Standard & Poor’s Ratings Services has issued a report comparing the income fund sector with project finance in the form of public-private partnerships.

It notes that Canadian investors have witnessed a rapid development of the income fund sector in the past several years and, more recently, the more gradual growth of the field of PPPs.

“The most notable similarity of Canadian income funds and PPP projects is that they both generally pay out substantially all of their residual cash flow following the payment of operating and maintenance expenses and debt service obligations,” said Standard & Poor’s credit analyst Paul Cadler. This feature provides a unique opportunity to compare and contrast their credit profiles and the rationales behind their respective ratings, it notes.

The report compares and contrasts the credit characteristics of the debt issued for PPPs and income trusts and highlights the factors that contribute to their debt ratings. PPPs and income funds also broadly share a comparable debt rating spectrum (mid-to-low investment grade space), as well as a common credit framework.

Their main differences can be observed in relative credit metrics, such as leverage, debt service coverage levels and liquidity, as well as in corporate structure and covenant protection, S&P notes.

The report notes that the Canadian PPP sector is still relatively immature.

“After a lengthy developmental period in which a variety of obstacles slowed the progress of PPPs in Canada as a form of alternative public sector asset procurement, the signs of firm traction appeared to take hold in late 2004 and early 2005,” it says. “By early May 2005, financial close had been reached on hospital PPPs in the Provinces of British Columbia and Ontario, while a preferred proponent had been selected on several large-scale transportation projects in British Columbia and Alberta.”

“Of interest in the Canadian context is the contrast of the relative immaturity of the PPP sector compared with the depth of the income fund market, which has grown dramatically in Canada in the past five years. Indeed, income fund offerings in Canada would represent one of the largest proportionate shares of domestic market capitalization in the world,” it notes.

“As the pipeline for Canadian PPP projects begins to fill, Standard & Poor’s estimates that large-scale PPP projects Canada may require, in aggregate, upwards of $2 billion in debt financing in the next 12 to 15 months,” it says. “It is unclear if this funding requirement will be met through the domestic public bond market or if the issues will be primarily procured through the domestic or cross-border private placement or bank loan market.”

It adds that in Canada, the large domestic financial institutions that dominate the banking landscape do not typically lend on a long-term project finance basis, “although this historical stance may be changing”.

Standard & Poor’s says it views the recovery prospects as higher for a PPP than for an income fund, in the event of a default. “This difference in recovery prospects between income funds and PPP projects generally reflects the fact that PPP-related debt benefits from a substantial compensation on termination payment from a (generally) highly rated government entity for a project company in the event of default. An income fund recovery prospect would reflect an uncertain estimate driven by the outcome of a CCAA restructuring process (following default),” it notes.