power Decommissioning Act" of January 1998 allows the government to decide that the right to operate a nuclear power plant will cease to apply at some point. Such a decision infers the right to compensation from the state.
State of debate
The "Commission Energie 2030" in its 2006 report recommended the reversal of the nuclear phase out policy.
Germany
The German government's coalition agreement includes a clause stating that there is no agreement on this matter. Policy of current government is to reduce recourse to nuclear power without compromising security of supply. No decision on phasing out of nuclear power to be taken by current government during term in office (2006-2010).
Spain
Sweden
Source: Standard & Poor's.
18 NOVEMBER 2007
Eurobarometer: European And Nuclear Safety

In your opinion, should the current level of nuclear energy as a proportion of all energy sources be reduced, maintained the same, or increased?
Eurobarometer: European And Nuclear Safety
When you think about nuclear power, what first comes to mind? on't know (8 )
on't know (13 ) ncreased (14 ) educed (39 )
Neither (spontaneous) (6 )
aintained the same (34 )
The advantages outweigh the risks (33 )
The risks outweigh the advantages (53 )
Source
uro arometer Fe ruary 2007
uropean and nuclear safety .
Source
uro arometer Fe ruary 2007
uropean and nuclear safety .
UTILITIES
For TVO, a strong turnkey, time-certain supply contract with ample guarantees, backed by strong suppliers and security bonds in the construction phase, as well as by offtake agreements with its main shareholders during the operation phase. For EDF, during the construction phase by the groups expertise in building nuclear plants, its last such plant in France having been commissioned in 2002, and by the groups leading domestic position and the protective French regulatory environment in the operation phase. For the Slovakian plants by the strong support of the government, which owns 34% of SE. From a financial perspective, both EDF and Enel have the financial flexibility to carry out the investments necessary for their new builds of, respectively, 3.3 billion and $2.2 billion. TVO is much smaller, but the protective turnkey contract and the offtake arrangements with its major shareholders provide substantial comfort. That said, in August 2007 we revised to negative the outlooks on Estonia-based integrated electric utility Eesti Energia AS (A-/Negative/--) and Lithuania-based electricity transmission company Lietuvos Energija (A-/Negative/A-2) to reflect the risks stemming from their possible participation in a prospective new nuclear power plant at Ignalina, Lithuania. The Ignalina nuclear project is based on a 2006 agreement between the governments of Lithuania, Estonia, Latvia, and, at a later stage, Poland. However, realization of the project, including funding, will be the responsibility of the participating state-owned power companies. Eesti Energia could participate in the nuclear project with a 22% stake, while Lietuvos Energija would have a 34% stake and would be responsible for the plants operations. The nuclear power plant would have maximum installed capacity of 3,400 MW at a projected cost of up to 4 billion.
additional eight were being reviewed. In the U.K., British Energy Group PLC (BE; BB+/Watch Neg/--) obtained approval in 2005 for a 10-year extension of its Dungeness plant. In 2008, BE may apply to extend the lives of its Hinkey Point and Hunterston plants, which are currently scheduled to close in 2011. Extending the operating life of its nuclear plant beyond the current 40 years is also a key pillar of EDFs strategy. Czech operator CEZ a.s. (A-/Stable/--), has also launched an upgrade program at its Dukovany nuclear plant, with a view to increasing capacity by 160 MW and extending operating life by up to 20 years. Although Swedish utilities have not applied for life extensions they have obtained approval for uprates (capacity increases), which will significantly boost their nuclear capacity: Uprates underway and planned between 2006-2011 at the Ringhals plant, which is operated by Vattenfall AB (A-/Stable/A-2), will increase its capacity by close to 500 MW. The group will also boost capacity at its other nuclear plant, Forsmarks, by 410 MW between 2008-10. E.ON Sverige AB (A/Stable/A-1) is also planning a 250 MW uprate of its Oskarshamn-3 reactor, to increase its capacity to 1,450 MW. We view such extensions very positively as, while running, nuclear power plants are highly cash generative in light of their low variable costs and limited capital expenditures for maintenance. Such extensions also delay decommissioning liabilities and capital expenditures for capacity replacement.
Conversely, New Nuclear Build Is Inherently Risky

Building new nuclear plants is challenging given: Long lead times with no offsetting revenue. EDF Energy PLC (A/Stable/A-1), which is interested in building four new nuclear plants in the U.K., believes that the earliest such a plant can be commissioned is 2017. High upfront capital costs (about 3 billion), with the risks of delays overruns, especially for first of a kind plants. The TVO plant in Finland is now about two years late and has experienced very substantial cost overruns. Such features are specific to nuclear power plants, conventional power plants having much shorter lead times and much lower capital costs.
Extension Of Existing Plants Would Be Credit Positive

A number of EU nuclear operators are seeking to extend the operating life of their plants drawing on the U.S. example, where at the end of 2006, 47 licenses extending the operating life of nuclear plants to 60 years had been granted and an
20 NOVEMBER 2007
UTILITIES
Conversely, conventional power plants are much more exposed to the vagaries of fuel prices. New nuclear plants also represent large capacity increases in one step (the new French and Finnish plants both have 1,600 MW capacity), whereas incremental capacity additions are better suited to deregulated markets.
Operational Inflexibility Is A Drawback In A Competitive Environment

In operation, nuclear plants low operating costs and lack of carbon emissions are key competitive advantages. Yet operational inflexibility partially offsets these benefits, with nuclear plant operators limited in their ability to alter output in response to fluctuating energy demands, which weakens their market position. Nuclear plants provide base-load power and are, therefore, price takers rather than price setters. This is a significant drawback in todays largely unregulated markets, which are characterized by volatile demand patterns. The risks of investing in new nuclear power stations are mitigated to a degree by the EUs rapidly declining capacity margin and the resulting substantial investments in power generation required to meet the growth in demand and planned power plant decommissioning. Moreover, only the largest EU utilities will be able to invest significantly in new nuclear capacity. These groups all have large customer bases as well as a diversified generation mix-except EDF, which has a quasi-exclusive focus on nuclear power but benefits from the protective French environment--and extensive experience in running nuclear plants. What is more, to mitigate risks they may chose to expand, especially abroad, through partnerships, and/or to enter into offtake agreements. The large European utilities are likely to invest both in their own markets--if nuclear phase-out agreements are revised--but also abroad. EDF and the German utilities have highlighted their interest in new nuclear builds in the U.K., while five
groups--Electrabel, which is part of Suez S.A. (A-/Watch Pos/A-2), CEZ, E.ON AG (A/Stable/ A-1), Enel, and RWE AG (A+/Negative/A-1)--have placed indicative bids for an up to 49% stake in the Belene nuclear power plant project in Bulgaria. Likewise Enel, Electrabel, Iberdrola S.A. (A/Watch Neg/A-1), RWE, and CEZ have bid to participate in the construction of reactors 3 and 4 in Romania at Cernavoda. Only EDF appears interested in investing in nuclear projects outside of Europe. It is focusing on the U.S., China, and South Africa. EDF recently announced an agreement with U.S. utility Constellation Energy Group Inc. (BBB+/Negative/A-2) to set up a 50/50 joint venture to build, own, and operate European pressurized reactors (EPRs) in the U.S. In the short term, we expect investments in nuclear power by EU utilities to increase only gradually, reflecting the long lead time for new nuclear projects and the time needed to build up political and public support. Investments in nuclear power are therefore unlikely to significantly weigh on ratings. Risks may increase in the medium term as investments in nuclear power rise, though. The pace of such investments and the context--the degree of competitiveness of power markets, share of generation to be derived from nuclear power, life extensions of existing nuclear plants, level of expected wholesale and carbon prices, and political environment--in which they are carried out, will be key to our assessment of any rating impact. As a rule of thumb, we are likely to consider too strong an exposure to nuclear power in an open market as risky. We expect most investments in nuclear power to be on balance sheet, given the financial firepower of major European utilities, the difficulty of nonrecourse funding of such projects in light of the risks entailed, and the difficulty of replicating alternatives approaches such as TVOs mixed-ownership structure, which encompasses both utilities and electro-intensive industrial groups.
NOVEMBER 2007 21
Publication Date:
ussia's Power Produ tion Mar et 2006
ther producers (14 ) osenergoatom (state nuclear monopoly) (16 )
S (70 )
Source
S of
ussia.
UTILITIES
Russian Energy Production
and its subsidiaries. The majority of the new gencos are still UES subsidiaries but are likely to be privatized in the short term. Some observers refer to UES new investment program as GOELRO-2 (the first GOELRO was the original Soviet plan in 1920 for national economic recovery and development). GOELRO2 envisages heavy investment in new generation capacity, which should result in an additional 34 gigawatts (GW)--the equivalent of 16% of the current national generation capacity--by 2011. The investment plan relies heavily on external equity and debt financing, and consequently most gencos are tapping the equity and debt capital markets (see map above and table 1 on next page). The reform plan stipulates that the privatization of all thermal generation will take place during 2007-2008 through IPOs, secondary public offerings, sales of equity stakes owned by UES, and the allocation of the remaining stakes to UES shareholders at the end of UES restructuring, scheduled for mid-2008. Between December 2006 and October 2007 generating companies WGC-3, WGC-4, TGC-1, TGC-8, and Mosenergo (AO) (BB/Stable/--; Russia national scale rating ruAA) completed share issues, and WGC-5 and TGC-5 were spun off, resulting in UES equity interest
falling below 50%. Many of the gencos remaining under control of UES already have a strategic minority investor that is looking to acquire a controlling stake through participation in IPOs and stake auctions. Strategic investors include major Russian industrial groups, coal and gas producers, and major European utilities and investment funds. The Russian government, however, is likely to remain the largest player in the power sector: It will retain all of Russias nuclear generation capacity through Rosenergoatom, most of the hydro generation capacity through Hydro-WGC, and a significant portion of thermal generation capacity through OAO Gazprom (BBB/Stable/--) and InterRAO UES (not rated). Gazprom, which controls Russias gas reserves and pipelines and is an important fuel supplier to the electricity generators, has recently underscored its investment ambitions in the electricity generation sector by acquiring major stakes in Mosenergo and TGK-1 and negotiating a swap of its 10.5% stake in UES for controlling stakes in OGK-2 and OGK-6. Gazprom is also playing a leading role in the creation of a joint venture with coal producer SUEK, which might receive most of Gazproms and SUEKs generation assets. Standard & Poors views the change of the
NOVEMBER 2007 23
UTILITIES
Table 1 - Russian Energy Producers Statistics Electricity production (full-year 2006)
Installed capacity Share of national total (%) 11 10.3 6.1 5 4.5 4.3 4.1 4.1 4.1 4 3.3 3.3 2.9
Capacity factor
Fuel
UES holding
Strategic (potential) investor
GW Rosenergoatom Hydro-WGC Irkutskenergo TGC-3 WGC-1 WGC-6 WGC-2 WGC-5 WGC-4 WGC-3 Tatenergo TGC-7 TGC-1 Far Eastern Generation Company Bashkirenergo TGC-9 TGC-5 TGC-12 23.2 21.7 12.9 10.5 9.5 9.1 8.7 8.7 8.6 8.5 7 6.9 6.1
TWh 154.7 74.6 57 64.4 47.2 32.9 48.1 40.4 51 30.6 24.9 27.2 23.6
(%) 76 39 50 70 57 42 63 53 68 41 40 45 44 Nuclear Hydro Hydro, Coal Gas Gas Gas, Coal Gas, Coal Gas, Coal Gas, Coal Gas Gas Gas Gas, Hydro Coal Gas Gas Gas Coal
(%) 0 100 0 36 92 93 65 0 29 37 0 54 14 Russian Federation Russian Federation UC RUSAL shareholders Gazprom N.A. Gazprom Gazprom Enel E.ON Norilsk Nickel Republic of Tatarstan Gazprom, IES Gazprom
5.8 5.1 4.8 3.8 3.6
2.7 2.4 2.3 1.8 1.7
21.5 25 20.1 12.5 19.9
44 56 48 37 63
48 21 50 0 49
Russian Federation N.A. IES IES Gazprom/SUEK Prosperity Capital Management Transnafta, CEZ, Korea Electric Power Corp IFD Kapital IES N.A. Gazprom, E.ON Gazprom/SUEK Russian Federation/Rosenergoatom Gazprom Prosperity Capital Management Norilsk Nickel
TGC-4
3.3
1.6
13
45
Gas
47
TGC-8 TGC-6 Novosibirskenergo TGC-10 TGC-13 InterRAO UES TGC-11 TGC-2 TGC-14
3.3 3.1 3 2.6 2.5 2.3 2 1.4 0.6
1.6 1.5 1.4 1.2 1.2 1.1 1 0.7 0.3
15.3 13.2 14.3 16.8 10.4 N.A. 8.4 6.4 2.8
53 48 55 73 48 N.A. 47.1 52.7 49.9
Gas Gas Coal Gas, Coal Coal Gas Gas, Coal Gas Coal
11 50 14 82 57 60 100 49 50
GW--Gigawatts. WGC--Wholesale generation company. TGC--Territorial generation company. N.A.--Not available. Source: RAO UES of Russia, media, corporate filings, and Web sites.
24 NOVEMBER 2007
UTILITIES
controlling owner as a major credit risk factor in 2007-2008 for thermal gencos due to the impact on business strategy, operational profile, and financial policy. The level of actual or implied support from the new owner is another consideration. The credit quality of gencos may therefore diverge substantially, with that of some improving and others weakening. Gencos may benefit from becoming part of diversified, vertically integrated energy groups and from ownership changes, if, for example, they then have better and cheaper access to fuel supplies, as well as financial support from the new owners. Any new controlling owner could, however, pursue a more aggressive financial policy, including higher debt leverage and higher dividend payouts to raise equity returns. Creditors of companies whose strategic investor is a large customer or fuel supplier also face the risk that transfer pricing may eliminate any benefits of higher wholesale power prices following price deregulation, if the corporate governance at new generation companies is not effective enough to balance the inherent conflicts of interest. UES intends to limit the strategic discretion of new owners by retaining minority stakes after privatization, shareholder agreements with new controlling owners, and contracts for generation capacity availability. Although these measures may reduce strategic risk, they create new challenges such as burdensome fines for delayed delivery of contracted capacity. This is likely to happen given the high construction risk inherent in all greenfield power projects and the risk that external funding or necessary equipment may be unavailable.
of creating a fair competitive landscape, while business logic may favor other asset combinations. Third, current UES shareholders, who will receive proportional stakes in the gencos and grid companies after liquidation of the UES holding, are likely to attempt to swap relatively small holdings for larger and more influential stakes in successor gencos and grid companies, giving additional impetus to M&A. The credit impact of post-privatization M&A may be both positive and negative depending on the credit quality of combined entities, the benefits of vertical integration, the synergies derived from new business combination, and the impact of transactions on the new entitys consolidated financial profile. Vertical integration might underpin generators business profiles One of the main aims of the Russian power sector reform is to unbundle each business segment in the electricity value chain--generation, transmission, distribution, and supply--to make each more competitive, gain efficiency, and improve the regulatory regimes transparency. So, wholesale generation companies (WGCs) and territorial generation companies (TGCs) have only generation operations in the electricity supply chain. We believe that deregulated, unbundled generation has relatively high business risk compared with other operations in the value chain. This is because of the high level of capital intensity; the commodity nature of the industry, with price-based competition, high exposure to other commodity prices (for example, fuel), or fluctuation of water resources; and high levels of competitive risk compared with transmission and distribution operations, which are natural monopolies. After unbundling, we expect Russian gencos to focus their strategies on business risk diversification by vertically integrating lower-risk regulated businesses segments and fuel and retail electricity supply operations. A similar approach is already taking place as fuel supply companies look to invest in power generation to unlock the benefits of vertical integration of power and fuel production and supply. Non-government controlled electric utilities, such as Irkutskenergo, AO EiE (B+/Positive/--; Russia national scale rating ruA), have shown a similar strategic intent by acquiring coal mines (to hedge fuel price and
After Privatization, More Consolidation?

Increased M&A is likely to follow the gencos privatization and become an important credit risk factor. We expect that the new controlling owners will employ asset consolidation, asset swaps, restructuring, and divestments to align their holdings with their business strategies. This is because, first, many strategic investors have demonstrated an interest in acquiring more than one generation company, as well as assets in other business segments such as electricity distribution and supply. These may be consolidated into one entity within existing unbundling requirements. Second, the government determined the current configuration of gencos with the primary purpose
NOVEMBER 2007 25
UTILITIES
supply risk) and obtaining control of municipally owned electricity and heat distribution networks (to provide a base of stable, network earnings and improve operations). However, the potential degree of diversification is limited by the legal prohibition of simultaneous ownership of monopoly (transmission, electricity distribution, and dispatching) and competitive (generation and supply) assets within one market price zone. The two power market zones are Europe and the Urals, and Siberia. This law prohibits the vertically integrated generation and distribution structures typical of European power utilities. Diversification, the potential synergies, and hedging opportunities should support the interest of gencos and their strategic minority investors to invest in supply companies, all of which UES plans to sell in 2007-2008. A combination of wholesale generation and supply should reduce overall business risk through diversification of the customer base and higher customer loyalty. This is likely to result in lower competitive pressure and reduced customer attrition, as well as higher margins in retail electricity sales. At the same time, on their own, electricity supply operations have the highest business risk in the electricity value chain.
The contracts have take-or-pay terms (that is, buyers will make payments to the electricity wholesaler for the contract electricity volume regardless of their actual power demand). Since 2008, the contracts will also have an automatic adjustment for passing fuel costs on to customers and an annual adjustment to regulated rates for other increasing costs through an inflationbased formula. In the new market model, a generator also recovers fixed costs through regulated bilateral contracts. The government plans to deregulate capacity payments in line with the spot market by reducing the portion of generation capacity covered by regulated payments. Wholesale market participants will have to procure capacity covering their peak demand, minus capacity paid through regulated contracts from generators through a market-based mechanism. The first auction is likely in 2007 for capacity to be delivered in 2008 and 2012. Exposure to spot price volatility will grow in line with market deregulation Seasonal, daily, and intraday power-demand variations make spot electricity prices highly volatile (see chart 4 on next page). While gencos current exposure to the spot price is limited because only 10% of the wholesale market has been opened, this exposure will increase in line with wholesale market deregulation and will reach 100% by 2011. Spot-price deregulation for generators in European Russia and in the Ural region has been positive to date (see chart 5 on next page).
A Whole New Wholesale System

In September 2006, Russia introduced new rules for its electricity market that are a big step toward full deregulation of wholesale power. In place of the old regulated pool system, where generators sold power at cost-based rates and received regulated payments for fixed capacity costs, the new market is based on bilateral regulated contracts between generators and wholesale customers, which initially covered 95% of planned generation volumes. Generators sell any volumes not covered by regulated contracts, and customers sell any surplus power from regulated purchases on the deregulated spot market. Actual supply/demand dynamics determine the deregulated markets share. The government intends to deregulate the market and reduce volumes sold under regulated contracts. In April 2007, it approved a new deregulation plan that would fully evolve from 2007 to 2010 (see chart 3). This is well ahead of previous plans that had a seven- to 20-year time frame.
Chart 3 Russian Wholesale Market Deregulation Schedule
26 NOVEMBER 2007
verage deregulated price (left scale) Spot sales as percentage of total (right scale)
verage regulated price (left scale)
(
900 800 700 600 500 400 300 200 100 0
h)
( )
14 12 10 8 6 4 2 0 N Nov. 2006 ec. 2006 an. 2007 F Fe . 2007 ar07 07 pr-07 ay07 un07 l 07 ul-07 ug. S t Sept. 2007 2007
S t t Sept. ct. 2006 2006
ont ly A era e Spot Electr c ty r ce

verage deregulated price (left scale) Spot sales as percentage of total (right scale)
European
a And
e ral
-- u le.
h-- egawatt-hour.
verage regulated price (left scale)
(
900 800 700 600 500 400 300 200 100 0
h)
( )
14 12
(
3,000 2,500
per tcm)
10 8 6 4 2 0 N Nov. 2006 ec. 2006 an. 2007 F Fe . 2007 ar07 07 pr-07 ay07 un07 l 07 ul-07 ug. S t Sept. 2007 2007
2,000 1,500 1,000 500 0 an. 1, 2006 uly 1, 2006 an. 1, 2007 uly 1, 2007 an. 1, 2008 uly 1, 2008 an. 1, 2009 uly 1, 2009 an. 1, 2010 uly 1, 2010
S t t Sept. ct. 2006 2006
-- u le.
h-- egawatt-hour.
-- u le. tcm--Thousand cu ic feet. Source Standard & Poor's 2007.
ussian Federal Tariff Service.
UTILITIES
pressure on market prices. However, new plants cant be built quickly, so it will take some time to ease this capacity constraint. Higher profitability from increased power prices will underpin generators business profile As seen in Western Europe, moving from regulated cost-plus regimes to a deregulated spot electricity market typically increases generators business risk and can often dilute credit quality. Standard & Poors believes that the new path to deregulation might support improved credit quality in the sector through higher transparency and price growth, while capacity payments and hedging will smooth the impact of volatile spot prices. The deregulated market will translate rising gas prices into higher electricity prices, reflecting the costs of the least efficient (marginal) gas-fired generators for all market players. Generators using other fuels such as coal, nuclear, hydropower would consequently reap higher margins, as would more efficient gas-fired producers. We expect the higher profitability to mitigate increased price volatility because stronger margins will cushion the impact on cash flow. This will somewhat offset price deregulations negative impact on cash flow stability. Generation companies profitability is currently low, with an average 10% EBITDA margin for UES and a tiny 1%-2% for some thermal generators. Despite most electricity being sold at regulated tariffs, relatively small changes in price or fuel costs-together with weak margins--result in substantial cash flow fluctuation. That implies high business risk. Political risk remains key to power price deregulation and growth Political risk, however, overshadows the rosy prospects for power generators in the new market deregulation plan. Customers will bear substantial price increases and could face soaring electricity bills in the next three to four years, potentially leading to a political backlash. In addition, most of the market deregulation and corresponding price increases are scheduled for 2009-2010. But this comes after the 2008 presidential elections, when Russia will have a new president who may have different views on electricity price policy and perhaps even on the sectors overall strategy.
Generators active hedging strategies could provide further cash flow stability After the wholesale market is fully deregulated, each generators decision on how to balance potentially profitable but volatile opportunities from spot sales in order to lock in a more certain level of profits will determine its spot-market exposure. More forward electricity sales at a fixed price that allows the generator to earn sufficient profits to support its credit quality (assuming that generation costs are also fixed) would imply a lower business risk. Generators currently can hedge price volatility through nonregulated forward contracts at a fixed price. Power exchanges plan to introduce other instruments, such as power futures, to expand hedging opportunities. Thus, a conservative hedging strategy would limit the impact of changes in spot prices on cash flow volatility in the coming one to two years. How capacity market contracts could help The proposed capacity market, a system of payments to generators that cover fixed costs, will also mitigate the impact of spot price volatility on cash flow stability. Standard & Poors believes that recovering fixed costs through the capacity market will underpin generation companies credit quality. Capacity payments, now accounting for about one-half of wholesale generation revenues, substantially reduce the operational gearing (the level of fixed operating costs that determines the dependence of operating income variability on sales variability) of generators. These payments arent common in other European generation markets. The still-to-be-determined capacity pricing mechanism will heavily influence the level of market-based capacity payments and generators profitability and cash flow. The final mechanism expected in 2007-2008 will reduce this uncertainty. Who will benefit from market deregulation? The competitiveness and profitability of gencos in the deregulated market depend heavily on their marginal cost position. The main factor for gencos is fuel costs and for hydro generators, water tax charges. Deregulation of the electricity market will result in a gradual transition of the average electricity price from regulated tariffs that reflect costs to a
28 NOVEMBER 2007
era e e ulated Electr c ty ar ff And Spot r ce Sept
n European u
ra e e ulated Electr c ty ar ff And Spot r ce
n S ber an u
an S
verage regulated electricity tariff for 2007 verage spot electricity price an.-Sept. 2007 ( per
900 800 700 600 500 400 300 200 100 0
en -1 er T go oa to ur m op T e) T -1 -4 nt ( u -10 e ro -3 r pe ( ) os en S er go ) T -2 T -8 sh T 7 ki re -6 ne rg T o -3 T 9 ( -6 uro 4 ( pe ur ) op T e) -2 -5 -5
verage regulated electricity tariff for 2007 verage spot electricity price an.-Sept. 2007 (
450 400 350 300 250 200 150 100 50 0
rg o rg o 3 2 ne ne er ia er er er -1 4 T ) ) ) ) (S i T -1 -1 -1 1 ia ia ia s (S th er i -3
h)
per
h)
rg
Ta t
ke
(S
id ose ro ne
(S
ut s
-4
Ba
rk
-6
-- u le.
h-- egawatt-hour.
-- u le.
h-- egawatt-hour.
ov os i
irs
ke
UTILITIES
Table 2 - Russian Thermal Generation Companies IFRS Financial Statistics (RUR mil.) Period Mosenergo 12 months ended June 30, 2007 67,336 HydroOGK OGK-5 OGK-1 2006 OGK-2 2006 OGK-3 2006 OGK-4 2006 TGK-1 2006 TGK-5 2006 TGK-12 2006
2006 12 months ended June 30, 2007 24,468 26,081
Total revenues Funds from operations (FFO) Capital expenditures Cash and investments Debt Common equity Total capital
30,062
25,433
23,070
26,110
21,594
11,402
19,637
4,738 18,853
4,942 15,532
2,729 5,578
2,105 1,738
(28.0) 826
386 1,265
1,720 1,092
441 3,372
476 512
2,252 1,249
50,483 17,722 135,963 153,685
6,768 17,179 81,868 120,033
11,925 5,089 50,071 55,159
549 1,622 23,708 25,330
1,720 5,737 13,075 18,812
355 3,704 15,256 18,960
778 1,023 22,436 23,459
650 6,397 24,595 30,991
132 868 10,400 11,267
271 1,254 15,874 17,128
Adjusted ratios
FFO interest coverage (x) FFO/debt (%) Operating income (bef. D&A) / sales(%) Return on capital (%) Debt to capital (%) 3.2 26.7 13.8 28.8 6.9 53.6 20.2 129.8 0.8 (0.5) 2.6 10.4 10.7 168.1 2.0 6.9 14.0 54.9 6.8 179.6
11.7 2.0 12.0
28.1 3.8 14.0
11.0 1.5 9.0
10.4 8.2 6.0
1.5 (3.5) 30.0
4.7 0.0 20.0
8.7 3.7 4.0
9.6 2.3 21.0
8.4 5.1 8.0
11.3 3.9 7.0
RUR--Ruble. D&A--Depreciation and amortization.
(although for some companies, very weak cash flow results in poor cash flow protection measures). In the next three to four years, the gencos debt levels are likely to grow substantially. This is a result of the sectors heavy capital-investment needs to replace capacity thats reaching the end of its productive life, to add capacity for demand growth, and to maximize returns for private shareholders. UES expects the financing of the huge investment program (which UES has estimated to be RUR1.45 trillion over the period) to result in significant borrowing by gencos of up to RUR400 billion-RUR500 billion. In 2007-2008, however, equity financing can cover the majority of external funding needs. For example, UES has set an ambitious target to raise as much as $17 billion in equity financing. Gencos are therefore generally likely to rely more on equity financing in 2007-2008, with
most of the debt hitting in 2009-2010. By that time, electricity market deregulation and likely price increases should have improved the gencos profitability and operating cash flow, and helped to mitigate increasing debt levels. While the proceeds from the share issues and sales in 2007 have been above expectations, the availability of equity financing that UES expects in 2007-2008 is subject to general capital market conditions, as well as investor perceptions of the risks involved. Those risks may be subject to change, and so the ability of UES and the gencos to meet the target is uncertain. If proceeds from equity sales fall below expectations, additional borrowing may be needed--assuming lenders are willing. Of course, such borrowing could weaken the gencos credit quality. If financing isnt available, the investment program would need to be scaled back and delayed.
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Table 3 - European Investments In The Russian Power Industry Investor E.ON AG Enel SpA Enel SpA Fortum Oyj
N.A.--Not available.
Rating A/Stable/A-1 A/Watch Neg/A-1 A/Watch Neg/A-1 A-/Stable/A-2
Investment 60.7% in WGC-4 29.9% in WGC-5 49.5% in Rusenergosbyt (supply company) 25.5% in TGC-1
Timing Oct. 2007 June 2007 2006 2003-2005
Cost $5.9 bil. $2.2 bil. $105 mil. N.A.
Why Russia Is Tempting For EU Power Utilities

The fast-growing Russian power sector and its ongoing liberalization present a particular lure for Western European utilities. The industry predicts that the sector will grow at about 5% over the next few years and that it will need investments of more than $20 billion per year over the next 15 years to modernize power stations and transmission systems and to construct new generation capacity. The restructuring and liberalization process that Russia is now undergoing is similar to what has occurred in the EU over the past seven or eight years. European companies such as E.ON AG (A/Stable/A-1), Enel SpA (A/Watch Neg/A-1), and Fortum Oyj (A-/Stable/A-2) have therefore gained valuable experience domestically and in other Eastern European countries that they can potentially transfer to Russia. This includes managing operating and capital costs, as well as regulatory and network risks in liberalized markets. In addition, new entrants can bring trading and hedging expertise to mitigate the commodity and power-price risks that are characteristic of liberalized power markets. Leveraging these skills is one way for the Europeans to add value to the sector. Indeed, several major European utilities have already made large investments in Russias power industry (see table 3). As Russian utilities have so far been statecontrolled companies, could find opportunities to improve efficiency. Up until now, the Russian tariff system has often been based on cost recovery, so that remuneration earned on assets depends on a cost-plus system that allows a return on reported costs, leaving no great incentive to improve efficiency. However, smaller, privately owned generation utilities have been very successful in cutting costs.
European utilities will have to guard against credit dilution Investments in the Russian power sector would generally dilute credit (as would most investment in Eastern Europe), owing to Russias greater macroeconomic, sovereign, and country risks. The Russian economy is less diversified and may be less stable over time, the political system may be subject to change, and the regulatory system is less mature, all of which creates regulatory and political uncertainty. These risk factors translate into a weaker business profile for Russian power utilities compared with Western European peers. Therefore, the average credit quality of Russian and Eastern European power companies is lower than that of EU power companies. The ratings on Russian utilities are below investment grade, in the BB or B category, because the companies are smaller, less diversified, and less profitable than Western European peers. They generate less or no free cash flow and face greater political, legal, and regulatory risks than utilities in the EU. By contrast, more than 90% of EU utility ratings are rated in the investmentgrade rating categories (BBB or higher). Although investments in Russia would dilute credit quality, we would expect EU utilities to manage the rating risk by proactively managing their exposure. Western European companies such as Germanys E.ON or Italys Enel are large, diversified companies with relatively strong balance sheets. We dont expect the share of future consolidated earnings and investment from Russia to represent a concentration risk. We expect the same to be true for smaller companies such as Czech Republic-based CEZ a.s. (A-/Stable/--) or Nordic utility Fortum, which also regard Russia as a target market. Other large acquisitions, however, such as Enels planned debt-financed purchase of Spanish power utility Endesa S.A. (A/Watch Neg/A-1), could lower ratings and debt capacity for Russian investment.
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The ultimate impact of any Russian investment on the credit ratings of a company depends on several factors. Among them are its size, whether it represents a majority interest that would be consolidated or a minority investment that would be accounted for using the equity method, how it is funded, its earnings and cash-flow visibility, and how much headroom is in the current ratings to absorb such an investment.
Better Credit Quality Likely, But Regulatory Risk Remains

Overall, the restructuring of UES and deregulation of the power prices may support improved credit quality in the sector through lower business risk strategies, higher transparency, and price growth, while capacity payments and hedging will smooth the impact of volatile spot prices. The downside is that customers will likely face much higher electricity bills in the next three to four years and political and regulatory risks will remain a key challenge for credit quality in the sector.
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COMBATING CLIMATE CHANGE IN THE EU: RISKS AND REWARDS FOR EUROPEAN UTILITIES
Publication Date:
May 10, 2007 Primary Credit Analyst: Peter Kernan, London, (44) 20-7176-3618 Secondary Credit Analysts: Michael Wilkins, London, (44) 20-7176-3528 Mark Schindele, Stockholm, (46) 8-440-5918 Hugues De La Presle, Paris, (33) 1-4420-6666
limate policy is a key high-level issue for the EU and its member states. Indeed, the European Council, the EUs main decisionmaking body, recently reaffirmed its commitment to the reduction of carbon dioxide (CO2) and other greenhouse gases (GHGs). It recommended that the Emissions Trading Scheme (ETS), which is the EUs principal policy instrument for hitting its emissions targets, be strengthened and broadened in scope. As a result, the ETS--and other climate policy initiatives such as the drive to increase the share of GHG-clean renewable energy in the energy mix--will continue to have a major impact on European electricity generators and vertically integrated utilities that Standard & Poors Ratings Services rates. Thats because the burning of fossil fuels such as coal, oil, and gas to generate electricity accounts for a very significant share of EU GHG emissions (see footnote at end of article). The most visible effect of the ETS to date has been through an increase in power prices, as fossil fuel generators in liberalized (deregulated) markets now include the cost of CO2 emissions in their pricing decisions. We expect the ETS to potentially have a greater impact on power prices in Phase 2 of the ETS (2008-2012), as the cap on CO2 emissions will be tighter. Until the form of any potential successor treaty to the Kyoto Protocol (an agreement made under the UN Framework Convention on Climate Change that requires industrialized signatory nations to collectively reduce GHG emissions) becomes known, European utilities lack visibility on the scope and potential impact of global climate change policies beyond 2012, when Kyoto expires. The European Councils decision in March 2007 to adopt either a 20% or 30% GHG reduction target by 2020, depending on the scope of any successor treaty to the Kyoto Protocol, reflects this uncertainty. Nevertheless, it is clear that GHG emission reduction will continue to be central to EU policy over the long term and that the operating and regulatory environment for electricity generators will remain influenced by this focus. In considering the effects of climate change policy on European utilities, we examine the impact of the ETS on power prices and on the profitability of the power generation sector. We discuss the challenge for generators in taking long-term investment decisions given the high
level of uncertainty about future policy, the possible roles that renewable and nuclear energy will play in the generation mix, and why technological developments will be key to the future of coal-fired generation.
High Power Prices Under The ETS: Benefits For Some, Rising Costs For Others
The principal impact of EU climate change policies has been a continued boost in the profitability and cash flows--and therefore credit quality--of European generation companies that operate in countries in which wholesale and retail power markets and prices have been fully liberalized. The key instrument of these policies has been the ETS. The ETS restricts CO2 emissions and requires power generation and energy-intensive companies in what are known as the covered sectors (encompassing oil refineries; coke ovens; iron and steel plants; and factories making cement, glass, lime, brick, ceramics, and pulp and paper) to hold tradable allowances to match their CO2 emissions. The covered sectors account for about 50% of total EU GHG emissions. The ETS began on Jan. 1, 2005, and Phase 1 will run until Dec. 31, 2007. Phase 2 will run from January 2008 to December 2012, the period over which the performance of the Kyoto signatory nations against their GHG emission reduction targets will be assessed. The impact of the ETS on the power generation and energy-intensive industrial sectors differs markedly. While both power generators and energy-intensive industrial power users face caps on CO2 emissions and have been granted free allowances to at least partly cover their emissions, it is the power generators that benefit from higher power prices, at the expense of electricity users. One of the foremost effects of the ETS has been to increase wholesale power prices in markets such as the U.K. and Germany in which fossil fuel-fired generation is the marginal price-setting plant. Electricity generators that burn fossil fuels-coal, lignite, gas, and oil (fossil fuel-based generation accounts for about 50% of EU generation)--include the cost of CO2 emissions in their cost base and pricing decisions. All other things being equal, the higher the price of CO2 allowances, the greater the impact on power prices. EU fossil fuel power generators that emit CO2 receive free allowances, however, under
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their respective governments national allocation plans (NAPs). These plans are vetted and approved by the EU. Allowances for Phase 1 are already known, while Phase 2 allowances are currently being finalized. Even though a generator will have received free allowances to cover its carbon emissions, it will still price emission costs as if it had purchased the allowances from the market, leading to higher wholesale prices. For many generators, these higher wholesale prices drop directly to the bottom line as windfall profits, either because the allowance was never purchased or because the generator (nuclear and hydro plants, for example) does not emit greenhouse gases. Companies currently benefiting from windfall profits are those operating in the U.K., German, and Nordic electricity markets, and include E.ON AG (AA-/Watch Neg/A-1+), RWE AG (A+/Negative/A-1), EnBW Energie Baden-Wuerttemberg AG (A-/Stable/A-2), Vattenfall AB (A-/Stable/A-2), Scottish and Southern Energy PLC (A+/Stable/A-1), Scottish Power PLC (A-/Watch Neg/A-2), and EDF Energy PLC (A/Stable/A-1). Approved NAPs indicate a tighter market in Phase 2 of the ETS The European Commission has now decided on the first 20 national plans for allocating CO2 emission allowances to energy-intensive industrial plants and the power sector for Phase 2 of the ETS (see table on next page). Seventeen of the 20 member states were told to reduce proposed allowances by almost 12.5% on average, while allowances for the U.K., France, and Slovenia were approved as presented (the adjustment to Spains proposed cap was negligible). To date, the overall cap allowed by the EU for Phase 2 is about 9% lower than the cap allowed for Phase 1. It is likely the electricity generation companies will take a significant share of this tightening through a lower allocation of free allowances in Phase 2. From an equity standpoint, the electricity generation companies may be best positioned to absorb a lower level of allowances given that they benefit from higher CO2-induced power prices while industrial and residential power users bear the cost. The tightening in Phase 2 could lead to stronger CO2 and power prices, albeit that the precise impact and direction for prices depends on a large number of other factors such as the generation
mix, oil and gas prices, and demand. This highlights the EUs continuing commitment to cutting greenhouse gas emissions, and to meeting targets under the Kyoto Protocol. Windfall profits will diminish as free allowances go down Under Phase 1 of the ETS, free allowances covered a very significant share of generators actual and forecast CO2 emissions. Despite an expected reduction of free allowances granted to generators in Phase 2, we expect the windfall profits generated in liberalized energy markets-such as the U.K., Germany, and the Nordic market--to continue, albeit to a lesser extent, reflecting a pricing strategy based on the marginal cost of generation (i.e. including emissions costs). The windfall benefit remains controversial because it applies not only to nonemitting facilities but to all--including coal plants, which emit the most GHGs. Many industrial end users have voiced their discontent. They maintain that while end users suffer from the higher cost of electricity due to the cost of CO2 emissions, the electricity generators--those actually releasing much of the CO2--are gaining incremental profits. As a result, Standard & Poors expects that the level of free emission allowances granted to fossil fuel-fired generators may continue to go down in future phases of the ETS (2012 and beyond). These generators will therefore either have to buy a greater proportion of their carbon allowances in the market or actually reduce CO2 emissions. They could cut their carbon output by switching generation from coal-fired to less CO2-intensive gas-fired generation, improving the efficiency of their coal plants, or by using carbon capture and sequestration (CCS) storage technology.
Climate Change Policies Present Investment Challenges

In addition to its focus on slowing climate change, the EU is also trying to increase competition in the power sector and to reduce dependence on imported gas, two goals that it believes are compatible. EU climate change and market liberalization policies have to date favored gas and--to a much lesser extent--wind power in the generation mix at the expense of coal, as wind and gas are cleaner than coal and it takes less time to build a gas plant than it does to build a coal plant, an important factor in liberalized
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Member State Annual CO2 Allowances Under The EU Emissions Trading Scheme
(Mil. tons) 2005-2007 Austria Belgium Czech Republic Estonia France Hungary Germany Greece Ireland Latvia Lithuania Luxembourg Malta The Netherlands Poland Slovakia Slovenia Spain Sweden U.K. Total Cap 2005-2007 33.0 62.1 97.6 19.0 156.5 31.3 499.0 74.4 22.3 4.6 12.3 3.4 2.9 95.3 239.1 30.5 8.8 174.4 22.9 245.3 1,834.7 2005 Verified emissions 33.4 55.6 82.5 12.6 131.3 26.0 474.0 71.3 22.4 2.9 6.6 2.6 2.0 80.4 203.1 25.2 8.7 182.9 19.3 242.4** 1,685.2** Cap allowed 2008-2012 30.7 58.5 86.8 12.7 132.8 26.9 453.1 69.1 21.2 3.3 8.8 2.7 2.1 85.8 208.5 30.9 8.3 152.3 22.8 246.2 1,663.5 Additional emissions in 2008-2012* 0.4 5.0 N/A 0.3 5.1 1.4 11.0 N/A N/A N/A 0.1 N/A N/A 4.0 6.3 1.7 N/A 6.7 2.0 9.5 53.4
*The figures indicated in this column comprise emissions from installations that come under the coverage of the scheme in 2008-2012 due to an extended scope applied by the member state and do not include new installations entering the scheme in sectors already covered in the first trading period. Including installations that Belgium opted to exclude temporarily from the scheme in 2005. Additional installations and emissions of more than 6 million tons are already included as of 2006.**Excluding installations that the U.K. opted to exclude temporarily from the scheme in 2005 but that will be covered in 2008-2012 and are estimated to amount to about 30 million tons. CO2--Carbon dioxide. N/A--Not applicable. Source: DG Environment (reference: IP/07/613, May 4, 2007).
markets. From a security-of-supply perspective, however, the resulting larger exposure to gas imports, particularly from Russia, raises a number of concerns about the EUs import dependency. For European utilities, these potentially conflicting priorities present challenges in investment planning. This emphasizes the potentially important role that could be played by technologies to reduce the CO2 intensity of coal and by nuclear power in mitigating security-ofsupply risk while meeting GHG reduction targets. The European Councils recent decision to adopt a variable 20%-30% GHG reduction target by 2020 reflects the still significant uncertainty about the form and breadth that any successor
treaty to the Kyoto Protocol may take (assuming that the successor treaty has sufficient international support, the EU is willing to commit to a 30% reduction target, if all developed nations agree to comparable targets). In addition, companies operating with GHG constraints under the ETS do not know what the absolute level of GHG caps will be beyond Phase 2, or what the level of free allowances at the installation or company level will be. Of course, if the EU were to adopt a 30% rather than a 20% GHG reduction target, the emissions cap would need to be tighter to support a higher emissions price and the higher target. Electricity generators operating in liberalized markets such as the U.K., Germany,
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Evolving political climate suggests long-term potential for increased nuclear generation The long-term outlook for significant nuclear construction is better today than it has been for many years. If the industry can overcome its unique problems of safety, decommissioning, and waste storage, and if political and social acceptance increases, a new generation of power plants could be built in the U.K. New build is currently being undertaken in France and Finland, with potential for new plants in the Baltic region and across a number of the Eastern European member states. The German nuclear consensus, which caps the lifetime of nuclear plants at 32 years and requires them to be phased out, could possibly be revisited, although the policies of Germanys main political parties differ sharply on the question of nuclear power. Nuclear has a competitive advantage in terms of CO2 emissions and security-of-supply risk mitigation, and longer term visibility on the price of CO2 and the level of allowances that will be provided to fossil-fuel generators, for example, could have a strong impact on the profitability of new nuclear generation.
its valuable contribution to the security of energy supply and the economy of both the EU and the world as a whole only with technologies allowing for drastic reduction of the carbon footprint of its combustion. Policymakers and certain generators are therefore researching ways of making coal more efficient and environmentally friendly, primarily through clean coal technologies and CCS. RWE has made it clear that it will continue to build coal plants, but with the help of clean-coal technologies it will achieve CO2 reduction requirements. Vattenfall has similar plans. Cleaner coal is possible, but there are drawbacks The two leading clean-coal technologies are integrated gasification combined-cycle technology (IGCT) and supercritical technology. IGCT turns coal into gas (usually hydrogen and other byproducts) and then burns this gas in a traditional gas-fired combined-cycle unit (with some modification to accommodate the burning of hydrogen). Supercritical technology works on the principle that the fuel efficiency of a traditional steam coal plant can be raised if it operates at a higher temperature and pressure. Both approaches have drawbacks, however. Supercritical technology, although no more expensive than traditional techniques, does not reduce CO2 emissions to anywhere near the levels of other fuels. And IGCTs effectiveness comes at a cost, threatening the relative economics of coal production and reducing the incentive for companies to invest in new coal plants. CCS could enhance competitive position of coalfired generation, despite costs CCS involves capturing carbon and piping it underground before it reaches the atmosphere. The technology could significantly enhance the competitive position of coal-fired generation by alleviating its environmental impact, which would enable coal to maintain a role in the EU generation mix and would also mitigate securityof-supply risk. CCS has a number of disadvantages, however: Its use would increase costs, and its technical effectiveness and scalability is still unproven. Nevertheless, decarbonizing economies and industrial and generation processes clearly will not happen without cost and investment, and the EU and a
Clean Coal And CCS Could Allow Coal-Heavy Economies To Meet Reduction Targets
GHG reduction targets could present mediumterm credit risk to companies that are heavily exposed to coal-fired generation such as Drax Power Ltd. (BBB-/Stable/--). Larger, more diversified companies like CEZ a.s. (A-/Stable/--), Vattenfall, and RWE that also generate power using coal face increasing risk that the relative economics and social acceptance of coal-fired generation may deteriorate. Although liberalization and climate change policies favor gas-fired over coal-fired generation, the latter reduces fuel supply risk and dependence on fuel imports from Russia, the Middle East, and Africa. Recognizing this and the economic and social dependence of several EU countries on coal, the European Council has urged member states and the Commission to work toward strengthening R&D and developing the necessary technical, economic, and regulatory frameworks to deploy environmentally safe CCS through new fossil-fuelled power plants--if possible, by 2020. According to the EU, coal can continue to make
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number of member states have announced their intention to champion CCS technical development. The U.K. government, for example, announced in March 2007 a competition to develop the U.K.s first full-scale CCS demonstration (the details are likely to be announced in the U.K.s Energy Policy White Paper, which could be published as early as May 2007). And the EU has said it would like to see 12 large-scale CCS projects operational by 2015 CCS. It also aspires to seeing CCS capture 4.5% of CO2 emissions from fossil fuel power plants by 2020, rising to 30% by 2030. The future of coal-fired generation will be significantly affected by the extent to which member states will subsidize or otherwise incentivize CCS. In the absence of such support, CCS development could be hindered and could render coal uneconomical and further weaken its competitive position in the generation mix. Given the importance of coal-fired generation to the EUs goal of easing supply risk, however, we expect policymakers to continue examining ways to speed the development of clean-coal and CCS technologies.
Note
In 2004, public electricity and heat production accounted for 24% of EU-15 GHG emissions. The other main sources were road transportation (19%), manufacturing industries and construction (13%), industrial processes (8%), agriculture (9%), residential emissions (10%), waste (3%), and oil refining (3%). Additional writing by Anna Crowley.
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ELECTRICITE
Publication Date:
Aug. 29, 2007 Issuer Credit Rating: AA-/Stable/A-1+ Primary Credit Analyst: Hugues De La Presle, Paris, (33) 1-4420-6666 Secondary Credit Analyst: Beatrice de Taisne, London, (44) 20-7176-3938
DE
FRANCE S.A.
Rationale
The ratings on French electricity incumbent Electricit de France S.A. (EDF) reflect its standalone creditworthiness--which would ensure an A+ rating--and a one-notch uplift for state support, given the groups primary focus on nuclear power generation and the entailed significant operational risks and decommissioning liabilities. EDFs stand-alone credit quality reflects the significant contribution to earnings, especially in France, of regulated businesses; its leading position by far in the only moderately competitive French generation and supply market, underpinned by its efficient nuclear generation fleet; the refocusing of its international operations on Western Europe; and its superior free operating cash flow generation. These strengths are offset to a degree by EDFs financial profile which, although improving, remains moderate given sizable unfunded postretirement and nuclear liabilities. EDFs French operations (64% of 2006 EBITDA) are split between regulated transmission and distribution operations (40% of French EBITDA), and competitive generation and supply operations (60%). EDFs leading position in the latter is underpinned by its efficient nuclear plants, which accounted for 88% of its French electricity production in 2006. EDFs French supply operations benefit only in part from higher wholesale power prices, however, as about twothirds of sales are made at much lower, regulated supply prices. These have been rising recently, albeit slowly. The group has refocused its international operations on the U.K. (9% of 2006 EBITDA), Germany (7%), and Italy (6.6%). EDFs financial profile has improved with funds from operations (FFO) coverage of adjusted net debt of 22.5% in 2006, thanks to the groups superior free cash flow generation, which, excluding tax exceptionals of 0.5 billion, was 6.2 billion in 2006. To a large extent this reflects the cash flow profile of EDFs nuclear plants, which, while running, are highly cash generative given low variable costs and limited capital expenditure for maintenance. EDFs financial profile remains moderate, though, given substantial net unfunded nuclear and postretirement benefit obligations of 19 billion and 10.6 billion, respectively, in 2006. EDF will be increasing its dedicated assets covering nuclear liabilities by 12.1 billion between 2006 and 2010, however. Short-term credit factors The A-1+ short-term rating is supported by EDFs strong liquidity and recurring free cash flow generation. EDFs available cash and liquidity of 13.4 billion at year-end 2006--which includes the proceeds of the 6.35 billion capital increase at the end of 2005--together with a 6 billion undrawn long-term syndicated bank facility maturing in 2012 at the Electricit de France level, more than adequately cover the groups 8.7 billion of long- and short-term financial debt maturing in 2007.
Outlook
The stable outlook reflects Standard & Poors Ratings Services expectation that EDF will maintain a financial profile in line with the ratings, in particular FFO coverage of fully adjusted net debt in excess of 20% (22.5% in 2006). EDF has the flexibility within the current ratings to carry out its significant 26 billion investment program for 2006-2008. The ratings also factor in EDFs retention of significant regulated operations and the continued support of the Republic of France (AAA/Stable/A-1+).
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ENDESA S.A.
Publication Date:
Aug. 10, 2007 Issuer Credit Rating: A/Watch Neg/A-1 Primary Credit Analyst: Ana Nogales, Madrid, (34) 91-788-7206 Secondary Credit Analyst: Peter Kernan, London, (44) 20-7176-3618
Rationale
The ratings on Spanish utility Endesa S.A. were placed on CreditWatch with negative implications on Sept. 6, 2005, at the start of what has since been a very long and protracted bidding war for this company. On April 11, 2007, Italian utility Enel SpA (A/Watch Neg/A-1) and Spanish construction company Acciona S.A. (not rated) announced a 41.3 per share conditional all-cash joint takeover bid for the remaining 54% of Endesas that they do not own. This represents an offer value of nearly 25 billion. Enel has a 25% stake in Endesa, and Acciona owns 21%. The offer has received all regulatory approvals and is now subject only to shareholder approval. The CreditWatch status reflects the risks and uncertainties that surround this new bid, as well as those presented by Endesas potential future strategy and financial structure after the prospective change of ownership. Furthermore, Endesas business profile will change if the offer is successful, owing to the asset split agreed between the new bidders and German utility, E.ON AG (A/Stable/A-1). The agreement stipulates that E.ON will receive a portfolio of Endesa assets in Spain, Turkey, and Poland, as well as Endesas share of Endesa France and Endesa Italia, and assets in Spain owned by Enel (through EnelViesgo), for a total estimated value of 10 billion. The terms and conditions of the bid reflect Enel and Accionas March 26, 2007, agreement. The offer is conditional upon a minimum acceptance of 50% of the share capital and the amendment of some of Endesas bylaws, including the removal voting-right restrictions. Acciona will purchase about 4% of Endesas capital, and Enel will purchase the rest of the tendered shares; both companies, however, will have equal representation on Endesas board. One of the worlds largest electricity utilities, Endesa has total installed capacity of 47,385 MW and 22.7 million customers. It has a market share of about 40% of Spains electricity production, distribution, and supply. This strong domestic position is one of the main rating supports. Operations in Spain and Portugal provided about 55% of EBITDA in 2006 and 52% in the first half of 2007. Short-term credit factors The short-term rating is A-1, reflecting Endesas acceptable liquidity. At June 30, 2007, the company (excluding subsidiary Enersis S.A. {BBB/Stable/--}) had 6.2 billion in undrawn, committed facilities, and about 0.3 billion in cash and equivalents, which together cover the final dividend paid against 2006 earnings on July 2, 2007, and debt maturing over the next 23 months. At the same date, Enersis had 0.5 billion in undrawn, committed facilities, and about 0.5 billion in cash, together covering debt maturing at Enersis over the next 19 months. Endesas debt maturity schedule is manageable, and the average life of the debt is 5.3 years. According to Endesa, there are no cross-default clauses for the debt at Enersis or any of its subsidiaries, and these entities are financed on a nonrecourse basis. Endesa generated funds from operations of about 4.6 billion in 2006. This strong performance should continue, mitigating the financial-flexibility constraints arising from the utilitys large capital-expenditure plan and generous dividend policy. Endesa is committed to paying out 100% of capital gains on asset disposals and increasing ordinary dividends by at least 12% annually. This will result in the payment of 9.9 billion in dividends over 20052009, of which 4.4 billion has already been paid. A change in financial, investment, and dividend policies may result, however, from the prospective change in control.
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ENEL SPA
Publication Date:
Nov. 12, 2007 Issuer Credit Rating: A/Watch Neg/A-1 Primary Credit Analyst: Ana Nogales, Madrid, (34) 91-788-7206 Secondary Credit Analyst: Peter Kernan, London, (44) 20-7176-3618
Rationale
The ratings on Enel SpA remain on CreditWatch with negative implications, where they were placed on April 3, 2007, following the companys 40 billion joint debt-financed takeover bid with Spanish construction firm Acciona S.A. for 100% of Spanish utility Endesa S.A. (A/Watch Neg/A-1). The continued CreditWatch listing reflects Standard & Poors Ratings Services expectations that Enels financial profile will further deteriorate as a result of the tender offer for Endesa. The offer was completed on Oct. 1, 2007, and Enel now owns 67% of Endesa. In connection with this acquisition, Enel and Acciona will sell certain Enel and Endesa assets in Italy, France, Poland, Turkey, and Spain to German utility E.ON AG (A/Stable/A-1) in the first half of 2008 for an expected 13 billion14 billion. We expect to resolve the CreditWatch status once details about Enels business strategy and capital structure are available. The current ratings reflect Enels significant position in the Italian power market, which is sustained by its vertically integrated operations. The acquisition of Endesa should enhance Enels business profile, through increased size and diversification. In addition, operating synergies could be material. Enels ability to reap the potential benefits, however, will depend on its degree of control of Endesa and the functioning of its partnership with Acciona. Although the transaction will enhance Enels business profile, it will lead to a material deterioration in the companys financial position, notwithstanding the benefit of the asset sales to E.ON. Enels debtfinanced investment in Endesa totals about 28 billion (equity value). This compares with net reported debt of 24.8 billion at Sept. 30, 2007, which already included the debt financing of a 25% Endesa stake. Enels acquisition earlier this year of about 1.8 billion in Russian assets and its desire to become an integrated energy player in the Russian market will also weigh negatively on the companys credit quality, due to country and industry risks, as well as to the financial impact. The companys public announcement that it has now almost completed its M&A activity and that it will focus on integrating all of its international assets somewhat reduces acquisition-related risks. Short-term credit factors Enels short-term rating is A-1. At Sept. 30, 2007, the company had committed credit lines of 5 billion, of which 2 billion had been drawn, and uncommitted credit lines of 2.6 billion, of which 0.9 billion had been drawn. The finance documentation for these facilities does not include material covenants. In addition, Enel had a 35 billion committed credit line to fully finance the Endesa acquisition, which has now been reduced to 23 billion after the June and September bond issues and the results of the Endesa tender offer. This credit line is split into three tranches with different maturities: 1) one year, subject to a termout option for a further 18 months, for a residual amount of 2.5 billion; 2) three years, for a residual amount of 12.3 billion; and 3) five years, for a residual amount of 8.2 billion. Consequently, short-term refinancing risk seems modest. Given Enels size and market position, and the successful placement of its $3.5 billion bond issued in the U.S., access to the capital markets and the ability to issue debt of an appropriate tenor are not credit concerns, even under current market conditions. Enels ultimate debt profile, in terms of maturity and composition, will depend upon the permanent financing that it arranges to replace the acquisition facility.
42 NOVEMBER 2007
UTILITIES
E.ON AG
Publication Date:
Aug. 28, 2007 Issuer Credit Rating: A/Stable/A-1 Primary Credit Analyst:
Rationale
The ratings on Germany-based utility E.ON AG factor in that the company will releverage its balance sheet through increased organic investment, a share buyback, and acquisition expenditure. Specifically, the ratings incorporate the assumption that the companys funds from operations (FFO) to net adjusted debt will remain above 20% and at levels commensurate with an A rating (absent any greater-than-expected increase in business risk that could necessitate a higher level of credit protection). E.ONs revised medium-term strategy includes significant organic growth investments (a 60 billion investment program has been budgeted through 2010), increased returns to shareholders (a 7 billion share buyback by the end of 2008), and more active management of the balance sheet. Further to E.ONs decision to withdraw its 70 billion bid for Endesa S.A. (A/Watch Neg/A-1) of Spain, E.ON has an agreement with Enel SpA (A/Watch Neg/A-1) and Acciona to acquire generation assets from Enel and Endesa mainly in Italy, Spain, and France for an estimated enterprise value of 10 billion, if Enel and Acciona gain control of Endesa. Large acquisitions also remain possible but are expected to be funded in line with the companys minimum rating target of A and its 3x economic net debtto-EBITDA target ratio (barring any material change in its business risk). As at Dec. 31, 2006, E.ON calculated that its ratio of economic net debt to EBITDA was 1.5x. Standard & Poors Ratings Services regards the companys business risk profile, pro forma for the new higher investment program, as slightly increased compared with the Endesa acquisition bid, owing to the lack of acquired vertical integration (including distribution assets) and focus on riskier growth markets. E.ON expects its European generation capacity to increase by 50% to 69 gigawatts (GW) from 46 GW by 2010, of which about 12 GW will come from generation assets and projects acquired under the agreement with Enel and Acciona. A materially increased earnings contribution from undiversified generation or from riskier growth markets could ultimately weaken E.ONs business risk profile. That said, the company still clearly recognizes the benefit of integrated generation and supply operations and fairly matched position, especially in highly
competitive markets, as well as a proactive generation margin hedging policy (for 2007 and 2008, 90% and more than 60%, respectively, of E.ONs economic generation has been hedged). Short-term credit factors The short-term rating on E.ON is A-1, reflecting the companys significant cash flows, a securities portfolio totaling about 11 billion at Dec. 31, 2006 (notionally available to meet future pension and nuclear liabilities), and significant unused facilities--specifically, an undrawn 10 billion syndicated multicurrency loan. E.ONs liquidity also benefits from the groups significant operating cash flow. In 2006, under U.S. GAAP, cash provided by operating activities was almost 7.2 billion, which comfortably financed E.ONs 2006 capital expenditure of 4.1 billion, and made a significant contribution to the groups 4.6 billion dividend paid in 2006. Although capital and investment expenditure will increase significantly and free cash flows before dividends might be negative and reach a low point in 2008, a significant portion of firmly planned capital expenditures and increased dividends should remain internally funded over 2007-2009. Ongoing financial flexibility is supported by the largely discretionary nature of the planned investments as well as E.ONs wide and discrete asset base, which could be reduced without affecting crucial core operations.
Peter Kernan, London, (44) 20-7176-3618

Secondary Credit Analysts: Ralf Etzelmueller, Frankfurt, (49) 69-33-999-123 Amrit Gescher, London, (44) 20-7176-3733
Outlook
The ratings factor in E.ONs plans to significantly releverage its balance sheet. The stable outlook reflects the companys continued strong financial flexibility. The ratings could conceivably improve in the case of a better-than-expected business profile, for example due to riskier investments not materializing (and barring other material changes in the companys business environment). A significantly better-than-expected financial profile could also have a positive effect on the ratings. The ratings could deteriorate, for example, due to greater-than-expected business risk from German or EU-wide regulatory initiatives or significantly increased exposure to the Russian Federation or Eastern Europe. Neither scenario is expected to have an impact on the ratings in the near term, owing to E.ONs clearly articulated strategy and its strong financial profile for the ratings.
NOVEMBER 2007 43
UTILITIES
GAZ
Publication Date:
Sept. 3, 2007 Issuer Credit Rating: AA-/Watch Neg/A-1+ Primary Credit Analyst: Hugues De La Presle, Paris, (33) 1-4420-6666 Secondary Credit Analyst: Beatrice de Taisne, London, (44) 20-7176-3938
DE
FRANCE S.A.
spun off to Suezs shareholders at the time of the merger, with the enlarged group retaining a 35% stake. The environment business had reported net debt of 5.4 billion at the end of June 2007, out of Suezs reported consolidated debt of 12.9 billion. Although the lack of a special dividend and the spin-off of Suez Environment--given its significant debt--are favorable from a financial standpoint compared with the initial terms, the enlarged group intends to offer substantial returns to its shareholders. From a business perspective, although the European water operations (39% of the EBIT of Suez Environment in first-half 2007) rank amongst Suezs strongest businesses, they would have been small in the context of the enlarged group. These revised terms are a significant step forward but the merger still faces some hurdles, especially its approval by both groups shareholders; the signing of the decree allowing the privatization of GDF following the passing of the law in the French parliament; and the opposition of GDFs unions. To resolve the CreditWatch placement we will focus on the enlarged groups strategy and financial policy. Short-term credit factors The A-1+ short-term rating is supported by GDFs sound liquidity, with available cash at the end of June 2007 of about 3 billion and an undrawn 3 billion committed syndicated credit facility, which more than cover short-term debt maturing in the next 12 months of 1.1 billion. Beyond 2007, GDF has limited debt maturities.
Rationale
On Sept. 3, 2007, Standard & Poors Ratings Services said that its AA-/A-1+ ratings on French gas utility Gaz de France S.A. (GDF) remain on CreditWatch with negative implications following the announcement of the revised terms for the merger between GDF and Franco-Belgian multiutility Suez S.A. (A-/Watch Pos/A-2). The ratings were placed on CreditWatch on Feb. 27, 2006, following the initial merger announcement. The continued negative CreditWatch reflects that, notwithstanding changes in the terms of the merger, it should have a dilutive impact on GDF from a credit standpoint--in terms of both business and financial risk--given Suezs weaker business mix and financial profile. This is despite the fact that the merger would address GDFs strategic issues, especially those related to its plans to expand further abroad and in electricity. From a business risk perspective, although Suez is larger and more diversified than GDF, Standard & Poors views GDFs business risk as lower, given the large share of earnings it derives from regulated French businesses. From a financial risk perspective, although Suezs financial profile has improved, its credit ratios remain significantly weaker than GDFs. Under the revised terms, 21 GDF shares will be exchanged for 22 Suez shares, with no special dividend being paid. Initially the terms of the merger were a one-for-one share exchange plus a 1 billion special dividend to be paid to Suez shareholders prior to completion. To mitigate the difference in the share prices of Suez and GDF, 65% of the share capital of Suezs environment arm (20% of first-half 2007 Suez EBIT) will be
44 NOVEMBER 2007
UTILITIES
IBERDROLA S.A.
Publication Date:
July 4, 2007 Issuer Credit Rating: A/Watch Neg/A-1 Primary Credit Analyst: Ana Nogales, Madrid, (34) 91-788-7206 Secondary Credit Analyst: Peter Kernan, London, (44) 20-7176-3618
Rationale
The ratings on Spanish utility Iberdrola S.A. remain on CreditWatch with negative implications following the acquisition of Scottish Power PLC (A-/Watch Neg/A-2) on April 23, 2007, and the companys announcement on June 25, 2007, of its bid to acquire 100% of U.S. utility Energy East Corp. (BBB+/Negative/A-2). For a summary of Iberdrolas CreditWatch history, see the section CreditWatch History toward the end of this article. Iberdrola will pay 3.4 billion in cash and assume Energy Easts debt of 3 billion. The transaction, subject to approval by Energy Easts shareholders and to receipt of all the necessary authorizations, is expected to close in the second half of 2008. Notwithstanding this, Iberdrola has already raised close to 3.4 billion of new equity to fund this transaction. Energy East is a holding company that owns six regulated utilities (mainly transmission and distribution) and several smaller, nonregulated companies in upstate New York, Connecticut, Maine, and Massachusetts. The ratings will remain on CreditWatch pending Standard & Poors meeting with Iberdrola in the second half of 2007 to discuss the groups revised business and financial strategy and analyze its financial forecasts and planned financial structure. We will also focus on the groups future risk tolerance and acquisition strategy. Standard & Poors understands that Iberdrola aims to maintain an A category rating. Based on publicly available information, we expect any lowering of our long-term rating on Iberdrola upon resolution of the CreditWatch listing to be limited to one-to-two notches. This preliminary assessment does not, however, include the potential fiscal benefits from the amortization of the goodwill from the acquisition of Scottish Power PLC or from synergies from Scottish Powers integration within Iberdrola.
Iberdrolas strong position as one of Spains two largest vertically integrated electricity groups underpins the ratings. The recently acquired business will increase the groups earnings diversity, both geographic and operational, but will result in a weaker capital structure and will present integration challenges. At March 31, 2007, the groups debt and EBITDA pro-forma figures (including the Scottish Power acquisition) were 29.8 billion and 5.8 billion, respectively. Short-term credit factors Iberdrolas short-term rating is A-1, underpinned by an acceptable liquidity position prior to the acquisition of Scottish Power. At end-March 2007, available cash, short-term financial investments of 1.15 billion, and committed undrawn credit facilities of 2.2 billion, more than fully covered the 1.1 billion in debt maturing in 2007. In addition, the group announced on May 28, 2007, that it intends to carry out a partial IPO of the combined groups renewable business, which could generate 3.3 billion-4.5 billion.
CreditWatch History
The ratings on Iberdrola were placed on CreditWatch with negative implications on Sept. 6, 2005, following Spanish utility Gas Natural SDG, S.A.s (A+/Negative/A-1) 22.55 billion bid for a 100% stake in Endesa S.A. (A/Watch Neg/A-1) and its agreement to a subsequent sale of an estimated 7 billion-9 billion in assets to Iberdrola. On Dec. 1, 2006, we lowered our longterm rating on Iberdrola to A from A+, owing to the groups offer for Scottish Power made on Nov. 28, 2006. The ratings on Iberdrola have remained on CreditWatch with negative implications since then, despite the withdrawal of Gas Naturals bid on Feb. 1, 2007, owing to the expected negative financial impact of the acquisition of Scottish Power.
NOVEMBER 2007 45
UTILITIES
RWE AG
Publication Date:
Aug. 17, 2007 Issuer Credit Rating: A+/Negative/A-1 Primary Credit Analyst: Peter Kernan, London, (44) 20-7176-3618 Secondary Credit Analysts: Amrit Gescher, London, (44) 20-7176-3733 Ralf Etzelmueller, Frankfurt, (49) 69-33-999-123
Rationale
The ratings on Germany-based utility RWE AG reflect the groups strong competitive position in the German electricity market, which provides the majority of group earnings and has delivered sustained strong operating performance. The ratings also reflect the groups strong financial profile. These strengths are partially offset by the weakening of RWEs business profile following the sale of its regulated water operations and its reliance on competitively exposed generation for future growth. Competition in the German retail market remains moderate. Nevertheless, the introduction of a network regulator and tariff cuts will likely increase competitive pressures. Meanwhile, RWEs substantially lower level of freely granted carbon dioxide (CO2) allowances for phase 2 of the EU Emissions Trading Scheme (2008-2012) will likely reduce generation margins. (RWE estimates that slightly more than 50% of its German CO2 emissions will be covered by free allowances.) RWE will, however, benefit from changes in the German tax regime, which will result in the average tax rate on German profits dropping to 31% from about 39%, from 2008. RWEs balance sheet has further strengthened following the sale of RWE Thames Water for an enterprise value of 8.0 billion (sale price of 4.8 billion plus pro forma net debt of 3.2 billion) in December 2006. At June 30, 2007, net debt (including pension provisions, and under RWEs definition) was 6.8 billion. RWE plans to complete the sale of its U.S. water business through an IPO by the end of 2007, subject to market conditions, which will further deleverage the group. RWE has a general net debt cap of between 22 billion and 24 billion and has substantial headroom relative to this cap to increase leverage. RWE has material nuclear asset retirement obligations, of which Standard & Poors Ratings Services treats about 7 billion as debt. The groups financial performance has been strong over the past few years, with funds from operations (FFO) increasing to more than 7 billion for full-year 2006, on the back of strong power prices. The medium-term outlook for power prices continues to be favorable on the back of tight capacity margins and tightness in fuel markets--given strong global demand for commodities--as well as a tighter market for CO2. RWEs target for 2007 is that revenue will rise slightly above the 2006 level of 44.2 billion and that EBITDA will rise by between 5% and 10% above the 2006 level of 7.17 billion. There is an ongoing debate within the EU about levels of competition in power markets, and a draft third liberalization directive is expected later in 2007. Among other areas, the debate has focused on ownership unbundling of transmission businesses to increase competition. Such a measure could adversely affect RWEs German business, but Standard & Poors currently considers that it is unlikely that this change will be required. Short-term credit factors The A-1 short-term rating is underpinned by large and diversified cash flows (cash flows from operating activities were in excess of 2.5 billion for the six months to June 30, 2007), RWEs current low level of net debt, and a benign maturity profile. The rating is also supported by substantial alternative sources of liquidity, including more than 12 billion of liquid securities held to offset on-balance-sheet nuclear liabilities. At Dec. 31, 2006, 5.5 billion of RWEs 20.0 billion debt issuance program was available. RWE faces a moderate maturity peak of about 3.7 billion in 2007. In addition, the company had unused funds of 3.5 billion equivalent under its $5.0 billion CP program at Dec. 31, 2006.
Outlook
RWEs financial profile is strong for the ratings. The negative outlook, however, reflects some near-term uncertainty about the direction of RWEs strategy, financial and acquisitions policies--in part due to planned changes in senior management--and the manner in which RWE could releverage its balance sheet. The deterioration of RWEs business profile as a result of the water disposals could negatively affect the ratings if the disposals are followed by rapid and substantial investments in riskier operations. To maintain the ratings, RWE needs to restrict itself to moderate-scale or low-risk acquisitions, and maintain conservative financial policies. The outlook could be revised to stable if RWE maintains its current strong financial profile.
46 NOVEMBER 2007
UTILITIES
SCOTTISH
Publication Date:
Aug. 30, 2007 Issuer Credit Rating: A+/Stable/A-1 Primary Credit Analyst: Paul Lund, London, (44) 20-7176-3715 Secondary Credit Analyst: Mark J Davidson, London, (44) 20-7176-6306
AND
SOUTHERN ENERGY PLC
Rationale
The ratings on U.K.-based energy utility Scottish and Southern Energy PLC (SSE) and its subsidiaries are supported by strong, predictable cash flows from the groups regulated monopoly electricity and gas network businesses, which will likely contribute 40%-45% of operating profits over the medium term. The groups strong financial profile, low-cost generation portfolio, and strong cost-cutting record also support the ratings. These strengths are offset by the exposure of SSEs operating profits to movements in wholesale-power, coal, and gas prices as well as the risk of customer losses in the highly competitive electricity and gas retail markets. An increase in the proportion of profits derived from the groups unregulated businesses, which is likely, could increase business risk. SSE is the third-largest electricity and gas supplier in the U.K. in terms of customer numbers. In June 2007, its customer base had increased to about 5 million electricity and 2.9 million gas customers, despite a period of significant increases in electricity and gas supply prices. The company remains the cheapest supplier of energy and was the first to reduce prices on March 1, 2007, lowering average annual electricity and gas bills by 5% and 12%, respectively. The group has a relatively diverse fuel portfolio compared with other U.K. powerstation operators, which provides good operational flexibility and risk mitigation in volatile markets. SSEs long generating and contractual position in relation to its residential supply volumes exposes its cash flows to greater long-term price risk than some of its peers (although this position is beneficial in a high wholesale-price environment). Accordingly, cash flows at SSE are vulnerable to a downward shift in long-term gas and power prices, although any such trend should largely be offset by higher supply margins. In addition, the companys diverse fuel portfolio allows for optimization of fuel sources. Standard & Poors Ratings Services proportionally consolidates the accounts of gas distribution networks Southern Gas Networks PLC (BBB/Positive/--) and Scotland Gas Networks PLC (BBB/Positive/--)--including 1.1 billion of debt at March 31, 2007--into SSEs financial statements. This reflects our view that the two entities (together known as Scotia) represent a core investment for the group. Excluding Scotia, SSEs financial profile remains solid. Adjusted EBITDA grew by more than 21% to 1.42 billion in the year ended March 31, 2007, from 839 million one year earlier. Standard & Poors adjusted gross consolidated debt figure for SSE, excluding Scotia, was 2.66 billion at March 31, 2007. This includes approximately 400 million in adjustments for operating leases, postretirement debt obligations, and power purchase agreements. Short-term credit factors The short-term rating is A-1. SSE has satisfactory liquidity, with a 650 million, fiveyear committed revolving credit facility due in 2009 to cover maturing obligations (principally CP). SSEs debt is generally long term, with only 40 million due to mature before March 2008. The group has good access to CP markets under a 1.5 billion program, which it has used only lightly. SSE will likely be required to raise debt and refinance maturing bonds to fund capital expenditures in 2008. The group has good access to capital markets, although it is a relatively infrequent issuer. Some financial flexibility is available from its dividends. SSEs financial flexibility has improved, as its additional debt requirement should be reduced in view of planning issues that are expected to delay the Beauly-Denny transmission line (which will have a knock-on effect on investment in major renewables projects in Scotland).
Outlook
The stable outlook reflects the likelihood that SSE will maintain cash flow protection measures in line with our expectations. Consolidated FFO to interest, excluding 50% contributions from Scotia that Standard & Poors rates on a consolidated basis, will likely remain close to current levels of about 9x, with FFO to debt at about 42%. Acquisition activity could, however, result in higher-than-expected debt levels, which could put pressure on the ratings. Furthermore, lower-thanexpected gas or electricity prices, or any largescale customer loss, could threaten cash flow ratios, which could also weigh on the ratings. Retaining customers and energy-supply margins will be challenging as wholesale prices fall back from the peaks of 2005 and 2006. Ratings upside potential is very limited over the short term.
NOVEMBER 2007 47
UTILITIES
SUEZ S.A.
Publication Date:
Sept. 3, 2007 Issuer Credit Rating: A-/Watch Pos/A-2 Primary Credit Analyst: Hugues De La Presle, Paris, (33) 1-4420-6666 Secondary Credit Analyst: Beatrice de Taisne, London, (44) 20-7176-3938
Rationale
On Sept. 3, 2007, Standard & Poors Ratings Services said that its A-/A-2 ratings on FrancoBelgian multi-utility Suez S.A. remain on CreditWatch with positive implications, following the announcement of the revised terms for the merger between Suez and French gas utility Gaz de France S.A. (GDF; AA-/Watch Neg/A-1+). The ratings were placed on CreditWatch on Feb. 27, 2006, following the initial merger announcement. The continued positive CreditWatch reflects that, notwithstanding changes in the terms of the merger, it should have a beneficial impact on Suez from a credit standpoint--in terms of both business and financial risk. From a business risk perspective this reflects that, although Suez is the larger and more diversified company, Standard & Poors views GDFs business risk as lower, given the large share of earnings it derives from regulated French businesses. Likewise, from a financial risk perspective, although Suezs financial profile has improved significantly, GDF still has much stronger credit ratios. Under the revised terms, 21 GDF shares will be exchanged for 22 Suez shares, with no special dividend being paid. Initially the terms of the merger were a one-for-one share exchange plus a 1 billion special dividend to be paid to Suez shareholders prior to completion. To mitigate the difference in the share prices of Suez and GDF, 65% of the share capital of Suezs environment arm (20% of first-half 2007 Suez EBIT) will be spun off to Suez shareholders at the time of the merger, with the enlarged group retaining a 35% stake. The environment business had reported net debt of 5.4 billion at the end of June 2007, out
of Suezs reported consolidated debt of 12.9 billion. Although the lack of a special dividend and the spin-off of Suez Environment--given its significant debt--are favorable from a financial standpoint compared with the initial terms, the enlarged group intends to offer substantial returns to its shareholders. From a business perspective, although the European water operations (39% of the EBIT of Suez Environment in first-half 2007) rank amongst Suezs strongest businesses, they would have been small in the context of the enlarged group. These revised terms are a significant step forward but the merger still faces some hurdles, especially its approval by both groups shareholders; the signing of the decree allowing the privatization of GDF following the passing of the law in the French parliament; and the opposition of GDFs unions. To resolve the CreditWatch placement, we will focus on the enlarged groups strategy and financial policy. Short-term credit factors Suezs European utility activities recurring cash flow generation and strong liquidity underpin the A-2 short-term rating. Debt maturities in the second half of 2007 amount to 5.1 billion (including 2.3 billion of CP) and represent 3.3 billion and 3.5 billion, respectively, in 2008 and 2009. These are covered by about 8 billion of available cash, excluding 1 billion of overdrafts in the next 12 months, while the group has 6.7 billion of undrawn bank lines, excluding the 2.3 billion of CP drawings.
48 NOVEMBER 2007
UTILITIES
VATTENFALL AB
Publication Date:
June 11, 2007 Issuer Credit Rating: A-/Stable/A-2 Primary Credit Analyst: Mark Schindele, Stockholm, (46) 8-440-5918
Rationale
The ratings on Sweden-based utility Vattenfall AB reflect its strong, vertically integrated position in the north European electricity market, competitive generation portfolio, significant monopoly utility operations, and strong cash flow generation. Negative rating factors include Vattenfalls exposure to competition and price volatility in power generation, political risks related to nuclear and coal generation, and increasing regulatory pressure on monopoly network operations. Standard & Poors Ratings Services currently factors no direct support from Vattenfalls 100% owner, the Kingdom of Sweden, into the ratings. Political and taxation pressures on the company have increased, although the Swedish government appears to have no plans for restructuring or major strategy changes. In addition, there is no plan to privatize Vattenfall in the foreseeable future. Vattenfalls capital expenditure is likely to increase over the medium term. By 2011, the company plans to invest about Swedish krona (SEK) 134 billion, mainly in new power generation capacity, reinforcement of its electricity network, and reinvestments. Following the integration of its acquired German operations, and the acquisition of SEK12.6 billion (on a net basis) of Danish power generation assets in 2006, we expect Vattenfall to continue its growth strategy and to be acquisitive --both in its current markets and in neighboring European countries. The number of potential acquisition targets will likely be limited and any acquisitions will be highly contested, however. Vattenfalls financial performance remains strong for the ratings, with funds from operations to adjusted debt of about 39% in 2006 (treating SEK8.9 billion in hybrid capital notes as 50% debt and 50% equity). Standard & Poors expects Vattenfall to exploit the financial headroom in the current ratings through debt-financed acquisitions or capital expenditures. In the absence of major acquisitions or large scale capital expenditures, and in view of strong wholesale power price developments, funds from operations to adjusted debt should remain at above 30% over the medium term.
Short-term credit factors Vattenfalls short-term rating is A-2. The company is expected to have adequate internal liquidity over the short term, reflecting strong operating cash flow protected by hedging arrangements, and significant access to alternative sources of liquidity. Although much of Vattenfalls operations are in highly competitive and volatile markets, movements in sales prices and volumes are not expected to have a material negative impact on the companys liquidity and financial performance over the short term. The companys adequate liquidity position is supported by the following factors: Cash and short-term investments at March 31, 2007 of about SEK27.9 billion, compared with SEK15.9 billion in shortterm debt. Strong free operating cash flow (about SEK23.4 billion for the twelve months ended March 31, 2007), reflecting solid profitability and manageable capital expenditure needs in the utility operations. Access to unused committed credit facilities of SEK9.7 billion as of March 31, 2007. In February 2006, the company refinanced a 600 million revolving credit facility and at the same increased the amount to 1 billion. The new revolver matures in 2013, and the company has good access to public debt markets. The absence of rating triggers or onerous covenants in Vattenfalls financing agreements. Free operating cash flow is expected to remain at SEK5 billion-15 billion a year, based on sustained operating profitability. Company policy is to maintain the equivalent of 10% of group turnover in cash or committed credit lines, or the equivalent of the next 90 days debt maturities, whichever is greater.
Outlook
The stable outlook reflects the increasing regulatory and political pressure in Vattenfalls main markets, which tempers the prospect of continued improved credit quality from its current
NOVEMBER 2007 49
UTILITIES
strong level. Such pressure has resulted in increasing shareholder demands, stricter regulation, and an increased focus on environmental and energy policy objectives for the company. Further adverse political or regulatory actions cannot be ruled out. The stable outlook also reflects our expectation that Vattenfall will continue its growth strategy, remain acquisitive, and increase capital expenditures over the medium term. This could weaken the financial profile from its current, strong, level, although we do not expect the company to jeopardize its objective of maintaining a rating in the A category. In the current environment, with increased political and regulatory uncertainty, upside ratings potential is limited.
50 NOVEMBER 2007
TRANSPORTATION INFRASTRUCTURE
tandard & Poors rates a wide range of transportation infrastructure entities in Europe, including airports, rail companies, toll road concessions, and ports. Continuing the trend of recent years, 2007 has been characterized by further M&A and privatization activity, with sponsors seeking to significantly increase debt leverage on the back of solid business risk profiles to fund the acquisition price or provide for shareholder returns. As a result, we have seen a number of ratings on stable investment-grade entities withdrawn, only to be replaced by much more aggressive--and likely noninvestment-grade--financial structures. Whether such structures are sustainable over the business cycle as it becomes more challenging remains to be seen. In recent years, acquisition has been the easiest part of the equation given the plentiful supply of credit and this, for the vendor, has given meaty returns. For some new owners, the second stage--the syndication of the acquisition debt into the secondary loan market or refinancing through the capital market--is proving more elusive. For example, the approximate 6.7 billion of acquisition debt following the acquisition of BAA PLC by Spanish infrastructure company Grupo Ferrovial S.A. remains outstanding 18 months after the launch of the acquisition despite the intention to undertake a capital markets refinancing. While the delay reflects a combination of factors, including the regulatory process and the complexity of the structure being developed, it will be interesting to watch the eventual execution and the price at which that occurs, given the changing climate of the credit markets. Government support is and will remain a key credit factor, particularly for the rail industry. Yet, government budgetary constraints caused by weak economic conditions are putting increasing pressure on state support for some rail entities. State support is likely to remain integral to the operation of rail infrastructure and services in Europe, although more privatizations in the long term cannot be ruled out as countries look to alternative ownership and funding structures. During 2007, Standard & Poors assigned its first ratings in the transportation sector in the Middle East to Dubai-based port operator DP World Ltd. As part of the companys financing activity a rating was also assigned to an Islamic finance sukuk instrument. The importance of the relationship with the government is fundamental to ratings within these jurisdictions, given the ownership structure and the significant social policy role that such companies often take. In general, most rated companies in the sector continue to perform well on the back of economic growth and positive industry developments such as the ongoing growth of low-cost airlines in the case of airports. The sustainability of these positive market features in the long term may become a challenge to transportation infrastructure credits, although companies with prudent management strategies, solid operations, and manageable financial risk are likely to continue to meet the challenges that the future brings.
Jonathan Manley Senior Director and Co-Team Leader Project Finance and Transportation Infrastructure
Lidia Polakovic Senior Director and Co-Team Leader Project Finance and Transportation Infrastructure
NOVEMBER 2007 51
Publication Date:
In addition, on March 22, 2007, the EU approved an aviation deal with the U.S. that will increase deregulation of the transatlantic airline market by opening up restricted routes. As a result, we expect air traffic between Europe and the U.S. to continue to increase over the next five years, starting in 2008. For instance, the lifting of previous U.K./U.S. bilateral constraints on air service provision between Heathrow and the U.S. is to be implemented at Heathrow in time for summer 2008. The impact is currently being assessed by BAA Ltd. (BBB+/Watch Neg/--) using latest airline thinking, but previous assessments suggested small net gains to London system airports (2.3 million passengers in total over the course of the next five-year regulatory periods Q5 and Q6). The impact may be higher for hub airports with more slot capacity. Finally, 2007 traffic growth should be in line or slightly better than semi-annual growth for some airports. Traffic was very high this summer, which will benefit annual traffic levels: The 2006 summer season was slightly affected by a temporary and limited passenger shortfall following the 2006 terrorist alerts in London and subsequent reinforcement of security measures across the EU. First-half 2007 annual traffic growth was healthy, but slowed down for one-half of the airports compared with the same period of 2006. Given increasing capacity constraints in most European airports, more limited but steady growth could prove easier to manage from a capital planning point of view. European Airports Traffic Growth
Growth 2007f (%) Aeroporti di Roma SpA Aeroports de Paris BAA Ltd. Birmingham Airport Holdings Ltd. Brussels Airport Co. (The) Copenhagen Airports A/S Dublin Airport Authority PLC FML Ltd. (East Line Group) Manchester Airport Group PLC (The) N.V. Luchthaven Schiphol Unique (Flughafen Zurich AG)
f--Forecast. N.A.--Not available.
A detailed analysis suggests the following main traffic drivers: International traffic continues to grow more rapidly than domestic traffic, which is likely to remain the case. Among international traffic, non-European (transfer) traffic has proved particularly dynamic. Low-cost carriers continue to grow more rapidly than others and represent a constantly climbing percentage of passengers at some airports; the airports traffic growth is, therefore, increasingly reliant on the success of these carriers. Successful airport operators are those that are not yet constrained by capacity and can accommodate growing passenger volumes, while some hubs (Heathrow and Frankfurt, for example) are increasingly constrained. As a result of its spare capacity, Aeroports de Paris (ADP; AA-/Stable/--) recorded the highest traffic growth rates among major European airports in first-half 2007, as in the three previous years, and is likely to benefit again from strong traffic growth in 2007; ADP has raised its full-year 2007 passenger growth guidance to between 4% and 4.4%, versus 3.7%-4.2% previously. Traffic was actually up 5.2% in the first nine months of 2007. Continental regional and O&D airports continued to post the strongest growth and to outperform hubs, mainly as a result of expansion in the low-cost segment. Only U.K.-based airport operator Birmingham Airport Holdings Ltd.
Growth January 2007June 2007 (%) 8.4 4.4 0.5 (0.5) 3.5 2.3 8.4 19.0 2.1 3.9 8.1
Passengers 2006 (mil.) 35.1 82.5 147.6 9.3 16.7 20.9 27.8 15.4 28.8 46.1 19.2
Growth January 2006December 2006 (%) 6.7 4.8 2.3 (2.5) 3.3 4.5 15.0 10.1 3.0 4.3 7.6
Growth January 2006June 2006 (%) 6.6 5.0 3.1 0.4 4.4 6.3 16.2 12.5 3.3 4.0 6.0
Growth January 2005December 2005 (%) 7.3 4.4 3.0 5.8 3.5 5.0 12.4 15.6 3.0 3.8 3.7
Growth January 2004December 2004 (%) 9.2 6.5 6.9 (2.3) 2.9 7.5 6.6 29.0 5.5 6.5 1.3
6.0-7.0 4.0-4.4 1.5-2.0 N.A. 4.0-5.0 4.0-6.0 7.5-8.0 19.0 5.0 4.0 7.0
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(BIA; A-/Stable/A-2) showed negative 0.5% growth in the first half of 2007: the semi-annual figure suggests traffic is however decreasing less rapidly than in full-year 2006 (2.5%). Second-half 2007 and 2008 will be crucial to confirm whether this decline suggests a departure from BIAs longterm growth trend. Improved profitability and cash flow generation overall but pressures mounting for some airports We expect most rated European airports EBITDA to improve in 2007, on the basis of more traffic, increases in airport charges, higher nonaeronautical revenues, and the implementation of cost-cutting measures. Reported interim accounts at June 30, 2007 by ADP, Brussels, Copenhagen or Schiphol airports support that view; only Aeroporti di Roma SpA (AdR; BBB/Watch Neg/ A-2) is showing a negative evolution. The disposal of ADR Handling and Italys 2007 budget law impacted AdRs reported EBITDA, which was down 2.9% against the first semester of 2006. Without this, EBITDA would have grown by 3.4%. Increased security and utilities costs could hamper EBITDA growth, however, particularly if rising costs are not offset by sufficient traffic and revenue growth or cost control. Brussels Airport reported a strong 14% EBITDA growth in its 2007 interim accounts, illustrating managements ability to cut operating costs; not all airports have such a track record and pressures could rise in the short to medium term for some of them. In some European regional airports (notably in the U.K.) aeronautical revenue is set to grow more slowly than passenger volume in the future, reflecting price incentives offered to grow traffic levels and the increasing proportion of low-cost traffic. This is due to smaller airports increasingly competing with more established regional hubs, as well as a continuing shift in market segments resulting in a growing reliance on low-cost traffic. Aeronautical yields per passenger have actually started to decline at Manchester Airport Group PLC (MAG; A/Stable/--) and the same could happen at BIA due to the companys growing exposure to low-cost traffic and aggressive pricing competition. So far, decline in aeronautical income has been offset by the resilience of nonaeronautical income. That might not always be the case, though, and ultimately steady cash flow generation could be at risk.
Most airports have benefited from increasing revenues and profits from their real estate-related businesses in the past years. Future contributions from that segment could shrink or prove less buoyant than in the past if the business and commercial real estate markets stabilize or decline after several years of sustained growth. We will continue monitoring airports strategies in real estate, its stability as a revenue source, and if any property development risks are being taken that we would consider as weakening the airports business risk profile. Governance and financial aspects paramount for future ratings stability The rating implications of overall higher profitability and stronger internal cash flow generation will depend on the use shareholders make of additional cash flow: The funding of capital spending or capital structure improvement will be neutral to positive from a credit perspective. Conversely, increasing distribution payout or M&A activity could put some pressure on the ratings. A clear example of that is Brussels Airport. Profitability and cash flow generation have been on the rise following the 2005 privatization, but we lowered the rating to BBB from BBB+ in June 2007, following a significant special distribution of 310 million to shareholders (subject to meeting certain performance hurdles). As the company was operating under a financing structure limiting extraordinary dividends, the shareholders had to make a recapitalization to repay existing debt in order to make their distribution. Looking ahead, it is crucial that airports maintain good credit quality and access to external funding for their capital expenditures and refinancing needs. In this respect, not only do operational and financial performance matter but ownership and governance are also key credit factors. Increasingly complex structures are being put in place in order to extract money from the airport operating companies for distribution and/or refinancing of acquisition debt, due to a spike in investor interest in acquiring airports. Standard & Poors rigorously examines ownership arrangements and changes so as to measure the debt obligations that are, directly or indirectly, supported by an airports operations. In June
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2007, the BBB/A-2 ratings on AdR were placed on CreditWatch with negative implications. The placement reflected the growing short-term risk to AdRs credit quality posed by the--ultimately successful--proposal by Gemina SpA (not rated) to buy out Macquarie Airports (Map) (BBB/Stable/--) 45% stake in AdR. Now that Gemina indirectly owns a 96% stake we will review the new ownership structure, focusing particularly on the now single, dominating shareholder. We will also evaluate any revisions to AdRs business and financial strategies. Governance and financial policies are increasingly important considering the releveraging that has taken place in the airport industry over the past few years; in most airports financial flexibility is weak. In addition, some airports need to strengthen their financial profiles or complete a refinancing to maintain current ratings. Regulation will remain a long-term rating driver One key factor to stable credit quality is to recoup short-term operating and long-term capital costs, which speaks to regulation. 2007 has already brought some regulatory changes and more are on the agenda with several regulatory reviews of airport charges in progress. In any event, the way in which the regulators allow airports to fund construction and remunerate their investments will remain an important rating factor. The Competition Commissions report to the U.K. Civilian Aviation Authority (CAA), published Oct. 3, 2007, proposes price controls at BAAs primary airport facilities at Heathrow and Gatwick that are not materially different from the CAAs December 2006 initial proposal. The report itself does not compromise BAAs ability to execute a proposed corporate securitization refinancing, including the refinancing of BAAs existing bonds into an investment-grade ringfenced entity. However, the proposed price controls are likely to affect the timetable for doing this, and, if the initial proposals remain unchanged, the overall amount of debt eventually
placed into the ring-fence structure. Firm proposals for the new price controls will not be revealed for the five-year period from April 20082013 until November 2007. On July 30, 2007, the Irish Commission for Aviation Regulation published its final decision on the maximum level of airport charges that may be set at Dublin Airport for 2006-2010. The commission decided not to increase the cap on airport charges at Dublin until 2010. The regulator made it clear that the financial sustainability of the airport (one of the regulators three main duties) can be achieved with an IG rating (high BBB category), and, therefore, maintaining the current A rating is not part of its statutory duty. However, airport passenger charges are likely to rise 22% between 2010 and 2014. The price rise is aimed at helping DAA to pay for Terminal 2 and related projects. As the cost can only be recovered when the terminal is operational, DAA will have to borrow a significant amount to pay for the investment program. Standard & Poors will be reviewing DAAs business plan in the next few weeks to assess the impact of the new debt on the rating. The ratings and outlook on ADP remained unchanged in July 2007 following the decision by the Conseil dEtat (Frances highest administrative court) to cancel the 2006 tariff increase charged to carriers last year, on the grounds that the company did not supply adequate financial information to the consultative committee. The decision did not call into question the level of tariffs itself or imply repayment by ADP of the corresponding amounts. ADP will have to apply again to the consultative committee to validate last years tariff increase, as well as tariffs decided for 2007. Importantly, on April 25, 2007, the court had confirmed the validity of the five-year regulatory contract between ADP and the state, paving the way to implement annual tariff increases of up to 3.25% plus inflation until 2010. On that basis, we expect ministerial confirmation of previously accepted 2006 and 2007 tariff increases in the course of 2007.
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BAA LTD.
Publication Date:
Aug. 21, 2007 Issuer Credit Rating: BBB+/WatchNeg/NR Primary Credit Analyst: Alexandre de Lestrange, Paris, (33) 1-4420-7316 Secondary Credit Analyst: Michael Wilkins, London, (44) 20-7176-3528
Major Rating Factors

Strengths:
Excellent competitive position as the
Weaknesses: Currently highly leveraged finance structure

Major capital expenditure program resulting
dominant U.K. airport operator and the key hub in Europe Strong cash-generative business Diversification through ownership of a portfolio of airports assets Expected continued supportive regulatory environment and government policies
in steady negative free cash flow

Forecast gradual increase in leverage, which
will reduce financial flexibility
Rationale
The ratings on U.K.-based airports operator BAA Ltd. are supported by the companys excellent business risk profile. BAA benefits from its ownership and operation of a portfolio of key U.K. airports catering for a diverse mix of passengers, and from supportive regulation and government policies. In addition, the key strategic position of its main asset, London Heathrow Airport, as a hub airport supports the companys competitive position, while its capacity constraints are expected to ease gradually with the opening of Terminal 5 (T5) at Heathrow and the ongoing capital program. The ratings are constrained by BAAs weakened financial profile, which reflects the companys debt-funded capital program and limited financial flexibility. BAA was delisted following its effective acquisition by Airport Development and Investment Ltd. (ADIL) (a consortium led by Grupo Ferrovial S.A.) on Aug. 15, 2006. The company was renamed BAA Ltd. in November 2006. Work is underway for the ultimate financing structure, which is expected to conclude toward the end of 2007. The ring-fencing structure to be implemented under the financing will be key, as--given existing debt and acquisition debt at ADIL--the ratings on a consolidated basis would be in the BB category. In the first six months of fiscal 2007, BAAs passenger growth slowed to 0.5%, reflecting the impact of the tightening of security measures and uncertainty over further terrorist attacks. Higher pension and security costs as well as a lower retail income per U.K. passenger limited profitability and cash flow growth to lower-thanexpected levels in the 12 months to December 2006, with the adjusted EBITDA margin--at 41.6%--lower than in previous fiscal years (about 45%). Adjusted funds from operations (FFO) to
debt and FFO interest coverage over the same period, at 10.6% and 2.7x, respectively, were, however, similar to those at fiscal year-end March 2006 (10.8% and 2.8x, respectively). The ongoing CreditWatch status reflects uncertainties about the ultimate financing structure, which is expected to allow existing bonds to achieve a rating that is the same or higher than the corporate credit rating. Although the transaction is taking more time than originally anticipated in 2006, it has been progressing satisfactorily so far. Standard & Poors Ratings Services expects to resolve the CreditWatch placement by the end of 2007. If, as currently expected, all rated debt migrates to a new, investment-grade structure, the corporate credit rating would be withdrawn. In the event that the long-term financing strategy that ADIL is contemplating is not implemented, the ratings on BAA could fall to the BB category, based on consolidated debt (including ADILs debt). Liquidity BAAs liquidity is good, reflecting strong cash flow generation. At Dec. 31, 2006, available bank lines and cash in hand combined was 2.135 billion (1.764 billion at the end of June 2007). BAA is a joint obligor with its 100% parent ADIL on a 2.25 billion facility maturing in April 2011. At Dec. 31, 2006, 200 million had been drawn on the facility. In addition, overdraft facilities of 25 million were available. These facilities comfortably cover BAAs negative free operating cash flow for 2007 (mainly due to capital expenditure investments) and forthcoming debt maturities. At June 30, 2007, BAAs short-term debt maturities were modest, with only one bond maturing in the next 12 months--the convertible 424 million notes due in April 2008, which are 100% owned by ADIL.
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Business Description
BAAs core business is the ownership and operation of seven U.K. airports, including its three designated airports: Heathrow (including the Heathrow Express rail link), Gatwick, and Stansted, which serve London and southeast England, and together generate about 90% of group revenues. The companys other airports are Southampton in southern England, and Aberdeen, Glasgow, and Edinburgh in Scotland. BAA also operates and owns a majority stake in Naples airport in Italy, has ownership and operational interests in six Australian airports, and runs retail or management contracts at three airports in the U.S. In addition, the company owns and operates World Duty Free and property management business BAA Lynton, although this operation is up for sale. Airport-related businesses (excluding duty free) account for more than 70% of total revenues. The ultimate parent company of ADIL in the U.K. is FGP Topco Ltd., a company owned by Ferrovial Infraestructuras S.A. (62%), Caisse de dpt et placement du Qubec (28%), and Baker Street Investment Pte Ltd. (10%), an investment vehicle controlled by GIC Special Investments.
ownership of Europes main hub airport; diversity of airlines, destinations, and passengers; sound traffic growth prospects in the U.K.; and a supportive regulatory environment. The business profile is also supported by the diversification benefits of the companys ownership of seven U.K. airports, each with different traffic characteristics. These strengths are only partly tempered by current capacity constraints at Heathrow and Gatwick and operational challenges pending the completion of the capital expenditure program. Competitive position BAA is the largest airport operator in Europe, handling about 148.0 million passengers (on a rolling basis) at its U.K. airports in the 12 months to June 2007. The companys strong passenger potential derives from its large and wealthy catchment area and Londons position as Europes major financial center and a leading tourist destination. A further competitive strength is that all three London airports are linked to the center of London via high-speed rail links. BAAs main hub, Heathrow, is Europes largest airport, with 67.0 million passengers in the 12 months to June 2007. Gatwick is also an important European hub airport, handling 34.5 million passengers in the same period. BAAs Heathrow and Gatwick airports compete with Europes other major international hub airports for connecting passengers only, most notably Frankfurt, Amsterdam Airport Schiphol, and Paris Charles de Gaulle (CDG). Capacity constraints at Heathrow and Gatwick have somewhat affected their competitive positions. In addition, the number of destinations served by Heathrow and Gatwick lags behind that of CDG, Frankfurt, and Schiphol. BAA, however, has higher frequency service to major destinations, which is an important factor for both travelers and airlines because it gives a choice of connections. In addition, Heathrow and Gatwick are less exposed than their peers to competition for transfer passengers or to any one particular airline, as both constitute a smaller proportion of traffic. Despite the additional capacity to be provided by T5 from 2008, Heathrows traffic is expected to grow more slowly than the expected long-term growth average in the U.K. and for other European hubs. This is due to runway capacity
Rating Approach
Since the June 2006 downgrade when ADILs offer for shares and convertible bonds became unconditional, weve adopted a forward-looking approach to the ratings. The ratings will remain on CreditWatch pending final execution of ADILs proposed permanent financing strategy following the acquisition. The BBB+ ratings reflects our expectation that existing bondholders will be migrated to a special-purpose vehicle, allowing BAAs existing debt to be rated at least at the current rating level. The ring-fencing structure should also isolate the future credit quality of the regulated airport companies backing the new financing from ADIL and its ultimate parents.
Business Risk Profile: Very Strong Competitive Position, Solid Operations, Supportive Regulation, High Profitability
Excluding industry event risk, we expect BAAs business risk profile to remain stable and supportive. BAAs excellent business profile reflects its strong competitive position owing to: its location;
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constraints. Although the U.K. Aviation White Paper The Future of Air Transport (the White Paper), published in December 2003, proposes the construction of a third runway at Heathrow and additional terminal capacity, this is only expected by 2015-2020 if environmental conditions are met and the planning process runs smoothly. Aeronautical activity BAA is forecasting average passenger traffic growth for its three designated airports of 2.8% per year over the 2007-2018 period. This is below the expected natural growth rate in England of 4.5% to 5.0%, reflecting capacity constraints at the London airports. Industry events, erosion of passenger confidence, and a weak economic climate, could result in lower-than-expected passenger growth. Our long-term scenario is annual passenger growth of about 2%. Historical trends have demonstrated the stability of aeronautical activity at BAAs airports and the increasing resilience of passenger demand behavior to external shocks. This supports BAAs business profile. BAA has a record of more than 40 years of almost continual traffic growth. During this period, only the years following the first oil crisis in 1974, the 1991 Gulf War, and the events of Sept. 11, 2001 showed traffic decreases. Nevertheless, with the exception of 1991, when traffic decreased by 7%, the rate of passenger volume decline was in the low single digits and was short lived. Since the beginning of the 2003-2008 regulatory period, traffic performance at the designated airports has been mixed. BAAs designated airports underperformed the regulatory assumptions in the fiscal years ended March 31, 2006, and Dec. 31, 2006 (the companys fiscal year-end was changed during 2006; see Accounting section), and outperformed the U.K. Civil Aviation Authoritys (CAA) assumptions in 2005. Based on first-half traffic figures, 2007 is likely to be below the CAAs assumptions. In the first six months of fiscal 2007, traffic at BAAs regulated airports was stable compared with the same period of the previous year, after a decline of 0.6% in June 2006. Performance at group level was stronger, with passenger growth at 0.5% (below the 1.1% increase in the 12 month rolling period to June 2007), thanks to the
performance of Southampton and the Scottish airports, which saw growth of 3.2% and 3.5%, respectively, over the period. The recent attempted terrorist attack at Glasgow airport contributed to a fall of 2.4% in June 2007, as more than 60% of flights were cancelled or diverted when the airport was temporarily closed in the immediate aftermath of the incident. Less than 24 hours after the incident the airport was reopened and operating a full flight schedule. A diversified airline, destination, and passenger mix supports traffic stability at BAAs airports. Customer concentration and dependence on the lower rated airline sector are perceived as weaknesses for airports in general, when compared with gas and water utilities. Nevertheless, airports with strong competitive positions are partially insulated from this risk, as the strength of routes is key for traffic stability. If there is sufficient demand for a particular destination, it is expected that a failing airline serving that route would be substituted. Although BAAs four largest customers contribute about one-half of its designated airports passenger traffic (the revenue contribution is lower), customer concentration is not perceived as a credit risk, particularly at Heathrow, where demand for slots exceeds supply. Of the hub airport operators rated by Standard & Poors, BAA has the lowest exposure to its flag carrier. For the nine months ended December 2006, 27% of total passenger traffic came from British Airways PLC (BBB-/Stable/--) (Heathrow 41%, Gatwick 21%). In comparison, Air France-KLM represented more than 50% of passengers at Aeroports de Paris (AA-/Stable/--) and more than 60% at Schiphol (N.V. Luchthaven Schiphol and Schiphol Nederland B.V.; AA-/Negative/--). Each of BAAs larger airports caters for different segments of the aviation market. This diversification is supportive of BAAs business profile because the negative effects of a downturn in one segment can be offset by strong performance in others. Heathrow is the largest hub in Europe, and almost all carriers are scheduled rather than charter, while Gatwick is the main U.K. charter airport, with a growing low-cost carrier presence. Stansted is an origin and destination airport and the U.K. center for the low-cost airline business. Stansteds rapid growth rates over the past 10 years result from
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the rapid expansion of low-cost carriers Ryanair and easyJet. The Scottish and Southampton airports have a mixture of carrier types. BAAs traffic base is relatively diversified across different markets. At the three London airports, the major destinations are Europe and North America, which accounted for 70% and 13% of total traffic in 2006, respectively. A balanced breakdown of business and leisure travel between U.K. and overseas residents supports diversification of the passenger mix. Revenue diversity and stability BAAs revenue stability is directly linked to the stability of traffic and a tested tariff-setting regime (see Regulation and government policy). A high proportion of revenues also comes from retail activities. The company conducts a large percentage of its commercial activity directly. About 45% of retail revenues come from the World Duty Free franchise, which is directly managed by BAA. This direct involvement is not a negative factor because airport retail activities, particularly airside, are more stable than highstreet retail. BAA recognizes revenues and costs associated with the World Duty Free operations, and so retail revenues represent about 35% of total revenues. This contrasts with other European airports, where commercial revenues, excluding properties, represent 20%-30% of the rated hubs revenue structure. Regulation and government policy: London airports In 2007, BAA will be reviewed by the U.K. Competition Commission (CC) in two parallel reviews. The regulatory review for the period from 2008-2009 to 2012-2013 (Q5, or the fifth quinquennium) will consider BAAs past and forecast future performance, assess its costs of capital, make recommendations on the price-cap, and determine whether the company, in its management of the three London airports, has acted against the public interest. In a separate process, a review by the Office of Fair Trading (OFT) will investigate the structure of the U.K. airport market.
General principles. The framework for airport regulation in the U.K. is set by the Airports Act 1986, with aviation policy determined by the Department for Transport (DfT). Although the CAA is the primary economic regulator of U.K. airports, the CC has a mandatory role as an adviser to the CAA. The regulatory responsibilities of the CAA and the CC include a duty to encourage investment in new facilities at airports in time to satisfy anticipated passenger demand. Unlike other regulators, such as those in the water industry, the regulator has no wider responsibility to ensure that BAA attains a specified credit rating level. It must, however, ensure that the company is able to finance its activities. The CAA does not have the power to dedesignate an airport; this is held by the DfT. BAA benefits from strong government support for its business as it provides key infrastructure for economic growth in the U.K. Although there is no expectation that the government will provide funds to finance airport infrastructure, Standard & Poors expects that it and the economic regulator will continue to create conditions for longer term investment in the expansion of aviation capacity in southeast England. The White Paper clarified the governments policies regarding airport expansion for the U.K. It emphasized the need for airport operators to invest in delivering new capacity. Price-cap mechanisms. Since 1986, the CAA has been required to set a five-year period price control formula fixing the maximum airport charges that may be levied at Heathrow, Gatwick, and Stansted on a standalone regulation basis (that is, by reference to each airports own air traffic, costs, and assets). The charges within the price-cap include runway landing, aircraft parking, and the departing passenger charge. The price-cap is set with reference to forecasts for traffic volumes, capital investment, operating costs, and operating revenues, as well as allowing BAA a reasonable rate of return on its investments. The formula follows a single-till approach, where retail and property activities subsidize aeronautical activities. To determine the price-cap, required revenues are calculated based on the sum of net expenditures, regulatory
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depreciation of remunerated assets, and required returns on the average value of remunerated assets. Although the CAA has demonstrated flexibility by allowing BAA to offset revenue losses caused by external events, such as the loss of duty free revenues in 1999, BAA does not benefit from regulatory protection in a situation of financial distress caused by financing decisions. Price control review: initial proposals. The formal process for setting the charges for Q5 began in December 2005 when the CAA published its policy issues paper for consultation. BAA then rejected the CAAs December 2006 initial regulatory proposals as failing to incentivize the company to invest at its airports. The next stage in the process sees a review by the CC before the CAA sets prices in early 2008. The CAA has proposed that the allowed weighted average cost of capital (WACC) should be cut to 5.90%-6.20% for Heathrow and 6.30%-6.70% for Gatwick, which would be a marked reduction from the 7.75% allowed in 2003. This change could arguably prompt ADIL to lower its intended capital program. Such large movements between quinquennia may well result in rating volatility for BAA in the future. Significantly, the CAA has stated that it will not reconsider the level of WACC in view of the tax shield provided by the higher leverage ADIL intends to implement, or adopt a higher proportion of debt in the WACC calculation. This is a credit positive for BAA. The CAA has put forward indicative ranges for caps on airport charges at Heathrow of the retail price index (RPI) plus 4.0%-8.0%, compared with the current rate of growth in price-caps of RPI plus 6.5%. For Gatwick airport, the CAA has proposed a price-cap ranging from RPI minus 2% to RPI plus 2%, compared with the current rate of growth of RPI plus 0%. Standard & Poors does not consider that these changes will affect its analysis. Importantly, Heathrow will be authorized to continue implementing high fee increases. This is a credit strength, given that Heathrow remains the largest airport in the U.K. in terms of passengers, and given the significant capital expenditure plan underway. The price control proposals suggested by the CAA are now with the CC. Given the CCs track record, we expect it to continue the supportive regulatory regime for investment that it delivered
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in the fourth quinquennium. Finally, the CAA has recommended that the government should consider removing the requirement for the CAA to set price controls at Stansted, and instead dedesignate the airport. In theory, BAA could therefore implement higher charges, but this may prove difficult considering the airports focus on low-cost carriers. This decision reflects the CAAs acknowledgement that BAA currently charges below the regulators pricecap, and the view that Stansted does not have significant market power. The dedesignation is viewed as mildly positive overall, depending on the future competitive position of Stansted and how stranded asset risk is mitigated. We understand that ADIL continues to see Stansted airport as a core asset. The potential removal of Stansted from the regulated asset base (RAB) is unlikely to affect the proposed securitization of BAA, given that the airport only accounts for about 9% of the combined RAB of 11.3 billion (at March 2007). About 10.3 billion of regulated assets will remain to back the securitization financing, which should ensure that the transaction goes forward. Standard & Poors recognizes the importance of the method by which Stansteds potential dedesignation will be accounted for within the ring-fence structure. Office of Fair Trading and Competition Commission investigation. The OFT launched an investigation into the U.K. airports sector in 2006. In December 2006, it reported its preliminary findings that BAAs ownership of its airports, the system of economic regulation of airports in the U.K., and capacity constraints combine to prevent, restrict, or distort competition and referred the supply of airport services by BAA within the U.K. to the CC. This review is expected to take up to two years to complete. On Aug. 9, 2007, the CC released a statement of issues it would look at following the reference made to it by the OFT in March 2007. The CC declared it would now determine whether there are any features of the market that prevent, restrict, or distort competition, and, if so, what remedial action might be taken. The CC expects to publish for consultation in the early part of 2008 a document setting its emerging thinking on all the key issues. It currently aims to publish its provisional findings around this time next year.
BAA has already been subject to a number of government sponsored studies of airports, which concluded previously that it would not be desirable to break up the airports in the southeast of England. The OFT referral includes the designated airports that are subject to an RABbased regulation with price-caps designed to offset their monopoly characteristics. We believe that a breakup would be negative from a rating perspective, as it would reduce the supportive portfolio diversification stemming from operating several airports with different airlines, traffic types, and capital cycles. We would expect ADILs proposed permanent financing to factor in any breakup of the designated airports. The potential rating impact would depend in part on the allocation of BAAs existing debt postbreakup. Nondesignated airport regulation BAAs nondesignated airports are subject either to much lighter economic regulation or no economic regulation and are therefore free to set airline charges directly with the customers (the airline users). Operations The company has strong aviation and retail operations, as reflected in its strong operating margin compared with some of its peers. External consultants used by the CAA for the ongoing regulatory review have not raised any severe issues in terms of operating or capital spending. They have, however, suggested ways to further improve operations. BAA has a good track record for capital projects. Phase 1 of T5, which incorporates the main terminal building and Satellite 1, was approximately 90% complete at Dec. 31, 2006. The project continues to make good progress and the development remains on budget and on schedule to open in March 2008. To incentivize further investment at Heathrow and Gatwick airports, the CAA is proposing that all of the 6 billion capital expenditures incurred over the 2003-2008 period be factored into the RAB and remunerated. Congestion and queuing times at BAAs airports have been the subject of severe public discontent in recent months. To alleviate this, BAA is in the process of recruiting 1,400 extra security guards and opening 22 new security lanes across its seven U.K. airports. The company is committed to
reducing queues to five minutes or less for 95% of the time. Capacity shortage, which is a negative rating factor, is being addressed. Existing planning approvals provide for approximate passenger traffic growth at Heathrow (including T5) to 90 million (55 million capacity at the moment), Gatwick to about 40 million, and Stansted to about 25 million. BAAs additional projects are to knock down Terminal 2 and replace it with a new terminal, Heathrow East. The terminal would not increase the capacity of the airport but would replace outdated buildings. Stansted Generation 2 includes the provision of a second runway and terminal, with initial capacity for about 10 million passengers per year. The current estimate of the net cost of the blight and compensation schemes for those people most affected by the Stansted development is up to 100 million. The White Paper also commits BAA to offering noise mitigation measures. Payments under the noise schemes are estimated at 7 million per year for the next four years and up to 350 million over the next 29 years for blight schemes. BAA has interests in various airports outside the U.K. The company also owns 50% of Airport Property Partnership, a property joint venture with Morley Fund Management that is in the process of being disposed as it is considered noncore activity. Budapest Airport was sold to a consortium led by Hochtief in June 2007. Profitability Airports tend to have high operating margins owing to growing revenues, a high proportion of fixed costs, and relatively low staff levels. BAA has demonstrated stability of earnings and cash flow despite adverse events. Passenger numbers, tariff changes, and retail activities are the main drivers of revenue growth. Although the companys operating margins will be subject to pressure in the years immediately following the opening of its new terminal at Heathrow, BAAs new owners expect profitability to eventually benefit from the additional capacity provided by T5. As a mechanism to encourage BAA to carry out its proposed investments, the CAA is considering maintaining the price profiling (or revenue advancement), which was incorporated in the Heathrow price review for 2003-2008. This
NOVEMBER 2007 61
allows a proportion of the costs associated with a future investment (depreciation) to be recovered before that new investment comes into operation. In addition, assets are remunerated during the course of construction at the regulatory cost of capital. This mechanism has significantly reduced risk in the T5 investment. Although the recovery of 75% of incremental security costs incurred in the event of additional security requirements (subject to minimal costs) being introduced by the government is viewed favorably, this is lower than in previous regulatory reviews. Although historically BAA has achieved or beaten operating cost forecasts assumed in the regulatory review, the group has underperformed in the current regulatory period due to new legal security requirements, market-driven costs such as utilities and business rates, and White Paper obligations on noise and blight. In the 12 months
to December 2006, the adjusted operating margin before depreciation was 42.1%. In previous years, margins have ranged close to or above 45%. Operating income in 2006 was affected by reorganization costs, bid advisory costs, staffrelated costs due to the change in ownership, and costs incurred to ensure that T5 becomes operational in March 2008. An increase in pension contributions put further pressure on operating costs.
Financial Risk Profile: High Leverage Reflects Capital Returns, Expected Releveraging After Takeover, And Weak Credit Metrics
BAAs weakened financial profile reflects the companys debt-funded capital program and limited financial flexibility.
Table 1 - Reconciliation Of BAA Ltd. Estimated Amounts With Standard & Poor's Adjusted Amounts (Mil. )*
--12 months to Dec. 31, 2006--
BAA Ltd. amounts

Shareholders' equity 6,339.0 -----Operating income (before D&A) 972.0 72.0 4.0 ---Operating income (before D&A) 972.0 53.8 4.0 --5.0 Operating income (after D&A) 702.0 53.8 4.0 ---Interest expense 159.0 53.8 --137.0 -Cash flow from operations 558.0 18.2 (4.9) ---Cash flow from operations 558.0 18.2 (4.9) ---Capital expenditure 1,106.0 16.9 -----
Debt Reported Operating leases Postretirement benefit obligations Additional items included in debt Capitalized interest Share-based compensation expense Reclassification of nonoperating income (expenses) Reclassification of working-capital cash flow changes Minority interest Other Total adjustments 6,392.0 895.9 162.0 192.0 ---
Standard & Poor's adjustments
--
--
--
--
29.0
--
--
--
--
---1,249.9
-10.0 -10.0
--31.0 107.0
--31.0 93.8
--(40.0) 46.8
--50.0 240.8
--192.0 205.3 Cash flow from operations 763.3
48.0 -191.0 252.3
--399.0 415.9
Standard & Poor's adjusted amounts

Operating income (before D&A) 1,079.0 Funds from operations 810.3
Debt Adjusted 7,641.9
Equity 6,349.0
EBITDA 1,065.8
EBIT 748.8
Interest expense 399.8
Capital expenditures 1,521.9
*Please note that two reported amounts (operating income before D&A and cash flow from operations) are used to derive more than one Standard & Poor's-adjusted amount (operating income before D&A and EBITDA, and cash flow from operations and funds from operations, respectively). Consequently, the first section in some tables may feature duplicate descriptions and amounts.
62 NOVEMBER 2007
Accounting BAA changed its reporting date to Dec. 31 (previously March 31) to align with Grupo Ferrovial S.A., its ultimate majority shareholder. Auditors issued an unqualified audit report for the last fiscal period. The consolidated financial statements for BAA Ltd. (formerly BAA PLC) are prepared in accordance with IFRS and under the historical cost convention, with the exception of investment properties, available-for-sale assets, derivative financial instruments, and financial liabilities that qualify as hedged items under a fair value hedge accounting system. During the course of 2006, BAA changed its accounting treatment for joint venture entities to proportionately consolidate the financial performance for the reporting period and the financial position at Dec. 31, 2006 (previously joint venture entities were equity accounted). This change in policy has no impact on net profit or reserves. The financial information presented in this report is based on the segregation of the fourth quarter of the fiscal year ended March 2006 from the financial report for the nine months to December 2006, and reflects the balance sheet at December 2006. Comparability with the fiscal year ended March 2006 must be considered in view of the three-month crossover. The main adjustments to the companys reported debt figures concern leases, postretirement obligations (192 million), and contingent liabilities. BAA has changed the disclosure of its lease obligations under IFRS. Comparing the previous 2004/2005 accounts with the 2005/2006 accounts, the amounts payable in 2005/2006 did not correlate to the previous disclosure or the actual charge in the accounts. The accounts for the year to December 2006 (with restated figures at March 2006) show a large lease liability. For comparison purposes, the adjustment of future lease obligations for the net present value at 6% has also been made for the years ended March 2005 and March 2006. Our adjustments to operating income (before D&A) and EBITDA (see table 1 on previous page) reflect three key components: the operating income contribution for three months (216 million) less the gain on investments (206
million) plus the derivatives losses (21 million) recognized in operating income. The adjustments to EBIT reflect the same items along with three months of depreciation (81 million) and interest income (10 million). The adjustments to interest expense, cash flow from operations, funds from operations, and capital expenditure relate entirely to the three-month pro forma adjustment. Corporate governance/Risk tolerance/ Financial policies ADILs strategy and intention is to migrate existing bondholders into an investment-grade ring-fenced entity backed by BAAs three designated airports. BAAs other airports in the U.K. (Southampton, Aberdeen, Glasgow, and Edinburgh) will remain outside of the ringfence and are expected to be financed on a standalone basis. We expect the future ring-fenced structure financing to be supported by: A strong overall covenant package; Limitations on additional debt and business activities, such as a rating confirmation requirement for acquisitions above certain thresholds (the latter creating certainty that the revenue profile will not change); Restrictions on upstream distributions outside the ring-fence; Likely achievable fixed and floating charges on the assets of the three designated airports; and The stability provided by BAAs designated airports business. BAAs main financial policy objectives are: To maintain a minimum of 70% of existing debt on fixed rates. To use foreign currency forward contracts to hedge capital expenditure in foreign currency once a project is certain to go ahead. At December 2006, there were no significant unmatched exposures. To ensure that the company is not exposed to excessive refinancing risk in any one year. In addition: Covenants are standardized wherever possible and are monitored on an ongoing basis. BAA continues to comply with all borrowing obligations and financial covenants.
NOVEMBER 2007 63
The treasury function is not permitted to speculate in financial instruments. An interim dividend of 165 million was proposed for the year ended March 31, 2006, and was paid during the nine-month period to Dec. 31, 2006. Further, an interim dividend of 78 million was paid to ADIL out of postacquisition profits on Nov. 11, 2006. Also, BAA made a 114 million loan to ADIL in 2006. Cash flow adequacy The high operating margins and the relatively stable and predictable cash flows produced by BAAs diversified airports are a significant credit strength. The 9 billion-plus 2007-2018 investment program for the three southeast England airports
will continue to drive BAAs financial risk profile for the next 10 years. Standard & Poors expects free cash flow generation to be negative during this period. From a credit perspective, the ability to recover the cost of investment in the course of construction is positive as it allows BAA to collect revenues associated with long-term projects before completion, boosting operating cash flow and, therefore, reducing the impact of the long-term investment plan on the companys financial profile. BAA has publicly stated that investments contemplated in the White Paper will only be made if future regulatory determinations are supportive, and if there are appropriate levels of demand to support the investment without putting the groups financial robustness at risk. Adjusted FFO coverage of interest and debt in
Table 2 - BAA Ltd. Peer Comparison*

--12 months to Dec. 31, 2006-BAA Ltd. Rating as of Aug. 13, 2007 (Mil. mixed currency) Revenues EBITDA Net income from continuing operations Funds from operations (FFO) Cash flow from operations Capital expenditures Free operating cash flow Discretionary cash flow Cash and investments Debt Common equity BBB+/Watch Neg/NR GBP 2,564.0 1,065.8 463.0 810.3 763.3 1,521.9 (758.6) (1,001.6) 93.0 7,641.9 6,339.0 41.6 42.1 1.9 2.7 5.0 10.6 10.0 (9.9) 7.2 54.6 41.9 1.9 10.9 7.0 54.1 --Fiscal year ended Dec. 31, 2006-N.V. Luchthaven Schiphol AA-/Negative/-EUR 1,036.7 440.4 526.9 348.6 359.3 241.4 117.9 62.5 257.1 1,075.0 2,702.8 42.5 42.8 5.1 7.3 8.5 32.4 33.4 11.0 2.4 28.3 42.9 5.3 33.8 2.3 27.6 Aeroports de Paris AA-/Stable/-EUR 2,076.8 665.1 152.1 537.7 464.0 712.5 (248.5) (311.7) 509.2 2,682.1 2,794.6 32.0 32.0 3.7 5.6 8.2 20.0 17.3 (9.3) 4.0 49.0 30.8 4.0 22.3 3.8 46.5
Adjusted ratios
EBITDA/sales (%) Operating income/sales (%) EBIT interest coverage (x) EBITDA interest coverage (x) Return on capital (%) FFO/debt (%) Cash flow from operations/debt (%) Free operating cash flow/debt (%) Debt/EBITDA (x) Debt/total capital (%) Ratios before adjustments for postretirement obligations Operating income/sales (before D&A) (%) EBIT interest coverage (x) FFO/debt (%) Debt/EBITDA (x) Debt/total capital (%)
*Fully adjusted (including postretirement obligations). Excess cash and investments netted against debt.
64 NOVEMBER 2007
the 12 months to December 2006 at 10.6% and 2.7x were quite similar to those at fiscal year-end March 2006 (10.8% and 2.8x, respectively). The debt-financed acquisition of BAA by ADIL and expected refinancing will have a significant impact on cash flow adequacy measures. Although financial ratios are likely to be weak, they should be interpreted in light of BAAs relatively low business risk and the transactions structural features. We would expect BAA to fund its future capital investment program in respect of the designated airports through further debt issuance from the ring-fenced designated airports, limiting the future cost of debt. Capital structure/Asset protection Leverage is forecast to increase as ongoing capital expenditure will be debt-financed. Future ratings will be constrained by an anticipated aggressive capital structure, moderate debt protection measures, and the ongoing need to raise debt to finance capital expenditures. At Dec. 31, 2006, gross unadjusted debt was 6.4 billion, as at March 31, 2006. Adjusted debt to capitalization in the 12 months to December 2006 increased to 54.6%, from 53.3% at March 2006.
BAAs debt structure was adequate at Dec. 31, 2006, with 80% of debt maturing in more than five years. Of the debt portfolio, 86% was at fixed interest rates. During the nine months to Dec. 31, 2006, ADIL acquired BAAs outstanding convertible bonds (424 million 2.94% and 425 million 2.625%). Unless previously redeemed or converted, BAA will redeem the bonds at par on April 4, 2008, and Aug. 19, 2009, respectively. At year-end 2006, secured debt was marginal at 234 million, out of gross unadjusted debt of 6.4 billion. Structural subordination for unsecured lenders is therefore minimal. BAAs long-term bonds benefit from upstream guarantees from Heathrow, Gatwick, and Stansted. Those due in 2016, 2021, 2028, and 2031 also carry interest coverage and gearing covenants, but do not contain negative pledge clauses. Under the terms of the ADIL senior and junior finance documents, BAA Ltd., as an obligor, jointly and severally guarantees the ADIL senior and subordinated facilities. The maximum value of this guarantee is limited by the threshold at which the financial and other covenants contained in the existing bonds would be breached.
Table 3 - BAA Ltd. Financial Summary

--12 months to Dec. 31-(Mil. ) Rating history Revenues Net income from continuing operations Funds from operations (FFO) Capital expenditures Free operating cash flow Discretionary cash flow Cash and investments Debt Common equity Total capital EBIT interest coverage (x) EBITDA interest coverage (x) FFO interest coverage (x) FFO/debt (%) Discretionary cash flow/debt (%) Net cash flow/capital expenditure (%) Debt/total capital (%) Return on common equity (%) Common dividend payout ratio (unadjusted) (%) 2006 2,564.0 463.0 810.3 1,521.9 (758.6) (1,001.6) 93.0 7,641.9 6,339.0 13,990.9 1.9 2.7 2.7 10.6 (13.1) 37.3 54.6 7.5 16.8 2006 2,313.0 531.0 738.3 1,502.2 (805.9) (1,036.9) 83.5 6,842.7 5,982.0 12,834.7 2.3 3.0 2.8 10.8 (15.2) 33.8 53.3 9.2 45.8 A/Watch Neg/A-1 A/Watch Neg/A-1 --Fiscal year ended March 31-2005 A+/Stable/A-1+ 2,115.0 672.0 732.4 2,288.9 (1,597.5) (1,811.5) 83.5 4,381.7 5,623.0 10,013.7 3.7 4.7 3.3 16.7 (41.3) 22.6 43.8 12.6 33.8 2004 A+/Stable/A-1+ 1,970.0 377.0 680.0 1,314.6 (680.5) (886.5) 890.0 3,983.9 5,018.0 9,009.9 3.2 4.1 3.9 17.1 (22.3) 36.1 44.2 7.9 56.2 2003 AA-/Negative/A-1+ 1,909.0 374.0 636.5 719.6 (96.1) (294.1) 1,156.0 3,506.1 4,575.0 8,089.1 3.2 4.0 3.9 18.2 (8.4) 60.9 43.3 8.0 54.0
NOVEMBER 2007 65
The 2012, 2013, 2014, 2018, and 2023, and convertible bonds contain a negative pledge clause, meaning that, as long as these bonds remain outstanding, the issuer will not permit its assets to be pledged in favor of any new bonds with a tenor of less than 20 years, unless the bonds are secured equally. Limited protection is also derived from a put option, under which bond investors can sell the bonds back to BAA if airport operations cease to be the companys major business and if this results in the long-term corporate credit rating falling below BBB-. The 1 billion revolving credit facility was cancelled on Aug. 21, 2006. BAA is a joint obligor with its 100% parent ADIL on a 2.25 billion facility maturing in April 2011. At Dec. 31, 2006, 200 million had been drawn on the facility.
66 NOVEMBER 2007
CHANNEL LINK ENTERPRISES FINANCE PLC

Publication Date:
Sept. 19, 2007 Primary Credit Analysts: Alexandre de Lestrange, Paris, (33) 1-4420-7316 Michela Bariletti, London, (44) 20-7176-3804 Secondary Credit Analyst: Michael Wilkins, London, (44) 20-7176-3528
Transaction Summary
Standard & Poors Ratings Services assigned credit ratings to the secured index-linked, secured floating-rate and secured fixed-rate notes issued by Channel Link Enterprises Finance PLC, a public limited liability company incorporated in England and Wales. At closing, the original lenders transferred the original loan and the rights attached to it to Channel Link Enterprises Finance PLC. The AAA ratings on the class G notes reflect the unconditional guarantee provided by AMBAC Assurance U.K. Ltd. (AMBAC) for the class G1 and G4 notes, FGIC UK Ltd. (FGIC) for the class G2 and G5 notes, and Financial Security Assurance (U.K.) Ltd. (FSA) for the class G3 and G6 notes. The underlying rating assigned to the class G1, G2, G3, and G4 notes is BBB. In addition, the rating assigned to the class A notes is BBB. The BBB ratings reflect, among other things: For the first time, the senior-loan leverage resulting in sustainable debt levels for the company under steady operations; Forecasted cash flow generation, which should provide some cushion for slowdowns limited in magnitude and in time; The concession to operate the tunnel, which runs for another 80 years until 2086; Strong operating margins: the EBITDA margin for Eurotunnel has consistently been over 50% since 1999; and Limited capital expenditure requirements resulting in positive free cash flow. On the issue date, the issuer also issued floating-rate liquidity notes to fund the liquidity
reserve accounts. The payment to the liquidity reserve accounts in case of funds withdrawn, and the interest and principal on the liquidity notes, rank senior to the class G and class A notes. The rating assigned to the sterling and euro liquidity notes is A-. The higher ratings assigned to the liquidity notes reflect, among other things, their seniority in the waterfall and their better recovery potential.
Notable Features
To rate the notes, Standard & Poors applied a mixed approach combining corporate/concession financing to reflect the borrowers characteristics (Eurotunnel Group, an infrastructure provider operating under a concession) and structured analysis (reflecting the repackaging of the borrowers loan). The analysis does not rely on looking through a post-insolvency scenario, as the underlying BBB rating on the notes is below Standard & Poors estimate of the borrowers business risk, the latter classified as satisfactory to strong (BBB+/A-). As such, this is not a standard corporate securitization cash flow transaction. In standard cash flow corporate securitizations, where the rating on the notes is typically above the business risk of the underlying entity, noteholders normally rely on enforcement of security (such as step-in rights and the appointment of a receiver) to take control over the company in the event of insolvency, and repay the rated debt. For Channel Link Enterprises Finance PLC, Standard & Poors analysis does not rely on the post-insolvency enforcement of the security. There is no right to appoint a receiver in France as there is in the U.K. As regards step-in rights,
Transaction Summary
Transaction Key Features Closing date Collateral Aug. 20, 2007 A permanent facility to the Channel Tunnel Group Ltd. (sterling tranches) and France Manche S.A. (euro tranches). The U.K. security includes first-fixed and first-floating charges over freehold and leasehold properties, charges and assignment over the principal project agreement and insurances, charges over bank accounts and intellectual properties, and a first-floating charge over all present and future assets. In France, security includes security over debt, pledges over bank accounts, trademarks, other intellectual property, and over shares in the Eurotunnel group members in France. U.K. and France 175 160
Countries of origination Sterling floating-rate liquidity notes (Mil. ) Euro floating-rate liquidity notes (Mil. )
NOVEMBER 2007 67
Ratings Detail
Class G1 Rating* AAA, (SPUR BBB) Amount (mil.) 300 Interest** Formula that accounts for relevant index-linked UKTi and interest rate of 3.487% Formula that accounts for relevant index-linked UKTi and 3.487% Formula that accounts for relevant index-linked UKTi and 3.487% Formula that accounts for relevant index-linked OATi and 3.377% Formula that accounts for relevant index-linked OATi and 3.377% Formula that accounts for relevant index-linked OATi and 3.377% 6.341% 5.892% Six-month LIBOR plus 1.25% Six-month EURIBOR plus 1.25% Six-month LIBOR plus 0.60% Six-month EURIBOR plus 0.60% Legal final maturity June 30, 2042
G2 G3 G4 G5 G6 A1 A2 A3 A4 Sterling liquidity notes Euro liquidity notes R
AAA, (SPUR BBB) AAA, (SPUR BBB) AAA, (SPUR BBB) AAA, (SPUR BBB) AAA, (SPUR BBB) BBB BBB BBB BBB AANR
150 300 73 147 147 400 645 350 953 175 160
June 30, 2042 June 30, 2042 June 30, 2041 June 30, 2041 June 30, 2041 June 30, 2046 June 30, 204 June 30, 2050 June 30, 2050 Dec. 30, 2050 Dec. 30, 2050
*Standard & Poors ratings address timely interest and ultimate principal on the notes. The margin is 3.47% until June 30, 2009 and 2.887% thereafter. The AAA ratings are supported by the unconditional guarantee provided by AMBAC Assurance U.K. Ltd. for the class G1 and G4 notes, FGIC UK Ltd. for the class G2 and G5 notes, and Financial Security Assurance (U.K.) Ltd. for the class G3 and G6 notes. **Subject to a step-up fee from July 30, 2012 for the class A3 and A4 notes. As part of Standard & Poors analysis, the step-up fee was modeled as being fully subordinated to the payments on all the classes of notes and not rated. NR--Not rated.
Standard & Poors notes that, although there are arguments to sustain the view that the lenders right of substitution under the concession should remain enforceable in the insolvency of the borrower, this has never been tested and therefore is not a determinant of the rating. Hence, the rating approach is closer to a concession or corporate financing than a traditional securitization. The rating approach is also reflected in the transactions leverage. Compared with traditional corporate securitization transactions, the leverage is high given Eurotunnels business risk, and the legal and structure features. Conversely, other infrastructure operators can bear similar leverages; for instance, Autoroutes Paris-RhinRhones (APRR) facility is rated BBB- with a maximum consolidated leverage of about 11.2x (in 2006) and minimum DSCR of 1.31x (in 2012). APRR is the third-largest toll road operator in Europe, with a network of 2,205 kilometers in service, and is under concession until 2032.
In the project finance market, transactions with higher leverages have reached investment grade. For instance, 407 International Inc. (a toll road in Canada) had total debt/EBITDA of about 12.7x at the end of 2006, including subordinated debt. The senior rating is A, while the rating is BBB for subordinated debt. The subordinated debt was stripped of most of its covenants (no pledge of shares) and the rating resides mostly on strong coverage, and solid performance and demand characteristics. Total DSCR (including notional amortization of principal) is estimated to be 1.4x in 2009 and 2010. Debt amortizes in 2039 for a 99-year concession. Supporting Ratings
Institution/role Deutsche Bank AG as issuer bank account provider and hedging provider Goldman Sachs Group Inc. as hedging provider AMBAC Assurance U.K. Ltd. FGIC UK Ltd. Financial Security Assurance (U.K.) Ltd. Ratings AA/Stable/A-1+ AA-/Stable/A-1+ AAA/Stable/-AAA/Stable/-AAA/Stable/--
68 NOVEMBER 2007
Strengths, Concerns, And Mitigating Factors

Strengths:
The business risk profile is considered Satisfactory To Strong (equating to a high BBB to low
A category) based on long concession, high profitability, and strong free cash flow generation.
The management has a proven track record, with the successful implementation of significant
cost reductions and revenue-enhancing strategy based on market segmentation.

Eurotunnel has the exclusive concession to operate the only fixed transportation link between
the U.K. and France, which runs for another 80 years until 2086.
Strong operating margins: EBITDA margin for Eurotunnel has consistently been over 50%
since 1999.
There are limited capital expenditure requirements resulting in positive free cash flow.
Concerns: The transaction is highly leveraged. The 2.9 billion of novated debt represents about 10.5x 2007 forecast EBITDA, increasing to 3.0 billion or 11x forecast EBITDA in 2013 due to debt accretion.
The amortization holiday may enable distribution to shareholders in the initial years, subject
to a dividend lock-up trigger.

The transaction has a back-ended amortization profile with final maturity in 2050. There is uncertainty regarding future competitive position over the medium to long term, due
to unpredictable behavior of competing transport modes between the U.K. and France.
There is exposure to demand risk from core shuttle services and, to some extent, railway
services, although the latter benefit from some government backing through guaranteed access charges.
As there is no currency hedge, there might be a mismatch between funds available in
euro/sterling and the amount paid in the respective currency.

The ratings do not rely on enforcement of security, as the survivability of the issuers right of
substitution post-insolvency, and the practical implementation of this right, have never been tested.
Mitigating factors:
The transactions high leverage is sustainable and should be considered in view of Eurotunnels
long concession and strong business position, and of a mortgage-style amortization profile to alleviate refinance risk.
The total senior debt will fully amortize by 2050, two years ahead of the RUC term. A payment test based on the synthetic debt-service coverage restricts distributions. The substitution right, coupled with the security package (which includes the right for the
security trustee to appoint an administrative receiver in England), and provisions ensuring that the issuer retains a blocking stake in creditors committees, should put the issuer in a favorable position in restructuring negotiations.
The debt breakdown between British pound sterling- and euro-denominated loans aims to
replicate the revenue breakdown from the U.K. (in British pounds sterling) and from the continent (in euros).
NOVEMBER 2007 69
Transaction Background
In November 2006, Eurotunnels junior- and senior-secured bank debt holders and trade creditors approved a restructuring proposal to reduce the companys debt from 6.20 billion to 2.84 billion. The plan was put forward under the French procdure de sauvegarde granted on Aug. 2, 2006, by the Paris commercial court, to Eurotunnel and 17 related entities. This was followed by the approval of bondholders on Dec. 14, 2006, the approval of the Paris commercial court in January 2007, and a successful share exchange in May 2007. Standard & Poors considers the proposed new financial structure as offering a credible base for future operations and a sustainable leverage.
Tariffs and commercial policy The concessionaires are free to set their tariffs. However, they must not discriminate between users, notably with regard to their nationality or direction of travel. Penalties Any failure by the concessionaires to perform their obligations under the CA entitles the states to impose penalties after a grace period. Early termination of the CA and compensation Each of the states may terminate the CA in the event of a fault committed by the concessionaires if, within six months, the concessionaires have not remedied the relevant breach, and subject to giving prior notice to the lenders of their right of substitution. The CA defines a fault as a breach of a particularly serious nature of the concessionaires obligations under the CA, or ceasing to operate the Fixed Link. Each of the states may terminate the concession for reasons of national defense. In this case, the concessionaires may claim a compensation governed by the law of the relevant state. Each party to the CA may request the arbitration tribunal, established under the Treaty of Canterbury, to declare the termination of the CA in exceptional circumstances, such as war, invasion, nuclear explosion, or natural disaster. In
The Concession Agreement

The Concession Agreement (CA) was signed on March 14, 1986 by the states and the concessionaires, under the Treaty of Canterbury. The CA expires in 2086. Initially entered into for a period of 55 years, the CA was extended by 10 years and then 34 years in 1994 and 1999. Under the terms of the CA, the concessionaires have the right and the obligation, jointly and severally, to design, finance, construct, and operate Eurotunnel (the Fixed Link), and to do so at their own risk, without any government funds or state guarantees.
Transaction Participants
Transaction Participants Borrowers Original lenders Lead managers Substituted entities Issuer cash manager and issuer account provider Security agent, note trustee, and issuer security trustee Facility agent Security trustee Principal paying agent and agent bank Borrowers hedge counterparties Total return swap counterparties Total return swap custodian Issuer corporate services provider Monoline providers The Channel Tunnel Group Ltd. (sterling tranches) and France Manche S.A. (euro tranches) Deutsche Bank AG and Goldman Sachs International Bank Deutsche Bank AG and Goldman Sachs International Sub CLEF Ltd. (the English substituted entity) and Sub CLEF S.A.S. (the French substituted entity) The London branch of Deutsche Bank AG Deutsche Trustee Co. Ltd. The London branch of Deutsche Bank AG Deutsche Trustee Co. Ltd. The London branch of Deutsche Bank AG The London branch of Deutsche Bank AG and Goldman Sachs International Deutsche Bank AG, London Branch and Goldman Sachs International Deutsche Bank Aktiengesellschaft Wilmington Trust SP Services (London) Ltd. AMBAC Assurance U.K. Ltd., FGIC UK Ltd. and Financial Security Assurance (U.K.) Ltd.
70 NOVEMBER 2007
such cases, in principle, no compensation is owed to the concessionaires. However, the states may pay the concessionaires an amount representing the financial benefits, if any, that they may derive from the termination. Any termination of the CA by the states, other than in a situation described above, gives the concessionaires the right to payment of compensation. This compensation is for the entire direct and certain loss actually suffered by the concessionaires and attributable to the states, within reasonably estimated limits at the date of the termination, including damage suffered and operating losses. Substitution Article 32 of the CA provides the lenders with step-in or substitution rights to allow the transfer of the concession and the assets required to operate the concession to two entities owned by the issuer. Step-in rights are triggered by certain predefined events including a payment default under the loan, an insolvency-related event regarding the concessionaires, or if it appears from an objective test that the estimated final maturity date for repayment of lenders will be materially extended. The U.K. and French governments, through a series of government letters, have confirmed that the issuer is a lender for the purpose of substitution, and that the rights to operate the fixed link will be transferred to one French and one English substitution entity. This right of substitution would in any case be subject to French and U.K. government confirmation that the substituted entities have the technical and financial capabilities to undertake substitution--a process that can take up to two months. In addition, under the provisions of intercreditor arrangements, the issuer (and hence the noteholders) always maintains at least 51% of the vote in any creditors committee, allowing the creditors to retain control of any future insolvency/restructuring process. This ensures the ability to effect its step-in rights.
2.84 billion, and the incorporation and formation of a new French holding company which, through an exchange tender offer, holds at least 93% of the current Eurotunnel group. The proceeds from the debt restructuring, as approved by the safeguard procedure, were used to repay Eurotunnels senior debt, Tier 1A, Tier 1, and Tier 2 in cash at 100% of par including accrued interests (892 million); to finance a cash payment to the holders of Tier 3 junior debt facilities; and to pay certain fees, costs and expenses related to the debt restructuring, including any interest accrued on existing Eurotunnel facilities. A subsidiary of Groupe Eurotunnel S.A. issued 1,275 million of notes redeemable in Groupe Eurotunnel S.A.s shares (NRS) that were offered to the Tier 3 debt holders in exchange for their existing 1.78 billion of lendings, and to the bondholders in exchange for their part of the debt. NRS were issued in addition to a cash element paid to both parties. NRS convert into up to 87% of the common equity over three years; they are structurally and contractually subordinated to the senior debt. The dilution may be lessened, however, by the exercise of warrants issued to existing shareholders and bondholders, and the companys ability, depending on its future operating performance, to repurchase the hybrid notes at a premium through proceeds from rights issues, or through the issuance of an additional
Chart 1 Channel Link Enterprises Finance PLC Debt Restructure Summary
Transaction Characteristics
The debt restructuring details The proposed Eurotunnel refinancing plan is structured around the existing concessionaires entering into a new long-term senior loan of
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Termination events under the swap agreements are limited to failure to pay, an event of default and acceleration of the notes, insolvency, illegality, and tax events. There is no foreign-currency hedge, as the debt breakdown between British pound sterling- and euro-denominated loans aims to replicate the revenue breakdown from the U.K. (in British pounds sterling) and from the continent (in euros). This creates foreign-currency risk if the revenue breakdown diverges from the loans currency split. Borrower call option agreement The issuer entered into a borrower call option agreement with the borrower hedge counterparties. Under this agreement, the issuer has an option to purchase a defaulting receivable for sums due but unpaid by the borrowers under their hedge agreements. The purpose is to allow the issuer to keep the borrower hedges current and therefore to avoid a termination of the borrowers swaps. The working capital facility There is a provision for a 75 million working capital facility. The working capital facility ranks pari passu to the securitized loan. Additional debt Obligors under the permanent facility, including the borrowers and Eurotunnel Group, can incur additional secured indebtedness from a third party in connection with certain defined circumstances, including: (a) any refinancing of all or part of the existing facility; (b) a working capital facility up to 75 million; and (c) any tap issues or new issues, subject to compliance with rating and financial tests. The obligors can also incur unsecured financial indebtedness subject to certain caps, rating, and/or financial testing. The intercreditor agreement limits the obligors ability to incur new secured or unsecured indebtedness. If the principal amount outstanding under the permanent facility is lower than 51% of the aggregate principal amount of all financial indebtedness of the group, no member of the group can incur any additional debt unless the facility agent, on behalf of the lenders under the term loan agreement, is granted rights to control 51% of the vote.
Table 1 - Description Of The Structure Of The Facility

Tranche Inflation-linked loans A1 A2 Fixed-rate loans B1 B2 Floating-rate loans C1 C2 350.0 953.0 2050 2050 400.0 367.0 2046 2041 750.0 367.0 2042 2041 Amount Legal maturity
Loan Characteristics
Table 1 summarizes the structure of the facility and details the different tranches. The tranches are all pari passu obligations of the borrowers. Interest on the loan The rate of interest on the loan is the aggregate of the following rate: From the issue date of the notes, a cash margin of 1.39%; A rate equal to 2.097% for tranche A1; A rate equal to 2.587% for tranche A2; A rate equal to 5.241% for tranche B1; A rate equal to 4.792% for tranche B2; A rate equal to six-month LIBOR plus 2% from June 20, 2012 for tranche C1; A rate equal to six-month EURIBOR plus 2% from June 20, 2012 for tranche C2; and Mandatory cost. Redemption profile The loans are payable according to a schedule, and payments start as follows: Tranches A1 and A2 are paid in installments starting on June 20, 2018, and ending on June 20, 2042 and June 20, 2041 respectively; Tranches B1 and B2 are paid in installments starting on June 20, 2013, and ending on June 20, 2046 and June 20, 2041 respectively; and Tranches C1 and C2 are paid in installments starting on June 20, 2046 and June 20, 2041 respectively, and ending on June 20, 2050.
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Chart 5 The Eurotunnel System
back rolling last-twelve-month basis is at least 1.25x; and Certain prepayments, capitalization, or waiver do not give rise to a tax liability. Synthetic DSCR is defined as the ratio of net cash flow (NCF) to the higher of debt service and synthetic debt service. NCF is defined as EBITDA, minus capital expenditures and working capital change, plus any interest revenue received. Synthetic debt service is defined as net finance charges other than the step-up amount, the synthetic amortization schedule of the loan, and any actual amortization profile of any debt obligation other than the loan. Synthetic amortization profile is modeled as if the loan was paid down as an annuity.
Business Profile
Business description Eurotunnel operates the Channel Tunnel between the U.K. (Folkestone) and France (Calais; see the system map in chart 5) under a concession granted by the U.K. and French governments until 2086. The Dover-Calais/Dunkerque corridor (the short straits) is the shortest and most widely used of all cross-channel routes. Eurotunnel offers a service that it operates itself between Calais and Folkestone, and which
competes directly with ferry operators in the transport of passengers, cars, coaches, and trucks in specially designed railway carriages (Eurotunnels own shuttle services generated 56% of 830 million turnover in 2006). It also offers an infrastructure facilitating a direct rail link for the Eurostar trains and freight trains; 50% of tunnel capacity is made available to the British Railways Board (BRB; a U.K. government agency) and Socit Nationale des Chemins de Fer Franais (SNCF; the French stateowned railway operator). Railway revenues represented 42% of turnover in 2006. The tunnel is directly linked to the British and French motorway and railway networks. All rail traffic in the tunnel is controlled from railway control centers on the French and British terminals. The system comprises three tunnels. Two of the tunnels are single-track rail tunnels, which in normal service are used by trains traveling in one direction only. The third tunnel provides a safe means of emergency evacuation and access for maintenance of the tunnel. There are also four crossing points between the rail tunnels, so that when maintenance work is being done on a section of one tunnel, trains can switch to the other.
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Profitability: large portion of operating costs fixed in nature Standard & Poors forecasts the EBITDA margin to remain high and above 50% in the coming years. The yield management strategy, through higher load factors and efficient pricing policy, is expected to keep the operating margin high, with more revenue and yield stability than in the past. In addition, the DARE plan has resulted in a lower break-even level, meaning the company is in a better position to withstand any future economic downturn or increased competition. As summarized in table 2, the combined effects of higher revenues (up 4.7%) and well-controlled operating expenses (up 3.8%) led to an 11.9% increase in EBITDA, to 490 million in 2006. The EBITDA margin reached a record 59% of revenues in 2006, up from 55% in 2005 and 53% in 2004. On the operating expenses side, the main increases in energy costs (up 25%), maintenance costs (up 6%), and local taxes (up 7%), were partially offset by reductions in the cost of consumables (down 11%), in consultants fees (down 10%), and in employee benefit expenses (down 15%). Total revenues for Eurotunnel during the first half of 2007 reached 252 million, 8% down from the previous comparable period. Excluding the effect of the loss of the MUC, revenues have
increased by 7% on trucks, Eurostar and car traffic growth; operating costs have decreased 2% and EBITDA at 56% of revenues rose 15%. If this trend is maintained for the year, 2007 revenues will exceed forecasts, resulting in higherthan-expected DSCR. The second half of the year will however include a proportion of the 88 million restructuring costs. Outlook by revenue segment Truck shuttles. The growth rates in Eurotunnel volume until 2009 are expected to be in line with GDP, reflecting the companys yield focus. In the longer term (post-2009), Standard & Poors estimates that Eurotunnels market share will stabilize, growing by an average rate of approximately 1% to 2% per year. The companys truck shuttle strategy is to give priority and cheaper prices to regular customers, who in return agree to forecast daily volumes. This policy, together with the regained control of distribution channels, has enabled Eurotunnel to match capacity with demand. As a result, load factors on the truck shuttle services have increased to 71% in 2006 from 59% in 2004; and revenue increased by 7% in 2006 over 2005, due to the increase in average prices. The first half of 2007 maintains strong momentum, with volumes up 9%, and overall shuttle revenues up
Table 2 - Eurotunnel Financial Summary

(Mil. ) Income statement (Mil. ) Exchange rate (/) Revenue Operating expenses Employee benefit expenses Operating income Depreciation Current operating income Impairment of property, plant and equipment Other operating income (expenses) Operating profit (loss) Income from cash and cash equivalents Cost of servicing debt (gross) Net cost of financing and debt service Other financial income (charges) Income tax expense Profit (loss) for the year 7 333 5 492 (487) (50) 0 (204) Dec. 31, 2006 1.462 830 219 122 490 164 326 Dec. 31 2005 1.465 793 211 143 438 208 230 2,490 (41) (2,301) 8 497 (490) (18) 0 (2,808) Dec. 31, 2004 1.466 789 213 154 421 228 193 475 (68) (350) 8 501 (493) 6 0 (836) 37 7 (22) 51 (45) 96 (2,490) 48 2,634 (2) (5) 3 (32) 0 2,604 4 (2) (11) 17 (19) 37 2,016 28 (1,951) 0 (3) 3 (24) 0 (1,972) 2006/2005 Change 2005/2004 Change
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8%, on the previous comparable period. Further downside risk cannot be excluded, however, and overall yields may come under significant pressure as ferry companies aggressively and increasingly compete for market share. The new approach has also yielded better visibility in terms of traffic forecasting, as some major customers have entered into multi-year contracts with Eurotunnel. These contracts enable customers to lock in their requirements in terms of number of crossings, and enable Eurotunnel to fine-tune its capacity planning. Further refinements of this approach are planned for 2007. Car shuttles. Standard & Poors considers that this segment will be relatively stable in the future. Eurotunnels share of the passenger car market on the short straits link has reduced to 43.5% in 2006 from 45.5% in 2004. This was largely due to SpeedFerries entry into the market in May 2005, to the gradual increase in Norfolklines passenger capacity in 2005 and 2006, and to the impact of Eurotunnels new commercial strategy. The new Eurotunnel strategy implemented during 2005 has focused on improving yields through dynamic ticket pricing after taking into account the load factor and time of arrival, changing the customer mix in favor of the nondaytrip passengers versus the daytrip passengers, and implementing a 34% reduction in capacity, with less availability for daytrip passengers. With this strategy, Eurotunnel has been able to increase the load factor on its passenger shuttles to 62.5% in 2006 from 45.1% in 2004, and car revenues by 10% (due to the 11% increase in the average yield). The first half of 2007 maintains strong momentum, with volumes up 8% on the previous comparable period. Coach shuttles. The coach market, which has declined by around 4% per year between 1998 and 2006, is expected to remain a marginal contributor to revenues. The continuing decline is due to factors such as the loss of duty-free, and increased competition from airlines for leisure and price-sensitive non-leisure trips. Further decline cannot be excluded in this price-sensitive market. Eurotunnels share of the passenger coach
market on the short straits link has risen to 38.9% in 2006 from 33.5% in 2004. Coach revenues were down 11%, mainly due to lower volumes, which decreased by 13% in 2006 and returned to a level comparable to that of 2004. Average yields increased by a modest 2%. Volumes decreased by another 2% in the first half of 2007 on the previous comparable period. Railways. Railway revenues (including MUC payments) increased by 2% to 350 million in 2006. Excluding the MUC, the underlying increase in railway revenues was 7% in 2006, due in part to the 5% increase in Eurostar passenger traffic traveling through the tunnel. In 2007, railway revenues are not protected by the MUC, and are forecasted to fall by approximately 25% (the actual figure was 27% in the first half of 2007). Passenger rail (Eurostar). Standard & Poors expects Eurostars long-term growth to be in line with GDP, with a market share stabilized a couple of years after CTRL2 (Channel Tunnel Rail Link-2). Eurostar has shown impressive passenger growth since 1997 except between 2000 and 2003, primarily due to low-cost airlines drawing passengers to other destinations. The company has however fallen short of expected volumes, which were overly optimistic. Further material growth is not expected before November 2007, when Eurostars competitive position should benefit from the second phase of the U.K. highspeed link CTRL2 (reducing inter-capital journey time by an additional 20 minutes, and the opening of two additional stations, increasing the catchment area). Thereafter, extension of Eurostars rail links to Amsterdam could potentially add some volume. Growth in Eurostar traffic, which had been restrained by the July 2005 terrorist attacks in London, resumed in 2006. Paris to London passenger numbers were up by 4.2% in 2006, at 5.66 million (and by 4.8% over the first six months of 2007, at 3.90 million). In 2006, Eurostar had 70.2% of the Paris to London passenger market. On the Brussels to London passenger market, the 2006 figures were 2.2 million (up 8.5%) and 71.7% respectively. Eurostar, whose first-half sales were up 13.6% on
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the previous year, announced that it will increase the number of weekday trains it runs between Paris and London in February 2008, to 17 from 15. This is positive for Eurotunnel. Rail freight. Stability of freight revenues in the short-tomedium term is a best-case scenario, while a further reduction is a more likely outcome. Future revenues are uncertain after the end of the subsidy to EWS in 2006, while the service has relied on state subsidy since services commenced in 1996. Also, the impact of the purchase of EWS by Deutsche Bahn AG (AA/Negative/A-1+) from BRB remains to be seen. Eurotunnel considers a possible upside, however. Eurotunnel intends to revive use of the tunnel by revising the fee structure for rail freight, making it cheaper for freight trains to run at night, while charging more at the busiest periods such as Friday evenings and Monday mornings. The move could be related to Eurotunnels intention to directly operate some cross-channel rail freight services (it has an operating license with its Europorte2 subsidiary). The group has purchased locomotives in the first half of 2007 and has also ordered some additional locomotives to Bombardier to be used in the development of its rail freight activity. Rail freight services have tended to fare less well than other Eurotunnel markets. Perhaps the most important episode was the severe disruption associated with asylum seekers using trains to attempt to travel to the U.K. in 2001. This has led to freight users pulling out in favor of other transport alternatives, and the market has never really recovered. The volume of goods transported by freight trains declined by 1% compared with 2005, to 1.57 million tons, after a 16% decline in 2005. In 1998, 3 million tons of freight moved through the tunnel, which is designed to carry a maximum of 10 million tons. In the first half of 2007, traffic volumes were 14% down on the previous comparable period. Competition Eurotunnel is the operator of an essential infrastructure, but its revenue streams are not as predictable as for toll road network, airport, or port operators, which benefit from the
monopolistic nature of their industries. The future strategy of competitors (such as ferry companies and airlines) remains difficult to predict, meaning GDP or market growth does not always materialize in volume or revenue growth. Since 1996 (1997 for Eurostar services), truck and rail passenger volumes have increased, whereas car, coach, and rail freight volumes have tended to fall. The primary competition risks in the passenger market are low-cost and flag airlines and, to a lesser extent, ferry operators. The shuttle service enjoys a competitive advantage in terms of speed, frequency of departures, and reliability, which is reflected in its premium pricing. A significant competition risk stems from the ferry operators P&O, SeaFrance, Norfolkline, and SpeedFerries. Standard & Poors considers the impact on Eurotunnels truck shuttle revenues to be limited as a result of the successful segmentation strategy; the expected impact on car and coach shuttle revenues could be higher, and was factored in the base case. Eurotunnel estimates that its share of the accompanied truck market on the short straits corridor decreased to 36.2% in 2006 from 39.5% in 2005, reflecting its new strategy. Finally, freight trains compete directly with road transport and maritime transport on container ships. Intense competition in the crosschannel freight market between road haulage companies has recently put downward pressure on freight rates, making it more difficult for the railways to compete. The goods transported by freight trains are mainly heavy, lower-yielding items for which speed of delivery is not generally a primary consideration. Capital expenditure and maintenance Scheduled weekly maintenance of the tunnel is organized and structured to minimize disruption to commercial operations and optimize capacity during peak periods. The second cycle of rail replacement began in 2005, and will continue until 2008 without disrupting commercial services. Under current rolling stock maintenance programs, essential maintenance and safety inspections are carried out on average every 21 days for the locomotives, freight shuttles, and passenger shuttles. The largescale maintenance program that began in 2003 is accelerating considerably in 2007, to restore and
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enhance the reliability of equipment that is now approaching one-third or one-half of its overall useful service life. At present, the tunnels capacity does not constrain the development of the different types of traffic. In the medium or long term, capacity could be improved by restricting access to slow freight trains at peak times, and by scheduling trains so that they run in batteries. Medium-term capital expenditures are expected to remain at about 30 million to 40 million per year, and are related to maintenance and upgrade programs. An increase in the existing shuttle fleet does not form part of Eurotunnels current strategy. Eurotunnel aims to take electric power for the entire tunnel from the French national grid, which distributes lower-priced energy than the British grid; this requires limited investment to help better control unhedged electricity costs. At the end of July 2006, Eurotunnel and the railways entered into an agreement, bringing an end to a dispute that began in 2001 over the calculation of the railways contribution to the tunnels operating costs. This confirmed the decisions made for the financial years before 2004, set out the agreement for 2005, and set the contributions on a fixed-payment basis for the Table 3 - Interest By Class Of Notes
Notes Class G1* Interest Formula that accounts for relevant index-linked UKTi and interest rate of 3.487% Formula that accounts for relevant index-linked UKTi and interest rate of 3.487% Formula that accounts for relevant index-linked UKTi and interest rate of 3.487% Formula that accounts for relevant index-linked OATi and interest rate of 3.377% Formula that accounts for relevant index-linked OATi and interest rate of 3.377% Formula that accounts for relevant index-linked OATi and interest rate of 3.377% 6.341% 6.341% Six-month LIBOR plus 1.25% Six-month EURIBOR plus 1.25%
financial years 2006 to 2014 inclusive. A consultation process was also established to determine the railway operators contributions to the renewal, and the related replacement costs. Insurance coverage Eurotunnels insurance program primarily comprises policies covering material damage/business interruption (including terrorism risk) and third-party liability. The material damage/business interruption policy covers for an amount corresponding to the maximum possible loss. The indemnification period for business interruption is 24 months from the start of the interruption. The most notable incident was a major fire in 1996, which interrupted the business for several months, but was covered by the insurance.
The Railways Usage Contract (RUC)

The railways use of the tunnel is governed by the RUC, which runs until 2052. Under this agreement, the railways must pay Eurotunnel a fixed annual charge, and variable charges determined by reference to the number of passengers traveling on Eurostar and the freight tonnage passing through the tunnel. The variable charges are determined according to a toll formula that takes into account inflation to a certain extent and makes adjustments when specified volume thresholds are exceeded. Any change to the RUC requires the lenders approval. Until the end of November 2006, the railways had to make additional monthly payments to bring Eurotunnels annual revenue up to the guaranteed minimum usage charge (MUC). In 2006, Eurotunnel received a total of 350 million in payments: 255 million in variable charges, fixed annual charges, and contributions to operating costs, and 95 million relating to the MUC.
Class G2*
Class G3*
Class G4
Class G5
Note Terms And Conditions

Interest Interest is paid semiannually on payment dates falling on June 28 and Dec. 28 of each year. However, the note interest accrual dates are the relevant loan interest payment dates, being June 20 and Dec. 20 of each year. The eight-day difference between the payment dates under the loans and the payment dates under the notes was
Class G6
Class A1 Class A2 Class A3 Class A4
*The margin is 3.470% until June 30, 2009 and 2.887% thereafter.
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included to allow the issuer to make a drawdown under the liquidity notes in the event of a shortfall, and to enable the trustee to serve a notice of demand under the financial guarantees in the event of a payment default under the loans. The interest paid by each class of notes is summarized in table 3 on the previous page.
Redemption Profile
If the issuer receives any unscheduled prepayment amount from the borrowers, it prepays the debt outstanding on a pari passu basis with the following priority: Any amounts due and payable on the X certificates; Any principal redemption amounts on the prepayment due on the corresponding tranches of the notes; and Any make-whole prepayment to the corresponding tranche of notes. On a mandatory prepayment, the issuer prepays the notes pro rata, except where the prepayment relates to refinancing of all or any tranche of the permanent facility, in which case the proceeds are applied by the issuer to redeem the corresponding tranches of notes pro rata. Each class of notes can be paid in whole or in part, subject to certain prepayment penalties, and in a minimum amount of 5.0 million or 7.5 million. On a substitution event of the existing concessionaires and the acceleration of the permanent facility, the issuer sweeps cash received to redeem the notes, unless it can invest in eligible investments that replicate the payment on the notes. Early redemption and the authorized investment (AI) Option Under condition 10(h), the monolines hold an option that can be exercised upon a full or partial prepayment of the tranche A loan (that corresponds to class G notes at the issuer level) in case the proceeds from prepayment of the loan are not sufficient to pay the relevant note redemption amount plus the net present value of the financial guarantee fee, provided no loan event of default has occurred. This option allows the monoline to invest the amount prepaid (which normally would have been applied in redemption of the tranche G notes) in a defeasance account to be invested in authorized investments. Such
investments need to produce amounts at least equal to amounts payable in respect of the notes (including the guarantee fee) on each scheduled payment date in respect of this principal amount and in respect of the relevant proportion of the tranche A loan prepaid. Practically, if the monolines exercise this option, they have to make sure that a defeasance account is opened with the issuer bank account provider in the name of the issuer--one for each class of G notes that would have been prepaid if the option were not exercised. In addition, a custodian is appointed with regard to defeasance accounts to hold the monoline authorized investments on the issuers behalf. The cash standing on these accounts together with the proceeds generated by the monoline authorized investments is taken into account in the waterfall for the payment of interest and principal of the relevant class G notes. This is because the loan has been prepaid and therefore no further interest or principal is paid by the borrower on that portion of the loan. If the tranche A1 or A2 loan has been prepaid in full and the authorized investment (AI) option has been exercised by the monolines, the trustee notifies the tranche G noteholders. Once the noteholders have been notified, within 30 days, they can ask to redeem the tranche G notes that they hold to the extent that the notes would have been redeemed had the prepayment not been the subject of the AI option. The amount received by the relevant tranche G noteholder follows the payment of amounts due to the relevant monoline. Issuers pre-enforcement priority of payments Before enforcement, the issuer applies the available funds plus any liquidity drawings, save that (i) if the monoline has exercised the AI option, any AI receipts generated from a certain defeasance account are used only to pay the relevant monoline or the relevant class G noteholder for which that account has been opened, and (ii) if the noteholders have exercised their AI option, the amounts received in the relevant defeasance account are used only to repay the relevant monoline, in the following order: Senior expenses related to the transaction, including trustee fees, rating services fees, and corporate servicer fees, total return
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swap custodian, plus any moneys to be paid into the issuers expenses reserve accounts and any amounts to be credited to the liquidity accounts up to the required liquidity amount; Any interests due on the liquidity notes; Any principal due on the liquidity notes; Any amount due to the TRS counterparties; Any amount due to the borrower hedge counterparties; Pro rata and pari passu, according to the respective amounts; Any interest due or accrued, any principal, any amount in excess of the par amount (always excluding step-up fees) on the tranche A notes, and any counterparty fixedrate note payment under the margin basis swap. All such amounts are applied pro rata and pari passu to all tranche A notes, but within each tranche applied according to the following order: Interest due and accrued; Principal due; and The amount in excess of the par amount upon early redemption and any counterparty fixed-rate note payment under the margin basis swap. For each class G note depending on the monoline, the aggregate of: (i) guarantee fees and other amounts then due to the relevant monoline, taking into account any AI receipt for that amount; (ii) all amounts of interest due or taking into account any AI receipt for that amount; (iii) any principal taking into account any AI receipt for that amount; and (iv) any amounts in excess of the indexed par amount payable on early redemption due and payable on the relevant tranche G notes, taking into account any AI receipt for that amount. This amount is applied pro rata and pari passu for the relevant tranche G notes, but in the following order of priority: Guarantee fees and other amounts due to the relevant monoline; Interest due and accrued on the relevant tranche G note; Any amounts to be reimbursed to the relevant monoline with regard to any interest paid under the guarantee; Scheduled principal due on the relevant tranche G note;
Any amounts to be reimbursed to the relevant monoline with regard to any scheduled principal paid under the guarantee; Any amounts to be reimbursed to the relevant monoline with regard to any unscheduled principal paid under the guarantee; Any amount of unscheduled principal due to the relevant tranche G notes; and Any amount in excess of the par amount upon early redemption on the relevant tranche G note. Step-up amounts on the class A3 and class A4 notes; Additional amounts including withholding tax gross-up; Any subordinated amounts to the hedge counterparties; and The amount in the issuers transaction account to the holder of the class R certificates, once all the amounts on the notes listed above have been paid in full.
The issuers post-enforcement waterfall is the same as the issuers pre-enforcement priority of payments, except for additional payments to the trustee on enforcement. Notes events of default The issuers events of default are limited to: Nonpayment under the notes; Failure to comply with the transaction documents; Misrepresentation; and Insolvency. Controlling creditors The controlling creditors are the monolines for as long as the wrapped tranches G1, G2, G3, and G4 are outstanding, or any payment due to the monolines is still outstanding. Once the tranche G notes have been redeemed in full and no further payments are due to the monolines, the tranche A1 and A2 notes become the controlling creditors. When the tranche A1 and A2 notes have been fully redeemed, the control passes to the tranche A3 and A4 noteholders. Once all the tranche G and A notes are redeemed, the trustee acts on behalf of the liquidity noteholders.
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Credit And Cash Flow Evaluation

Standard & Poors analysis focused on a stressed business plan and EBITDA levels from the managements base case. The companys case that was used for the debt restructuring was elaborated in 2005 on reasonable assumptions. Standard & Poors implemented a 20% haircut to the net present value (NPV) of the companys net cash flow (NCF) (equivalent to 23% of the sum of revenues) on the life of the transaction. In this case, the business grows on average by a nominal 2.2% per year. Bearing in mind that Eurotunnels management case is already operating at a fairly low level, Standard & Poors estimates that the level of stress implemented is commensurate with a BBB rating. Eurotunnels significant tax loss carry-forward allows all the pre-tax cash flow to be used for
debt service in the first 10 years or so. NCF is used for the DSCR calculation. At the borrower level, under the management base case, the minimal scheduled NCF DSCR is at 1.48x (first year); it then improves, reflecting the expected volumes and cash flow growth. Under Standard & Poors stressed case, the ratio reaches a minimum of 1.36x in year six when principal amortization kicks off. This is a low but acceptable ratio for a concession with volume risk. That is above the 1.1x event of default covenant. The results from the cash flow analysis are shown in table 4. As a result of Standard & Poors cash flow analysis, 2.9 million (or 10.5x forecast EBITDA) is considered commensurate with a BBB rating. Given the hybrid nature of the business, the
Table 4 - Cash Flow Analysis Compared Outcomes Under Management And Standard & Poors Cases
June 30, June 30, June 30, June 30, June 30, June 30, June 30, June 30, June 30, June 30, 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
NCF DSCR (scheduled)

Management case (x) Standard & Poors case (x) Management case (x) Standard & Poors case (x) Management case (x) Standard & Poors case (x) 1.48 1.47 1.54 1.44 1.62 1.46 1.67 1.49 1.75 1.53 1.59 1.36 1.63 1.40 1.73 1.44 1.90 1.48 2.05 1.53
Debt/(EBITDA-essential capex) 12.53 12.64 12.11 12.90 11.54 12.81 11.18 12.53 10.72 12.27 10.28 11.95 10.01 11.58 9.41 11.22 8.52 10.87 7.89 10.52
Synthetic DSCR (NCF/(Higher of actual and synthetic DS))

1.33 1.31 1.37 1.29 1.45 1.30 1.50 1.33 1.56 1.36 1.59 1.36 1.63 1.40 1.73 1.44 1.90 1.48 2.05 1.53
NCF ICR
Management case (x) Standard & Poors case (x) (FFO + interest)/interest Management case (x) Standard & Poors case (x) 1.75 1.72 1.80 1.70 1.92 1.68 1.99 1.70 2.00 1.72 2.07 1.76 2.17 1.82 2.28 1.88 2.42 1.95 2.58 2.02 1.48 1.47 1.54 1.44 1.62 1.46 1.67 1.49 1.75 1.53 1.82 1.56 1.88 1.62 2.01 1.68 2.23 1.74 2.42 1.80
FFO/Net debt
Management case (%) Standard & Poors case (%) 9.2 9.1 9.4 8.9 10.0 8.8 10.4 8.9 10.4 9.0 10.8 9.2 11.3 9.5 11.9 9.8 12.5 10.1 13.3 10.4
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length of the concession, and its bi-national economics, it is impossible to find a suitable peer to Eurotunnel.
Accounting Issues
Since December 2005, Eurotunnel Groups financial statements have been prepared in accordance with IFRS. Going concern The auditors and Commissaires aux Comptes have reported on the 2006 accounts. Their report contained matters of emphasis relating to going concern, the valuation of property, plant, and equipment, the consequences of the implementation of the safeguard plan on the accounts, and the nonapproval of the 2005 accounts. Treatment of the accounts on a going concern basis depends on the full implementation of the safeguard plan, which seems increasingly likely now that the exchange tender offer has been successful, with 93% of the share capital finally tendered. Going concern involved, notably, the drawing of the term loan (this has now been successfully implemented), and the failure of any legal action aimed at blocking the safeguard plan (all recourses seem to have been rejected). If all of the elements of the safeguard plan are not put into place, Eurotunnels ability to trade as a going concern would not be assured. The accounts would be subject to certain adjustments, whose amounts cannot be measured at present. The adjustments would relate to the impairment of assets to their net realizable value, the recognition of liabilities, and the classification of noncurrent assets and liabilities as current assets and liabilities. The asset value on liquidation has been estimated at 890 million by the valuer/auctioneer appointed by the safeguard procedure. Impairment of property, plant, and equipment Since 2003, the group has applied IAS 36 methodology, which requires the net book value of assets to be compared with discounted future operating cash flows. The application of this standard at Dec. 31, 2005 gave rise to a value in use 1.75 billion lower than the net book value of the assets, and led to an impairment charge for this amount in the 2005 accounts. Impairment charges for 1.3 billion and 395.0 million were already made in the 2003 and 2004 accounts.
The recognition of impairment charges at Dec 31, 2005 caused Eurotunnels main companies to have negative total equity. Under the safeguard plan, these companies equity was reconstituted through debt capitalization after the tender offer. In 2006, Eurotunnel did not make any impairment charge. The depreciation charge decreased by 21% in 2006 following the impairment charge in 2005.
Recovery Rating Analysis

Standard & Poors assigned a recovery rating of 2 to the 2.84 billion senior secured loans. This indicates Standard & Poors expectation of substantial (70% to 90%) recovery of principal in the event of a payment default. Approach For the loan recovery estimate, Standard & Poors combined an NPV approach (akin to project finance transactions) with a debt multiple approach (as for corporates), reflecting the hybrid nature of Eurotunnel. Standard & Poors used an enterprise valuation based on going concern because it considers that greater value will remain in the business if it is reorganized rather than liquidated. Based on the live example of Eurotunnels debt negotiations and financial restructuring between 2005 and 2007, Standard & Poors assumes that an event of default at the borrower level would be followed by a successful negotiation with the creditors, leading to a consensual debt restructuring instead of a substitution. The new debt structure is becoming much simpler, favoring a consensual restructuring. Payment default scenario Standard & Poors simulated payment default assumes a severe traffic shock in 2013, leading to a borrowers default at the time of the first principal payment that year. In 2013, the borrowers total debt service will be about 182 million; NCF needs to fall to 200 million for an event of default on the term loan. Assuming 15 million of saving could be made on capital and operating expenditures, the event of default requires EBITDA to fall to approximately 225 million (a 20% fall under Standard & Poors scenario, which is already stressing the managements case). Following the event of default at the borrowers
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level, Standard & Poors assumes the issuer would have to draw entirely on its debt-service reserve facility to meet its obligations on the notes. Estimated recovery Under the NPV approach, Standard & Poors assumes EBITDA to remain constant at 230 million per year in real terms (assuming an annual 2% inflation) from 2015 until 2050 (with capex and WC assumptions unchanged). The LLCR (loan life cover ratio) at year 2015 is at about 0.9x, calculated with a discount rate of 8%. Standard & Poors focused more on LLCR than on CLCR (concession life cover ratio); although the concession matures in 2086 and there will be cash flows beyond 2050, the visibility of cash flows more than 40 years from now is limited (especially as the RUC ends in 2052). In addition, with regard to the period between 2052 and 2086, the concessionaires will be obliged to pay to the states a total annual sum, including all corporate taxes of any kind, equal to 59% of all pre-tax profits. Under the debt multiple approach, Standard & Poors has estimated the recovery prospects based on: A similar distressed EBITDA base of about 230 million; and Average valuation multiples of 8x to 10x, representing a haircut with the current restructuring (10.5x to 11x), and more in line with some other infrastructure deals. This would result in a recovery ranging from about 60% to 74%.
84 NOVEMBER 2007
COPENHAGEN AIRPORTS A/S

Publication Date:
July 23, 2007 Issuer Credit Rating: BBB+/Stable/-Primary Credit Analyst: Maria Lemos, CFA, London, (44) 20-7176-3749 Secondary Credit Analyst: Alexandre de Lestrange, Paris, (33) 1-4420-7316
Rationale
The rating on Copenhagen Airports A/S (CPH) is supported by the airports strong competitive position as a natural hub for Scandinavian countries. The rating also reflects CPHs efficient aviation and strong commercial operations, the adequate regulatory environment, strong cash flow generation, and sound financial flexibility. Offsetting these strengths are CPHs relatively large proportion of transfer traffic and high customer concentration. The rating is also constrained by the companys weakened financial profile following Macquarie Airports (MAp)s (BBB/Stable/--) acquisition of a controlling stake in CPH in December 2005 through financing vehicle Macquarie Airports Copenhagen Holdings ApS (MACH; BBB+/Stable/--). As a result of this partial acquisition we consolidate MACHs debt with CPHs own Danish krone (DKK) 2.0 billion debt (about 269 million), given the level of MACHs control and ownership. The acquisition debt is nonrecourse to CPH, however, leaving CPHs pre-existing debt structure unaffected. Copenhagen Airport handled 20.9 million passengers in 2006. In the first half of 2007, traffic increased by 2.3% year on year on the back of increased flight frequencies and new routes. CPH enjoys a strong competitive position, supported by its main carrier Scandinavian Airlines (SAS), which uses the airport as its regional hub. Nevertheless, CPHs proportion of transfer traffic has been declining since 2003, albeit remaining high at about 30%, which Standard & Poors Ratings Services considers a weakness. Moreover, the company derives about half of its passenger volume from SAS and runs the risk of losing part of its transfer traffic if SAS ceases to operate. CPH achieved an EBITDA margin of 54.1% in 2006--which is high compared with peers--owing to its efficient operations, strong cost manage-
ment, and successful commercial operations, which rank among the best in Europe. At June 30 2007, gross debt at MACH and CPH combined declined to DKK7.1 billion, from DKK8.9 billion at Dec. 31, 2006, as proceeds from a special dividend distribution from CPHs associated company Newcastle International Airport Ltd. and from the sale of CPHs Chinese and part of its Mexican operations were used for debt repayment. At end-December 2006, funds from operations (FFO) to average total debt and FFO interest coverage were 12.6% and 3.2x, respectively, and free cash flow generation was DKK494.7 million, according to Standard & Poors calculations. Liquidity CPH has strong liquidity. At June 30, 2007, the company had about DKK1.0 billion in unused committed bank lines and DKK225.4 million in cash. Debt maturing within the next five years is not a concern, because maturities are manageable and we expect CPH to remain cash flow positive after dividend distributions. Liquidity is further supported by a modest and flexible capital expenditure program.
Outlook
The stable outlook reflects our expectation that CPH will maintain its strong competitive position and focus on growth of internal cash flow generation. Free cash flow generation is expected to continue, but is unlikely to result in significant early debt repayments given our expectation that the company will use the cash for dividend payments and capital spending. Any capital return to shareholders will limit rating upside. Major industry events causing a consistent passenger volume decline or a significant deterioration in SAS operations could pressure the rating, as could a further increase in leverage.
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DEUTSCHE BAHN AG
Publication Date:
Sept. 19, 2007 Issuer Credit Rating: AA/Negative/A-1+ Primary Credit Analyst: Ralf Etzelmueller, Frankfurt, (49) 69-33-999-123 Secondary Credit Analysts: Eve Greb, Frankfurt, (49) 69-33-999-124 Amrit Gescher, London, (44) 20-7176-3733
Rationale
The ratings on Germany-based integrated railway and logistics company Deutsche Bahn AG (DB AG) reflect the companys strong business risk profile derived from its dominant position and strategic importance in the German transport sector, as well as the close relationship with, and support from, its current 100% owner, the Federal Republic of Germany (AAA/Stable/A-1+). DB AGs strengths are offset by an intermediate financial risk profile and uncertainties related to the expected privatization of up to 49% of the companys capital. Standard & Poors Ratings Services applies a top-down rating approach for governmentsupported companies, which notches down from the sovereign rating, as the credit standing is linked to that of the government. The ratings on DB AG, which are two notches lower than those on Germany, reflect the absence of direct state guarantees for outstanding debt and that timeliness of financial support for the company is not explicitly guaranteed. Nevertheless, the state has demonstrated its support for DB AG through the full backing of its acquisitions and investments in recent years, significant direct grants for network investments, and indirect payments through the regional states for services provided by DB AG and its subsidiaries. Ministry officials have also repeatedly given clear statements to Standard & Poors that the state will continue to support DB AG in its current form and ensure that it maintains a sustainable credit profile. DB AG continues to provide essential railway services within Germany, but its acquisitions, mainly in the logistics sector, have transformed the company into a worldwide integrated mobility and logistics firm that in 2006 derived about 50% of its revenues from non-railway services. State support is therefore a key consideration for the AA rating, as Standard & Poors assesses the business risk profile of the logistics industry as weaker than that of the railway business, and DB AGs current stand-alone financial risk profile is not in line with an AA rating. DB AGs first-half 2007 results were in line with Standard & Poors expectations and boosted by a strong performance across all business areas. DB AGs financial debt decreased by about 600 million to 18.9 billion compared with the end of December 2006 and its EBIT improved by
about 400 million to 1.35 billion. Standard & Poors expects that DB AGs key debt and interest coverage ratios will improve further in 2007. Moreover, we expect that the company will continue to reduce leverage and improve its financial risk profile over the medium term. Short-term credit factors DB AGs liquidity remains strong, owing mainly to its easy access to capital markets and a comfortable cash position of 992 million at the end of June 2007. In our view, DB AG should be able to refinance upcoming maturities owing to its very good access to the capital markets. In addition, the company has sound liquidity through committed bank facilities.
Outlook
The negative outlook reflects our concerns and questions related to the expected partial privatization that was approved by the German government on July 24, 2007. Areas of uncertainty are DB AGs ability to continue reducing leverage under a partial privatization, whether it could come under pressure to make dividend payments that are currently not part of its financial forecasts, and whether it would potentially adopt a more aggressive acquisition strategy. We will need to assess whether similar government support will and can be provided for the privatized entity. The service and financing agreement currently being negotiated would suggest consistent levels of financial commitment for extended time periods. We would also need to assess the company structure post privatization. An important factor will also be how much of the privatization proceeds will be used to improve the companys balance sheet. After a minority privatization, we expect to switch to a bottom-up rating approach, most likely still factoring in state support, but reflecting reduced government ownership in the business. We would also adopt this approach if DB AG made additional large acquisitions in the meantime, similar to those of logistics companies BAX Global and Stinnes AG, which would further expose DB AG to logistics activities. The latter could have negative rating implications, as the business risk would increase because strategic rail and infrastructure services would become less relevant.
86 NOVEMBER 2007
DP WORLD LTD.
Publication Date:
June 13, 2007 Issuer Credit Rating: A+/Stable/A-1 Primary Credit Analyst: Jonathan Manley, London, (44) 20-7176-3952 Secondary Credit Analysts: Florian De Chaisemartin, London, (44) 20-7176-3760
Rationale
The ratings on Dubai-based port operator DP World Ltd. principally reflect Standard & Poors Ratings Services expectation of sovereign support based on the companys indirect ownership by the government of Dubai and its pivotal role in diversifying the emirates revenues away from oil and fostering international expansion. DP World is a major international port operator and its key activities in Dubai benefit from a strong hub position. DP World also has geographic diversification after recent large international acquisitions. Like other port operators, DP World is exposed to the global economy and developing international trade streams, particularly to and from China and India. The company is also likely to face heightened port competition for transshipment along with increasing consolidation in the shipping industry. Given DP Worlds national importance, Standard & Poors has factored implicit sovereign support into the rating; there are, however, no formal guarantees. State support for DP World is demonstrated by: the emirates 100% ownership through its Dubai World holding company; the emirates direct influence over the company through Dubai Worlds representation on DP Worlds board, including the position of chairman; the companys strategic importance as a conduit for diversifying the economy of the emirate away from oil; and the previous tangible financial, operational, and extraordinary support for the companys activities. The companys standalone rating is solid investment grade within the BBB rating category. DP World benefits from a strong position in the global ports sector, where barriers to entry are high. The company has a highly diversified revenue base in terms of location and cargo, significant sector experience, and a good operating track record. DP World is not an integrated business, however, in that it is not, at present, a landlord. Within this context the emirate has demonstrated its support of DP World by awarding the company a 99-year lease for the Jebel Ali port facility located in Dubai-against an industry norm of 20-50 years--while making significant infrastructure investments in the hinterland surrounding the port. Reflecting the importance of the company to the emirate, Standard & Poors expects a significant
proportion of the companys EBITDA to continue to be generated at the Jebel Ali and Port Rashid facilities in the medium term. Port activity is either as a transshipment hub or for the import and export of goods for a region or hinterland. The more a port relies on transshipment, the more it is exposed to world trade development. The port sector, like shipping, is experiencing very brisk business due to the current positive economic climate and, especially, Chinas and Indias growth. Clearly, DP Worlds ports--like other ports--would be negatively affected in the event of a global economic downturn or changes in trade patterns and/or volumes. A potential industry downturn could be exacerbated by increasing bargaining power, due to size, mounting concentration of container shipping companies, and intensifying competition between ports for transshipment cargo. Furthermore, the company faces the potential geopolitical risk of the location of its main port asset--Jebel Ali--in the Gulf region. DP Worlds recent, sizable acquisitions include Peninsular & Oriental Steam Navigation Co. (P&O) and CSX World Terminals. The company has consequently faced the challenge of integrating these assets while maintaining existing performance and deriving expected returns from the new acquisitions. Furthermore, although the company may have some degree of flexibility over its future capital expenditure program, it needs to maintain its competitive position against other operators by investing in new technology and undertaking new projects, such as the recently announced 1.5 billion investment in the complex London Gateway Port facility. The company has a relatively aggressive financial profile. Debt leverage is likely to increase, primarily as a result of the debt financing of capital expenditures. At the same time, cash flow cover ratios are relatively low, leaving limited room for underperformance in executing future capital investment. There may be flexibility to postpone or cancel planned capital expenditures, however, should the need arise. Liquidity At Dec. 31, 2006, DP World benefited from more than $2.2 billion in back-up liquidity, primarily through free cash of $1.7 billion. The companys future primary liquidity will, however, be provided via credit facilities of $0.5 billion. In
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addition, DP World will likely be able to call on Dubai World to provide liquidity, as has occurred previously to fund acquisitions.
Outlook
The stable outlook assumes that DP World will continue to benefit from its close strategic relationship with, and ownership by, the government of Dubai. Any indication that the governments support for the company has weakened would result in a change in the rating although, of itself, the sale of a minority stake in the company would be unlikely to affect the ratings. The outlook also assumes that the company will successfully execute its business plan and fulfill its financial forecasts, in the light of any global economic downturn, increased competition, and successful execution of the capital expenditure program, including acquisitions.
88 NOVEMBER 2007
SANEF
Publication Date:
June 7, 2007 Issuer Credit Rating: A/Negative/A-1 Primary Credit Analyst: Alexandre de Lestrange, Paris, (33) 1-4420-7316 Secondary Credit Analyst: Lidia Polakovic, London, (44) 20-7176-3985
Rationale
The ratings on Sanef are equalized with those on Abertis Infraestructuras S.A. (A/Negative/--). Following its privatization, Sanef is controlled by Abertis through 52.6%-owned Holding dInfrastructures de Transport S.A.S. (HIT; A/Negative/--), the intermediary vehicle that acquired Sanef. The rating on Abertis reflects the companys excellent business profile, with strong and stable cash flow generation derived largely from its tollroad concession business, a supportive regulatory framework both in Spain and France, and fairly manageable future capital-expenditure needs. These strengths are offset by Abertis weakened financial profile and lack of dividend flexibility, as well as its appetite for additional acquisitions, which could further impair its business and financial profile. It is important to note that without this support, HIT and Sanefs underlying credit quality would be significantly weaker. On a combined, stand-alone basis, HIT and Sanef would have very low investment-grade ratings. If Abertis continued acquisitive strategy significantly reduces Sanefs contribution to Abertis consolidated financial profile, HIT and Sanef could be rated one notch below Abertis. The ratings on Sanef reflect its strong market position as the third-largest interconnected tollroad network across key economic and tourist corridors in France, supportive concession agreements, high profitability, and increasing positive free cash flow generation. These strengths are offset by Sanefs exposure to traffic risk, a weakened financial profile following its acquisition by HIT--particularly when HITs debt is factored in--and aggressive dividend payout to HIT limiting debt burden curtailment and exposing lenders to substantial refinancing risk. In the financial year ended Dec. 31, 2006, Sanefs consolidated EBITDA amounted to 809 million, up 8.6% on 2005. EBITDA essentially derived from toll revenues, which grew 6% in 2006, and should continue to represent 90% or more of revenues over the medium term. The unadjusted EBITDA margin increased to 66%. Consolidated HIT and Sanef net debt peaked at about 6.8 billion (excluding Sanefs debt revaluation following acquisition), in line with expectations, at year-end 2006. With a consolidated net-debt-to-EBITDA ratio of 8.7x, the companies were still comfortably complying with the consolidated covenants at HITs level (maximum ratio of 10.5x) at year-end 2006. Based on the consolidated covenants at the HIT level, leverage is expected to decrease to 6.5x at year-end 2012. Sanefs group net debt at 5.2x EBITDA at year-end 2006 is still well below the threshold of 7.0x set by Caisse Nationale des Autoroutes (AAA/Stable/--). Liquidity Sanefs liquidity is satisfactory, owing to steady cash flow generation stemming from the tollroad business. Financing needs for 2007 include some 469 million of debt maturing until Dec. 31, 2007, and a forecast 176 million dividend payment to HIT based on 100% payout of 2006 net income. These were partially covered by available cash and marketable securities of 223 million at yearend 2006 and expected positive free operating cash flow (defined as funds from operations {FFO} plus working capital change, minus capital expenditures) of about 280 million in 2007, making debt refinancing necessary.
Outlook
The negative outlook mirrors that on Abertis and reflects mainly our concern that Abertis is now pursuing a more aggressive acquisition strategy following the purchase of a 32% stake in Eutelsat Communication S.A. (BB+/Stable/B), the holding company of Eutelsat S.A. We expect Abertis to be able to meet the target ratios we indicated on June 1, 2006: FFO to gross debt of about 13%-15% and FFO interest coverage of about 3.5x-4x. We expect Abertis to approach the lower end of these ranges over the next two years, and to make continued improvements toward the higher end of the ranges thereafter. Abertis does not have headroom for further debt-financed acquisitions at the current rating level. A stronger-than-originally-expected financial performance could lead to a revision of the outlook to stable on Abertis, and therefore on Sanef and HIT.
NOVEMBER 2007 89
VINCI S.A.
Publication Date:
June 11, 2007 Issuer Credit Rating: BBB+/Negative/A-2 Primary Credit Analyst: Alexandre de Lestrange, Paris, (33) 1-4420-7316 Secondary Credit Analyst: Hugues De La Presle, Paris, (33) 1-4420-6666
Rationale
The ratings on VINCI S.A. reflect its strong market positions in a wide variety of concession and construction activities, and the considerable contribution from its stable and profitable concession businesses--59% of pro forma operating profit from ordinary activities in 2006. These strengths are mitigated by the capitalintensive nature of the concessions business, high leverage, the cyclical and relatively lower margin nature of construction activities, and VINCIs acquisitive strategy. At the beginning of 2007, VINCI increased its stake in Cofiroute, and is to do so in Soletanche (subject to approval by antitrust authorities). It acquired Nukem Ltd. and recently announced that it had agreed the acquisition of 41% of Entrepose Contracting and will file a takeover bid covering the remaining Entrepose Contracting shares within the next few days. Standard & Poors Ratings Services will monitor the impact of VINCIs flow of acquisitions on the groups business and financial risk profiles. The current ratings do not provide flexibility for any new large debt-financed acquisitions. Overall, we view the recent acquisitions as positive for VINCIs business, even though they have increased leverage and pay-off for the Cofiroute stake will only come when Cofiroute completes its large construction program in 2008. Given that VINCI had ownership in or commercial involvement with these entities prior to the transactions, acquisition risk is limited. Nukem Ltd. and Entrepose Contracting will complement VINCIs presence in value-added and specialty businesses, while broadening geographic coverage in rapidly growing markets. The share buyback of 12 million of VINCI shares announced in September 2006 (to the tune of more than 1 billion) has been factored into the ratings. However, our concerns on how VINCI intends to finance further buybacks and over its appetite for further external growth contribute to the negative outlook on the group. VINCI has, however, announced to investors that it will be less active on the share buyback front if interesting external growth opportunities arise. Acquisitions have delayed the improvement of the groups financial profile and VINCIs credit ratios will weaken slightly in 2007 versus 2006, despite an expected strong operating performance. However, we still expect the company to achieve
a financial profile commensurate with the BBB+ rating, strengthening funds from operations (FFO) to net debt and FFO to net interest to about 20% and 5.0x by 2010, respectively, from 15% and about 4.5x in 2007. At year-end 2006 and on a pro forma basis, adjusted FFO to net debt was about 16%, and adjusted FFO to net interest close to 5.0x. Short-term credit factors The A-2 short-term rating reflects VINCIs good liquidity, which stems from the groups cashgenerative toll road and construction businesses. Liquidity was supported by about 5.5 billion of cash and marketable securities at March 31 2007. VINCI also had 5.7 billion fully available under five- to seven-year revolving credit facilities (out of which 3.9 billion is not subject to financial covenants) maturing between 2011 and 2013. This figure includes ASFs and Cofiroutes facilities. In addition, VINCIs liquidity benefits from a CP program--of which about 1 billion was used at March 31, 2007--and positive free cash flow generation. A downgrade or negative CreditWatch placement of the ratings on VINCI following a winding up or dissolution of the company would allow bondholders to demand early redemption of the 1 billion bonds maturing 2009, and in this case refinancing would be required. A normal acquisition would not trigger early redemption, however. Early redemption of the 1 billion bonds could also be required if VINCI is placed on CreditWatch negative following the transfer of a principal subsidiarys undertakings and assets. Principal subsidiary refers to a 51%-owned (85% for Cofiroute) subsidiary accounting for more than 1% of total sales, where the group has a board majority. We do not, however, expect any transfer of assets that would lead to early redemption of the bonds. VINCIs 500 million hybrid issued in February 2006 does not include a change of control clause.
Outlook
The negative outlook reflects our concerns that debt-financed acquisitions and share buybacks further to those we have already factored into the ratings could weaken VINCIs financial profile and delay the achievement of target ratios.
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To sustain a BBB+ rating, VINCIs strong business risk profile requires continuing support from its solid and mature concessions businesses, which provide about two-thirds of EBITDA. The ratings will be lowered if the financial profile deteriorates or the target ratios are not met by 2010. Beyond what we have already factored into the rating in terms of acquisitions, share buybacks, public private partnership (PPP) investments, and dividends, there is very little headroom for a weakening in the financial profile. We have not assumed a further increase in VINCIs ownership of Cofiroute. The outlook could revert to stable if it becomes clear that the company will achieve its target ratios by 2010, meeting our strategy expectations. The improvement of VINCIs credit metrics is predicated on improved cash flow generation, rather than debt reduction.
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PROJECT FINANCE/PUBLIC-PRIVATE PARTNERSHIPS
PROJECT FINANCE
AND
PUBLIC-PRIVATE PARTNERSHIPS
ur project finance ratings, including those for public-private partnerships (PPPs), remain relatively stable. Notwithstanding this, 2007 has continued to present credit challenges to the sector. The 1.6 billion debt-financed Metronet London Underground PPP projects, for example, entered PPP administration as the capital cost and progress of undertaking the upgrade works outstripped expectations. While the resolution of this situation is yet to unravel, the 2.8 billion launch of the Channel Link Enterprises transaction marked the rebirth of the Eurotunnel project--albeit following a significant reduction in debt. Our coverage of projects and PPPs continues to grow, particularly in the U.K. PPP sector for schools and hospitals, in road projects throughout Europe, and natural resource projects in the Middle East. Furthermore, increased activity has been noted in the project finance CLO market--where banks seek to transfer credit risk on existing project finance loans--as effective ways of recycling capital are sought. Although only one such transaction launched in 2007 (Smart PFI 2007), many wait in the wings until stability returns to the credit markets. During 2007, Standard & Poors updated its criteria for analyzing project finance transactions. While the overall framework for evaluation remains the same, our criteria has evolved to reflect the pace of change presented by the project finance market. Globally Standard & Poors has identified increasing risks and complexity in project structures, including accreting swaps, the introduction of facilities instead of reserves to support liquidity, and the removal of debt-free tails. All of these areas, and others, have been considered by the global analytical teams in the past year and, no doubt, 2008 and beyond will continue to present new challenges. As the infrastructure market has, at least until recent months, remained very much the focus of attention, so has the application of project finance techniques to corporate acquisition structures. The sponsors aim has been to isolate the acquired structure from their ownership. This has often proven to be a challenge and, in effect, a hybrid market has evolved that reflects the characteristics of corporate finance but with some of the structural protection of project finance. Although there are benefits from certain protections, it has proven elusive for many airport and port assets, for example, to fully mitigate the highly aggressive financial risk. We expect ratings to remain stable overall, as projects and PPPs are likely to continue to be structured to ensure relative operating stability. Nevertheless, counterparty risk such as the insolvency of contractors, inadequate estimates of future costs, and increasing construction costs in the Middle East present challenging credit factors that we will continue to monitor.
Jonathan Manley Senior Director and Co-Team Leader Project Finance and Transportation Infrastructure
Lidia Polakovic Senior Director and Co-Team Leader Project Finance and Transportation Infrastructure
92 NOVEMBER 2007
UPDATED PROJECT FINANCE SUMMARY DEBT RATING CRITERIA

Publication Date:
Sept. 18, 2007 Primary Credit Analysts: Terry A Pratt, New York, (1) 212-438-2080 Ian Greer, Melbourne, (61) 3-9631-2032 Arthur F Simonson, New York, (1) 212-438-2094 Secondary Credit Analyst: Lidia Polakovic, London, (44) 20-7176-3985
he world of project finance has continued to grow since Standard & Poors published its last comprehensive rating criteria. Project financing has become increasingly sophisticated and often riskier, with a wider investor base attracting new finance structures and investors across the globe. We have closely followed these developments over the years, extending and revising our criteria from time to time to enable appropriate assessment of projectfinance risk originating from new markets, new structures, and new avenues of ownership. Factoring different market circumstances into our analysis remains challenging, but global consistency of our criteria and approach has been our prime objective in responding to these new market developments. The combined magnitude of these criteria additions and changes is not great; it is, rather, more of a rearrangement that better reflects current practice and changes to associated criteria, such as recovery aspects. Additionally, we want to note that we have revised certain aspects of our internal analytical framework for rating projects, and stress that although we have adopted one significant change --eliminating our scoring approach--no ratings will be affected. We introduced scoring six years ago to facilitate the compare-and-contrast of key project risks across the spectrum of rated projects. The scores, and the criteria on which they were based, represented only guidelines. Scores were never meant to be additive, but nevertheless, many readers understood them as such. Because the scoring caused confusion among some users of our criteria, we decided to remove those suggested scores and focus more on other analytical tools to compare risk across projects. In response to the changing world of project finance and the blurring of boundaries from pure project-finance transactions to hybrid structures, our analysis has been expanded and now incorporates some corporate analytical practice, to look at a combination of cash-flow measures, capital structure, and liquidity management. We also have reincorporated our assessment of force majeure risk into our analysis of a projects contractual foundation and technical risk, rather than addressing these as a separate risk category. The overall criteria framework has not been changed, however, and still provides a very effective framework for analyzing and understanding the risk dynamics of a project transaction.
Recent Trends
As project finance continues to adjust to the increasingly diverse needs of project sponsors, their lenders, and investors, in many cases the analysis of risk continues to grow in complexity. Despite this growing variety of project-finance application and location, the continuing market desire for nonrecourse funding solutions suggests that project finance will remain a robust means of raising infrastructure capital. More aggressive financial structures sometimes blur the boundaries of nonrecourse finance both in reality and perception. Also, the greater exposure to market risk has forced many sponsors to seek greater flexibility in project structures to manage cash, take on additional debt, and enter new businesses with few restrictions--which makes some projects look more like corporates. Projects continue to evolve from their traditional basis of long-term contracted revenue, and now involve a greater exposure to a number of risks. Initial project finance primarily was focused on power markets that had strong contractual bases; but these days, more projects are exposed to the risks of volatile commodity markets or traffic volume exposure, among other types. Strong global demand for construction and commodities has increased construction risk, even for simple projects. Fewer projects have been able to secure the more creditor-friendly fixed-price, turnkey, datecertain construction contracts that better protect lenders from construction and completion risk. Term B loan structures--mini-perms, with minimal amortizations and risky bullet maturities --have established themselves firmly in the project world, but these capital plans have now been joined by more complex first- and second-lien structures, and more debt within holdingcompany structures, particularly for payment-inkind instruments that we view essentially as debt. Many long-term concession projects are maximizing leverage by employing accreting debt structures that enable sponsors to recoup quick equity returns--sometimes before any debt has been repaid--but that can greatly increase lenders exposure to default risk in the later years (see Credit FAQ: Accreting Debt Obligations And The Road To Investment Grade For Infrastructure Concessions on page 105). Private equity has made strong inroads to project lending and ownership--either directly or through managed infrastructure funds. The trend away from
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ownership by experienced sponsors raises new concerns about ownership and long-term operational performance. Positively, the usage of project finance is growing in part thanks to these new structures. In particular, financing of publicprivate partnerships (PPPs) has grown significantly over the years, with PPPs often considered to be a lower-risk investment due to the involvement of a public authority or government entity. Another observation is the increase of insured project finance transactions. Monoline insurance companies providing guarantees for timely-andfull debt servicing in cases of projects being unable to do so has opened different investment opportunities for the financial markets. However, we closely monitor and analyze the underlying risk of these projects to determine the underlying credit quality, as a part of the insured rating exercise. Finally, the emergence of the Middle East markets as one of the largest global markets of project finance has challenges of its own. Driven by low default track records and strong government support or sponsorship, these projects have created a class of their own in terms of investors perception of risk allocation. Middle East project finance is an area that remains under criteria development while we aim to adequately weigh up the hard facts, such as risk structure and allocation, terms and conditions of project financings in the region, and stated support from governments.
first is to create an entity that will act on behalf of its sponsors to bring together several unique factors of production or activity to generate cash flow from the sale/provision of a product or service. The second is to provide lenders with the security of payment of interest and principal from the operating entity. Standard & Poors analytic framework focuses on the risks of construction and operation of the project, the projects longterm competitive position, its legal characterization, and its financial performance--in short, all the factors that can affect the projects ability to earn cash and repay lenders.
Project Finance Defined

A project-finance transaction is a cross between a structured, asset-backed financing and a corporate financing. A project-finance transaction typically is characterized as nonrecourse financing of a single asset or portfolio of assets where the lenders can look only to those specific assets to generate the cash flow needed to service its fixed obligations, chief of which are interest payments and repayment of principal. Lenders security and collateral is usually solely the projects contracts and physical assets. Lenders typically do not have recourse to the projects owner, and often, through the projects legal structure, project lenders are shielded from a project owners financial troubles. Project-finance transactions typically are comprised of a group of agreements and contracts between lenders, project sponsors, and other interested parties who combine to create a form of business organization that will issue a finite amount of debt on inception, and will operate in a focused line of business over a finite period. There are many risks that need to be analyzed when rating a project-finance transaction; however the chief focus within Standard & Poors rating process is the determination of the projects stability of projected cash flow in relation to the projected cash needs of the project. This criteria article addresses the areas on which we focus when conducting analysis, and how this translates into a rating on a project-finance transaction as a whole. For each focus area, we gauge the relative importance for the project being rated and the impact that focus area could have on the projects overall cash-flow volatility. The process is very systematic, but is tailored to each project rating.
General Approach
For lenders and other investors, systematic identification, comparison, and contrasting of project risk can be a daunting task, particularly because of the new complexity presented to investors. To assess project-finance risk, Standard & Poors continues to use a framework based on the traditional approach that grew out of rating U.S. independent power projects but which has been adapted to cover a growing range of other projects globally, such as more complex transportation schemes, stadiums and arenas, hotels and hospitals, and renewable energies. Our approach begins with the view that a project is a collection of contracts and agreements among various parties, including lenders, which collectively serves two primary functions. The
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The rating Standard & Poors project debt ratings address default probability--or, put differently, the level of certainty with which lenders can expect to receive timely and full payment of principal and interest according to the terms of the financing documents. Unlike corporate debt, project-finance debt is usually the only debt in the capital structure, and typically amortizes to a schedule based on the projects useful life. Importantly, also unlike our corporate ratings, which reflect risk over three-to-five years, our project debt ratings are assigned to reflect the risk through the debts tenor. If refinancing risk is present, we incorporate into the rating the ability of the project to repay the debt at maturity solely from the project sources. Our project ratings often factor in construction risk, which in many cases can be higher than the risk presented by expected operations once the project is completed. In some cases, the construction risk is mitigated by other features, which enables the debt rating to reflect our expectations of long-term post-construction performance. Otherwise, we will rate to the construction risk, but note the potential for ratings to rise once construction is complete. Another important addition to our projectdebt ratings is the recovery rating concept that Standard & Poors began to assign to secured debt in late 2003. The recovery rating estimates the range of principal that lenders can expect to receive following a default of the project. Our recovery scale is defined in table 1. We define the likely default scenario, and then assess recovery using various techniques, such as discounted cashflow analysis or EBITDA multiples. Or, we will examine the terms and conditions of project assets, such as contracts and concession Table 1 - Standard & Poors Recovery Scale
Recovery rating 1+ 1 2 3 4 5 6 Recovery description Highest expectation, full recovery Very high recovery Substantial recovery Meaningful recovery Average recovery Modest recovery Negligible recovery Recovery expectations* 100% 90%-100% 70%-90% 50%-70% 30%-50% 10%-30% 0%-10%
agreements, for example, to estimate the expected recovery. The added importance of the recovery rating is that recovery can affect the ratings on certain classes of project debt when more than one class of debt is present.
Framework for Project Finance Criteria

Thorough assessment of project cash flows requires systematic analysis of five principle factors: Project-level risk Transactional structure Sovereign risk Business and legal institutional development risk Credit enhancements
Project-Level Risks
Project-level risk, or the risks inherent to a projects business and within its operating industry, will determine how well a project can sustain ongoing commercial operations throughout the term of the rated debt and, as a consequence, how well the project will be able to service its obligations (financial and operational) on time and in full. Specifically, we look at a projects: Contractual foundation. Operational and financing contracts--such as offtake agreements, concessions, construction arrangements, hedge agreements, loan contracts, guarantees--that, along with the physical plant, serve as the basis of the enterprise. Technology, construction, and operations. Does it have a competitive, proven technology, can construction be performed on time and on budget, and can it operate in a manner defined under the base case? Resource availability. Capacity to incorporate input resources, such as wind or natural gas. Competitive-market exposure. Competitive position against the market in which it will operate. Counterparty risk. Risk from relying on suppliers, construction companies, concession grantors, and customers. Financial performance. Risks that may affect forecast results, and cash-flow variability under likely stress scenarios.
*Recovery of principal plus accrued but unpaid interest at the time of default. Very high confidence of full recovery resulting from significant overcollateralization or strong structural features.
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Contractual foundation We analyze a projects contractual composition to see how well the project is protected from market and operating conditions, how well the various contracted obligations address the projects operating-risk characteristics, and how the contractual nexus measures up against other project contracts. The structure of the project should protect stakeholders interests through contracts that encourage the parties to complete projectconstruction satisfactorily and to operate the project competently in line with the requirements of the various contracts. The projects structure also should give stakeholders a right to a portion of the projects cash flow so that they can service debt, and should provide for the releasing of cash in the form of equity distributions (dividends or other forms of shareholder payments) in appropriate circumstances. Moreover, higher-rated projects generally give lenders the assurance that project management will align their interests with lenders interests; project management should have limited discretion in changing the projects business or financing activities. Finally, higherrated projects usually distinguish themselves from lower-rated projects by agreeing to give lenders a first-perfected security interest (or fixed charge, depending on the legal jurisdiction) in all of the projects assets, contracts, permits, licenses, accounts, and other collateral; in this way the project can either be disposed of in its entirety should the need arise, or the lenders can step in to effectively replace the projects management and operation so as to generate cash for debt servicing. As infrastructure assets have become increasingly popular for concessions, not only is the analysis of the strengths and weaknesses of the concession critical but, also the rationale for the concession becomes an essential element of our analysis. Contract analysis focuses on the terms and conditions of each agreement. The analysis also considers the adequacy and strength of each contract in the context of a projects technology, counterparty credit risk, and the market, among other project characteristics. Commercial versus collateral agreements. Project-contract analysis falls into two broad categories: commercial agreements and collateral arrangements.
Commercial project contracts analysis is conducted on contracts governing revenue and expenses, such as: Power purchase agreements; Gas and coal supply contracts; Steam sales agreements; Liquefied natural gas sales agreements; Concession agreements; Airport landing-fee agreements; Founding business agreement; and Any other agreements necessary for the operations of the project. Collateral agreements typically require analysis of a projects ownership along with financial and legal structures, such as: Credit facilities or loan agreement; Indenture; Equity-contribution agreement; Mortgage, deed of trust, or similar instrument that grants lenders a firstmortgage lien on real estate and plant; Security agreement or a similar instrument that grants lenders a first-mortgage lien on various types of personal property; Assignments to lenders of project assets, accounts, and contracts; Project-completion guarantees; Depositary agreements, which define how the project cash is handled; Shareholder agreements; Collateral and inter-creditor agreements; and Liquidity-support agreements, such as letters of credit (LOCs), surety bonds, and targeted insurance policies. An important objective of our contractual assessment is the understanding of a projects full risk exposure to potential force majeure risks, and how the project has mitigated such risk. Project financings rely on asset and counterparty performance, but force majeure events can excuse performance by parties when they are confronted with unanticipated events outside their control. A careful analysis of force majeure events is critical in a project financing because such events, if not properly recompensed, can severely disrupt the careful allocation of risk on which the financing depends. Floods and earthquakes, civil disturbances, strikes, or changes of law can disrupt a projects operations and devastate its cash flow. In addition, catastrophic mechanical
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failure due to human error or material failure can be a form of force majeure that may excuse a project from its contractual obligations. Despite excusing a project from its supply obligations, the force majeure event may still lead to a default depending on the severity of the mishap. Technology, construction, and operations In part, a projects rating rests on the dependability of a projects design, construction, and operation; if a project fails to achieve completion or to perform as designed, many contractual and other legal remedies may fail to keep lenders economically whole. The technical risk assessment falls into two categories: construction and operations. Construction risk relates to:
Engineering and design Site plans and permits Construction Testing and commissioning
Operations risk relates to:

Operations and maintenance (O&M)
strategy and capability

Expansion if any contemplated Historical operating record, if any
Project lenders frequently may not adequately evaluate a projects technical risk when making an investment decision but instead may rely on the reputation of the construction contractor or the project sponsor as a proxy for technical risk, particularly when lending to unrated transactions. The record suggests that such confidence may be misplaced. Standard & Poors experience with technology, construction, and operations risk on more than 300 project-finance ratings indicates that technical risk is pervasive during the pre- and post-construction phases, while the possibility of sponsors coming to the aid of a troubled project is uncertain. Thus, we place considerable importance on a projects technical evaluation. We rely on several assessments to complete our technical analysis. One key element is a reputable independent experts (IE) project evaluation. We examine the IEs report to see if it has the proper scope to reach fundamental conclusions about the projects technology, construction plan, and expected operating results, and then we determine whether these conclusions support the sponsors
and EPC contractors technical expectations. We supplement our review of the IEs report with meetings with the IE and visits to the site to inspect the project and hold discussions with the projects management and construction contractor or manager. Without an IE review, Standard & Poors will most likely assign a speculative-grade debt rating to the project, regardless of whether the project is in the pre- or post-construction phase. Finally, we will assess the projects technical risk using the experience gained from examining similar projects. Another key assessment relates to the potential credit effect of a major equipment failure that could materially reduce cash flow. This analysis goes hand-in-hand with the contractual implications of force majeure events, described above, and counterparty risk, described below. If the potential credit risk from such an event is not mitigated, then a projects rating would be negatively affected. Mitigation could be in the form of business-interruption insurance, cash reserves, and property casualty insurance. The level of mitigation largely depends on the project type--some types of projects, such as pipelines and toll roads--are exposed to low outage risks and thus could achieve favorable ratings with only modest risk mitigation. In contrast, a mechanically complex, site-concentrated project-such as a refinery or bio-mass plant--can be highly exposed to major-equipment-failure risk, and could require robust features to deal with potential outages that could take months to repair. Resource availability All projects require feedstock to produce output, and we undertake a detailed assessment of a projects ability to obtain sufficient levels. For many projects, the input-supply risk largely hinges on the creditworthiness of the counterparty that is obligated to provide the feedstock, which is discussed below under Counterparty Exposure. Other types of projects, however, such as wind and geothermal power, rely on the type of natural resources of which few third parties are willing to guarantee production. In these cases, we require an understanding of the availability of the natural resource throughout the debt tenor. We use various tools to reach our conclusions, but most important will be the analysis and conclusions of a reputable IE or market consultant on the
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resource sufficiency throughout the debt tenor. In many cases, such as wind, where the assessment can be highly complex, we may require two surveys to get sufficient comfort. Just as with IE technical reports, a project striving for investment-grade and high speculative-grade ratings will require a strong resource-assessment report. However, given the potential for uncertainty in many resource assessments, stronger ratings are likely to require either more than one IE resource assessment, geographic diversity, or robust liquidity features to meet debtrepayment obligations if the resource does not perform as expected. Competitive market exposure A projects competitive position within its peer group is a principal credit determinant, even if the project has contractually-based cash flow. Analysis of the competitive market position focuses on the following factors: Industry fundamentals Commodity price risk Supply and cost risk Regulatory risk Outlook for demand Foreign exchange exposure The projects source of competitive advantage Potential for new entrants or disruptive technologies Given that many projects produce a commodity such as electricity, ore, oil or gas, or some form of transport, low-cost production relative to the market characterizes many investment-grade ratings. High costs relative to an average market price in the absence of mitigating circumstances will almost always place lenders at risk; but competitive position is only one element of market risk. The demand for a projects output can change over time (seasonality or commodity cycles), and sometimes dramatically, resulting in low clearing prices. The reasons for demand change are many, and usually hard to predict. Any of the following can make a project more or less competitive: New products Changing customer priorities Cheaper substitutes Technological change Global economic and trade developments
Experience has shown, however, that offtake contracts providing stable revenues or that limit costs, or both, may not be enough to mitigate adverse market situations. As an example, independent power producers in California had to restructure parts of fixed-price offtake agreements when the utilities there came under severe financial pressure in 2000 and 2001. Hence, market risk can potentially take on greater importance than the legal profile of, and security underlying, a project. Conversely, if a project provides a strategic input that has few, if any, substitutes, there will be stronger economic incentives for the purchaser to maintain a viable relationship with the project. Counterparty exposure The strength of a project financing rests on the projects ability to generate stable cash flow as well as on its general contractual framework, but much of a projects strength comes from contractual participation of outside parties in the establishment and operation of the project structure. This participation raises questions about the strength and reliability of such participants. The traditional counterparties to projects have included raw-material suppliers, principal offtake purchasers, and EPC contractors. Even a sponsor becomes a source of counterparty risk if it provides the equity during construction or after the project has exhausted its debt funding. Other important counterparties to a project can include: Providers of LOCs and surety bonds; Parties to interest rate and currency swaps; Buyers and sellers of hedging agreements and other derivative products; Marketing agents; Political risk guarantors; and Government entities. Because projects have taken on increasingly complex structures, a counterpartys failure can put a projects viability at risk. Standard & Poors generally will not rate a project higher than the lowest rated entity (e.g., the offtaker) that is crucial to project performance, unless that entity may be easily replaced, notwithstanding its insolvency or failure to perform. Moreover, the transaction rating may
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also be constrained by a project sponsors rating if the project is in a jurisdiction in which the sponsors insolvency may lead to the insolvency of the project, particularly if the sponsor is the sole owner of the project. During construction, often the project debt rating could be higher than the credit quality of the builder by credit enhancement and where there is an alternate builder available (see Credit Enhancements (Liquidity Support) In Project Finance And PPP Transactions Reviewed, published on RatingsDirect on March 30, 2007). Financial performance Standard & Poors analysis of a projects financial strength focuses on three main attributes: The ability of the project to generate sufficient cash on a consistent basis to pay its debt service obligations in full and on time; The capital structure and in particular debt paydown structure; and Liquidity. Projects must withstand numerous financial threats to their ability to generate revenues sufficient to cover operating and maintenance expenses, maintenance expenditures, taxes, insurance, and annual fixed charges of principal and interest, among other expenses. In addition, nonrecurring items must be planned for. Furthermore, some projects may also have to deal with external risk, such as interest rate and foreign currency volatility, inflation risk, liquidity risk, and funding risk. We factor into our credit evaluation the projects plan to mitigate the potential effects on cash flow that could be caused by these external risks should they arise. Standard & Poors relies on debt-service coverage ratios (DSCRs) as the primary quantitative measure of a projects financial credit strength. The DSCR is the cash-basis ratio of cash flow available for debt service (CFADS) to interest and mandatory principal obligations. CFADS is calculated strictly by taking cash revenues from operations only and subtracting cash operating expenses, cash taxes needed to maintain ongoing operations, and cash major maintenance costs, but not interest. As an operating cash-flow number, CFADS excludes any cash balances that a project could draw on to service debt, such as the debt-service reserve fund or maintenance reserve
fund. To the extent that a project has tax obligations, such as host-country income tax, withholding taxes on dividends, and interest paid overseas, etc., Standard & Poors treats these taxes as ongoing expenses needed to keep a project operating (see Tax Effects on Debt Service Coverage Ratios, published on RatingsDirect on July 27, 2000). In our analysis, we examine the financial performance of the project under base-case and numerous stress scenarios. We select our stress scenarios on a project-by-project basis, given that each project faces different risks. We avoid establishing minimum DSCRs for different rating levels because once again, every project has different economic and structural features. However, we do require that investment-grade projects have strong DSCRs--well above 1.0x-under typical market conditions that we think are probable, to reflect the single-asset nature of the business. Strong projects must show very stable financial performance under a wide range of stress scenarios. We also note that DSCRs for project with amortizing debt may not be directly comparable to DSCRs for a project using capital structures that involve a small annual mandatory principal repayment--usually around 1%--coupled with a cash-flow sweep to further reduce principal balances. Capital structure. Standard & Poors considers a projects capital structure as part of any rating analysis. A project usually combines high leverage with a limited asset life, so the projects ability to repay large amounts of debt within the asset lifetime is a key analytical consideration and one of the primary differences between rating a project and a typical corporate entity. The same holds true for projects that derive their value from a concession, such as a toll road, without which the project has no value; these concession-derived project financings likely have very long asset lives that extend well beyond the concession term, but nevertheless the project needs to repay debt before the concession expiration. Projects that rely on cash balances to fund final payments demonstrate weaker creditworthiness. Refinancing risk associated with bullet maturities typical of corporate or public financings are becoming more common in projectfinance transactions. Examples include Term Loan
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B structures, in which debt is repaid through minimal mandatory amortizations--usually 1% per year--coupled with a debt repayment from a portion of distributable cash flow. While these structures certainly reduce default risk due to lower mandatory principal repayments, they almost always involve a planned refinancing at around seven-to-eight years. In these types of arrangements, our credit analysis determines if the project can refinance debt outstanding at maturity such that it fully amortizes within the remaining asset life on reasonable terms. The finite useful life of projects also introduces credit risk from an operational standpoint. Given its depreciating characteristics, an aging project may find it more difficult to meet a fixed obligation near the end of its useful life. Thus, for projects in which the useful life is difficult to determine, those structured with a declining debt burden over time are more likely to achieve higher credit ratings than projects those that do not. Many projects with high leverage seek capital structures that involve second-lien debt, subordinated debt, and payment-in-kind obligations. These structures and instruments are used to tap different investor markets and buffer the senior-most debt from default risk. These other classes of debt are issued either at the operating project or at the holding company that wholly owns the project. Although such structures can be helpful for senior debt, it obviously is to the detriment of the credit quality of the subordinated debt because in most cases this debt class is inferior to senior lenders rights to cash flow until senior debt is fully repaid, or to collateral in the event of a bankruptcy. When looking at the creditworthiness of subordinate debt, the DSCR calculation is not CFADS to subordinate debt interest and principal, but is, rather, total cash available within the entire project--after payments of all expenses and reserve filling--divided by both senior and subordinate debt service. Such a formula more accurately measures the subordinated payment risk. This differs from the notching applied in corporate ratings, and the actual rating might be lower than the coverage ratio implies, depending on the level of structural lock-up and separation of senior debt.
Another analytical approach for multiple-debttype structures is to examine the performance of the project with all of the debt on a consolidated basis, and then determine the risk exposure for the different classes of debt based on structural features of the deal and provisions within the financing documents. To the extent that senior debt is advantaged, lesser obligations are penalized. Liquidity. Liquidity is a key part of any analysis, because lenders rely on a single asset for debt repayment, and all assets types have unexpected problems with unforeseen consequences that must be dealt with from time to time. Liquidity that projects typically have included: A debt-service reserve account, to help meet debt obligations if the project cannot generate cash flow due to an unexpected and temporary event. This reserve is typically sized at six months of annual debt service, although amounts can be higher as a result of specific project attributes (e.g., strong seasonality to cash flow, annual debt payments, etc.) The reserve should be cash or an on-demand cash instrument. However, if the reserve is funded with an LOC, we will factor in the potential for the additional debt burden that would occur if the reserve is tapped to help meet debt obligations. A maintenance reserve account is expected for projects in which capital expenditures are expected to be lumpy or where there is some concern about the technology being employed. Almost all investment-grade projects have such a reserve. We do not establish minimum funding level for these reserves, but gauge the need based on the findings of the IEs technical evaluation and our experience. Look-forward-and-back distribution and lock-up tests to preserve surplus but lower than expected cash flows. For investmentgrade consideration, a project structure will typically have a minimum of 12 months look forward and look back. The DSCR hurdle that should allow distribution is project dependent. The test ensures cash is retained to meet the projects liquidity needs in times of stress.
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Transactional Structure
Standard & Poors performs detailed assessment of the projects structural features to determine how they support the projects ability to perform and pay obligations as expected. Key items include assessing if the project is structured to be a single-purpose entity (SPE), how cash flow is managed, and how the insolvency of entities connected to the project (sponsors, affiliates thereof, suppliers, etc.), who are unrated or are rated lowly, could affect project cash flow. Special-purpose entities (SPEs) Projects generally repay debt with a specific revenue stream from a single asset, and since for projects we rate to debt maturity, we need to have confidence that the project will not take on other activities or obligations that are not defined when the rating is assigned. When projects are duly structured as and remain SPEs, we can have more confidence in project performance throughout the debt tenor. If such limitations are absent, we would tend to rate a project more like a corporation, which would typically assume higher credit risk. Standard & Poors defines a projectfinance SPE as a limited-purpose operating entity whose business purposes are confined to: Owning the project assets; Entering into the project documents (e.g., construction, operating, supply, input and output contracts, etc.); Entering into the financing documents (e.g., the bonds; indenture; deeds of mortgage; and security, guarantee, intercreditor, common terms, depositary, and collateral agreements, etc.); and Operating the defined project business. The thrust of this single-purpose restriction is that the rating on the debt obligations represents, in part, an assessment of the creditworthiness of specific business activities and reduces potential external influences on the project. One requirement of a project-finance SPE is that it is restricted from issuing any subsequent debt that is rated lower than its existing debt. The exceptions are where the potential new debt was factored into the initial rating, debt is subordinated in payment, and security to the existing debt does not constitute a claim on the project. A second requirement is that the project should not be permitted to merge or consolidate
with any entity rated lower than the rating on the project debt. A third requirement is that the project (as well as the issuer, if different) continues in existence for as long as the rated debt remains outstanding. The final requirement is that the SPE have an anti-filing mechanism in place to hinder an insolvent parent from bringing the project into bankruptcy. In the U.S., this can be achieved by the independent-director mechanism, whereby the SPE provides in its charter documents a specification that a voluntary bankruptcy filing by the SPE requires the consenting vote of the designated independent member of the board of directors (the board generally owing its fiduciary duty to the equity shareholder[s]). The independent directors fiduciary duty, which is also to the lenders, would be to vote against the filing. In other jurisdictions, the same result is achieved by the golden share structure, in which the project issues a special class of shares to some independent entity (such as the bond trustee), whose vote is required for a voluntary filing. The anti-filing mechanism is not designed to allow an insolvent project to continue operating when it should otherwise be seeking bankruptcy protection. In certain jurisdictions, anti-filing covenants have been enforceable, in which case such a covenant (and an enforceability opinion with no bankruptcy qualification) would suffice. In the U.K. and Australia, where a first fixed and floating charge may be granted to the collateral trustee as security for the bonds, the collateral trustee can appoint a receiver to foreclose on and liquidate the collateral without a stay or moratorium, notwithstanding the insolvency of the project debt issuer. In such circumstances, the requirement for an independent director may be waived. The SPE criteria will apply to the project (and to the issuer if a bifurcated structure is considered), and is designed to ensure that the project remains nonrecourse in both directions: by accepting the projects debt obligations, investors agree that they will not look to the credit of the sponsors, but only to project revenues and collateral for reimbursement; investors, on the other hand, should not be concerned about the credit quality of other entities (whose risk profile was not factored into the rating) affecting project cash flows. Where the project acts as operator, the analysis
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will look to the ability of the project to undertake the activities on a stand-alone basis, and any links to external parties. Cash management Nearly all project structures employ an independent trustee to control all cash flow the project generates, based on detailed project documents that define precisely how cash is to be managed. This arrangement helps prevent cash from leaking out of the project prior to the payment of operating expenses, major maintenance, taxes, and debt obligations. In those cases where there is no trustee, the creditworthiness of the project will be linked directly to the cash manager, which is usually the sponsor. Projects seeking investment-grade ratings will have cash-management structures that prevent any distributions to sponsors--including tax payments--unless all expenses are fully paid, reserves are full, and debt-service coverage rations looking back and forward for a sufficient period are adequate.
Sovereign Risk
A sovereign government can pose a number of risks to a project. For example, it could restrict the projects ability to meet its debt obligations by way of currency restrictions; it could interfere with project operations; and, in extreme cases, even nationalize the project. As a general rule, the rating on a project issue will be no higher than the local-currency rating of the project in its host country. For cross-border or foreign currencydenominated debt, the foreign currency rating of the country in which the project is located is the key determinant, although in some instances debt may be rated up to transfer and convertibility (T&C) assessments of the country Standard & Poors has established. A T&C assessment is the rating associated with the probability of the sovereign restricting access to foreign exchange needed for servicing debt obligations. For most countries, Standard & Poors analysis concludes that this risk is less than the risk of sovereign default on foreign currency obligations; thus, most T&C assessments exceed the sovereign foreign currency rating. A non-sovereign project can be rated as high as the T&C assessment if its stress-tested operating and financial characteristics support the higher rating. A sovereign rating indicates a sovereign
governments willingness and ability to service its own obligations on time and in full. The sovereign foreign currency rating acts as a constraint because the projects ability to acquire the hard currency needed to service its foreign currency debt may be affected by acts or policies of the government. For example, in times of economic or political stress, or both, the government may intervene in the settlement process by impeding commercial conversion or transfer mechanisms, or by implementing exchange controls. In some rare instances, a project rating may exceed the sovereign foreign currency rating if: the project has foreign ownership that is key to its operations; the project can earn hard currency by exporting a commodity with minimal domestic demand, or other riskmitigating structures exist. For cross-border deals, however, other forms of government risk could result in project ratings below the T&C rating. A government could interfere with a project by restricting access to production inputs, revising royalty and tax regimes, limiting access to export facilities, and other means (see Ratings Above The Sovereign: Foreign Currency Rating Criteria Update, published on RatingsDirect on Nov. 3, 2005).
Business and Legal Institutional Development Risk

Even though a projects sponsors and its legal and financial advisors may have structured a project to protect against readily-foreseeable contingencies, risks from certain country-specific factors may unavoidably place lenders at concomitant risk. Specifically, risk related to the business and legal institutions needed to enable the project to operate as intended is an important factor. Experience suggests that in some emerging markets, vital business and legal institutions may not exist or may exist only in nascent form. Standard & Poors sovereign foreign currency ratings do not necessarily measure this institutional risk or country risk, and so equating country risk with a sovereigns credit rating may understate the actual risk the project may face (see Investigating Country Risk And Its Relationship To Sovereign Ratings In Latin America, published on April 4, 2007). In some cases, institutional risk may prevent a projects rating from reaching the host countrys foreign currency rating, despite the projects other
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strengths. That many infrastructure projects do not directly generate foreign currency earnings and may not be individually important for the hosts economy may further underscore the risk. In certain emerging markets, the concepts of property rights and commercial law may be at odds with investors experience. In particular, the notion of contract-supported debt is often a novel one. There may, for example, be little or no legal basis for the effective assignment of powerpurchase agreements to lenders as collateral, let alone the pledge of a physical plant. Even if lenders can obtain a pledge, it could be difficult for them to exercise their collateral rights in any event. Overall, it is not unusual for legal systems in developing countries to fail to provide the rights and remedies that a project or its creditors typically require for the enforcement of their interests.
associated with the credit-enhancement mechanism is critical in the rating evaluation. For Standard & Poors to give credit value to insurers, the insurer must have a demonstrated history of paying claims on a timely basis. Standard & Poors financial enhancement rating (FER) for insurers addresses this issue in the case of private insurers.
Outlook For Project Finance

Project finance remains a robust vehicle for funding all types of infrastructure across the globe, and its creative financing structures continue to attract different classes of both issuers and investors. Project finance continues to be a chosen financing technique due to a strong global push to add all types of energy and transportation infrastructure, and to build new or more publicoriented assets, such as stadiums, arenas, hospitals, and schools, just to name a few. In the Middle East, the continuing development of mega-sized, government-driven energy and real-estate projects is likely to continue for years to come. Related investment in shipping to deliver energy projects from the region is also enormous. In the U.S., project-finance transactions in the power sector, both for acquisitions but also for new gas- and coal-fired plants and a host of renewable energies, remain very robust. Additionally, development activity of new nuclear power plants, some of which are likely to be undertaken on a project-finance basis, is being studied. The U.S. market is also noteworthy for large investments in natural-gas prepay deals. In Europe, project investment in rail and air transportation remains sound, and private-finance initiative investment in the U.K. continues to be robust. Its cousin, public-private partnerships lending for transportation and social infrastructure investments in Australia and Canada, has also strengthened. These favorable trends offset less-favorable developments in other parts of the world, such as in Latin America, where policies in some countries (Venezuela, for example), have led to nationalization of some project assets and an unfavorable market for further project funding. Investor attention to project risk is important, especially in light of the relatively easy lending covenants and asset valuations seen in a number of project transactions in recent years. Standard & Poors expects that project sponsors
Credit Enhancement
Some third parties offer various creditenhancement products designed to mitigate project-level, sovereign, and currency risks, among other types. Multilateral agencies, such as the Multilateral Investment Guarantee Agency, the International Finance Corporation, and the Overseas Private Investment Corp. to name a few, offer various insurance programs to cover both political and commercial risks. Project sponsors can themselves provide some type of support in mitigation of some risks--a commitment that tends to convert a nonrecourse financing into a limited-recourse financing. Unlike financial guarantees provided by monoline insurers, enhancement packages provided by multilateral agencies and others are generally targeted guarantees and not comprehensive for reasons of cost or because such providers are not chartered to provide comprehensive coverage. These enhancement packages cover only specified risks and may not pay a claim until after the project sustains a loss. Since they are not guarantees of full and timely payment on the bonds or notes, S&P needs to evaluate these packages to see if they may enhance ultimate post-default recovery but not prevent a default. Once a project defaults, delays and litigation intrinsic in the claims process may result in lenders waiting years before receiving a payment. Therefore, our estimation of the timeliness
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and their advisors will continue to develop new project structures and techniques to mitigate the growing list of risks and financing challenges. As investors and sponsors return to emerging markets, particularly as infrastructure investment needs increase, project debt will remain a key source of long-term financings. Moreover, as the march toward privatization and deregulation continues in markets, nonrecourse debt will likely continue to help fund these changes. Standard & Poors framework of project risk analysis anticipates the problems of analyzing these new opportunities, in both capital-debt and bank-loan markets. The framework draws on Standard & Poors experience in developed and emerging markets and in many sectors of the economy. Hence, the framework is broad enough to address the risks in most sectors that expect to use project-finance debt, and to provide investors with a basis with which to compare and contrast project risk.
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CREDIT FAQ: ACCRETING DEBT OBLIGATIONS AND THE ROAD TO INVESTMENT GRADE FOR INFRASTRUCTURE CONCESSIONS
Publication Date:
Sept. 5, 2007 Primary Credit Analyst: Paul B Calder, CFA, Toronto, (1) 416-507-2523 Secondary Credit Analysts: Kurt Forsgren, Boston, (1) 617-530-8308 Ian Greer, Melbourne, (61) 3-9631-2032 Lidia Polakovic, London, (44) 20-7176-3985 Additional Contact: Santiago Carniado, Mexico City, (52) 55-5081-4413
Overview
Since the groundbreaking Chicago Skyway transaction in late 2004 (Skyway Concession Company LLC), Standard & Poors Ratings Services has observed rapid growth globally in accreting debt and swap structures applied to project finance infrastructure transactions. Infrastructure is one of the hottest asset classes, with private and public pension fund equity and various long-term debt providers significantly funding long-term concessions or infrastructureasset purchases. In some transactions we have observed, accreting debt and swap structures have facilitated significant acquisition premiums (or refinancing gains). This is because accreting debt allows the partial deferral of interest payments to reduce debt service early in the concession or provides an additional non-operating source of funds to the project in the form of payments from an accreting swap early in a concession. The cash flow effects of a deferral of interest payments or the addition of swap inflows to operating revenue results in overstated debt service coverage ratios (DSCRs) that, in turn, allow for the tailoring of debt service to meet a projects early-year cash flow deficiency and, in many instances, early outflows in the form of equity distributions. Without these structural features, a highly leveraged projects net cash flows available to service debt early in the concession would not meet debt service obligations under a traditional amortizing or even interest-only debt service profile. Simple economics of numerous global capital pools pursuing a limited number of concessions or acquisition targets results in predictably high valuation multiples, boosted by financial structures that front-load dividends and returns to equity while risk for debt holders lies toward the end of a concession. As a result, metrics such as enterprise value-to-EBITDA and debt-to-EBITDA, on a current and pro forma basis, have become increasingly aggressive in a relatively short period while investors still assume these to be investment grade structures. Given that business risk has not shifted, this could be a challenging assumption. Moreover, the acquisition multiples are considerably higher for many infrastructure financings than investment-grade M&A transactions in other sectors. In the near term, the
recent shift to conservatism in credit sentiment by lenders (as demonstrated by stricter covenant requirements, tighter loan underwriting standards, less aggressive structures etc.), together with a rise in nominal interest rates, could curb the fairly aggressive debt financing structures observed in many recent long-term infrastructure concessions and acquisitions. In the long term, we expect infrastructure assets to maintain their appeal given generally solid business positions and ability to leverage relatively stable cash flows through long-dated concessions--permitting long-term debt maturities. This report follows Credit FAQ: Assessing The Credit Quality Of Highly Leveraged Deep-Future Toll-Road Concessions and Global Infrastructure Assets And Highly Leveraged Concessions Raise New Rating Considerations. This article expands upon topics addressed in the previous reports and provides analytical insight to our approach in evaluating accreting debt within project finance transactions. Overall, Standard & Poors believes that infrastructure financings for long-term concessions capitalized with accreting debt can achieve investment-grade ratings; however, there are several key factors that will differentiate--in combination with the assets under consideration-investment-grade structures from those exhibiting speculative-grade characteristics. In particular, at the investment-grade level, we place greater emphasis on distribution test multiples, potential cash lock-ups and sweeps, examining the percentage of accretion relative to total debt at transaction inception--with little-to-none for short-term concessions (for example, 20-35 years), limits to additional indebtedness, and emphasize the risk/reward allocation between sponsors and lenders. Question 1: Does accreting debt increase the probability of default for an infrastructure project? Yes and no. In the early years of an accreting debt structure, the probability of default is lower compared with that of a traditional amortizing structure, as the debt service is artificially low. However, towards the middle and end of the concession, when higher accreted debt balances amortize or when bullet payments are due as the
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risk of refinancing is introduced while performance risk can have increased at an even higher debt burden. At this point, default risk increases significantly. Compared to an amortizing profile--all else being equal, including the proportion of equity contribution to a project--an accreting debt structure will have weaker credit quality. Accreting debt establishes a more aggressive financial risk profile and defers repayment of debt, often well into the future. The longer the debt repayment profile, the greater the cash flow uncertainty could lead to deterioration in a projects financial risk profile, thereby raising default risk. Moreover, accreting debt and swap structures allow significant early period dividends paid to equity sponsors (before debt repayment) as a result of the excess cash flow produced by the accretion or deferral component of the debt structure. This practice and its effect on credit quality are discussed in Question 6. Even for infrastructure assets with strong business risk profiles, the presence of accreting debt in the capital structure would temper credit quality. Standard & Poors believes that the more aggressive the financial structure, the less robust the business risk profile; the weaker the legal provisions and the greater the contractual risk allocation to the concessionaire, the weaker the rating on a long-term concession or infrastructure asset will be. In addition to accreting debts influence on default probability, characteristics of transactions that, in the absence of offsetting credit strengths, are likely to experience weaker debt ratings, include the following: A weaker business risk profile. The importance of the project rationale and business profile to credit quality cannot be understated and is discussed more fully in Question 4; A shorter concession term and shorter equity tail; Notable construction risk without commensurate offsetting third-party credit supports or cost and schedule risk mitigation strategies; Annual increases in debt service payments that significantly exceed those in total project revenues; Refinancing risk; Unhedged currency risk;
High country risk, including political stability, currency transferability and exchange matters; and, Weak swap or transaction counterparties. Question 2: Why is early return to equity (through cash distributions) a concern? Project ratings address not only the ability but also the willingness to pay obligations in full and on time. An equity party that had already received a full return on an investment early in the concession would have reduced incentive in resolving issues in times of distress, as preserving the equity return might no longer be a consideration. As such, where an equity party reaped a full return in the early stages of the concession, Standard & Poors would want to be confident that the sponsors had sufficiently strong incentives to ensure the project would operate successfully throughout the debts life. In general, we consider that a more closely aligned interest of debt and equity is a project strength. In addition, the equity participants, through their agents--management--can also make decisions about timing of capital expenditure and other revenue or profit enhancing measures- such as toll increases, which could bring forward returns at the expense of the projects viability. Question 3: In what asset classes have you observed accreting debt structures? Accreting debt structures arise in volume-driven transactions. The assumption in these transactions is that an increasing debt level can be absorbed as usage (traffic, tonnage, and containers, for example) and increases in revenue (tariff/toll increases) generate higher net cash flows. Assets that lack this characteristic will unlikely see accreting debt as a long-term funding source. The breadth of potential infrastructure acquisition and concession interests by private equity and public pension fund sponsors has increased with project finance structures becoming more aggressive and complex. Standard & Poors has observed a growing universe of potential asset classes to which long-term concessions might apply. Some of those sectors include airports, port and port terminal operators, parking facilities, toll roads and bridges, water and waste water facilities, lotteries and mass transit projects. Accreting structures are not only
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found in project and concession financing but in corporate securitizations of the aforementioned sectors as well. Question 4: Why is the business risk profile so important to the credit quality of infrastructure transactions that use accreting debt? A project rating is a composite of many factors. To narrow the analysis to two factors--business and financial risks--some straightforward observations can be made. The stronger the business risk profile, the weaker the financial risk profile (including accreting debt and swaps) can be to achieve a certain rating, and vice versa. To gauge the appropriate financial risk at investmentgrade, the prime focus should be on the underlying business risk. Accordingly, to assess whether at investment-grade an accreting debt structure is commensurate, it is important to understand the business risk first, hence the importance of the business risk to the rating. As we view accreting debt structures to be more aggressive, for a similar rating an accreting transaction would need to have other strengths to compensate for this credit weakness. The strong business risk profiles and generally robust cash flow streams of infrastructure assets, together with strong covenant packages, compliance with SPE bankruptcy remoteness criteria, and supportive structural features allow infrastructure projects to be more highly leveraged and use accreting debt compared with a corporate entity at the same rating level. A strong business risk profile for long-term concessions and infrastructure providers would include a combination of the following characteristics (the listing below does not imply any ranking of relative importance): An essential or high-demand service; Where user fees are involved, a high degree of demand inelasticity with respect to rate increases; Monopoly or near-monopoly characteristics, or, alternatively, few providers in the industry with substantial barriers to entry and limited incentives for competition among these service providers; A limited reliance on increases in volume growth rates (for example, market exposure to traffic, parking activity, tonnage, or maritime containers), and aggressive
assumptions of price inelasticity to rate or tariff increases to meet base case revenue projections; A favorable legal environment and regulatory regime; Limited government interference probability, either through public policy changes and/or change-in-law risk; A favorable rate-setting regime, although we recognize that it is rarely unfettered and, even then, can face challenges or political contention; Strong bargaining power in relation to suppliers and customers; Low, contained, or manageable ongoing capital expenditure requirements; Strong counterparty arrangements with, for example, contractual offtaker agreements or remittance of payments from a highly rated public sector entity; Strong historic track record of the asset. To this end, a project that is exposed to greenfield or start-up operations with no usage history (for example, a complete reliance on independent consultant projections) would be considered to have a weaker business risk profile; and Proven technology for construction and major maintenance activities, as applicable. Question 5: Do you differentiate between the forms of debt increase in an infrastructure transaction? In our credit evaluation of long-term concessions, we attempt to understand the economic substance and evolving profile of the debt structure: its rise and repayments over time relative to the business risk profile of the project and the term of the concession. The project debt balance could increase based on a contractually agreed to schedule. Alternatively, the debt balance could vary based on required cash flows procured from an alternate financing source to meet debt service requirements and equity distribution targets. Finally, the project debt could rise due to a direct contractual link to an inflation index that increases during the term of the debt. Standard & Poors has observed several forms of debt instruments that can cause a projects debt to increase early in a concession and result in overstated traditional DSCRs. For comparative
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purposes, Standard & Poors will also calculate an adjusted DSCR assuming the accretion is a debt service cash flow item (see Question 10). Types of instruments in which debt could rise include: Capital Appreciation Bonds (CABs)--These are debt instruments where a portion of the interest due and payable to the creditor is deferred and added (capitalized) to the principal balance according to an agreed debt service schedule between the borrower and lender. Accreting swaps--These can be used alongside a conventional debt instrument to create the same economic effect as CABs. As the accreting swap counterparty is a debt provider, we expect that the accreting swap will be considered pari passu with senior debt obligations under the project financing documents. Although there could be variations on accreting swap use, one form uses a floating-rate (e.g. LIBOR-based) loan. In this case, the project enters into an interest rate swap to convert the floating rate exposure to a fixed basis. Part of the interest obligation on the projects fixed-rate payment to the swap counterparty is deferred and capitalized with the swap principal balance to create the accreting structure. The floating-rate payments from the swap counterparty meet the projects floating (LIBOR) based obligations originally incurred. This synthetically creates the CAB structure described in the first bullet. Accreting swap with embedded loan--In this instance, the swap payment from the counterparty is a cash inflow for the project rather than an interest payment deferral and floating rate pass-through as noted in the second bullet. Credit facilities--Ostensibly the same as the third bullet, a credit facility can be used to create the same economic effect as the accreting swap (an embedded loan). The credit facility can provide cash flow to a project in the early years of a concession, bridging debt service obligations that may be higher than cash flow available. The draws can also provide cash flow funding for equity distributions early in the concession. Similar to an embedded loan, this form of financing would likely also rank pari passu
with project senior debt. Inflation-indexed securities--Treasury inflation protected securities (TIPS) in the U.S.; capital indexing bonds in Australia; indexed linked notes in the U.K.; inflation units in Mexico; and real return bonds in Canada are examples of securities that see the principal payment or principal balance (if it is a bullet maturity instrument) and coupon payment adjusted upward based on changes in an inflation index (such as the consumer price index). Projects with revenue streams or rate increase mechanisms strongly linked to inflation benchmarks typically issue these securities. The weaker the revenue link to inflation, the greater the potential deterioration in DSCRs due to a mismatch over time between cash flow available to service debt and the projects debt service obligations. Whether the accreting swap payment is included as income (or a credit facility is provided to the project as an inflow) or a project companys debt and swap repayment schedule allows the partial deferral of interest payments (understating debt service), the economic effect is the same. DSCRs are overstated and less comparable with DSCRs in more traditional amortizing debt structures. While the form of the project debt increase and its subsequent repayment profile is important, so too is the absolute size of the debt increase relative to the original debt issuance at transaction inception. This is discussed in Question 7. Question 6: What are the observable effects of accreting debt on a transaction and its potential credit quality? The primary effects relate to imposing aggressive financial structures on the asset dependent on long-term revenue growth. In particular, we note the following compared with traditional amortizing or many bullet structures associated with infrastructure financings: Growing debt levels. Unlike a conventional debt refinancing for a volume risk asset (which typically occurs when construction has been completed and/or a usage history is known), accreting debt or an accreting swap crystallizes the future debt burden before the
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project economics and expected revenue growth are known. Unless revenue and EBITDA growth is at least equal to the proportion of debt accretion, DSCRs will narrow and the enterprise value of the project will decline. Greater reliance on growth. Accreting debt structures cause an overstatement of DSCRs in the early years of a concession (by the amount of the interest accrual or swap inflow to the project). This allows early-year cash flow deficiency to be managed (relative to expected net revenue) while maintaining dividend payments. Moreover, to the extent the revenue, EBITDA, operating, and capital cost and refinancing assumptions are aggressive, as the accreting debt balance amortizes in the medium-to-long term, longterm DSCRs are at risk of not meeting base case projections. Increased flexibility. Deferred-pay mechanisms and non-amortizing structures can inject flexibility into an infrastructure financing structure, especially under more aggressive revenue growth assumptions or during the projects start-up phase. However, these deferability features introduce additional credit risks for senior lenders as debt increases. Allocation of risk/reward altered. Significant dividend distributions remitted as a result of the accreting structures deferral of senior debt payments effectively puts equity ahead of debt in the payment structure. This is a reversal of the traditional role of capital structure priority and funds flow subordination, whereby equity acts as patient capital and a buffer for senior debt during periods of revenue ramp-up or project cash flow weakness and is not seen as earning a notable proportion of its projected return ahead of senior debt. Sponsors have advocated accreting debt structures by highlighting lengthy concession terms of many infrastructure transactions that provide ample time in later years to repay higher debt, although that same opportunity to earn cash flow returns later in the concession also applies to equity distributions. Nonetheless, combined with solid business positions and inflation-linked revenues streams, sponsors view the risk profile of
these assets as low. In many respects, long-term concessions can be viewed as corporate transactions (perpetual economic ownership of an asset). Generally, corporate entities debt-finance and refinance on an ongoing basis. For projects, we assume that finite debt is issued and repaid along the depreciating asset life. Also, the benefit of covenants in rating corporate type structures is less so than for projects. While the sponsor argument of more corporate style financing of very long-term concessions is reasonable, the rating challenge is that transaction participants cannot have both the benefit of undertaking a corporate-style financing but calling it a project financing by adding structural features that have less value in a corporate finance rating approach. To the extent that a good portion of equity returns in the early years of a concession is derived from excess cash flow that accreting debt or swap structures produce, rather than outperformance by the project, there are clear benefits and incentives for sponsors to promote financing structures that use accreting debt. Standard & Poors has observed financial models for infrastructure transactions in which aggressive growth assumptions for revenue, together with the cash flow benefits of using accreting debt (or accreting swaps), results in the original paid-in equity capital being returned to sponsors before any debt repayment occurs. This has appeal to project sponsors but a fundamental credit issue is how the shift in risk to long-term lenders and the enhanced returns to equity sponsors affect credit quality. Equity risk premiums (the difference between a projects cost of debt and its expected equity return) can provide a quantitative proxy for the relative risk of an entity. The equity risk premiums observed for accreting debt structures in infrastructure financings have been as high as 8%-12% (800-1,200 basis points). This reflects only pretax cash equity yields and excludes additional equity return benefit that might be earned by sponsors through tax deductibility of interest expense and amortization items (capital cost allowance deductions or amortization of goodwill) should economic ownership and tax benefits be conferred to the concessionaire due to the concessions lengthy term. In contrast, regulated utilities, which we rate slightly higher than low investment-grade infrastructure projects
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with accreting debt, see equity risk premiums above their cost of debt of 300-400 basis points. A traditional risk-reward relationship between equity and debt capital providers includes equity capital taking more of a projects cash flow risks (such as later-period uncertainty) than senior creditors given the significant risk premium that the project sponsors can earn. The expectation of higher equity returns than fixed-rate debt should incorporate the achievement of base case financial projections and reflect higher risk incurrence by sponsors, thus providing incentive for equity to take a longer view and keep skin-in-the-game. As noted earlier, to the extent a large proportion of the value is derived in the early years of the concession through accreting instruments, such incentives might be reduced and the interests of equity or sponsors and lenders are not as closely aligned. Question 7: How do we analyze peak debt accretion and subsequent amortization guidelines for long-term concessions? In analyzing transaction structures for mature assets that have used accreting debt or swaps, Standard & Poors has set out broad principles as to how far into the concession debt can rise; when we would expect a certain proportion of the maximum accreted debt balance to paid down; and when we would expect final maturity (100% paydown of the maximum accreted debt balance). This amortization principle has varied depending upon the concessions length, the assets business risk profile, and offsetting structural features that might provide support to the credit risks of debt accretion. We are likely to view shorter term concessions (e.g. 20-35 year terms) with short-to-no tail or concessions with significant construction risk, for example, as more speculative unless their debt burden and accretion proportion is considerably lower than an asset with a longer concession term, all else being equal. In many cases, a shortterm concession is not likely to exhibit the characteristics that allow for accreting debt and still achieve investment grade. We have not previously commented on the magnitude of maximum debt accretion relative to the original debt at transaction inception. This will be a function of different asset classes, business profiles, structural protections, and
desired rating levels. Our credit analysis also focuses on the physical and economically useful life of an infrastructure asset to which to link amortization and the final maturity of debt (particularly if the asset risks physical or economic obsolescence, substitution, or increasing competition). For this reason, there are no fixed standards for acceptable investment-grade leverage levels, credit ratios, or debt accretion and subsequent amortization guidelines. We assess each credit independently on all these factors, although broad business risk profile distinctions reflect the strength of certain asset classes and the ability to support relative accreting debt burdens. For example, a long-term airport concession, all else being equal, would likely be considered to have a stronger business position than a parking facility concession, which is likely to have greater competition and substitution risks.
Debt Structure And Deferred Pay

25-year amortizing debt (x) 2.5 Moderate accreting debt Significantly accreting debt
2.0
1.5
1.0
0.5
2005
2010
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2020
2025
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2045
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Standard & Poors 2007.
Principal Outstanding The chart above illustrates project debt accretion proportion and subsequent principal amortization under three different payment profiles. The lines in the graph do not represent any specific project that Standard & Poors rates, but illustrates the potentially different risk profile of varying debt and maturity structures, as well as the impact the concession term length might have on credit quality. The curve at the bottom of the table represents a traditional 25-year amortizing debt instrument common in the U.S. public
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2035
2070
finance market that has a predominately interest-only payment profile in the first few years of the concession with full amortization occurring thereafter. This amortization schedule may be used to produce level annual debt service costs or, in concert with a capitalized interest period, to manage construction of an asset--for which there could be no revenue receipt until completion. Such a structure might have a modest (to no) equity tail based on a shorter concession. The middle curve represents a long-term concession (a term of at least 50 years if there is no equity tail but up to 75 years if there is a 25-year tail). In this senior debt repayment profile, debt accretes to about 25% higher than the original par issuance at or about year 20 and amortizes to zero in the next 30 years. The top curve represents a concession that is likely at least 75 years in term, as the senior debt accretes to more than 2x (100%) relative to original par issuance in the first 40 years of the concession and then amortizes rapidly in the next 15-20 years. Assuming the same asset and business risk profiles and debt-to-capital ratio at transaction inception, with the notable potential differences being variations in concession term, covenants, legal provisions, and debt and maturity structure, Standard & Poors would likely view the first curve (colored light green) as the most conservative financial risk profile and the third (red) as the most aggressive. This is the case given the absence of accretion and the proportion of debt repayment early in the concession for the first scenario and the very high proportion of accretion and the back-ended nature of the repayment profile for the third scenario, which would also likely imply high dividends payable to sponsors during the period of considerable accretion. Standard & Poors would not view the third scenario as investment-grade regardless of how strong the business risk profile or underlying asset quality. The second curve (dark green) could be investment grade if it had a solid business risk profile, supportive covenants and legal provisions, and a lengthier equity tail--although how close this scenario could get to the credit quality of the
first one would be determined by the relative differences of these factors. In summary, our ratings will incorporate the maximum accretion relative to original par debt issuance, the proportion of back-ended principal repayments and the share of paid-in equity capital returned in the form of dividends referenced in Questions 5 and 6 into our analysis with less aggressive structures generally associated with higher rated concessions. Question 8: How would Standard & Poors analyze the accretion characteristics and subsequent amortization guidelines for public infrastructure owners and debt issuers? These transactions will be evaluated on a case-bycase basis. In the U.S. public finance market, capital appreciation bonds have been employed for many years, often in the start-up toll road sector. Although these structures provide cushion and flexibility during the initial years of toll projects when revenues are still growing, they in fact result in a higher debt burden in later years. This can be problematic for a start-up facility, especially during a restructuring, if net toll revenues fall short of projections and debt service requirements. All things being equal, the ability of a public sector entity to assume accreting debt structures is comparatively better than for projects for several reasons including the ability to pledge revenues from a variety of assets (not just a single project), the lack of a concession term, its long-term interests as the permanent asset owner and the lack of dividend payouts which presumably allows for better liquidity and capital expenditures that improve asset quality and enhance revenues. As such, adherence to our amortization guidelines is not necessary for consideration of investment grade structures. However, on a relative basis, the financial risk profile of a public sector debt issuer would be viewed as more aggressive and highly leveraged and a weaker credit compared to traditional amortizing debt structures. Additionally, the same fundamental credit concerns regarding shifting long-term risks to lenders exist, although they can be mitigated through the mechanisms discussed in this FAQ including cash sweeps and debt reduction under scenarios when revenue projections fall short of forecasts.
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Question 9: Do you review ratios and financing assumptions differently when reviewing accreting debt structures? No. In addition to ratios and cash flows we examine the capital structure and liquidity as part of the financial analysis. Our approach to the analysis of ratios and financing assumptions places emphasis on: The magnitude of the accretion in the concessions early years along with the schedule and pace of debt repayment; Distribution policy based on the accreting debt or swap structure; Capital (debt-to-total capital) and debt structure; Financing rates, including estimated credit spreads on risk-free reference rates and swap rates; Refinancing risk, including market risk for refinanced debt and any exposure to changing interest rates and credit spreads at refunding dates; Inflation expectations and linkage to revenue setting ability; Volume growth estimates for the assets; Revenue projections and assumed growth rates--in particular, for proposed toll- or user-rate increases and the modeled demand elasticity associated with such increases; Capital expenditure obligations; The relationship between the growth in annual debt service costs for the project and the projected growth in revenue; and Operating cost assumptions and forecast synergies or savings through a long-term concession respecting a formerly publicly managed asset. We believe that the private management of a formerly publicly managed infrastructure asset could present revenue optimization and costsaving opportunities that might not have historically been a priority for a public sector body that managed operations with rate affordability and a break-even financial position as strategic goals. Public infrastructure owners are currently reevaluating this approach to rate setting in the face of growing capital and maintenance needs, in addition to other fiscal pressures. Nevertheless, despite the financial
incentives inherent in an entity with equity sponsors, we consider the reasonableness of the financing and operating assumptions in our analysis. Tightly defined and higher permitted distribution tests (DSCR based equity lock-ups) provide some measure of protection for dividend distributions to equity ahead of debt. As part of future accreting debt transactions, Standard & Poors expects more aggressive structures will likely necessitate some form of debt repayment through a partial cash sweep mechanism funded from locked up equity proceeds. This provision would be linked to a period of time in which the permitted distribution test has been invoked and locked-up cash proceeds can be redirected for debt repayment. This provides additional incentive to sponsors to avoid equity lock-up all altogether, but particularly for a prolonged period, as it might significantly reduce their equity return by the amount of trapped cash that might be permanently redirected to debt reduction through mandatory prepayments. For investment-grade ratings, Standard & Poors also expects to see an alignment between cash flows allocated to a projects equity sponsors and its long-term lenders. Among the ratios that we will analyze to guide our approach to better balancing cash flow returns between debt and equity is a dividends payable to EBITDA measure that more closely follows the metrics observed by regulated utilities or other infrastructure companies. Regulated utilities have dividends payable to EBITDA ratios of 15%-25%, whereas a credit such as 407 International Inc. (a 99-year Canadian toll road concession company) has posted dividend-to-EBITDA ratios in the mid-tohigh 20% range. For many of the accreting debt concession transactions that we observe, this ratio is considerably higher because of debt accretion and swaps. Standard & Poors is reviewing using debt stock ratios (such as debt to EBITDA) and cash distribution measures (such as annual dividend distributions relative to annual project EBITDA) to complement DSCRs, traditional credit metrics, and stress testing scenarios. These ratios will play an increasing role in investment-grade credit metrics for infrastructure concession projects that use accreting debt structures.
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Question 10: If traditional DSCRs are less meaningful, how do other measures such as Loan Life Coverage Ratios (LLCR) or Project Life Coverage Ratios (PLCR) factor into the analysis? Traditional DSCRs are of limited analytical value when a financial risk profile has significant accreting debt or accreting swaps because the cash flow effects (deferral of interest or nonoperational inflows) to the project early in the concession term overstates this ratio. To this end, we estimate the projects cash flow based DSCR (including the effects of accreting debt or accreting swaps) but also calculate a DSCR profile that would adjust for the effects of accretion and debt capitalization. This is of particular value in the review of the early years of a concession, when accretion features tailor debt repayment to revenue growth assumptions. In calculating an alternative DSCR, we include in the denominator the projects actual cash-based payment of debt and swap obligations, as well as the capitalized amount that is deferred and added to the projects debt balance. For certain kinds of accreting swap structures, the adjustment removes from the numerator swap inflows payable to the project that achieve the same effect as the interest payment deferral. This adjusted DSCR calculation complements the review of the percent rise in debt (due to accretion) that occurs from the original issuance to the projects maximum peak debt balance (including accrued swap amounts owing). In calculating the base case DSCRs for accreting debt projects, we include in the numerator operating revenue (excluding interest income, earnings from asset sales, debt or equity proceeds, and insurance proceeds) minus operating and maintenance expenses (including mandatory major maintenance reserve account deposits). The DSCR numerator can also exclude swap payments to the project from the swap counterparty if these payments are viewed as a pass-through to meet the project companys obligation to a debt provider. Drawdowns on an LOC or accreting swap proceeds that achieve the same effect as an interest payment deferral can be an adjustment to the DSCR numerator given their primary cash flow structuring role. In addition to traditional cash interest obligations, which deferral features will understate, the DSCR
denominator includes any monoline bond insurance costs and swap costs associated with synthetic debt products. LLCRs and PLCRs are less relevant to debt ratings, which assess an issuer or debt issues probability of default; however, these ratios provide important analytical value to our recovery rating process, in which we assess the recovery of accrued interest and principal outstanding following an unremedied payment default. In addition to being based on projected revenues, LLCRs and PLCRs are generally higher than DSCRs, which typically reflects the equity tail at the end of the concession (when the project debt has been retired.) During cash flow weakness, LLCRs and PLCRs can remain well above 1.0x, whereas periodic DSCRs during the same time frame could fall below 1.0x, requiring draws on liquidity to avoid default. A project could default on its debt obligations, while depending on assumptions of capital structure, discount rate, and revenue growth following the default for the remainder of the concession, the LLCRs and PLCRs (a proxy for recovery) could be greater than 1.0x (or greater than 100% recovery). For projects with manageable peak accretion and a considerable equity tail, such a solid recovery scenario is quite possible. Question 11: Can security features and structure and protective covenants offset the relative higher risks of an accreting debt structure? Protective covenants can strengthen a transactions credit profile by limiting the ability of the project to incur more debt, acquire dilutive businesses or distribute cash when it performs below base case expectations. No amount of structuring or covenant protection, however, can completely compensate for a weak business risk profile or overly aggressive financial structure. Standard & Poors expects the standard structural features or covenants to be considered for a project rating, particularly one that incorporates accreting debt and has a more aggressive financial profile. Where covenants require quantitative limits (such as DSCR based tests), there is no fixed rule of thumb that can be applied to achieve an investment grade rating.
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Question 12: Is the documentary and legal review for an accreting debt or swap structure different from other project finance or PPP ratings? No. The legal review across project structures is comparable, and Standard & Poors expects that transactions using accreting debt will have a robust legal structure. Our documentation and legal review includes a detailed examination of the concession agreement terms, and its supporting schedules and appendices, which govern the long-term relationship and risk allocation between the concessionaire and the concession grantor. Standard & Poors legal review will also examine any proposed intercreditor agreement and the covenant package. Certain jurisdictions benefit from more creditorfriendly legal regimes that can contribute to infrastructure project rating differences. Infrastructure project financings are generally more susceptible to local law exposure than other types of structured financing because of the physical location of the assets and the often essential and politically sensitive nature of the assets. For more information, see Jurisdiction Matters For Secured Creditors In Insolvency and Emerging Market Infrastructure: How Shifting Rules Can Stymie Private Equity. Question 13: Beyond the already stated effects of accretion, how does Standard & Poors evaluate swap transactions as part of its credit analysis? Many project sponsors employ interest rate or currency swap strategies to achieve cost-effective debt financing. These swaps are generally integrated into an overall swap that includes accretion features. A capital structure that includes both debt and accreting swaps will require a review of the relevant swap documentation and inter-creditor agreement. As an accreting swap counterparty is allowing a portion of the project companys interest payable under its swap arrangement to accrue, it is acting as debt provider, and these swap obligations will likely be considered pari passu with other debt obligations. It is important to determine if there are cross default provisions on events, such as early swap termination, which could lead to acceleration of the debt obligations. One potential credit issue is whether or not the
transaction is swap-independent. For example, if the swap were to terminate, the issuer would pay or receive a payment to or from the swap counterparty. If the issuer did not receive a payment due to a counterparty default, it might not be able to replace its swap position at similar rates or terms, so might not be able to perform at previously expected (rated) coverage levels without rate increases or possible rating implications. For transactions originating in the U.S. with U.S. swap counterparties, Standard & Poors might undertake a debt derivative profile (DDP) exercise. Although we consider many factors, the DDP scores principally indicate an issuers potential financial loss from over-the-counter debt derivatives (swaps, caps, and collars) due to collateralization of a transaction or, worse, early termination resulting from credit or economic reasons. We integrate DDPs into rating analyses for swap-independent issuers, and they are one of many financial rating factors. These credit issues are central to our rating analysis as monoline bond insurance policies might guarantee swap payments due from (but not due to) the issuer. As a highly rated financial guaranty policy should maintain payments to the swap counterparty (should a wrapped project not be able to meet its swap and debt obligations due to poor performance), the project company should not be in default on its side of the swap. Swap renewal, if applicable, and swap counterparty credit quality remain analytical issues, even for monoline wrapped transactions. As a result, Standard & Poors will examine within a swap transaction the level and minimum credit quality of collateral posting, and replacement requirements should minimum credit rating levels be violated by swap counterparties. Question 14: Given the commitments of monoline bond insurers, how is refinancing risk factored into the credit rating for an accreting debt structure? A monoline insurer that provides a guarantee policy for refinancings reduces the market access risk and the spread risk at refinance. Even AAA interest rates and credit spreads vary and in the absence of a hedging strategy, the uncertain future cost of debt refunding could narrow coverage ratios in a stress case. We evaluate the underlying
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credit quality of a transaction before overlaying and assessing the incremental contribution of credit substitutions such as monoline wraps. Moreover, our view of refinancing risk depends in large part on the expected cash flows of the project at the time of refinancing. Our starting point is to assume that refinancing risk within an accreting debt structure is manageable in long-dated concessions with a sufficient tail (about 10-30 years). We will examine financial models to understand the assumptions being made about refinancing (such as the interest rate employed) and stress tests will be used to evaluate the sensitivity of transactions to less-favorable interest rate assumptions at refinancing points. The history, record and expectation of local debt markets will have a different weight on emerging markets. Investment-grade structures will typically have secured appropriate hedging arrangements in this regard. A monoline insurers commitment simply gives additional comfort to any refinancing risk analysis.
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CREDIT FAQ: THE EVOLVING LANDSCAPE FOR SUBORDINATED DEBT IN PROJECT FINANCE
Publication Date:
Sept. 19, 2007 Primary Credit Analyst: Andrew Palmer, Melbourne, (61) 3-9631-2052 Kurt Forsgren, Boston, (1) 617-530-8308 Terry A Pratt, New York, (1) 212-438-2080 Secondary Credit Analysts: Paul B Calder, CFA, Toronto, (1) 416-507-2523 Lidia Polakovic, London, (44) 20-7176-3985 Santiago Carniado, Mexico City, (52) 55-5081-4413
mboldened by active competition and continued demand for project and infrastructure assets, the landscape for subordinated debt structures in project finance transactions continues to evolve. Indeed, some debt arrangers are pushing new boundaries to structure and fund ambitious greenfield and brownfield asset developments or leveraged acquisitions (see The Changing Face Of Infrastructure Finance: Beware The Acquisition Hybrid on page 8). Notwithstanding the recent upheaval in credit markets, the driving force behind debt structuring is usually simple: lower the after-tax weighted-average cost of capital while providing flexibility to project sponsors and investors and enhancing cash returns on equity. The result is most often higher leverage and added complexity through a mix of senior and subordinated debt--more eloquently referred to as structural optimization by debt arrangers. As employed in project finance for many years, market participants are tranching a projects liability structure into senior debt, subordinated debt, and in more recent years--depending on the window of opportunity--payment in kind (PIK) notes (see LBO Equity Hybrids: Too Good To Be True published on RatingsDirect on Aug. 10, 2007). Importantly from a credit perspective, regardless of the underlying project, the common theme is increased gearing and more complex funding and documentation structures--both which have varying effects on a projects debt ratings and recovery prospects in terms of the potential level of default and loss given default. This FAQ will highlight the criteria issues related to analyzing senior and subordinated structures in the context of issue ratings and recovery analysis.
Typically, the rights for project subordinated debt are defined under a projects structural, contractual, and legal framework. This structural framework for projects should incorporate a ring-fenced entity, a pre-default cash-flow waterfall, cash lock-up and sweep triggers, a debtservice reserve account, and post-default liquidation processes. Consequently, given the varying characteristics of subordinated debt the default and loss given default of any tranches of project subordinated debt may occur at different time intervals over the term of a transactions life cycle. Why is subordinated debt used in project transactions? Subordination gives project finance transactions the ability to create one or more classes of debt, which can allow access to more debt or alternate investor classes. One of the main objectives of using subordinated debt is to improve a projects after-tax weighted-average cost of capital through improving the rating on senior debt while segregating credit risk and enhancing the return on equity. At the same time, sponsors of a project often use subordinated debt for tax and accounting reasons, particularly where there may be restrictions in distributing cash from a specialpurpose-vehicle structure due to retained accounting losses. Subordinated debt may also be an option explored by debt arrangers if seniorsecured financing options have be exhausted or capped out. Can subordinated debt be treated as equity for analytical purposes? Often project sponsors use subordinated debt as a substitute for equity. Depending on the underlying project ring-fence structure, security, contractual, and legal framework in each jurisdiction, Standard & Poors may consider treating subordinated debt as equity for analytical purposes on a case-by-case analysis. Such an analytical scenario may occur if a projects debt: is deeply subordinated within a strongly ring-fenced vehicle with a structural waterfall and distribution triggers; has no rights to call default or accelerate payment; ranks after senior debt under predefault and post-default cash-flow waterfalls; and matures after senior debt. Like most financing structures, however, the answer will reside in the detail of a particular transaction in its relevant jurisdiction.

What is project subordinated debt? In its purist and simplest form, a projects subordinated debt typically ranks behind a projects senior debt in terms of priority over predefault cash flows and security over collateral, and in the event of insolvency behind any enforcement proceeds, assuming there is anything left. In this context, project subordinated debt is used in structures as a form of credit enhancement for senior debt that establishes the distribution of a projects default and recovery over the life of the financing structure.
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What are some of the key types of project subordinated debt? While there are project-specific nuances, in most instances the type and level of subordinated debt has been tailored to the cash-flow characteristics of each project. Standard & Poors has identified a variety of structural, contractual, and legal forms of subordinated debt in project finance transactions: Deeply subordinated (pre- and post-default) debt. A form of deeply subordinated debt is shareholder loans, which display many of the characteristics of equity, and have no rights to call default or rights on enforcement, or calls on the post-default recovery proceeds. This form of subordinated debt is often used in the public-privatepartnership (PPP) space as tax-efficient equity for sponsors. Residual value subordinated debt. This debt is structurally reliant on residual or dividend cash flow from another project-financed vehicle with senior-ranking debt and possibly even subordinated debt obligations. These residual cash flows or dividends are usually only available subject to certain debt lock-up tests being achieved at the underlying project funding vehicle. Dividends or residual flows may also be dependent on the ability of a project company to distribute cash flows due to retained accounting losses. PIK notes. Typically, PIK notes are structurally subordinated to senior debt or second-ranking lien debt in a projects pre-default and post-default cash-flow waterfall, with coupon payments at the discretion of the issuer. If coupon payments under the PIK notes are not made in the form of cash distributions, the coupon is usually made whole by the issuance of PIK notes of equivalent value. Unlike true equity, PIK notes usually have a maturity date and at least some rights against the issuer to help ensure repayment. Standard & Poors will treat PIK notes as debt in calculating credit metrics. While it may be possible to carve-up a projects cash flows to create a subordinated instrument in a number of forms, there is no free lunch, and at some point the key consideration is how a subordinated debt instrument will or will not
affect default or recovery of senior-ranking debt from a credit and legal perspective. What are the key structural elements considered by Standard & Poors? In examining a projects liability and capital structure, we are often asked what the main structural and documentation considerations it undertakes to assess how a projects debt is structurally, contractually, or legally subordinated. The objective is relatively simple: if subordinated debt obligations are to provide credit support and collateral to senior rated debt, then subordinated debt must have no rights that could accelerate or cause default or increase the level of loss given default of any senior-ranking debt. Nevertheless, Standard & Poors will typically review several aspects in any assessment: The rights of subordinated debt to call a default or cross default to senior classes of debt. It is not appropriate that a payment default on a tranche of subordinated debt could cause a default under the senior debt provisions. The rights of subordinated debt to accelerate payment while senior debt is outstanding. Subordinated debt should not have any right to accelerate while senior debt is outstanding. Senior debt rights to lock-up or sweep cash flow. Following any breach of a senior debt cash-flow lock-up trigger or cash-flow sweep trigger, subordinated debt should not be entitled to any cash flow, other than what might be available from reserves that are specifically dedicated to the subordinated debt obligations. Similar to the point above, this should also not give subordinated debt any rights to call or trigger default or acceleration as a result of a senior lockup or sweep trigger being breached. The pre-default and post-default cash-flow waterfall and transaction documentation. This is necessary to understand how subordinated debt is structurally and legally subordinated. This would include an understanding of how cash flows are distributed and shared in a transactions cash-flow waterfall. Typically, subordinated debt should be serviced after payments to operations, senior debt interest and principal, any net hedging settlements, and any senior debt-service reserves
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and maintenance accounts, which are there to support the senior debt rating. Likewise, collateral security interests or claims upon liquidation granted to subordinate lenders should rank after senior debt. The maturity profile of subordinated debt should be longer dated than senior debt, otherwise it is not truly subordinated. The voting rights of debt participants. These rights should be limited solely to senior debt participants; subordinated debt should have no rights while senior debt is outstanding. Nonpetition language. This needs to be considered to ensure that no winding-up provisions are allowed while senior debt is outstanding either permanently or for a specified period. Typically, the objective is to ensure that subordinated debt has no right to challenge any enforcement rights or validity in the priority of payments of senior debt holders. The events of default and termination events of any interest-rate swaps used to hedge subordinated debt. These need to be closely examined. Although the majority of subordinated debt is fixed-rate debt, if variable subordinated debt is used and overlaid and mitigated with a interest-rate hedge, the events of default and termination events of the swap would need to be limited so as not to accelerate or cross-default senior debt. Subordinated debt rights or remedies in a restructuring, insolvency, or bankruptcy proceeding. Deeply subordinated debt should not have any such rights or remedies. For beneficial equity treatment, project subordinated debt should only be able to enforce its security and creditor rights unless, and until, senior debt has done so. What is the analytical framework for project subordinated debt? Some market participants think of the analytical assessment behind rating subordinated debt as one of simply solving a target debt-service cover ratio (DSCR) or simply notching off the senior debt issue rating. But our approach is more sophisticated. No two projects are the same from
a business, industry, market, operational, structural, or legal perspective. Certainly, it is fair to say that a senior debt issue rating provides some starting point for the subordinated debt rating. However, in order to make a proper assessment, we assess a projects cash flows to understand where the credit stress points may be relative to the payment structure under the subordinated debt instrument and its exposure horizon. In assessing the ability and willingness of a projects subordinated debt to pay its obligations in full and on time, our analytical framework reviews and measures a number of elements that influence the level of potential default and rating of a subordinated debt tranche: The underlying business and industry risk of a project. This examines the key business and industry economic fundamentals that influence the underlying volatility of a projects operating cash flow. A projects financial ratios (for example, DSCR on a total debt basis {senior and subordinated debt} and segregated subordinated debt basis after {senior debt}). It is important to note that the DSCR should not be viewed in isolation. This is particularly true when a project includes accreting debt structures that can overstate a transactions DSCR, while also deferring senior debt amortization. (see Accreting Debt Obligations And The Road To Investment Grade For Infrastructure Concessions on page 105). As a result, we closely examine all financial ratios, particularly revenue growth assumptions and the components of the coverage ratios that are can be overstated by such financing instruments. Senior debt cash lock-up triggers, sweep triggers, and reserve limits (for example, senior debtservice reserve and maintenance reserves). Understanding these triggers and reserves is a critical part of the analytical framework for subordinated debt, as such lock-up triggers and reserves are for the protection of senior lenders only, and may result in subordinated debt being more susceptible to default, particularly if subordinated debt does not have its own dedicated debt-service or liquidity reserve.
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Sensitivity and break-even analysis on each project is undertaken. This takes into account the specific cash-flow waterfall structure and repayment terms and conditions of senior and subordinated debt. Sensitivity analysis helps demonstrate and highlight potential downside thresholds under which subordinated debt may miss a payment of interest or principal. Stress tests, which are usually in the form of break-even analysis, assist in understanding whether a missed payment is due to any lock-up triggers or other distribution stoppers being breached and stopping cash flowing through to subordinated debt (and any dedicated debt-service reserve running out), or just the fact that there is not enough cash after the senior debt has been serviced irrespective of any distribution trap or stopper. Stress sensitivities are run on revenues, availability, prices, operating costs, capital expenditure, inflation, and refinancing spreads. Typically, the level of stress placed on subordinated debt is reconciled with the overall risk of the project and likelihood of a stress scenario occurring. Assessing the level and type of credit enhancement supporting subordinated debt. Such credit enhancement can take the form of equity, and project cash flows available after senior debt-service and liquidity reserves, usually in the form of dedicated debt-service reserves for the benefit of subordinated debt. If a subordinated debt instrument does not have its own debt-service reserve, it is likely to be more susceptible to default under stressed scenarios. Ability for senior debt to raise additional debt or offer security ahead of subordinated debt. Most projects allow limited other financial indebtedness to be raised and security granted to enhance the rating of senior debt. However, if this right is too broad, it may affect the level of subordination, which may change over time. What will influence the probability of default on subordinated debt? Apart from a projects underlying operating and business fundamentals, which will be the major influence on the performance of a project, the probability of default of a projects subordinated debt will be influenced typically by:
The contractual and legal structure of a project, which usually incorporates a predefault cash-flow waterfall, cash lock-up and sweep triggers, a timeframe before cash is released from lock-up, and debt-service reserve accounts for senior debt; and The terms and conditions of the underlying subordinated debt and any dedicated liquidity or debt-service reserve allocated for subordinated debt. Accordingly, key subordinated debt rating considerations include: how likely a project will go into distribution or equity lock-up; how long it will remain there; what happens to the trapped cash once in lock-up; and what type of credit or liquidity support (such as reserves) exist to lower default probability. If a distribution-trap mechanism does not last for an indefinite period, it could be argued that the resumption of debtservice payments on subordinated debt-depending on the project, scenario, and subordinated liquidity reserves--is likely to be certain. The analytical challenge is determining the duration of any under performance. We typically run stress scenarios for each project to analyze how long it would take for a rated tranche of subordinated debt to default under varying scenarios. Nonetheless, any significant deterioration in the performance of a project is likely to magnify the level of potential default on any subordinated debt. What will affect the recovery of subordinated debt? If a project suffers from poor performance and there is a missed payment of interest or principal on a projects subordinated debt, a major determinant on the recovery prospects of subordinated debt is whether senior debt has also defaulted. If senior debt has not defaulted, it would prevent any recovery action of subordinated debt until senior debt is repaid or defaults. If this was to occur, there may be limited or zero recovery for subordinated debt. Should senior debt default or be repaid, factors that would influence the recovery prospects of subordinated debt include: The nature of the default; The type of security, collateral, and any first-loss protection;
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The type of security enforcement scenario (liquidation versus selling the project as a going concern); Senior debts ability to influence the recovery for its benefit; Macroeconomic conditions and its impact on the value of any collateral; The level of any break costs under a hedging or derivative instrument; The insolvency or bankruptcy regime in a jurisdiction or country; Third-party costs, such as legal and insolvency-related costs; The time it takes to emerge from default; The length and value of a projects cashflow tail after the repayment of senior debt; Any other equal-ranking obligations. As each of these factors can vary considerably from market to market across the globe, so too will the level of recovery for each projects subordinated debt. Consequently, each project needs to be examined on a case-by-case basis. Why can subordinated debt issues be rated one or more notches below the senior debt rating? As each projects business profile is unique, so too is its financial, contractual, and legal structures. Depending on the unique features of each project, our ratings on project subordinated debt issues have on average ranged up to three notches below the senior debt rating. However, there have been exceptions in both directions, depending on the project and specific structural elements, covenants, and security features. Some credit features that have led to subordinated debt being rated more than one notch below senior debt (and hence more equity-like treatment) have included: Severe cash-flow encumbrances on subordinated debt servicing due to senior debt distribution lock-ups, the timeframe before cash is released from lock-up, and debt-service reserve maintenance; No rights or remedies in the event of a default affecting senior debt; No cross-acceleration or cross-default mechanisms; and Low debt-service coverage ratios and stress buffers.
Conversely, some credit features that have led to subordinated debt being rated closer to the senior debt rating have included: Contingent support from sponsors to mitigate cash-flow encumbrances on subordinated debt servicing; Lower probability of reaching equity lockup, which could occur in a project due to simple services to be delivered, a benign payment mechanism, strong and/or highly rated service providers to whom cost and revenue deduction risk is passed, and considerable third-party support; Subordinated debt liquidity support in the form of a dedicated debt-service reserve (up to six months), the ability to capitalize or defer interest, PIK notes, and contingent third-party support; Sharing of collateral security enforcement rights with senior lenders; and Strong debt-service cover ratios and stress buffers. There are also examples of subordinate debt being rated on par with senior lien obligations. These have occurred in situations where the senior lien debt amounts are very small in relation to the subordinate lien, when a senior lien may be closed, or when the project operates with significant financial margins. (For examples of our ratings and related research on project subordinated debt issues, see the following issuers on RatingsDirect: 407 International Inc., Express Pipeline L.P., Reliance Rail Finance Pty Ltd., San Joaquin Hills Transportation Corridor Agency, and Alameda Corridor Transportation Authority.) Where to from here for subordinated debt structures? As active competition for project and infrastructure asset continues to move prices higher, market participants will continue to explore subordinated debt funding options and product structures to increase leverage to meet this strong demand. So long as the economic cycle continues, market participants will continue to push boundaries in debt structuring; however, market participants should remember that debt structuring is not a way to obtain funds at no risk
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and that project fundamentals rather than financial engineering are the key to investmentgrade structures. So where to from here? Given the long-term nature of project and infrastructure assets, and the competitive nature of debt arrangers and the risk appetite of investors for long-term assets, the landscape for project subordinated debt will continue to evolve. Standard & Poors expects to see variations in subordinated debt products for project and infrastructure transactions. While cash flows from projects will continue to be carved up to create subordinated debt instruments, at the end of the day there is no free lunch, and the key credit consideration will remain--what will cause a rated tranche of subordinated debt to default and how will a particular subordinated debt instrument affect the default or recovery of any senior-ranking debt?
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CREDIT FAQ: RECENTLY UPGRADED NAKILAT PROVIDES CASE STUDY FOR CREDIT ANALYSIS OF LNG SHIPPING PROJECTS
Publication Date:
April 13, 2007 Primary Credit Analysts: Karim Nassif, London, (44) 20-7176-3677 Terry A Pratt, New York, (1) 212-438-2080 Secondary Credit Analyst: Michael Wilkins, London, (44) 20-7176-3528
ur first-ever public rating on a liquefied natural gas (LNG) shipping entity was recently raised when Qatar-based Nakilat Inc. was upgraded to A+ with a stable outlook. The rating on Nakilat, a wholly owned subsidiary of Qatar Gas Transport Co. Ltd. (QGTC), was raised following the upgrade of the State of Qatar (AA-/Stable/A-1+). This reflected our continued expectation of strong potential extraordinary sovereign support for Nakilat in an event of stress. Since then, Standard & Poors Ratings Services has received several questions concerning our rating analysis of LNG shipping financings. Currently Nakilat is the only publicly rated LNG shipping entity and so, understandably, it represents the best case study of our rating approach. This article attempts to answer the most frequently asked questions we have been receiving concerning Nakilat and our general credit analysis of LNG shipping financings. Further information can also be read in the article titled Global LNG Shipping Projects May Be On Course For Investment Grade, published on March 6, 2006, on RatingsDirect.
financing. The upstream project is often also the charterer under the charter agreement. If there is an alternative charterer other than the project company the credit quality of the alternative charterer would also be important, because it provides a measure of the certainty and reliability with which cash flows will be earned by the vessel owners under the charter agreement for the purposes of repaying debt. There is also a counterparty risk inherent in the construction of ships. The credit quality, experience, transaction support through thirdparty liquidity, and reputation of the shipbuilder are also essential elements, therefore, in the overall analysis of an LNG shipping project. Legal structure (including construction and charter agreements). The second key element in our analysis is the risk to lenders that arises based on the charterparty contract and construction contracts. For an investment-grade rating we would expect the charterparty contract to last through the debt tenor and guarantee availability-based fixed payments with inbuilt escalation clauses to cover growing operating and material costs. For construction contracts we would expect fixedprice, date-certain arrangements with established shipbuilders coupled with shipbuilder-completion guarantees. Most LNG ship financings we have reviewed have been structured as projects and have used special purpose entities (SPEs). There are specific contracts and documentation for single ships, although often several ships are operated as a group. In effect, the financings have involved a portfolio of ships with the contractual nature being determined on a ship-by-ship basis. For the single ships we look to our project finance criteria in analyzing underlying risks given the single-asset nature of the SPEs and the contractual structure. In many cases, however, there is a holding company sitting on top of the SPE that ultimately owns multiple ships, albeit through an SPE structure. The review of the holding company as part of a portfolio review might, therefore, require more of a corporate analysis. Ultimately, a portfolio of LNG ships is often presented as a hybrid structure featuring both project and corporate features. Our rating analysis, therefore, has to take into account these unique features.

What are the major factors that underpin Standard & Poors approach to rating LNG ship financings? Generally our approach is to consider LNG shipping as an integral part of the complete LNG supply chain, which starts from natural gas development and production from the gas field, moves through liquefaction of the natural gas, and ends with regasification at the import terminals and then sale to the end markets. The two key elements that underpin our approach are counterparty risk and the legal structure (including construction and charter agreements). Counterparty risk. One of the key elements determining the rating for LNG ships is related to counterparty risk, specifically to the upstream project producing the LNG. In most, if not all, cases the project is the source of payments to the shipper. If the project fails, the alternative use for the LNG ships is still limited given the absence of a large LNG spot market. As a result, the credit quality of the underlying LNG project usually provides one of the key constraints for the rating of the LNG ship
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What approach did you take when analyzing Nakilat? We regard Nakilat as more of a corporate entity than a typical project financing, due to the strong corporate features inherent in the transaction. Ultimately our ratings on Nakilat reflect the mainly corporate nature of the entity. Although some features of its lending package are structured like a corporate, however, its cash flow arises from asset-specific features. We, therefore, also analyzed some aspects of the transaction as if it were a project. We also consider Nakilat to be a governmentrelated entity. Our conclusion of this government link is supported by the importance of Nakilats LNG ships to Qatars economy and the states strategic plans to maintain its leading position as the worlds No. 1 LNG exporter. The overall capital investment by the Qatari state and its partners in the LNG sector (upstream, midstream, and downstream) is expected to total just over $65 billion by 2010. Qatar and QGCT plan to use the Nakilat LNG ships on some of the major LNG projects in Qatar. These include Ras Laffan Liquefied Natural Gas Co. Ltd. (3) (senior secured debt A/Stable), Qatar Liquefied Gas Co. Ltd. (QatarGas) 2, QatarGas 3, and QatarGas 4. The government is involved directly through its ownership of Qatar Petroleum (AA-/Stable/--), which is a majority owner of the LNG projects. Therefore, the ratings on Nakilat are linked to the credit quality of the Qatari state (currently rated AA-/Stable/A-1+). Nakilats financial profile is weak for the ratings but its business profile and strategy are very strong. Given the companys important role in the Qatari LNG sector, which is a strategic sector for the nations GDP growth, we expect that as long as the government stands behind its LNG and gas monetization strategy, it will support Nakilat. The one-notch differential between the corporate credit rating on Nakilat and the sovereign rating on Qatar reflects the absence of explicit financial state support in the form of a guarantee or equivalent, despite implicit state support for the entity.
What impact did the Qatari sovereign upgrade have on the Nakilat ratings? Following the upgrade of Qatar we raised our corporate credit rating on Nakilat to A+ with a stable outlook. The subordinated debt was also raised, to A. The senior secured debt rating was affirmed at A+. The one-notch increase in the corporate credit rating reflected the one-notch increase in the rating on Qatar and our top down approach for Nakilat as a government-related entity. The corporate credit rating continues to reflect our unchanged expectation of potential strong extraordinary sovereign support for Nakilat in an event of stress. The senior secured debt rating (previously one notch above the corporate credit rating) remained unchanged because, although the available security package and debt structures have not changed, the higher corporate rating on Nakilat now means that the added value of the security package relative to the rating is reduced. Similar sovereign support for the subordinated debt is expected as for the senior debt, and for that reason a one-notch differential between the corporate and subordinated debt ratings was maintained. How does the sovereign rating influence the ratings on LNG ship projects? In the case of Nakilat, the importance of LNG for Qatar and the implicit support provided by the state through the involvement of Qatar Petroleum along the supply chain supports our conclusion that Nakilat is a government-related entity. In a sense Nakilat is a unique entity given the state of Qatars LNG strategy. In other instances where state support is not deemed as significant, a project might not receive the same benefits of state support as Nakilat and the focus will therefore be more on that projects own strengths and weaknesses. As noted above, the creditworthiness of the LNG shipping deal would be affected by the credit profile of the underlying LNG supply project. For a project to obtain rating uplift toward a sovereign rating, the strategic rationale for the countrys LNG sector must be very strong--that is, material to that countrys government. In other words, the
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governments financial position would be materially harmed if the shipping entity were to default. Government ownership of a shipping company and direct financial support mechanisms are also ways to link the rating on a shipping project more closely to that of the sovereign. As with project finance analysis, sovereign and institutional risks are assessed as well as credit enhancements. Could LNG ships have a rating above the underlying project rating? Typically the creditworthiness of the underlying LNG supply project will constrain the rating of the shipping deal. The two are inextricably linked in the value chain because the ships rely on the project to produce the LNG and the project is paying the charter fees. It might be possible, however, for the LNG shipping project to achieve a rating above that on the supply project if some delinkage is achieved from the underlying supply project. In this situation, we require comfort that the ships could earn sufficiently robust cash flow without the supply project, through either redeployment by obtaining long-term contracts or through the spot market. In this case, our charterhire price assumptions would be very conservative given the likely long-term nature of the debt. This situation might be more realistic in the long term than in the short-to-medium term, assuming that in the long term a deeper spot market develops. The current high amount of ships contracted for LNG projects, the lack of a deep LNG spot market, and the expectation that older-generation LNG ships might also be available for the spot market once their charter agreements end, all render unlikely the potential redeployment of the vessels at rates commensurate with servicing of debt under severely stressed scenarios. What recovery potential would you ascribe to LNG ships? Although we have not issued any public recovery ratings on LNG ship projects and continue to refine appropriate recovery scenarios, our analysis of recovery potential for LNG ship financings is likely to include an assessment of the redeployment of LNG vessels after a project default in a similar way to the process described above under a delinking approach. Given the
absence of any material sale and purchase market for LNG vessels, we would not typically ascribe much value to an enterprise value approach (such as using EBITDA multiples or net present values) when calculating our recovery ratings. Rather, we would likely focus our recovery analysis on the ability of the vessels to continue to service debt under low charter-hire rate assumptions, which could reflect historical lows witnessed in the spot market or long-term charter market or future lows anticipated in either market as appropriate. Do you view LNG ship projects with more than one vessel as less risky than single-ship deals? All else being constant, the greater the number of ships involved for a given financial profile, the greater the potential for higher ratings. Adding diversity can reduce operational risk as well as exposure to force majeure risk by having a safety cushion consisting of a residual operating fleet in the event that specific problems occur with some of the vessels. Although the LNG shipping industry has a very favorable performance record, the risk remains that some vessels might have their payment streams affected due to technical problems, political risk, or environmental conditions. The technical risk issue is present because LNG ships are becoming much larger to improve economies of scale and are employing reconfigured drive systems. If we were to hypothetically compare a standard single-ship project serving the same underlying LNG project (with all other risks remaining constant) with a multiple-ship project serving the same underlying LNG project, the chances are that rating would not be necessarily enhanced by having more ships. There would likely be more financial cushion at the same rating category for the LNG ship project with a higher number of vessels. The reason is that under the two different scenarios the credit quality of the same underlying LNG project continues to provide a constraint on the rating on the LNG shipping projects. Nevertheless, there could be examples where a ship project, because of its particular risk features, benefits by virtue of being structured with a large number of vessels, and therefore manages to achieve a rating above that of the underlying LNG project rating.
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What leverage levels and debt service coverage ratios are required to ensure an investment-grade rating for LNG shipping projects? There are simply no magic numbers for debt service coverage ratios or leverage levels that would guarantee an investment-grade rating. Ultimately the financial risk that a project or entity can absorb is derived from the underlying project risks, structure of financing, liquidity, and other factors. As a starting point, the financial ratios are a result of the underlying risk analysis. One typical element of LNG ship financing is a refinance risk that is often incurred, despite contracts backing the transaction far beyond the anticipated refinancing or initial maturity date. Although we consider this a weakness, it can, nevertheless, be somewhat mitigated through a refinancing strategy as well as incentives to start looking early at refinancing (such as margin or coupon step-ups and cash sweeps). The most important mitigating factor is, however, the sale and purchase agreements that will support the transaction far beyond the refinancing date and provide comfort to the financial markets that the entity will generate sufficient cash to repay the new debt.
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STANDARD & POORS METHODOLOGY FOR SETTING THE CAPITAL CHARGE ON PROJECT FINANCE TRANSACTIONS
Publication Date:
Sept. 12, 2007 Primary Credit Analyst: Lidia Polakovic, London, (44) 20-7176-3985 Parvathy Iyer, Melbourne, (61) 3-9631-2034 Secondary Credit Analysts: Arthur F Simonson, New York, (1) 212-438-2094 Dick P Smith, New York, (1) 212-438-2095 David Veno, New York, (1) 212-438-2108
n recent years, project debt issuers worldwide have increasingly been using financial guarantee insurance provided by monoline insurers, also referred to as monoline wraps. A key element in the process of the monoline wrap is the capital charge Standard & Poors assigns. This capital charge is important for determining the capital adequacy of, and ultimately the rating on, the monoline insurers. This article aims to make transparent the way Standard & Poors determines each projects capital charge and supersedes the capital charges listed in our Global Bond Insurance criteria book, which are no longer valid for project finance transactions. A monoline wrap provides an unconditional and irrevocable financial guarantee from the insurer to pay all or a certain portion of a projects scheduled principal and interest on time and in full to debt providers if the project is unable to do so. The project debt guaranteed by the monoline is assigned a higher rating than the projects underlying rating. This higher rating is equalized with the financial strength rating on the monoline. The underlying project debt rating, which Standard & Poors assigns to each wrapped project, is generally lower, reflecting the projects real underlying business and financial risks. As a result of providing the guarantee, monolines are exposed to the underlying risk of the project. This determines their portfolio risk and the charge to capital. Each project finance transaction is unique, both in terms of risks and structural features, and so is the capital charge. Consequently, Standard & Poors uses the same methodology for every monoline insured project to calculate the applicable capital charge. Capital charges have been assigned by Standard & Poors since the mid 1980s but have been adjusted over time to reflect credit conditions and market trends.
Defining The Capital Charge

Capital charge is the theoretical loss based on a worst-case economic environment, i.e. an economic depression case. The capital charge is expressed as a product of: Likelihood of default by the issuer (i.e. default risk or frequency); and Severity of default measured in terms of loss in asset value recovery.
The default risk is equivalent to Standard & Poors default probability at a given rating. It does not vary between different projects that have been assigned the same rating. The severity factor is transaction specific, however, because each project has a unique combination of asset-related risks and contractual, financing, and legal issues. Consequently, the capital charge varies across asset classes and primarily reflects differences in the recovery potential. Once the two factors have been determined, the capital charge for issues is a percentage of par value. Standard & Poors applies the same capital charge across an entire rating category. Issues rated A, A+, and A-, for example, have the same capital charge. Once a capital charge has been assigned, Standard & Poors reviews it regularly as part of its surveillance. Furthermore, the same capital charge is used for all the insurers involved in that project, irrespective of which insurer provides the wrap. This is because the transaction default frequency and severity measure reflect the project risks and are independent of the insurance company that insures the project debt. The process of estimating capital charges can be complex and involve reasoning and modeling. Empirical data on new asset classes or new financing types, for example, is not always available or useful. Estimating loss-given default can also be complex in countries where the creditor regime has not been tested or the enforcement of security is complex and lengthy. The fundamental approach to calculating the capital charge for project debt is generally the same as that adopted for corporates. Nevertheless, the financing and structural aspects of a project can demand subjective judgment of recovery potential, and therefore the capital charge. Even so, similar transactions under a similar creditor regime are often likely to provide a good benchmark for a new transaction.
Prerequisites
Assigning an underlying rating to the project is a required step toward enabling the calculation of the capital charge. The underlying rating is determined in the same way as an unwrapped project debt rating and is based on the same criteria. The underlying rating is determined
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irrespective of whether the monoline guarantee applies to all the project debt or only a portion of it. Standard & Poors relies only on in-house determinations of default frequency and recovery estimates. Ratings and recovery values estimated by other rating agencies or professional bodies are not used as reference points for assigning the capital charge. The in-house data enable Standard & Poors to maintain consistency across various jurisdictions, transactions, and operating environments.
Calculating The Capital Charge

Default frequency The default frequency for a given rating is determined using Standard & Poors corporate default study. The default study identifies the highest historical default rates across various sectors by rating category over a period of years. The leading global economies, the U.S. and Europe, have not, over the past 15 years, represented a worst-case depression-like scenario, and so the default rates are grossed up to what Standard & Poors believes to be worst-case levels. Through simulations of such scenarios across various sectors, Standard & Poors calculates worst-case default frequency for longterm risks across the rating categories (see table). Worst-Case Default Frequency
Rating category AA A BBB BB Worst-case default frequency (%) 5.9 7.1 14.8 55.4
Example. This example gives an illustration of how the capital charge on a project rated A is determined. The steps are: to determine the A underlying rating on the project; read the default frequency from the table above; estimate the loss-given default; and finally determine the capital charge. The projects underlying rating is A. The default frequency for the A rating category is 7.1%. The estimated asset recovery value is 60%. The loss-given default is 40% (100% minus 60%). The capital charge is 7.1% multiplied by 40%: 2.84% of par value. Cross-border issuance Projects located in one country often raise debt in another market. Such situations give rise to sovereign-related risks that could affect the ability and willingness of the entity to service its foreign currency debt. In the past, we adjusted capital charges to reflect these risks. Effective this year, however, our methodology for calculating capital charges for project cross-border issuance has been revised. Based on evidence that sovereigns under political and economic stress are less often restricting nonsovereign entities access to the foreign exchange needed for debt service, crossborder transactions (even without structural sovereign risk mitigation features) can be rated above the sovereign foreign currency rating, up to the Transfer and Convertibility Risk Assessment for the relevant sovereign jurisdiction. Project ratings incorporate all transfer and convertibility risk and other relevant country risks. Furthermore, many cross-border project finance transactions contain significant additional structural mitigants for direct sovereign interference risk, which make an additional sovereign risk adjustment to the capital charge unnecessary. Our new methodology for setting the capital charge for cross-border project finance transactions is therefore based on the default rate associated with the transactions foreign currency rating and severity of loss-given default. The latter will continue to be an analytical assessment based on the unique characteristics of each individual transaction analyzed by Standard & Poors.
Loss-given default Loss-given default is unique for each project, for the reasons given in Defining The Capital Charge. It can differ between two assets in the same sector and jurisdiction. There can also be different degrees of confidence regarding recovery. Subjective judgments are critical for deciding how to stress collateral values in hypothetical postdefault scenarios, but market trends can supplement theoretical estimates. For the purposes of assigning a capital charge, Standard & Poors currently assumes a maximum recovery of 90%.
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Surveillance Of The Capital Charge

The capital charge is dynamic and all projects that have a monoline wrap have been surveilled since 2005. This surveillance enables an adjustment to the capital charge if the underlying projects default risk or recovery prospects improve or worsen.
The Capital Charge And New Ratings

Project debt issuers and monoline insurers are encouraged to begin dialogue with Standard & Poors at an early stage in the project-financing process to help avoid any surprises later on. Early dialogue is particularly important because most projects are rated at the lower end of the rating scale, where the capital charge is substantially higher and can affect the premium payable to the monoline. Borderline differences in rating outcome can have a substantial impact on the applicable capital charge. Standard & Poors is often asked by monoline insurers to give indicative capital charges, sometimes even before the rating process is initiated. We provide this indication based on estimated default risk and recovery levels. Only once the rating (default risk) has been assigned to a project and the recovery rate determined is the final capital charge calculated. The final capital charge can therefore differ from the indicative one, as the latter is based on estimates and on very limited information.
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SWEDEN MOVES CLOSER TO PPP MODEL AS ALTERNATIVE FINANCING FOR INFRASTRUCTURE ASSETS
Publication Date:
Nov. 2, 2007 Primary Credit Analyst: Lidia Polakovic, London, (44) 20-7176-3985 Secondary Credit Analysts: Karin Erlander, London, (44) 20-7176-3584 Michael Wilkins, London, (44) 20-7176-3528
weden is making significant steps in developing a model for public-private partnerships (PPPs) to provide an alternative means of financing public infrastructure. On June 18, 2007, a joint working group commissioned by the Swedish government--made up of the public rail authority (Banverket), the public road authority (Vgverket), and the Swedish National Road and Transport Research Institute (VTI)-published a proposal for a Swedish PPP model and identified a number of potential future PPP projects. Recently, the countrys public road and railway authorities announced the deferral of a substantial number of state-funded investments. A solution involving PPP financing could minimize future delays in necessary infrastructure developments. For private investors, the existence of a project pipeline detailing projects in terms of both number and size is important, given the relatively high costs associated with PPP bidding. It is also important for the public sector, to keep transaction costs low. For now, however, it is not clear if the PPP model will be selected and used on a larger scale, and, if so, how long implementation will take.
Large Investment Needed, But Grants Might Not Suffice

Currently, transportation infrastructure investments are funded mainly through the state budget on a year-by-year basis. State budget grants for road investments for the 2006-2009 period total about Swedish krona (SEK) 70 billion (SEK17 billion-SEK18 billion per year), while earmarked spending on rail for the period comes to about SEK52 billion (SEK11 billion-SEK14 billion per year) (see table 1). While the need for investment in infrastructure,
mainly roads and rail, is evident in certain regions to develop economic growth, in other areas investment is needed to alleviate congestion. In these cases, the approval of projects via the budget on a year-by-year basis could prove too slow to meet increasing demand. In addition, budgeted state contributions for the infrastructure sector have remained largely unchanged, failing to reflect cost increases. Recently, both the Vgverket and the Banverket announced significant investment reductions due to insufficient funding. As an example, total Vgverket investment grants for 2007 amount to SEK42.5 billion, unchanged from 2004, while construction costs have increased by 16% since 2004. Consequently, the Vgverket has had to cut spending on projects by a similar amount. Although investments can be delayed on a shortterm basis, the Vgverket is concerned about the long-term effects on road quality and safety if this situation continues. The rail sector faces a similar situation, with capacity shortages in major cities and traffic disruptions. If investment spending remains unchanged, investments in infrastructure are likely to slow further. The current system, in certain cases, allows public authorities with access to budget funds to finance major projects by taking loans from the national debt office. Total debt issued by the national debt office to the Vgverket and the Banverket stood at SEK32.4 billion at year-end 2006. In some cases the government (Kingdom of Sweden; AAA/Stable/A-1+) has guaranteed private debt, as in the case of the resund bridge between Sweden and Denmark. In rare cases, infrastructure investments are financed by charges paid by the user (for example the train link between Stockholm and Arlanda airport and the Svinesund bridge between Sweden and Norway).
Table 1 - Major Rail Projects In State Budget

Project Malm city tunnel Investment (bil. SEK) 9.5 (4.6 used) Details Financed by the government, the municipality of Malm, the county council of Skne, and EU contributions N.A. SEK4 billion to be financed by Stockholm municipality and Stockholm county council N.A.
Hallandssen railroad tunnel Citybanan line in Stockholm Botniabanan railroad in northern Sweden
SEK--Swedish krona. N.A.--Not available.
7.5 13.7 (1.0 used) 13.2 (9.5 used)
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Public And Private Support For Change

The active search by the Swedish government together with public entities and private parties for a new model to finance public infrastructure marks a change from the past. Infrastructure Minister sa Torstensson has said that the government is looking at alternative financing for infrastructure investments, with the intention of finding ways to achieve PPP solutions. The minister considers that there is a direct connection between new jobs, welfare, and efficient infrastructure. If the government and parliament approve a broad domestic PPP initiative, a concessional framework will have to be developed. A standardized PPP regime with similarities to existing regimes in Europe and elsewhere could attract more potential bidders. Concessions must be designed to provide optimum value, not only financially but also in terms of other targets. Environmental issues have recently become increasingly important in Sweden, as in many other countries. Setting the right goals and requirements from the start is key due to the longterm commitments involved. These considerations have been addressed by the findings of the joint working group, which propose a Swedish PPP model and potential projects.
Working Group Scrutinizes PPP Alternative

The findings center on the profitability of projects both from a social and economic perspective, transparency of state funding, procurement competition to ensure efficiency and lower costs, and a system that allows for program evaluation. Innovation to introduce more efficient solutions, flexibility, and the potential to start projects at short notice were also identified as key features of a future PPP program. The key findings are: Quality, safety, and environment. The investment should be of good quality, open to traffic, fulfill safety requirements, and ensure that environmental regulation is met. Effective risk allocation. The project company should carry construction, operational, and lifecycle risks. The state should be left with risks associated with the use of the asset (for example traffic volume risk) as well as those risks that could be
better managed by the state (such as acquisition of land, permit processes, pollution, and archeological finds). In the longer term, the working group believes more appropriate risk allocation measures should be developed. Financing. This should be a combination of a projects own capital and borrowing to ensure that the sponsors incentives are in line with the aim of the project and that they remain committed. Public financing as a last resort. If the agreements between companies and local/regional authorities fall short, the project should ultimately be financed by the state. A long-term pipeline. PPP projects should be selected in line with long-term plans in order to control the expansion of infrastructure. Importantly, the working group believes it would be reasonable for the Swedish parliament and government to ultimately decide on the projects to be tendered, as long as taxes continue to finance the asset. Comparison with public finance. The working group believes that a rule should be established to enable the government to directly compare the cost of a project, to ascertain whether it should be financed via a PPP contract or purely via public funds. Drilling down. The PPP model should be applicable to smaller projects in the future, once the fixed costs of the bidding process are decreased.
Essential Criteria Identified To Facilitate Project Selection

In the same report, the working group identified projects it believed suitable for PPP financing. It achieved this by first establishing the criteria a project must fulfill: Investment volume: The amount invested should be between SEK1 billion and SEK3 billion. Planning stage: The design plans should be final and must be legally approved. Profitability: The projects profitability should measure nettonuvrdeskvot (NNK; a ratio that calculates societys benefit from a project) of at least 0.5x. Competition: The project should attract
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both national and international interest. Holistic approach: The project must take due regard of lifecycle costs. Duration of the contract: Approximately 25 years should be permitted, with no reconstruction in the near future. Final financing: This should be through cofinancing. Alternatively, user fees could finance all or part of the investment.
Pipeline Of Potential PPP Projects

The working group identified four projects it believed to fulfill all key criteria (see table 2). The working group subsequently identified projects that could be suitable for PPP, but that do not currently fulfill all essential criteria (see table 3). Similarly, the working group identified railroad projects that should be continually evaluated as to their suitability for PPP financing. These are: Railroad East (Ostlnken); Railroad Norrbotten (Norrbotniabanan); a railroad between Mlnlycke and Rvlanda/Bollebygd; a railroad between Malm, Staffanstorp, and Dalby (Simrishamnsbanan); and combination terminals and connections to harbors.
Table 2 - Prospective Projects That Meet All Criteria For PPP Financing
Length (kilometers) Riksvg 50 road between Mjlby and Motala E22 motorway between Hurva and Kristianstad E4 Sundsvall South motorway Lnsvg 259 Sdertrn road 28 41 (57) 22 9 Investment (mil. SEK) 1,330 1,100 (1,360) 2,500 1,300 NNK* (x) 1.4 0.7 0.9 0.7
*NNK (nettonuvrdeskvot) measures profitability and needs to be at least 0.5x. SEK--Swedish krona.
Table 3 - Prospective Projects That Meet Some Criteria For PPP Financing
Length (kilometers) E22 motorway between Kristianstad and Karlshamn E22 motorway between Karlshamn and Jmj E22 Sderkping motorway E6/45 new connection to river E20 motorway between Alingss and Vrgrda E4 motorway between Hjulsta and Hggvik E4 motorway between Sdertlje and Hallunda E12 Ume motorway (Umepaketet) 53 69 (74) 17 1.5 25 7 15 28 Investment (mil. SEK) 1,430 1,840 700 2,500 1,550 4,500 3,300 1,100 NNK* (x) 0.5 0.0 0.7-1.9 2.2 0.5 0.2 N.A. 0.0-2.1
*NNK (nettonuvrdeskvot) measures profitability and needs to be at least 0.5x. SEK--Swedish krona. N.A.--Not available.
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ABU DHABI NATIONAL ENERGY COMPANY PJSC

Publication Date:
Sept. 28, 2007 Issuer Credit Rating: AA-/Stable/A-1+ Primary Credit Analyst: Jonathan Manley, London, (44) 20-7176-3952
Rationale
On Sept. 28, 2007, Standard & Poors Ratings Services affirmed its AA- long-term and A-1+ short-term corporate credit ratings on Abu Dhabi National Energy Company PJSC (TAQA) following TAQAs announcement of its intention, subject to various regulatory and administrative approvals, to acquire Canada-based PrimeWest Energy Trust for approximately C$5 billion, funded primarily by debt. The affirmation reflects our expectation of ongoing implicit sovereign support for TAQA given the companys importance to the Emirate of Abu Dhabi (AA/Stable/A-1+) and its status as a government-related entity (GRE). The ratings continue to be based on a top-down rating approach, which takes the sovereign rating as the starting point of the analysis, reflecting the companys position as a key entity in Abu Dhabis economy and its importance as a national vehicle for global investment and public policy. Following the PrimeWest acquisition, up to onehalf of the companys forecast EBITDA will likely be generated outside of the United Arab Emirates (UAE). This is consistent with the companys originally stated investment policy to undertake international infrastructure investments. Our opinion remains that, in a financial stress scenario, unlike the companys UAE-based assets that are, for example, critical to the provision of water and power to the Emirate, non-UAE activities may not receive the same level and timeliness of sovereign financial support. In respect of this specific acquisition, however, Standard & Poors has analyzed the extent and timing of support that could be forthcoming in the event of a stress scenario. In this case, we understand that it is the Emirates intention to treat these non-UAE assets in the same manner as those in the UAE. In addition, the Emirates review of all acquisitions (including that proposed for PrimeWest) and the proposed corporate structure of the acquisition within the overall TAQA group of companies further substantiate the sovereigns likely support for these assets. No explicit guarantee has been provided, however. Including the PrimeWest acquisition, TAQA has committed nearly $10 billion in the acquisition of various energy-related assets outside the UAE in the past 12 months. The acquisitions have been broadly consistent with the investment framework originally set out by management, although both the pace of the acquisitions and the level of
Secondary Credit Analysts: Karim Nassif, London, (44) 20-7176-3677 Luc Marchand, London, (44) 20-7176-7111 Lidia Polakovic, London, (44) 20-7176-3985
investment in Canadian assets have been greater than originally planned. We estimate that the investments acquired to date are likely to be of low investment-grade/high speculative-grade credit quality on a stand-alone basis. A key challenge for TAQA remains the successful integration and realization of anticipated returns from these various acquisitions. As a result of this debt-financed investment activity, TAQAs financial profile is very aggressive, characterized by high leverage and relatively low interest coverage levels. Standard & Poors will increasingly focus on the credit quality of the underlying investment portfolio and the strength of the relationship with the sovereign as critical elements driving the ratings. Investment in weaker credit quality assets, for example, increases the likelihood that sovereign financial support will be called on. Standard & Poors will meet with management and Emirate representatives in the next month to discuss the future investment strategy and the potential parameters and method by which sovereign support can be given to the company. Liquidity TAQAs liquidity derives from its above-average UAE dirham 6.239 billion ($1.7 billion; as at June 30, 2007, prior to the execution of recent acquisitions) cash balance invested in various short-term deposits. The company also has an established $1 billion revolving credit facility from a domestic bank.
Outlook
The stable outlook reflects Standard & Poors expectation that there will be no major changes in the implicit government support to the company as a GRE. This implies that the state will support TAQA in the event of financial distress should existing or future investments not perform in line with expectations. The outlook also assumes that the company will execute its business plan successfully and meet its financial forecasts. The rating would be raised, or the outlook revised to positive, if there is a similar change in the rating or outlook on the sovereign, or in the case of enhanced sovereign support. The rating would be lowered, or the outlook revised to negative, if there is any weakening of sovereign support for the company or if the underlying consolidated credit quality of the investment portfolio reduces.
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AUTOROUTES PARIS-RHIN-RHONE
Publication Date:
June 13, 2007 Issue Credit Rating: Senior secured debt BBB-; BBB-/Stable Primary Credit Analyst: Karim Nassif, London, (44) 20-7176-3677 Secondary Credit Analyst: Alexandre de Lestrange, Paris, (33) 1-4420-7316
Rationale
The senior unsecured debt rating on the French toll road operator Autoroutes Paris-Rhin-Rhones (APRR) seven-year, 1.8 billion, revolving credit facility maturing in 2013 is BBB-. The outlook is stable. As of May 25, 2007, the facility had a utilization of 0.8 billion. At the same date, total debt was 6.4 billion. Since its privatization in 2006, APRR is 81.48% owned by Eiffarie (not rated), a consortium controlled by Eiffage and Macquarie Autoroutes de France (MAF). The remaining shares are publicly held. Total debt at Eiffarie as at May 25, 2007, is 3.9 billion. The APRR group includes both APRR and Eiffarie, which, because Eiffarie is an 81.48% shareholder, leads us to consolidate the debt of Eiffarie into APRR. We have fully consolidated Eiffaries debt and related interest expenses with those of APRR because we treat the two entities as one group for default analysis purposes. Eiffaries debt is nonrecourse to APRR. APRR is the third-largest toll-road operator in Europe, with a network of 2,215 kilometers (km; 1,370 miles) in service and 2,279 km under concession until 2032. APRR groups highway concession network is well located across central and eastern France, representing the major axes between the two wealthiest French regions, Ile-deFrance (AAA/Stable/A-1+) and Rhne-Alpes, and the two largest French cities of Paris (AAA/Stable/--) and Lyon, as well as links to Benelux and Germany. APRRs subsidiary AREA has the major road network connection to the Alps, related ski resorts, and Geneva, Switzerland. The network therefore comprises key economic and tourist corridors to southern France. No major new competing roads or transport links are expected. The revolving credit facility is sized to support about two years of capital expenditures, debt repayments to Caisse Nationale des Autoroutes (CNA; AAA/Stable/--), and working capital at APRR following its acquisition by Eiffarie. The BBB- rating reflects the following risks: APRR has an aggressive financial structure, with low debt service coverage levels and high consolidated leverage, taking into account total debt at APRR and Eiffarie. Standard & Poors Ratings Services base case assumes traffic growth of 1.75% over the life of the concession, with consolidated
minimum debt service coverage at 1.31x. This minimum occurs in 2012, based on an assumed refinancing of the Eiffarie debt in 2011, and an assumed amortization profile post refinancing. Prior to the forecast refinancing, the minimum coverage ratio is 1.42x. Although this is low compared with other rated highways projects with traffic risk, the maturity and large scale of APRRs road network mitigate this. The structure contains considerable refinancing risk, as significant debt amounts are due from CNA by 2018. We understand that APRR is currently looking at ways to refinance CNA obligations due in late 2007 and beyond. APRR also has large capital expenditure requirements, and the Eiffarie acquisition facility has little amortization until it needs to be refinanced. Although the revolving credit facility, the strong cash flow generating ability over the life of the concession, and an increasing cash sweep in the acquisition facility mitigate refinancing risk, it remains higher than that of comparable investment-grade transactions. Although Standard & Poors takes a concession financing approach to APRR, we regard the overall structural package, with regard to shareholder lock-in periods, as weaker than those of comparable investment-grade concessions. The privatization process resulted in lock-in requirements for Macquarie and Eiffage of two and 10 years, respectively. Given the importance of retaining two balanced shareholders in the structure, the absence of further structural mitigants to prevent the emergence of a dominant shareholder remains a key structural weakness. Traffic growth was weak in 2006, but has shown recovery in the first quarter of 2007. Traffic growth reported for 2006 at 1.3% was below what we considered to be a conservative assumption of 1.75% traffic growth under our base case. Nevertheless, although traffic growth has been low and is not expected to improve substantially over the short term, revenues have met budgeted targets and are expected to continue to do so going forward. Although about 95% of all debt at Eiffarie and APRR is hedged, the structure remains
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sensitive to interest rate increases. This is a key consideration, given the existing refinancing risk. The following strengths offset these risks at the BBB- level: APRR benefits from strong and recurring cash flow generation, stemming largely from a mature and very large toll road network. APRRs concessions are regulated by supportive agreements, including management contracts that guarantee a minimum, inflation-linked toll rate increase for each five-year period. APRR benefits from the combined experience of Macquarie Bank Ltd. (A/Stable/A-1) and Eiffage in the financing, construction, and operation of toll roads worldwide, although this is Macquaries first major investment in French toll roads. APRR has a strong track record in toll road operation. The project is resilient to a number of downside scenarios, at the same time as being able to service debt at both APRR and Eiffarie. A zero traffic growth scenario results in a minimum debt service coverage ratio of 1.06x. APRR is the third-largest toll-road operator in Europe, with a network of 2,215 km in service out of 2,279 km under concession until 2032, after Italy-based Atlantia SpA (A/Negative/A-1) and French peer Autoroutes du Sud de la France S.A. (ASF; BBB+/Negative/A-2). APRRs 2006 turnover and EBITDA were 1.67 billion and 1.07 billion, respectively, up 6.3% and 9.7% on 2005 and in line with expectations. As at Dec. 31, 2006, APRR complied with the financial covenants set by the state as part of the privatization. The APRR network has shown moderate, but below budget, traffic growth of 1.3% overall for the 12 months to end-December 2006 compared with the same period of the previous year. This remains weaker relative to APRRs peers ASF and Cofiroute (BBB+/Negative/A-2), but similar to traffic growth reported by French toll road operator Sanef (A/Negative/A-1) for the period. Poor weather conditions in the first quarter of the year and a heat wave in July that affected light vehicle traffic were responsible for lower-than-
expected traffic growth, somewhat offset by an upturn in the French economy and completion of repair work at the Epine and Frjus tunnels. Overall revenues grew by 6.3% in 2006 year on year, exceeding budgeted targets by about 24 million. Improvement in total revenues reflected the contractual increase of rates in October 2005 and 2006, as well as a rebound in heavy traffic volumes and reduced discount rates for heavy vehicle subscribers. EBITDA margins improved by 2% in 2006 compared with the previous year. We expect EBITDA margins to continue improving by 1% per year over the short term based on similar traffic growth and continued implementation of cost controls and operational efficiency. Traffic growth for the first quarter of 2007 was 3.5% above that of the same period the previous year due to better weather and macroeconomic conditions.
Outlook
The stable outlook reflects our expectation of continued stable, recurring cash flows from the road network under the concession agreements. The ratings could be lowered if one of the key sponsors gains a dominant position in the structure (in which case the ring-fencing would no longer hold), traffic falls consistently below our base case assumptions, or if the refinancing does not proceed as assumed in the base case. Upgrade potential is limited. Eiffage is subject to a takeover bid by its major shareholder Sacyr, a Spanish construction company, but we do not expect any change of ownership to affect the structure and working of the APRR group.
Concession Financing Factors

The structure implemented following privatization led us to adopt a concession financing approach to APRR, rather than the previous corporate approach. This was due to: Compliance with Standard & Poors criteria for special-purpose entities at the level of the Eiffage and Macquarie consortium, which owns the majority of APRR after privatization; Restrictions on individual sponsor control in APRR, owing to Eiffage and Macquaries roughly equal shareholder ownership; Commitment of the two shareholders to maintaining their equity interests in the
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consortium for at least two years (Eiffage has committed for 10 years); and The sponsors commitment to ensuring the single business focus of APRR. The key supporting factor for our concession financing approach is that the sponsors respective control of Eiffarie and APRR is roughly balanced. If this were to change--for example through one sponsor selling its equity interest to the other, leading to majority ownership by a single sponsor--we would likely review our rating approach to the structure.
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METRONET RAIL BCV FINANCE PLC/ METRONET RAIL SSL FINANCE PLC
Publication Date:
Sept. 10, 2007 Issue Credit Rating: Senior secured bank loan BB+/Watch Neg; senior secured debt AAA, BB+(SPUR)/Watch Neg Primary Credit Analyst: Jonathan Manley, London, (44) 20-7176-3952 Secondary Credit Analysts: Beata Sperling-Tyler, London, (44) 20-7176-3687 Liesl Saldanha, London, (44) 20-7176-3571
Rationale
On Sept. 10, 2007, Standard & Poors Ratings Services kept its BB+ long-term and underlying debt ratings on the 1.620 billion combined senior secured bank loans and debt issued by U.K.-based underground rail infrastructure financing companies Metronet Rail BCV Finance PLC and Metronet Rail SSL Finance PLC (Metronet BCV and Metronet SSL; the Metronet companies) on CreditWatch with negative implications, where they were placed on May 22, 2007. This follows the agreement of bilateral standstill arrangements between Transport for London (TfL; AA/Stable/--) and the funders to the Metronet companies. A public-private partnership (PPP) administration order was granted over Metronet Rail BCV Ltd. and Metronet Rail SSL Ltd. (the Infracos) on July 18, 2007. At the same time, Standard & Poors affirmed its AAA insured rating on the 165 million index-linked bonds and 350 million fixed-rate bonds outstanding at Metronet BCV, reflecting the unconditional and irrevocable guarantee of payment of interest and principal by Financial Security Assurance (U.K.) Ltd. (FSA; AAA/ Stable/--) and Ambac Assurance U.K. Ltd. (Ambac; AAA/Stable/--), respectively. In addition, Standard & Poors affirmed its AAA insured rating on the 165 million index-linked bonds and 350 million fixed-rate bonds outstanding at Metronet SSL, reflecting the unconditional and irrevocable guarantee of payment of interest and principal by Ambac and FSA, respectively. As at Sept. 10, 2007, Metronet BCV had 515 million bonds and a combined 433 million bank debt outstanding. At the same date, Metronet SSL had 515 million bonds and 194 million bank debt outstanding. The CreditWatch status continues to reflect the risks and uncertainties regarding both the PPP administration process and the ultimate restructuring of the Infracos to deliver their responsibilities under their respective service contracts. The PPP administration process is untested and the outcome is therefore uncertain. On Sept. 4, 2007 a standstill agreement was entered into between TfL and the funders to the Metronet companies (representing both the bond and bank debtholders) that will run until January 2008. Under the terms of this agreement, TfL will provide funding to the Metronet companies to enable them to fund the combined 46.4 million
debt service payment due on Sept. 15, 2007, and associated financing costs including swap payments. In return, the funders will not take any enforcement action to seek, for example, accelerated payment of the debt outstanding. Standard & Poors expects that there will be ongoing negotiations between TfL, London Underground Ltd. (LUL), the PPP administrators, and the senior lenders in relation to the future of the PPP service contracts. On Aug. 24, 2007, TfL lodged an expression of interest to the PPP administrators to take over the PPP contracts and assets of the Metronet companies. We believe that the most likely long-term outcome is that a restructuring of the contracts will occur that gives a new Infraco revised PPP service contract responsibilities. The restructured contract will be based on a new prioritization of service requirements, reflecting the revised level of ongoing infrastructure service charge (ISC) to be paid to the Infracos. The support and role of the various parties to the PPP service contract, including the Statutory Arbiter, TfL, LUL, and the U.K. Department of Transport (DoT) will remain critical to the analysis. Standard & Poors will resolve the CreditWatch as the PPP administration process and the contract restructuring proposal develops and the likely outcome becomes clear. The long-term and underlying debt ratings would be lowered if there was a significant downturn in the Infracos operating performance or it became clear that existing senior debtholders would not be kept whole in any new Infraco structure. In particular, we will focus on the ongoing performance of the Infracos during the PPP administration as significant performance-related deductions from the ISC may result in a deterioration in credit quality. In addition, we will monitor the ongoing process of negotiations between the relevant parties including TfL and DoT to understand the potential ownership and capital structure of any new Infraco that will assume the PPP service contract responsibilities. Standard & Poors will also review the likely treatment of senior debtholders within any new capital structure to ensure that they receive full and timely payment of debt service obligations and that any restructuring proposal does not result in a loss of value to the debtholders. Should a proposal be brought forward that would result in a loss of value, the long-term and underlying
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debt ratings would likely be lowered. If the proposal was subsequently implemented, the longterm and underlying debt ratings would likely be lowered to D. Although the Infracos are in administration, we have maintained the BB+ ratings on debt issued by the Metronet companies, reflecting the structural protections within the PPP service contract that are likely to benefit debtholders. For example, as an insolvency event has occurred for the Infracos, the funders ultimately have the ability to exercise a put option, requiring TfL to pay a put option price--that is, at least 95% of the outstanding debt at each company. It is therefore unlikely that the funders will accept any proposed restructuring that would result in them receiving less than the amount they would receive through the exercise of the put option. There is no track record of implementing any of these arrangements, however, including determining the value of the put option, or enforcing these obligations. Although they provide significant comfort at the rating level, the protections may be subject to challenge and delay. If, as part of the PPP service contract restructuring process, the various debt obligations of the Metronet companies are assumed by TfL-prior to a final restructuring solution being implemented--the long-term and underlying debt ratings could be raised.
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PETERBOROUGH (PROGRESS HEALTH) PLC

Publication Date:
June 20, 2007 Issue Credit Rating: AAA (insured); BBB-(SPUR)/Stable (preliminary) Primary Credit Analyst: James Hoskins, London, (44) 20-7176-3393 Secondary Credit Analysts: Lidia Polakovic, London, (44) 20-7176-3985 Hugo Foxwood, London, (44) 20-7176-3781
Rationale
On June 20, 2007, Standard & Poors Ratings Services assigned its preliminary AAA long-term insured debt rating to the proposed 442.8 million (including 50.0 million variation bonds) fixed rate guaranteed bonds due October 2042, to be issued by U.K.-based health funding special purpose vehicle Peterborough (Progress Health) PLC (ProjectCo). The preliminary rating reflects the unconditional and irrevocable payment guarantee of scheduled interest and principal provided by FGIC UK Ltd. (FGIC; AAA/Stable/--). At the same time, Standard & Poors assigned its preliminary AAA long-term insured debt rating on the liquidity facility, change-in-law facility (CiLF), and swap facility provided by ABN AMRO Bank N.V. (AA-/Watch Pos/A-1+). The preliminary rating reflects the unconditional and irrevocable payment guarantee of scheduled interest and principal provided by FGIC. The preliminary underlying long-term ratings on the proposed debt are all BBB- with a stable outlook. The debt and all the facilities have also been assigned preliminary recovery ratings of 2, reflecting expectations of substantial (70%-90%) recovery of principal in the event of a default. Final ratings will depend on receipt and satisfactory review of all final transaction documentation, including legal opinions. Accordingly, the preliminary ratings should not be construed as evidence of final ratings. If Standard & Poors does not receive final documentation within a reasonable timeframe, or if final documentation departs from materials reviewed, Standard & Poors reserves the right to withdraw or revise its ratings. The proposed debt will finance the design, construction, and operation of three new buildings on two sites for three separate National Health Service (NHS) Trusts as part of the Greater Peterborough Health Investment Plan: A new mental health unit will be built on the existing Edith Cavell Hospital site for Cambridge and Peterborough Mental Health Partnership NHS Trust (the MHU Trust). A new acute hospital will be built on the existing Edith Cavell Hospital site for the Peterborough and Stamford Hospitals NHS Foundation Trust (the Acute Trust). A new integrated care center will be built on the existing Peterborough District Hospital
site for the Greater Peterborough Primary Care Partnership Trust, which is acting through the Peterborough Primary Care Trust (the ICC Trust). All three Trusts are acting jointly, but not severally, via a project agreement (PA) with a term of 35 years and four months under a U.K. government private finance initiative (PFI) program. The Acute Trust has full termination rights over the project, as it will provide about 86% of the unitary payments, while the two smaller Trusts only have termination rights over the part they are responsible for. The preliminary BBB- underlying senior debt and facilities ratings take into account the following project risks: The project is exposed to the counterparty risk of unrated Australia-based construction group Multiplex Ltd. and a number of its U.K.-based subsidiaries--also unrated--as shareholder, design, and construction contractor, and hard facilities management (FM) services providers. Although this integrated approach to project delivery might have advantages such as enhanced coordination, there is no diversification of counterparty risk. This is the first health construction project undertaken by Multiplex Ltd. in the U.K. Although the company has experience in complex construction projects worldwide, its experience in health construction is limited to a small number of relatively low-value projects in Australia. In line with standard industry practice, the works will be fully subcontracted in packages. Multiplex may, however, be subject to fallout from the difficulties it encountered during the construction of Wembley Stadium in terms of availability and pricing of suitable subcontractors. All fixed price appointments required before financial close have now been made, however, and the technical adviser, Faithful & Gould, considers them satisfactory. The size of the largest phase of construction (280 million) may limit the number of contractors able to take over should Multiplex Construction (UK) Ltd. be replaced. This is also the first hard FM contract Multiplex Facilities Management UK Ltd.
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(Multiplex FM) has signed in the U.K. Multiplex FM has some health experience but on a smaller scale and with shorter contracts. It provides FM services to several hospitals in Australia totaling 2,100 beds-this PFI project alone provides 780 beds. The Australian contracts have an average duration of 10 years, significantly lower than for this project. The technical adviser has reviewed Multiplex FMs processes and procedures and considers them satisfactory. Unlike most rated PFI projects to date, the project makes use of a liquidity facility and CiLF instead of cash reserve accounts. The facilities have minimal drawstops and should provide relatively timely liquidity to the project if required. The project is highly leveraged (94%) and the structure is quite aggressive with no tail. In lieu of a tail, a cash reserve is built up by the start of the last year of the concession, assuming sufficient cash is available. ProjectCo is exposed to increased labor costs beyond those budgeted for, and for which it cannot claim relief from the Trusts through the market testing process. The project is exposed to the uncertainty of more than 35 years of capital-replacement costs. The contractor is dependent on key personnel. Given its lack of experience in the U.K., Multiplex Construction (UK) has had to recruit a new construction team specifically for this project. As this experience is vested within individuals, rather than the organization, Multiplex could be exposed if it failed to retain the services of these personnel, as it would need to recruit externally, and therefore may not be able to rapidly transfer staff internally if necessary. The following strengths mitigate these risks at the preliminary BBB- rating level: Construction risk is partially mitigated by an 18% (60 million) LOC provided by ABN AMRO, which would be sufficient to fund construction delays of 12 months and replacement cost premiums of about 15% or more through the whole construction period.
An LOC equivalent to about 20% of the annual hard FM fee and a cash reserve equivalent to about 20% of the annual hard FM fee (replaceable by an additional LOC for the same amount) by the planned commencement of full services provides third-party liquidity support for the hard FM services. This liquidity can only be removed once Multiplex FM has met specific performance and financial targets consistently over a three-year period. There are alternative hard FM providers capable of undertaking the services if Multiplex FM is replaced. A 24-month longstop date is included for the acute facility. This is significantly longer than for similar hospital projects (usually 12-18 months). The building contract longstop is 12 months, which gives ProjectCo a minimum 12 months to appoint a replacement contractor if necessary. The Trusts have invested significant resources in assessing the design and working with Multiplex to develop and verify the details. In particular, all 1:50 scale drawings have been signed off by clinical user groups before financial close. The construction works, although large, are relatively simple, with limited decanting and phasing requirements. A large part of the Acute and MHU hospital works are on a greenfield site next to the existing hospital. Capital-replacement risk is partially mitigated by a three-year, forward-looking lifecycle reserve, and a 12-year guarantee from the construction contractor for latent defects. Sensitivity testing also indicates that ProjectCo could withstand significant increases in lifecycle costs before encountering financial distress. Multiplexs construction liability is limited only on termination to 55% of the construction contract sum. Termination liability steps down to 40% on completion of the Acute facility and to 20% six years after practical completion. In addition, the liquidated damages cap is sized to enable damages to be paid until the PA longstop date of 24 months from programmed completion. This is 60% of the expected construction period.
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The liquidity facility is revolving and pari passu with the senior debt in all respects. The facility is fully committed, and valid requests must be honored by the lender unless there is a liquidity facility event of default outstanding. The facility events of default are limited to the following: Nonpayment of principal and interest on an outstanding liquidity loan. Each liquidity loan has a term of six months only. If the loan is not repaid within the term, a new request for an additional liquidity loan may be made by ProjectCo. The lenders must make a new liquidity loan available to repay the previous loan and meet any additional liquidity shortfalls so long as the maximum commitment of the facility is not exceeded. ProjectCo insolvency. It becoming illegal for ProjectCo to make or receive payments under the liquidity facility. If the bonds are accelerated or the bonds are made immediately due and payable under the terms of the collateral deed by the controlling creditor. The facility may be drawn to service senior liabilities, including liquidity facility payments. With written permission from the controlling creditor, however, it may also be used to fund specified operating costs as defined by the accounts agreement. This applies only to operational costs that are senior to senior debt liabilities in the operational cash waterfall. The liquidity facility may not be used to fund increases in capital costs. The distribution covenant will be triggered if any liquidity loans are outstanding. The facility is available from the start of the concession until replaced by the earlier of an equivalent cash debt service reserve account, or the end of the concession. Under the base case, a cash reserve is to be built up toward the end of the concession to replace the liquidity facility. During this period, a full six-month debt service reserve is available at all times, which will be based on a part cash/part liquidity facility reserve. Standard & Poors project finance ratings approach does not address the potential for changes in law within its ratings methodology. The U.K. PFI standard form contract specifically addresses the allocation of risk in relation to potential future changes in law. In this project, the
standard risk allocation for change in law is adopted. The Trusts will assume the risk of discriminatory and NHS-specific changes in law in terms of compensation and extensions to construction completion dates. ProjectCo has shared general change-in-law risk up to a maximum liability of 3.13% of the capital cost of the project during the operational period. During the construction period, general changein-law risk has been passed in full to the construction contractor. Change in law in relation to medical equipment services is treated separately from this regime and is fully borne by the relevant technology contractor. This project has a facility available to meet possible change-in-law requirements during the operational period of the concession. The changein-law facility is pari passu to the senior debt and the facility is available from the start of the concession until the time of the mandatory drawdown--scheduled to occur toward the end of the concession--of any undrawn proceeds, which are deposited in the change-in-law account. Any drawings used to fund valid changes in law before the mandatory drawdown are interest only until then and the facility is subsequently repaid under a predetermined schedule. With prior written permission from the controlling creditor, the facility may also be used to fund operational or finance costs. If it is used in this manner, any drawings must be repaid in full (principal and interest) under a cash sweep, and the distribution covenant will be triggered until full repayment of the facility has been made. The swap facility is provided under a standard form ISDA master agreement with a projectspecific schedule. Standard & Poors has reviewed the details of this agreement and confirmed that it complies with the criteria. Recovery analysis The senior secured debt and the facilities have each been assigned preliminary recovery ratings of 2, indicating Standard & Poors expectation of substantial recovery of principal (70%-90%) in the event of a payment default. To date, however, there has been limited experience regarding default or loss in this sector. The senior debt facilities benefit from a strong security package, covenants, and contractual features for compensation on termination that are
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standard in U.K. PFI transactions. The creditorfriendly U.K. insolvency framework gives secured creditors of PFI transactions with step-in rights who have floating charges the ability to appoint an administrative receiver to enforce security and thereby control the insolvency process. Additional features supporting substantial recovery include the relative clarity of the termination regime (although this remains largely untested), the expectation of timely repayment by the Trusts according to defined procedures and dates, and the robust credit quality of the Trusts as payers of termination sums. Exposure to a Trust credit default following termination is, therefore, minimal. The PA stipulates the mechanism for determining how ProjectCo (and its lenders) will be compensated for various events leading to termination. In the event of a Trust default, force majeure, or a voluntary termination, compensation will fully cover senior debt service, i.e. 100% recovery will be possible. As the Trusts responsibility is joint but not several, however, the PA only terminates for Trust default if the Acute Trust (representing 86% of the unitary payment) defaults. If one of the two smaller Trusts defaults, full compensation is payable to ProjectCo in standard terms but the PA does not terminate. The medical equipment services agreement does not have any partial termination provisions. A ProjectCo event of default arising from issues like insolvency, prohibited change of control, construction delay beyond the longstop date (24 months after the scheduled completion of the Acute hospital), material breach of obligations, or accumulation of excessive penalty points, however, can trigger a termination where the repayment of debt is not guaranteed by the Trust. These scenarios have therefore been considered in order to arrive at potential recovery rates.
Senior lenders have step-in rights to resolve a ProjectCo event of default. If termination occurs, compensation is based on a market retendering process (if a liquid market exists) or a net-presentvalue calculation, less certain expenses. Recovery rates for the project should improve as time passes because debt will be paid down and reserves built up. The recovery analysis assumes a relatively unfavorable scenario where a severe delay occurs in the initial years of construction, with a substantial increase in costs following contractor replacement. Scenarios that reduce the unitary payment by various amounts have also been considered, reflecting ProjectCos inability to achieve its original operating performance. The liquidity available to the project through reserves (such as the guaranteed investment contract) and cash is factored into the analysis. The recovery scenarios also assume that both the liquidity facility and the CiLF are fully drawn at default.
Outlook
The stable outlook on the preliminary underlying ratings reflects Standard & Poors expectation that construction will proceed in line with the planned program and budget. This expectation is based on the contractors ability and the professional team it has assembled, the favorable opinion of the technical adviser on the proposals, and the significant third-party construction support provided. The rating could be lowered if there were substantial delays in construction-increasing concerns about the contractors ability to deliver and maintain the hospitals--and/or substantially higher-than-expected cost increases. An upgrade in the short to medium term is unlikely.
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TRANSFORM SCHOOLS (NORTH LANARKSHIRE) FUNDING PLC

Publication Date:
Oct. 11, 2007 Issue Credit Rating: Senior secured debt AAA, BBB-(SPUR)/Stable Primary Credit Analyst: James Hoskins, London, (44) 20-7176-3393 Secondary Credit Analyst: Jose R Abos, Madrid, (34) 91-389-6951
Rationale
The 88.7 million index-linked senior secured bonds due 2036 and the 70 million European Investment Bank (EIB; AAA/Stable/A-1+) loans due 2034 issued by U.K.-based special purpose vehicle Transform Schools (North Lanarkshire) Funding PLC (Issuer) have a AAA insured rating and a BBB- Standard & Poors underlying rating (SPUR). The outlook on the SPUR is stable. In addition, the underlying rating on the bonds has a recovery rating of 2, indicating Standard & Poors expectation of substantial recovery of principal (70%90%) in the absence of a guarantee in the event of a debt default. The insured rating reflects the unconditional and irrevocable payment guarantee of scheduled interest and principal provided by XL Capital Assurance (U.K.) Ltd. (AAA/Stable/--). The underlying BBB- rating represents a composite of credit factors, outlined below. The funds have been onlent by the Issuer to Transform Schools (North Lanarkshire) Ltd. (ProjectCo), and are being used to finance the design and construction of 17 new facilities for 24 schools for North Lanarkshire Council in Scotland. Following the completion of construction, ProjectCo, via its subcontractor Haden Building Management Ltd. (HBML), will provide hard and limited soft facilities maintenance services, including building maintenance, lifecycle, security, energy management, cleaning and janitorial services to the schools for the remainder of the 32-year project agreement, which expires in 2037. Construction commenced in October 2004 under an advanced works agreement and continued under the private finance initiative (PFI) contract upon financial close in April 2005. Final completion is due to occur in October 2008 and works are being undertaken by an unincorporated joint venture between Balfour Beatty Construction Ltd. and Balfour Kilpatrick Ltd. (construction joint venture; CJV), both of which are subsidiaries of Balfour Beatty PLC (not rated). Construction works are currently proceeding reasonably well, with 11 facilities successfully completed, two facilities due to be completed in October 2007, two in November 2007, and the final two schools in October 2008. The BBB- underlying rating reflects the following credit risks: Although the completion of this multisite project should be within the capabilities of
the contractor Balfour Beatty PLC to deliver successfully, it is being run concurrently with a number of other Scottish education PFI portfolio projects. The ability to procure sub-contractors to carry out key construction activities in a reasonably constrained labor market will be crucial, therefore, in ensuring construction delivery in line with the contractually agreed timetable. Furthermore, Balfour Beatty itself is undertaking a number of significant PFI projects at this time so its ability to manage this project alongside others will be challenging, although achievable given the companys significant experience in the sector. One school facility, St. Ignatius and Wishaw Academy Primary, which was handed over in August 2007, was found to be about 136 square meters smaller than required by the output specification immediately prior to handover. In addition, one school is currently in delay by around 12 weeks due to poor ground conditions. ProjectCo is being protected from the financial impact of these two issues by CJV. At Wishaw, CJV is currently implementing the additional works required to bring the floor area of the school up to standard at its own expense. The project relies on about 23 million of revenue earned through phased construction to provide funding for further construction activities. Any delays to the attainment of these revenues could reduce the funding available for construction. The third-party financial support and liquidity during the construction phase is relatively low, although adequate. Construction risk is partially financially mitigated through an adjudication bond from Banco Bilbao Vizcaya Argentaria S.A. (AA-/Positive/A-1+). ProjectCo is exposed to the uncertainty, in terms of budgeting and timing, of more than 32 years of capital-replacement risk. This risk is partially mitigated by: a three-year forward-looking reserve; a 12-year limit on the construction joint-venture liabilities for serious latent defects; and the relatively simple nature of schools projects. The financial structure is aggressive, as is typical for the PFI sector. Senior debt to total funds is 90% (excluding construction
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revenue), and base-case senior debt-service coverage levels are a minimum of 1.19x and average 1.21x, which is low but in line with most recently rated PFI projects in the U.K. In addition, forward and historical distribution lock-up levels are slightly lower than recent transactions at 1.125x. The financial model, however, performs satisfactorily under a range of stress scenarios. These risks are mitigated at this rating level by the following credit strengths: The project receives an availability-based revenue stream, with no volume or market exposure, no reliance on third-party revenues, and a relatively benign payment mechanism. The experience and capability of Balfour Beatty and its subsidiaries in their capacities as sponsor, constructor, and facilities maintenance (FM) provider. All individual schools will be 100% newbuild, with construction on largely vacant sites within the existing school sites. Furthermore, the project is likely to benefit from the portfolio effect of construction on various sites. The FM service requirements are relatively simple and, therefore, are likely to be within the capabilities of the FM provider. In addition, benchmarking and market testing provides an adequate pass-through of operational risks from ProjectCo. With the exception of the two schools mentioned above, progress on the construction is adequate to date, with a total of eight sites (accounting for 11 schools) completed so far, with works having commenced on all tranche-2 schools as anticipated. A number of minor grantorfunded variations have been executed and relations between parties continue to be positive. Construction remains on schedule for final completion and handover in October 2008.
Recovery analysis The secured bonds and EIB loan have been assigned a recovery rating of 2. This indicates Standard & Poors expectation of substantial recovery of principal (70%-90%) in the absence of a guarantee in the event of a debt default. To date, however, there has been limited experience regarding default or loss in this sector. This recovery rating reflects the strong security package, covenants, and contractual features for compensation on termination that are inherent in U.K. public-private partnership (PPP) transactions. A key feature supporting this assessment is the creditor-friendly U.K. insolvency framework. Secured creditors of PPP transactions with step-in rights that have floating charges have additional advantages, because they are one of the categories of creditors that can appoint an administrative receiver to enforce security and thereby control the insolvency process. Additional features supporting Standard & Poors expectation of substantial recovery include the relative clarity of the termination regime (although this is largely untested), the expectation of timely repayment according to defined procedures and dates by the procuring authority, and the robust credit quality of the procuring authority as payor of termination sums. Exposure to authority credit default following termination is, therefore, minimal.
Outlook
The stable outlook reflects our expectation that the necessary rectification works at St. Ignatius and Wishaw Academy Primary will be completed to the satisfaction of ProjectCo and in a timely manner. If further significant delays are encountered or the rectification works are not adequately completed the outlook may be revised to negative or the rating lowered. There is currently limited scope for an upgrade.
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RATINGS LIST
RATINGS LIST
Standard & Poor's Infrastructure Finance Ratings
Utilities Name Acea SpA Acquedotto Pugliese SpA AEM SpA Anglian Water Services Financing PLC Artesian Finance PLC ASM Brescia SpA Bord Gais Eireann BOT Elektrownia Turow S.A. British Energy Group PLC CE Electric U.K. Funding Co. Centrica PLC CEZ a.s. C.N. Transelectrica S.A. Delta N.V. DONG Energy A/S Drax Power Ltd. Dwr Cymru (Financing) Ltd. E.ON AG E.ON Sverige AB E.ON U.K. PLC Edison SpA EDP - Energias de Portugal, S.A. Eesti Energia AS Electricite de France S.A. EDF Energy PLC RTE EDF Transport S.A. Elia System Operator S.A./N.V. Enagas S.A. EnBW Energie Baden-Wuerttemberg AG Endesa S.A. ENECO Holding N.V. Enel SpA Enemalta Corp. Energie AG Oberoesterreich Energie Steiermark AG Energinet.dk SOV ESKOM Holdings Ltd. Essent N.V. EVN AG EWE AG Federal Grid Co. of the Unified Energy System Fingrid Oyj Fortum Oyj Gas Natural SDG, S.A. Gaz de France S.A. Hera SpA Hrvatska Elektroprivreda d.d. Iberdrola S.A. Irkutskenergo, AO EiE
*At Nov. 8, 2007. All ratings are issuer credit ratings unless otherwise stated.
Issuer credit rating* A/Stable/A-1 BBB/Negative/A-3 BBB/Watch Pos/A-2 Guaranteed debt AAA; senior secured debt A-; subordinated debt BBB Senior secured debt AAA A+/Watch Neg/A-1 A/Stable/A-1 B/Positive/-BB+/Watch Neg/-BBB-/Positive/A-3 A/Negative/A-1 A-/Stable/-BB+/Positive/-A-/Negative/-BBB+/Positive/A-2 BBB-/Stable/-Secured bank loan A-; senior secured guaranteed AAA; senior secured A-; subordinated BBB A/Stable/A-1 A/Stable/A-1 A-/Stable/A-2 BBB+/Positive/A-2 A-/Negative/A-2 A-/Negative/-AA-/Stable/A-1+ A/Stable/A-1 AA-/Stable/A-1+ A-/Stable/A-2 AA-/Stable/A-1+ A-/Stable/A-2 A/Watch Neg/A-1 A/Negative/A-1 A/Watch Neg/A-1 BBB+/Stable/-A+/Negative/-A/Positive/-AA+/Stable/A-1+ Foreign currency BBB+/Stable/-A+/Negative/A-1 A/Stable/-A/Negative/-BB+/Watch Pos/-A+/Stable/A-1 A-/Stable/A-2 A+/Negative/A-1 AA-/Watch Neg/A-1+ A/Stable/A-1 BBB/Stable/-A/Watch Neg/A-1 B+/Positive/-STANDARD & POORS EUROPEAN INFRASTRUCTURE FINANCE YEARBOOK
Country Italy Italy Italy U.K. U.K. Italy Ireland Poland U.K. U.K. U.K. Czech Republic Romania The Netherlands Denmark U.K. U.K. Germany Sweden U.K. Italy Portugal Estonia France U.K. France Belgium Spain Germany Spain The Netherlands Italy Malta Austria Austria Denmark South Africa The Netherlands Austria Germany Russia Finland Finland Spain France Italy Croatia Spain Russia
144 NOVEMBER 2007
RATINGS LIST

Utilities Name Israel Electric Corp. Ltd. Kazakhstan Electricity Grid Operating Co. (JSC) KazTransGas KazTransOil KELAG AG Kelda Group PLC Landsvirkjun Lietuvos Energija Lunds Energikoncernen AB (publ) Mosenergo (AO) N.V. Nederlandse Gasunie N.V. NUON National Central Cooling Co. PJSC National Grid PLC Natsionalna Elektricheska Kompania EAD Northern Gas Networks Holdings Ltd. Northumbrian Water Ltd. Polish Oil and Gas Co. Public Power Corp. S.A. Rand Water RAO UES of Russia Red Electrica de Espana S.A. RWE AG Saudi Electric Co. S.C. Hidroelectrica S.A. Scotland Gas Networks PLC Southern Gas Networks PLC Scottish and Southern Energy PLC Scottish Power PLC Severn Trent PLC Sociedad General de Aguas de Barcelona S.A. South East Water (Finance) Ltd. South Staffordshire PLC Southern Water Services Ltd. S.N.T.G.N. Transgaz S.A. Medias Statkraft AS Statnett SF Suez S.A. Sutton and East Surrey Water PLC Tekniska Verken i Linkoeping AB Terna SpA Thames Water Utilities Ltd. Union Fenosa S.A. United Utilities PLC Vattenfall AB Veolia Environnement S.A. Vodokanal St. Petersburg Three Valleys Water PLC Verbundgesellschaft (Oesterreichische Elektrizitaetswirtschafts Aktiengesellschaft) Wasser und Gas Westfalen GmbH Wessex Water Services Ltd. Western Power Distribution Holdings Ltd.
Issuer credit rating* BBB+/Negative/-BB+/Stable/-BB/Stable/-BB+/Positive/-A+/Negative/-A-/Stable/A-2 Foreign currency A+/Negative/A-1 A-/Negative/A-2 BBB+/Stable/A-2 BB/Stable/-AA+/Stable/A-1+ A+/Negative/A-1 BBB-/Stable/-A-/Stable/A-2 BB/Developing/-BBB+/Stable/-BBB+/Stable/-BBB+/Stable/-BBB+/Stable/-Foreign currency BBB+/Stable/-BB/Watch Pos/-AA-/Stable/A-1+ A+/Negative/A-1 AA-/Stable/-BB/Positive/-BBB/Positive/-BBB/Positive/-A+/Stable/A-1 A-/Watch Neg/A-2 A/Stable/A-1 A/Stable/A-1 Senior secured guaranteed AAA; senior secured BBB A-/Watch Neg/A-2 Bank loan ABB+/Positive/-BBB+/Stable/A-2 AA/Stable/A-1+ A-/Watch Pos/A-2 BBB+/Stable/-A-/Stable/A-2 AA-/Stable/A-1+ BBB+/Watch Neg/-BBB+/Stable/A-2 A/Watch Neg/A-1 A-/Stable/A-2 BBB+/Stable/A-2 BB+/Positive/B A-/Stable/-A/Stable/-BBB+/Stable/-BBB+/Stable/-BBB-/Stable/A-3 STANDARD & POORS EUROPEAN INFRASTRUCTURE FINANCE YEARBOOK
Country Israel Kazakhstan Kazakhstan Kazakhstan Austria U.K. Iceland Lithuania Sweden Russia The Netherlands The Netherlands United Arab Emirates U.K. Bulgaria U.K. U.K. Poland Greece South Africa Russia Spain Germany Saudi Arabia Romania U.K. U.K. U.K. U.K. U.K. Spain U.K. U.K. U.K. Romania Norway Norway France U.K. Sweden Italy U.K. Spain U.K. Sweden France Russia U.K. Austria Germany U.K. U.K. NOVEMBER 2007 145
RATINGS LIST

Transportation Infrastructure Name Abertis Infraestructuras S.A. Aeroporti di Roma SpA Aeroports de Paris Angel Trains Ltd. Atlantia SpA BAA Ltd. Birmingham Airport Holdings Ltd. BRISA Auto-Estradas de Portugal S.A. Brussels International Airport Co. Caisse Nationale des Autoroutes CFR Marfa S.A. CFR S.A. Cofiroute Copenhagen Airports A/S Deutsche Bahn AG DFS Deutsche Flugsicherung GmbH DP World Ltd. Dublin Airport Authority PLC Fjellinjen AS Hutchison Ports (U.K.) Ltd. INFRABEL Kazakhstan Temir Zholy Macquarie Airports Copenhagen Holdings ApS Macquarie Motorways Group Ltd. Manchester Airport Group PLC (The) N.V. Luchthaven Schiphol NATS (En-Route) PLC Network Rail Infrastructure Finance PLC Network Rail MTN Finance PLC Norges Statsbaner AS NS Groep N.V. Oresundsbro Konsortiet Rede Ferroviaria Nacional REFER, E.P. Reseau Ferre de France Russian Railways (JSC) Societe Nationale des Chemins de Fer Belges Holding Societe Nationale des Chemins de Fer Francais Transnet Ltd. Unique (Flughafen Zurich AG) VINCI S.A. West Coast Train Finance PLC
Issuer credit rating* A/Negative/-BBB/Watch Neg/A-2 AA-/Stable/-A/Negative/A-2 A/Negative/A-1 BBB+/Watch Neg/NR A-/Stable/A-2 A/Watch Neg/A-1 BBB/Stable/-AAA/Stable/-B-/Watch Neg/-BB/Negative/-BBB+/Negative/A-2 BBB+/Stable/-AA/Negative/A-1+ AAA/Negative/A-1+ A+/Stable/A-1 A/Negative/A-1 AA/Stable/-A-/Stable/A-2 AA+/Stable/A-1+ BB+/Stable/-BBB+/Stable/-BBB/Stable/-A/Stable/-AA-/Negative/-A/Stable/-Senior secured debt AAA Senior secured debt AAA AA/Stable/A-1+ AA/Stable/-Senior unsecured debt AAA A/Stable/-AAA/Stable/A-1+ BBB+/Stable/-AA+/Stable/A-1+ AAA/Stable/A-1+ Foreign currency BBB+/Stable/-BBB+/Stable/-BBB+/Negative/A-2 Senior secured debt A/Stable
Country Spain Italy France U.K. Italy U.K. U.K. Portugal Belgium France Romania Romania France Denmark Germany Germany Dubai Ireland Norway U.K. Belgium Kazakhstan Denmark U.K. U.K. The Netherlands U.K. U.K. U.K. Norway The Netherlands Denmark Portugal France Russia Belgium France South Africa Switzerland France U.K.
146 NOVEMBER 2007
RATINGS LIST

Project Finance Name Abu Dhabi National Energy Company PJSC (TAQA) Ajman Sewerage (Private) Co. Ltd. Alpha Schools (Highland) Project PLC Alte Liebe 1 Ltd. Aspire Defence Finance PLC Autolink Concessionaires (M6) PLC Autoroutes Paris-Rhin-Rhone Autovia del Camino S.A. Bina-Istra, d.d. Breeze Finance S.A. Capital Hospitals (Issuer) PLC Catalyst Healthcare (Manchester) Financing PLC Catalyst Healthcare (Romford) Financing PLC Central Nottinghamshire Hospitals PLC Consort Healthcare (Birmingham) Funding PLC Consort Healthcare (Mid Yorkshire) Funding PLC Consort Healthcare (Salford) PLC Consort Healthcare (Tameside) PLC CountyRoute (A130) PLC Coventry & Rugby Hospital Co. PLC (The) CRC Breeze Finance S.A. CTRL Section 1 Finance Delek & Avner - Yam Tethys Ltd. DirectRoute (Limerick) Finance Ltd. Discovery Education PLC Education Support Enfield Ltd. Exchequer Partnership (no. 1) PLC Exchequer Partnership (no. 2) PLC Fixed-Link Finance B.V. Issue credit rating* AA-/Stable/A-1+ (issuer credit rating) AAA (insured); BBB (SPUR)/Stable AAA (insured); BBB (SPUR)/Stable AAA (insured); BBB- (SPUR)/Stable AAA (insured); BBB- (SPUR)/Stable AAA (insured); BBB+ (SPUR)/Stable Senior unsecured bank loan, term loan BBB-/Stable; senior unsecured MTN BBB AAA (insured); BBB (SPUR)/Stable Senior secured debt BBB-/Stable Senior secured debt AAA (insured), BBB (SPUR)/Stable; subordinated debt BB-/Stable (preliminary) AAA (insured); BBB- (SPUR)/Stable AAA (insured); BBB (SPUR)/Negative AAA (insured); BBB (SPUR)/Stable AAA (insured); BBB (SPUR)/Stable AAA (insured); BBB- (SPUR)/Stable AAA (insured); BBB- (SPUR)/Stable (preliminary) AAA (insured); BBB (SPUR)/Stable (preliminary) AAA (insured); BBB (SPUR)/Stable (preliminary) Senior secured debt BBB/Stable; subordinated debt BB/Stable AAA (insured); BBB (SPUR)/Stable Senior secured debt BBB/Stable; subordinated debt BB+/Stable Class A1 and A2 debt AAA Senior secured debt BBB-/Stable AAA (insured); BBB- (SPUR)/Stable (preliminary) AAA (insured); BBB- (SPUR)/Stable Senior secured bank loan A/Stable Senior secured debt AAA (insured) AAA (insured); BBB+ (SPUR)/Stable G1 and G2 notes: AAA; junior subordinated class C notes: C/Negative; senior secured class A notes and subordinated class B notes: AAA/Stable Senior secured debt AAA (insured) AAA (insured); BBB- (SPUR)/Stable AAA (insured); BBB- (SPUR)/Stable (preliminary) AAA (insured); BBB (SPUR)/Stable AAA (insured); BBB+ (SPUR)/Stable AAA (insured); BBB- (SPUR)/Watch Neg AAA (insured); A (SPUR)/Stable BB-/Stable/-- (issuer credit rating) Senior secured bank loan and debt AAA Senior secured debt BBB-/Negative Senior secured bank loan BB+/Watch Neg; senior secured debt AAA, BB+(SPUR)/Watch Neg A+/Stable/-- (issuer credit rating) AAA (insured); BBB (SPUR)/Stable AAA (insured); BBB (SPUR)/Stable AAA (insured); BBB- (SPUR)/Stable (preliminary) AAA (insured); A (SPUR)/Stable AAA (insured); A/Stable Country United Arab Emirates United Arab Emirates U.K. Channel Islands U.K. U.K. France Spain Croatia Luxembourg U.K. U.K. U.K. U.K. U.K. U.K. U.K. U.K. U.K. U.K. Luxembourg U.K. Israel Ireland U.K. U.K. U.K. U.K. The Netherlands
Health Management (Carlisle) PLC Healthcare Support (Newcastle) Finance PLC Healthcare Support (North Staffs) Finance PLC Highway Management (City) Finance PLC Hospital Co. (Swindon & Marlborough) Ltd. (The) InspirED Education (South Lanarkshire) PLC Integrated Accommodation Services PLC International Power PLC M6 Duna Autopalya Koncessios Zartkoruen Mukodo Eszvenytarsasag Max Two Ltd. Metronet Rail BCV Finance PLC and Metronet Rail SSL Finance PLC Nakilat Inc. NewHospitals (St. Helens and Knowsley) Finance PLC Octagon Healthcare Funding PLC Peterborough (Progress Health) PLC Premier Transmission Financing PLC Ras Laffan Liquefied Natural Gas Co.
*At Nov. 9, 2007. All ratings are issue ratings unless otherwise stated.
U.K. U.K. U.K. U.K. Channel Islands U.K. U.K. U.K. Hungary Channel Islands U.K. Marshall Islands U.K. U.K. U.K. U.K. Qatar
NOVEMBER 2007 147
RATINGS LIST

Project Finance Name Ras Laffan Liquefied Natural Gas Co. Ltd. (II) and Ras Laffan Liquefied Natural Gas Co. Ltd. (3) RMPA Services PLC Road Management Consolidated PLC Services Support (Manchester) Ltd. Socit Marseillaise du Tunnel Prado-Carnage (SMTPC) Sutton Bridge Financing Ltd. TAQA North Ltd. THPA Finance Ltd. Transform Schools (North Lanarkshire) Funding PLC Tube Lines (Finance) PLC Issue credit rating* Senior secured debt A/Stable AAA (insured); BBB- (SPUR)/Positive AAA (insured); BBB (SPUR)/Stable Senior secured bank loan BBB/Stable Senior secured bank loan AAA (insured) Senior secured debt BBB-/Stable Senior unsecured debt AAClass A2 debt A; class B debt BBB; class B debt BB AAA (insured); BBB- (SPUR)/Stable Senior secured bank loan AAA/Stable (insured); senior secured B notes BBB/Stable; senior secured A-1 notes AA/Stable; subordinated C notes BBB-/Stable; subordinated D notes BB/Stable AAA (insured); BBB- (SPUR)/Stable (preliminary) Country Qatar U.K. U.K. U.K. France U.K. United Arab Emirates U.K. U.K. U.K.
Walsall Hospital Co. PLC (The)

*At Nov. 9, 2007. All ratings are issue ratings unless otherwise stated.
U.K.
148 NOVEMBER 2007
CONTACTS
KEY ANALYTICAL CONTACTS

London
Michael Wilkins Managing Director Head of Infrastructure Finance Ratings (44) 20-7176-3528 mike_wilkins@standardandpoors.com Peter Kernan Managing Director and Team Leader European Utilities (44) 20-7176-3618 peter_kernan@standardandpoors.com Jonathan Manley Senior Director and Co-Team Leader Project Finance and Transportation Infrastructure (44) 20-7176-3952 jonathan_manley@standardandpoors.com Lidia Polakovic Senior Director and Co-Team Leader Project Finance and Transportation Infrastructure (44) 20-7176-3985 lidia_polakovic@standardandpoors.com Paul Lund Director and Team Leader Corporate Securitization (44) 20-7176-3715 paul_lund@standardandpoors.com Elif Acar Director (44) 20-7176-3612 elif_acar@standardandpoors.com Vincent Allilaire Director (44) 20-7176-3628 vincent_allilaire@standardandpoors.com Mark Davidson Director (44) 20-7176-6306 mark_j_davidson@standardandpoors.com Maria Lemos Director (44) 20-7176-3749 maria_lemos@standardandpoors.com Karim Nassif Associate Director (44) 20-7176-3677 karim_nassif@standardandpoors.com Olli Rouhiainen Associate Director (44) 20-7176-3769 olli_rouhiainen@standardandpoors.com Beata Sperling-Tyler Associate Director (44) 20-7176-3687 beata_sperling-tyler@standardandpoors.com Beatrice de Taisne Associate (44) 20-7176-3938 beatrice_detaisne@standardandpoors.com Karin Erlander Associate (44) 20-7176-3584 karin_erlander@standardandpoors.com Amrit Gescher Associate (44) 20-7176-3733 amrit_gescher@standardandpoors.com James Hoskins Associate (44) 20-7176-3393 james_hoskins@standardandpoors.com Tania Tsoneva Ratings Specialist (44) 20-7176-3489 tania_tsoneva@standardandpoors.com Florian de Chaisemartin Ratings Analyst (44) 20-7176-3760 florian_dechaisemartin@standardandpoors.com Terence Smiyan Research Assistant (44) 20-7176-3800 terence_smiyan@standardandpoors.com
NOVEMBER 2007 149
CONTACTS
KEY ANALYTICAL CONTACTS

Frankfurt
Ralf Etzelmueller Associate Director (49) 69-33-999-123 ralf_etzelmueller@standardandpoors.com Timon Binder Ratings Specialist (49) 69-33-999-139 timon_binder@standardandpoors.com Ekaterina Lebedeva Senior Research Assistant (49) 69-33-999-134 ekaterina_lebedeva@standardandpoors.com
Milan
Monica Mariani Director (39) 02-72-111-207 monica_mariani@standardandpoors.com
Moscow
Eugene Korovin Associate Director (7) 495-783-4090 eugene_korovin@standardandpoors.com
Group E-mail Address

InfrastructureEurope@standardandpoors.com
Madrid
Ana Nogales Director (34) 91-788-7206 ana_nogales@standardandpoors.com Jose Ramon Abos Associate Director (34) 91-389-6962 jose_abos@standardandpoors.com
Paris
Hugues de la Presle Director (33) 1-4420-6666 hugues_delapresle@standardandpoors.com Alexandre de Lestrange Director (33) 1-4420-7316 alexandre_delestrange@standardandpoors.com
Stockholm
Mark Schindele Associate (46) 8-440-5918 mark_schindele@standardandpoors.com
150 NOVEMBER 2007
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STANDARD & POORS EUROPEAN INFRASTRUCTURE FINANCE YEARBOOK

Project Finance and Public-Private Partnerships

Ratings List Key Analytical Contacts

STANDARD & POORS EUROPEAN INFRASTRUCTURE FINANCE YEARBOOK

Michael Wilkins Managing Director and Head of Infrastructure Finance Ratings

HOW INFRASTRUCTURE ASSETS HAVE WEATHERED A DECADE OF STORMS

Power Projects Hit By Falling Commodity Prices

Chart 1 Breakdown Of Projects By Sector, December 1997

Chart 2 Breakdown Of Projects By Sector, May 2007

STANDARD & POORS EUROPEAN INFRASTRUCTURE FINANCE YEARBOOK

ject Finance Rating Distribution: Investment Grade Versus Speculative Gr

Standard & Poor's 2007.

STANDARD & POORS EUROPEAN INFRASTRUCTURE FINANCE YEARBOOK

THE CHANGING FACE OF INFRASTRUCTURE FINANCE: BEWARE THE ACQUISITION HYBRID

Fusion Of Project Finance And Leveraged Finance

Breaking New Boundaries: Hunger For Infrastructure Drives Development

STANDARD & POORS EUROPEAN INFRASTRUCTURE FINANCE YEARBOOK

Leveraged Finance And Project Finance Structuring Techniques

Infrastructure--An Ever Expanding Asset Class?

The Origins Of The Acquisition Hybrid

STANDARD & POORS EUROPEAN INFRASTRUCTURE FINANCE YEARBOOK

First quarter Fourth quarter

Second quarter Transaction count*

STANDARD & POORS EUROPEAN INFRASTRUCTURE FINANCE YEARBOOK

STANDARD & POORS EUROPEAN INFRASTRUCTURE FINANCE YEARBOOK

Frequently Asked Questions

STANDARD & POORS EUROPEAN INFRASTRUCTURE FINANCE YEARBOOK

STANDARD & POORS EUROPEAN INFRASTRUCTURE FINANCE YEARBOOK

Top 20 Rated European Utilities

STANDARD & POORS EUROPEAN INFRASTRUCTURE FINANCE YEARBOOK

STANDARD & POORS EUROPEAN INFRASTRUCTURE FINANCE YEARBOOK

Carbon Emissions By Type Of Power Generation

The EU's Main Providers Of Uranium, 2006

South frica (Nami ia) (5 ) ustralia (14 ) Niger (16 )

Standard & Poor's 2007.

Limited Nuclear Revival In The EU Nevertheless...

Table 1 - Nuclear Power Plants In the EU

...Given Relatively Limited Political And Public Support So Far...

Slovakia Others Total

Source: World Nuclear Association, October 2007.

Table 2 - Nuclear Power Phase Out Policies In Europe Country

Existing nuclear phase out legislation/policy

Source: Standard & Poor's.

STANDARD & POORS EUROPEAN INFRASTRUCTURE FINANCE YEARBOOK

Eurobarometer: European And Nuclear Safety

Eurobarometer: European And Nuclear Safety

on't know (13 ) ncreased (14 ) educed (39 )

aintained the same (34 )

The advantages outweigh the risks (33 )

The risks outweigh the advantages (53 )

uro arometer Fe ruary 2007

uropean and nuclear safety .

uro arometer Fe ruary 2007

uropean and nuclear safety .

Standard & Poor's 2007.

Standard & Poor's 2007.

Conversely, New Nuclear Build Is Inherently Risky

Extension Of Existing Plants Would Be Credit Positive

STANDARD & POORS EUROPEAN INFRASTRUCTURE FINANCE YEARBOOK

Operational Inflexibility Is A Drawback In A Competitive Environment