Fitch Ratings: PPP Counterparty Risks in the Spotlight

Carillion

12/02/2019 11:42

(The following statement was released by the rating agency)


Fitch Ratings-London-February 12: The collapse of Carillion in January 2018 and 
Interserve's restructuring efforts highlight the importance of counterparty 
considerations in assessing construction risk of public-private partnerships 
(PPPs), Fitch Ratings says. The financial strength and experience of contractors 
and the ability to replace a failing contractor within the set cost and time 
budgets drive our assessment of completion risk of PPPs. Furthermore, our 
approach assumes a default of the contractor as a standard scenario.

Carillion managed about 50 private finance initiative (PFI)/PPP social 
infrastructure contracts before it went into liquidation last year. Counterparty 
risk concerns were highlighted again last week as Interserve, a large UK 
government contractor, agreed a restructuring using a debt-for-equity swap with 
its creditors, which would allow it to remain operational. Although we rate 
neither of these two companies, nor any PFI/PPP projects involving them as 
contractors, these cases inform our analysis and verify our view that 
counterparty risk considerations play a key role for projects in construction.

The assessments of financial strength and experience of construction contractors 
are an integral part of our project rating considerations as they determine the 
contractors' ability to complete a project. Contractor troubles can lead to, 
among other things, poor project management, substandard workmanship, delays in 
paying sub-contractors and disputes with public-sector grantors. We view the 
sole focus on the lowest cost bid during the tender process as a risk as this 
may erode the quality of security provisions, contingencies and ultimately of 
the quality of the construction itself, which may then lead to operational risk.

Carillion's first profit warning came as a surprise to the market and the public 
sector, but the government awarded contracts worth nearly GBP2 billion to the 
company even after three profit warnings were issued within six months. This 
emphasises the need to closely monitor the financial position of 
contractors /a  even if these are large and have demonstrated successful project 
completion. 

Proper costing of construction works is another important rating factor. It 
needs to be verified rigorously by technical advisors and peer analysis is 
essential to validate construction budgets. We have not rated a project that 
terminated during construction, but the termination of the Royal Liverpool and 
Midland Met hospital PFIs following Carillion's collapse provides valuable 
insights. Both projects would have required the injection of large sums beyond 
the amounts lenders and equity investors were able to provide. The UK government 
decided not to bail the projects out based on its assessment of best 
value-for-money for taxpayers, leading to the termination of these PFI contracts 
with substantial losses to lenders. While there is still a need for the 
hospitals to be built, these examples demonstrated that the public need did not 
preclude the projects' termination.

Our methodology for assessing completion risk assumes a default of the 
contractor as a standard scenario, including resulting delays in construction. 
We will analyse projects to determine their ability to find replacement 
contractors, and to replace the contractor by the long-stop date. We also test 
projects' liquidity by increasing construction costs to account for potential 
replacement costs. Continuity planning by the project company, lenders and 
public-sector counterparties, and transparency of information are essential to 
allow a successful replacement. In the case of Carillion, operational projects 
were transferred to new counterparties without disrupting services, but this has 
not been the case for all projects under construction, such as the 
above-mentioned hospitals.

For more case studies discussing completion challenges of PPP transactions in 
the US and further examples of how completion risks can crystallise, please see 
our recent report "Avoiding the Potholes: Public-Private Partnerships and 
Takeaways for Investors and Grantors" by clicking the link below. 

Contact: 

Christiane Kuti 

Director, Global Infrastructure and Project Finance

+44 20 3530 1396 

Fitch Ratings Limited

30 North Colonnade 

London

E14 5GN

Kim Locherer 

Director, Global Infrastructure and Project Finance

+44 20 3530 1918

Tatiana Kordyukova

Senior Director, Fitch Wire

+44 20 3530 1954

Media Relations: Athos Larkou, London, Tel: +44 20 3530 1549, Email: 
athos.larkou@thefitchgroup.com.

The above article originally appeared as a post on the Fitch Wire credit market 
commentary page. The original article can be accessed at www.fitchratings.com. 
All opinions expressed are those of Fitch Ratings.

Related Research 

Avoiding the Potholes: U.S. Public-Private Partnerships and Takeaways for 
Investors and Grantors (Case Studies of Recent Projects’ Completion Challenges)

https://www.fitchratings.com/site/re/10059285

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. 
PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK:  
HTTPS://WWW.FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING 
DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S 
PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. PUBLISHED RATINGS, CRITERIA, AND 
METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF 
CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE, 
AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE CODE OF 
CONDUCT SECTION OF THIS SITE. DIRECTORS AND SHAREHOLDERS RELEVANT INTERESTS ARE 
AVAILABLE AT HTTPS://WWW.FITCHRATINGS.COM/SITE/REGULATORY. FITCH MAY HAVE 
PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD 
PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED 
IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS 
ISSUER ON THE FITCH WEBSITE.

Copyright © 2019 by Fitch Ratings, Inc., Fitch Ratings Ltd. and its 
subsidiaries. 33 Whitehall Street, NY, NY 10004. Telephone: 1-800-753-4824, 
(212) 908-0500. Fax: (212) 480-4435. Reproduction or retransmission in whole or 
in part is prohibited except by permission. All rights reserved. In issuing and 
maintaining its ratings and in making other reports (including forecast 
information), Fitch relies on factual information it receives from issuers and 
underwriters and from other sources Fitch believes to be credible. Fitch 
conducts a reasonable investigation of the factual information relied upon by it 
in accordance with its ratings methodology, and obtains reasonable verification 
of that information from independent sources, to the extent such sources are 
available for a given security or in a given jurisdiction. The manner of Fitch's 
factual investigation and the scope of the third-party verification it obtains 
will vary depending on the nature of the rated security and its issuer, the 
requirements and practices in the jurisdiction in which the rated security is 
offered and sold and/or the issuer is located, the availability and nature of 
relevant public information, access to the management of the issuer and its 
advisers, the availability of pre-existing third-party verifications such as 
audit reports, agreed-upon procedures letters, appraisals, actuarial reports, 
engineering reports, legal opinions and other reports provided by third parties, 
the availability of independent and competent third- party verification sources 
with respect to the particular security or in the particular jurisdiction of the 
issuer, and a variety of other factors. Users of Fitch's ratings and reports 
should understand that neither an enhanced factual investigation nor any 
third-party verification can ensure that all of the information Fitch relies on 
in connection with a rating or a report will be accurate and complete. 
Ultimately, the issuer and its advisers are responsible for the accuracy of the 
information they provide to Fitch and to the market in offering documents and 
other reports. In issuing its ratings and its reports, Fitch must rely on the 
work of experts, including independent auditors with respect to financial 
statements and attorneys with respect to legal and tax matters. Further, ratings 
and forecasts of financial and other information are inherently forward-looking 
and embody assumptions and predictions about future events that by their nature 
cannot be verified as facts. As a result, despite any verification of current 
facts, ratings and forecasts can be affected by future events or conditions that 
were not anticipated at the time a rating or forecast was issued or affirmed. 

The information in this report is provided "as is" without any representation or 
warranty of any kind, and Fitch does not represent or warrant that the report or 
any of its contents will meet any of the requirements of a recipient of the 
report. A Fitch rating is an opinion as to the creditworthiness of a security. 
This opinion and reports made by Fitch are based on established criteria and 
methodologies that Fitch is continuously evaluating and updating. Therefore, 
ratings and reports are the collective work product of Fitch and no individual, 
or group of individuals, is solely responsible for a rating or   a report. The 
rating does not address the risk of loss due to risks other than credit risk, 
unless such risk is specifically mentioned. Fitch is not engaged in the offer or 
sale of any security. All Fitch reports have shared authorship. Individuals 
identified in a Fitch report were involved in, but are not solely responsible 
for, the opinions stated therein. The individuals are named for contact purposes 
only. A report providing a Fitch rating is neither a prospectus nor a substitute 
for the information assembled, verified and presented to investors by the issuer 
and its agents in connection with the sale of the securities. Ratings may be 
changed or withdrawn at any time for any reason in the sole discretion of Fitch. 
Fitch does not provide investment advice of any sort. Ratings are not a 
recommendation to buy, sell, or hold any security. Ratings do not comment on the 
adequacy of market price, the suitability of any security for a particular 
investor, or the tax-exempt nature or taxability of payments made in respect to 
any security. Fitch receives fees from issuers, insurers, guarantors, other 
obligors, and underwriters for rating securities. Such fees generally vary from 
US$1,000 to US$750,000 (or the applicable currency equivalent) per issue. In 
certain cases, Fitch will rate all or a number of issues issued by a particular 
issuer, or insured or guaranteed by a particular insurer or guarantor, for a 
single annual fee. Such fees are expected to vary from US$10,000 to US$1,500,000 
(or the applicable currency equivalent). The assignment, publication, or 
dissemination of a rating by Fitch shall not constitute a consent by Fitch to 
use its name as an expert in connection with any registration statement filed 
under the United States securities laws, the Financial Services and Markets Act 
of 2000 of the United Kingdom, or the securities laws of any particular 
jurisdiction. Due to the relative efficiency of electronic publishing and 
distribution, Fitch research may be available to electronic subscribers up to 
three days earlier than to print subscribers. 

For Australia, New Zealand, Taiwan and South Korea only: Fitch Australia Pty Ltd 
holds an Australian financial services license (AFS license no. 337123) which 
authorizes it to provide credit ratings to wholesale clients only. Credit 
ratings information published by Fitch is not intended to be used by persons who 
are retail clients within the meaning of the Corporations Act 2001

Fitch Ratings, Inc. is registered with the U.S. Securities and Exchange 
Commission as a Nationally Recognized Statistical Rating Organization (the 
"NRSRO"). While certain of the NRSRO's credit rating subsidiaries are listed on 
Item 3 of Form NRSRO and as such are authorized to issue credit ratings on 
behalf of the NRSRO (see https://www.fitchratings.com/site/regulatory), other 
credit rating subsidiaries are not listed on Form NRSRO (the "non-NRSROs") and 
therefore credit ratings issued by those subsidiaries are not issued on behalf 
of the NRSRO. However, non-NRSRO personnel may participate in determining credit 
ratings issued by or on behalf of the NRSRO