Using Credit Enhancements 

Credit enhancements include all techniques and instruments that improve the creditworthiness of an investment. To optimize the ability to access finance, project owners need to systematically assess the benefits and costs of the full menu of proven credit enhancement solutions.  Key concepts underlying the successful use of credit enhancement techniques include:

1) Special Purpose Vehicles (SPVs): Infrastructure services are often provided by SPVs as their legal status as separate companies can result in bankability based on an analysis of whether its cash flow enables timely debt service payments. The SPV independent legal structure can make its obligations secure even if the project owner defaults. In fact, the annual Moody’s bank default study for infrastructure loans states the cumulative default rates for infrastructure projects are consistent with low investment-grade corporate loans (Baa3-rated), even in low-income developing countries. To access the summary of the 2021 Moody’s default study, click here.

2) Structured Finance: Bankability can be achieved by creating structures that ensure the payment of debt principal and interest. A key mechanism is ringfencing specific funds and/or collateral for debt payments.

3) Project Finance: Infrastructure projects usually use project finance techniques as they have been the foundation for bankability, using both SPVs and structured financing. First, project finance involves the creation of a Special Purpose Vehicle (SPV) created by the sponsors. Second, project finance uses structured finance as the lender considers the cash flow generated from this entity as the major source of debt service, usually ringfencing revenues.

4) Risk Mitigation Instruments: There are many types of risk mitigation instruments. For example, many highly rated Development Financial Institutions (DFIs) issue credit guarantees that  leverage their limited resources and credit ratings to attract private sector financing for development projects. These products can be used to guarantee a portion of the public sector borrower’s debt service to lenders or bond holders. The objective is to help countries access capital markets or open up new sources of financing. The DFI’s participation as guarantor not only makes commercial financing possible by enhancing the credit profile of projects and borrowers, but also improves the terms of the financing by extending debt tenors and lowering spreads. New issuers benefit by establishing a track record in the capital markets.