Default rates for project finance bank loans drop

LONDON, April 6: Default rates for project finance bank loans have gone down and continue to improve relative to the 10-year cumulative default rates from earlier studies, according to Moody’s Investors Service in its latest annual study, “Default and Recovery Rates for Project Finance Bank Loans, 1983-2013.”

“Our report shows that the 10-year cumulative default rate for project finance bank loans is 6.4%, down from the 8.1% shown in our previous study published in March 2014,” says Andrew Davison, a Moody’s Senior Vice President and author of the report. “This fall continues a downward trend compared with 10-year cumulative default rates for earlier studies.”

More generally, the report shows that project finance is a robust class of specialised corporate lending. Most project finance borrowers are highly leveraged, thinly capitalised special purpose vehicles with limited financial flexibility. However, the findings suggest that the risk allocation, structural features, underwriting disciplines and incentive structures of the project finance asset class effectively limit defaults and minimise losses.

“Our study shows that 10year cumulative default rates of project finance bank loans are consistent with those of low investment-grade corporate issuers,” adds Davison. “However, it also shows that marginal annual default rates improve materially over time, trending towards rates consistent with single-A category ratings by year 10 from financial close, differentiating project finance bank loans from corporate bank loans.”

Nevertheless, Moody’s finds that ultimate recovery rates for project finance bank loans are similar to ultimate recovery rates for senior secured corporate bank loans, despite features such as high gearing and long tenor that are typical for project finance loans, but generally associated with higher-risk corporate loans. Ultimate recovery rates for the whole study average 80.3% for defaults as defined by Basel II and 77.3% on defaults as defined by Moody’s.

The results of this study and the previous study in March 2014 are consistent. Moody’s notes that the data set in this year’s study is 20% larger than last year’s, consisting of 883 additional projects and 52 more defaults (as defined by Basel II), and that the results of studies based on different data sets will necessarily be different.

The study reviews data from 5,308 projects, which account for some 60.6% of all project finance transactions originated globally during a 31-year period from 1 January 1983 to 31 December 2013. The study is based on an updated and expanded aggregate data set from a consortium of leading sector lenders and investors.