Financial Stress Testing of Toll Road Projects: The Effect of Feedback Loop Dynamics

Abstract

Infrastructure development often requires a partnership between a government agency (e.g. Department of Transportation) that seeks to meet a public need, and a profit-maximizing private developer. These infrastructure public-private partnership (PPP) projects are typically developed using high levels of debt-to-equity ratios, leaving the lenders exposed to revenue risks. This article describes a feedback loop mechanism for financial stress testing for PPP projects that takes into account lenders' exposure on the secondary market. The proposed model can be used as a diagnostic tool to evaluate the effects of typical project characteristics on the occurrence of tipping point dynamics. This diagnostic is based on a simulated extreme condition wherein developers and sponsors have to continuously refinance the senior debt based on the current level or risk and corresponding premium. The results show that the initial leverage and the dynamics of debt cover ratio (or DSCR) during the loan tenor could play an important role in the secondary market, regulatory asset valuation, as well as the capacity to structure mezzanine debt.

TOPICS: Project finance, other real assets, legal/regulatory/public policy