38446299 rating approach to toll roads project financing

7/28/2019 38446299 Rating Approach to Toll Roads Project Financing

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RATING APPROACH FOR TOLL ROADS PROJECTFINANCING

Company No.: 364803 V

RRAATTINGING AAPPRPPROOACACHH FFOROR TTOLLOLL

RROAOADDSS

PPRORO JE JECTCT FFIINNAANNCCIINNGG

Contact:Sandeep BhattacharyaVice President, Ratings

[email protected]

+603 2092 5398

www.marc.com.my



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RATING APPROACH FOR TOLL ROADS PROJECTFINANCING



RATING APPROACH FOR TOLL ROADS PROJECT FINANCING

INTRODUCTION

Toll road is defined as a road on which a toll authority collects a fee for use.

There arealso toll bridges and toll tunnels. Malaysia has extensive toll roads, whichform themajority of the expressways in the country. Malaysian expressways spanmore than1,000 km in length from North to the border of Thailand, from South to theCausewayand Second Link to Singapore, from West to Klang and Pulau Indah and; fromthe Easttowards Kuantan. Most of the toll roads are in major cities and surburbanareas such as

Klang Valley, Johor Bahru and Penang. All of Malaysia’s toll roads aremanaged underthe build, operate, transfer (BOT) basis.

The Malaysian expressway system which started with the North-SouthExpressway isexpanding substantially, built by private corporations under thesupervision of thegovernment highway authority. The construction, standards, managementand usagesof expressways in the country are subject to Federal Roads Act (PrivateManagement)

1984. Expressways in Malaysia are defined as high speed routes with atleast fourlanes, consisting of two lanes in each direction with either limited or partialaccessibility.Most expressways in Malaysia are limited access expressways.

Under the Ninth Malaysia Plan (2006-2010), the Highway NetworkDevelopment Plan

(HNDP) review which is expected to be completed in 2006, will identifypriority projectsto improve the national road network in Peninsular Malaysia. Road projects

which canbe implemented under the privatization programme will also be identified. To expedite

development of Sabah and Sarawak, a study will be undertaken to identifythe requiredroad networks. To improve traffic flows and dispersal in major cities,several urbanroads will be constructed or upgraded, including the construction of ringroads and

bypasses in Georgetown, Pulau Pinang; Seremban, Negeri Sembilan; and Johor Bahru,



Johor.

MARC rates a number of toll road debts/ finance facilities of several issuers. The ratingsof these facilities range from AA- to BB-, and MARC-1 to MARC-2. MARC-ratedtoll roadscomprise of pre-operational toll roads, semi-matured and matured toll roads.

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ANALYTICAL FRAMEWORK

The rating approaches as for pre-operational toll roads and operational tollroads havesome similarities and differences. Pre-operational toll roads areexposed to pre-completion or construction risk namely cost overrun, delay risk, etc.

MARC’s analystalso has to rely on the independent traffic study report for projections of traffic volumeand revenues, which are estimates and most of the time, are less thanaccurate.

Ratings for project financing of toll roads encompass a multiplicity of factorswhich are

listed below:

Project Sponsors/ManagementPrincipal Project Agreements

o Concession Agreement and other pertinent project documents

o Shareholders’ agreemento Turnkey contract agreementConstruction Risk AnalysisOperational Risk AnalysisMarket Risk

o Independent traffic study

o Traffic forecast – volume and revenueo Toll-rate setting mechanismo Demographic and key drivers of traffic growth analysisIssue Structure AnalysisFinancial Risk Analysis

o Project Costso Earnings and Cashflow - Actual and Projectionso Capital Structure and Financial Flexibility

PROJECT SPONSORS/MANAGEMENT

Documents related to ownership structure (i.e. articles of incorporation andshareholders’ agreement), financial data and other corporate informationof projectsponsors will form the basis of evaluation for the following risk factors:

The project sponsor’s background, track record The project sponsor’s previous involvement with toll road projects that

have beenbuilt and operated successfully will be evaluated. Successful experience

in building



and operating toll roads would be positive rating factors. An assessmentof the key

management personnel including qualification, skills and experienceshall also be

carried out.

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Financial strength The financial strength of the project sponsors is assessed. The audited

accounts of the sponsors for the past three to five years will form the basis of this

assessment. The credit quality of the sponsors is important to ensure that they will

be able to

meet any future obligations, in particular, contingent equityrequirements.

CommitmentEvidence of the sponsor’s commitment to the project will be looked

at. If thesponsors have significant resources and time already invested in the

project, they

are less likely to abandon it. Higher levels of equity investments on thepart of the

sponsors are considered a positive factor when evaluating a project. Thestrategic

importance of the project to the sponsor is also considered.Examples of

commitment may be in the form of undertaking to cover cost overruns,to provide

liquidity support and to maintain a material interest in the project duringthe life of

the financing facilities.

For example, SPRINT Holdings, the sole shareholder of SPRINT provided anundertakingto subscribe to loan stocks issued by SPRINT of up to a maximum of RM410 million,demonstrating the commitment of the project sponsor. SPRINT also has astrong set of

shareholders namely Gamuda, LITRAK Berhad and Kumpulan PerangsangBerhad whichafford the project some degree of financial flexibility. SPRINT’s rating wasreaffirmed atAA- in 2005. In the case of Konsortium Lapangan Terjaya (KLT), in the event

that theconstruction of the toll road is delayed by one year from the stipulatedtime of completion due to the fault of KLT, Maju Holdings (the ultimate shareholder)undertakesto cover any shortfall to fulfill profit payments due within the delayed period.

PRINCIPAL PROJECT AGREEMENTS

All of the toll road concessions currently rated by MARC are awarded by the



Governmentof Malaysia (GOM). These concessions are governed by concessionagreements (CA)entered into between the concessionaire and the government. Thus, theconcessionagreement is the first document that shall be rigorously reviewed. TheConcessionAgreement amongst others spells out the job scope, rights and

responsibilities of bothparties entering into the agreement. The CA also serves as a basis for anevaluation of regulatory risk, particularly in conjunction with the ability to increase tollrates by theagreed quantum and time frame, as well as compensation to theconcessionaires if thereis an adverse amendment to the CA. The extraction of salient pointswithin theagreement that would have bearing on the rating shall be scrutinized, whichinclude:

o Type of ConcessionNormally, toll road concession in Malaysia is based on build, operate

and transfer(BOT), whereby the concessionaire is responsible to construct and

operate the tollroad on its own or to contract out the toll revenue collections, and/or

carry out themaintenance of the toll road during the concession period. At the

end of theconcession period, the toll road including the rights to collect toll

shall be

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transferred back to the government. The rights, roles andresponsibilities of both

parties under the concessions would have to be examined.

o Concession period The duration of the concession agreement is normally long term (20 to

30 years)as toll roads have relatively long gestation period before the

shareholders wouldrealize any return on the investments. The concession period can

usually beextended under certain circumstances, such as in the event

that theconcessionaire has to carry out required additional works on the

infrastructure of

the toll roads.

o Availability and form of government supportClause indicating strong government support is a positive rating

factor. Forexample, SPRINT was given government support loans of up to RM390

million andit has also obtained the government’s approval to defer the

repayments of someof these loans, to match the toll revenue expectation. The strategic

importance of particular toll roads to the holistic development of infrastructure in

Malaysia tosupport economic growth shall be looked at. The rationale is that

government’s

involvement may mitigate the non-completion or delay risk of certainprojects.

Nevertheless, the timeliness of such support would also be animportant

consideration.

o Compensation in the event toll rates revision does not

materialize or

below the projected toll rates and sharing of excess toll revenueOther form of support includes minimum traffic growth guaranteed

by thegovernment, termed as the Support Traffic Volume (STV). This form of

support isevident in MTD Prime Sdn Bhd, the highest rated toll road which was

upgradedone notch to AA in 2005. MTD Prime also exhibits the most favourable

score formarket risk segment, partly as a result of this minimum traffic growth

guarantee.



If the actual traffic volume falls below the STV, the concessionairewill be

compensated by the government. In return for the trafficguarantee, the

concessionaire will share an agreed percentage of the excess with thegovernment

if the actual traffic volume exceeded an agreed growth rate (the firstthreshold toll

income).

o Provision for termination and the compensation for termination

for bothparties

This is a normal provision in a concession agreement like anyother similar

agreements. The analyst shall look at the events of defaults, force majeure (events

that are beyond the company’s control) terms and conditionsrelating to

termination as well as the subsequent compensation. The question thatneeds to

be addressed is how the CA protects the bondholders as a result of terminations.

In the case of most of the toll roads rated by MARC, if the governmentterminates

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the concession, the government must pay the financiers within sixmonths of

termination the aggregate amount owing to the financiers at the date of payment.

However, the government’s liability to lenders is usually subject to acertain limit.

o Conditions for extension of concession period There are instances where the concession period is extended, as

part of thecompensation package provided by the government due to

expected loss of earnings for the remainder of the period resulting from lower revised

toll rates ascompared to the agreed toll rates as per CA. MTD Prime is one example

where theconcession period was extended for five more years. MARC’s analyst

shall assessthe impact of the extended concession period and the lower toll

rates on theproject’s cash flow projections and the consequent ability to

service debtobligations during the bond tenure.

o Toll rate setting mechanism and its enforceabilityProvisions in respect of the toll rate setting mechanism will need to be

studied by

MARC’s analyst. A thing to note though is that the increase in toll ratesmay have

a negative impact on traffic volume for a period of timeafter theincrease. The

effect on revenue would thus need to be factored as part of MARC’ssensitivity

analyses. Given the public sensitivity of any toll rate revision, it can beexpected

that the approval process would be somewhat time consuming. Thusthis fact

would also need to be factored into MARC’s sensitivity analyses.

CONSTRUCTION RISK ANALYSIS

Two toll roads rated by MARC are still under construction and expected to becompleted

and fully operational in 2008. KLT and Konsortium Lebuhraya Utara – Timur(KL) SdnBhd (Kesturi) are both rated at A+. For both cases, construction risk isgiven a riskweightage of 20%, in arriving at the overall ratings for the projects.



Construction risk isthe risk that the toll road project is not completed on time, within thescheduled budgetand up to the required performance standards. In reviewing these risks,MARC shallconsider factors such as the appointed contractors, projected costs, delayrisk, operationand maintenance risk and other terms of the construction contract.

Turnkey Contract Agreement The turnkey contract agreement governs the contractual relationship

between theconcessionaire and the turnkey contractor, and outlines the scope of

work, rightsand responsibilities, the construction period during which the

contractor isresponsible to design, construct, complete and commission the highway

as well asthe turnkey contract price. A lump sum fixed price contract would be

favourableto the concessionaire as the first layer of protection against costoverrun arising

from any unexpected increase in variable contract costing above thebudgeted

cost.

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Design-build or other contractsContracts are normally on the basis of ‘design, build, operate andmaintain’ wherethe concessionaire appoints an independent consultant to undertakethe detaileddesign. The MARC’s analyst shall assess the track record andexperience of the

consultant in related projects and whether the contractor has given aperformanceguarantee for the design, and the period covered by the guarantee.

Variation order and additional work processes The analyst shall examine the circumstances which warrant thecontractor to becompensated if there are additional works requested by the

government ornecessitated by the contractor’s default or variation arising fromamendments tothe approved design.

Performance bonds, guarantees, insurance policies andliquidateddamages, as well as extension of timeIn the event of failure to complete by the specified date, the contractormay have

to pay liquidated ascertained damages payment (LAD) computed on adaily basis;the maximum amount allowed under the contract is normally 5% of the turnkeycontract price. Apart from the LAD, MARC shall examine therequirement for thecontractor to deposit a Performance Bond equivalent to 5% of theContract Sum. The performance bond is usually assignable to the government for thecontractor’sdue obligations to perform under the CA during the construction periodas well asduring the defect liability period specified under the contract. Similar

to otherprojects of this nature, construction works are insured against any lossor damageduring the construction period up to the end of the defects liabilityperiod. Theturnkey contractor has the responsibility to effect and maintain,amongst others,the contractor’s all risks insurance policy, workmen’s compensation andthird partyliability insurance. Basically, the turnkey contract shall ensurethat the



concessionaire is protected against any cost overrun and delay risk, asthese riskshave been passed to the turnkey contractor through the back-to-backliquidatedascertained damages arrangement in the turnkey contract. Theanalyst shallensure that there are cash reserves and credit lines available to coverinstances of

cost overruns/delays.

Extension of time and early completionMARC’s analyst shall also look at the provision for an extension of timeand whenthe LAD shall be effective in the event of any delays. There areinstances wherethe turnkey contract also provides for an early completion incentive tothe turnkeycontractor if any section of the works is completed before the date of completion

for the works. For example, in KLT’s case, the bonus incentive equalsto 50% of the Net Toll Revenue attributable to the section of work for the periodbetweenthe scheduled completion date and the actual early completion date.

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Site/terrain risks, requirement for land acquisitions The question to be addressed here is which party will be or is

responsible formaking available to the concessionaire the land required in

relation to theconcession area and costs involved in the land acquisition. Another

question is

which party will bear the costs for the removal and resettling of squatters or

occupiers and the compensation for each squatter family. The status of the land is

also an issue to be looked at. Ideally, the land shall be free of encumbrances to

enable the concessionaire to proceed with the construction works.MARC’s analyst

shall also look at the compensation payable by the governmentto the

concessionaire if the former fails to make available the land resulting incompletion

delay.

Major contractorsMARC shall evaluate the experience and track record of the major

contractors inrelated toll road projects and their financial profile, including

profitability,shareholders’ funds and the list of projects completed. The

qualification andexperience of the management of the construction company would

also beexamined.

Independent engineer’s report, progress report, scheduledtime frame,

project costingDuring the construction period, MARC shall monitor the construction

progress of the toll road by examining the construction progress report

prepared by anengineering consultant, which is responsible for overseeing and

monitoring the

construction progress of the toll road on behalf of theconcessionaire and its

financiers. The engineering consultant would act as the supervisoryengineer

ensuring that construction works are executed in strict accordancewith the

turnkey contract. The presence of the supervisory engineerprovides an



independent surveillance on the construction progress. MARC’s analystshall note

the construction scheduled time frame; when the construction shall beginand end;

the beginning of the defect liability period and the expiry of such period.

Other considerationsMARC’s analyst shall need to know the contractor’s plan for acquiring

sufficientequipment, labour and materials necessary to complete the project,

the locallabour situation, with respect to strikes and labour laws/rules that could

affect theproject and any dispute settlement/resolution process with

contractors andsubcontractors. MARC shall also look at any requirement for

controlleddisbursement of construction funds.

The existence of early completion incentives, reasonable liquidateddamage provisionand sufficient insurance coverages provide some protections in the event of unexpecteddelays, damages or overruns. However, while a fixed-price contract mayprotect against

cost overruns, it may actually cost more in a long term, complexconstruction project if change orders are strictly limited.

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OPERATION RISK ANALYSIS

Apart from concession agreement and construction risk, other majorrating criteriainclude the operation and maintenance of the toll road. Operationalactivities includethe operation of the toll collection system, traffic management andemergency andrecovery functions. Maintenance is broadly classified into routinemaintenance andmajor repairs. Routine maintenance consists of works generally repetitivein naturesuch as grass cutting, roadway clearing, desilting and drainage systemcleaning, whilst

major repairs consists mainly of road resurfacing, equipment replacement

and heavymaintenance. MARC shall assess the experience of the toll road operator,clearly definedresponsibilities of the operator during the concession period, and arequirement toproduce periodic financial reports. MARC shall request for the relevantinformationwhich include:

Operating and maintenance (O&M) contractA clear understanding of the operator’s relationship to project owners,

the scope of

work, rights and responsibilities shall be established. MARC’s analystshall look out

for measures to cover instances where the operator’s performance isbelow the

required performance standards, perhaps in the form of performanceguarantee

and ability to be replaced, if necessary. For example, KLT and Kesturi,pursuant to

the respective CA, shall provide a maintenance bond with a maximumvalue of

RM1,000,000 as a security against the performance of the company in

maintainingthe structural overlay obligations. Upon full completion of the highway,

KLT shallprocure a maintenance bond with a cap of RM3,000,000 replacing the

previousbond, to be maintained throughout the concession period plus one year

thereafter.

Ability to contract-outIf the O&M activities are to be contracted-out, MARC’s analyst takes

note of the



arrangement to manage these sub-contractors. For example,MTD Prime

contracted-out its toll operation and management and the contractor’sworks are

regularly monitored by MTD Prime. If the contractors are in defaultof their

obligations set out in the CA, compensation in terms of amount andtiming shall be

assessed by MARC. For example, MTD Prime is to be compensated fora sum of

5% of all fees and receivable in the last 12 months preceding thedate of

termination of the toll operation contract, due to default by thecontractor.

Project experience of operator with toll road projectsMARC’s analyst shall assess the experience and track record of the

operator inoperating similar toll road projects as well as the latest financial

position of theoperator.

Toll revenues and its legal capacity The party actually handling toll revenues and its legal capacity in

respect of tollcollections shall be clearly defined.

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Other factorsMARC shall look at the operator’s ability and experience in

handling newtechnology associated with toll collections, carrying out traffic

surveillance andcontrol systems, and communication network to manage the toll road

effectively

and efficiently. For example, KLT highway will be equipped withclosed circuit

television and variable message sign system at interchanges, ramps, tollplazas.

The operation and maintenance costs shall be ascertained during the bondtenure, aswell as a reasonable escalation rate for these costs to be used in the

cash flowprojections.

MARKET RISK ANALYSIS

The most important underlying factor in our analysis of a toll road is itsinherent projecteconomics, i.e the balance between the cost of developing and operatingthe projectand the revenues it is expected to generate over its useful life. While otherfactors mayconstrain or enhance a given project’s overall credit quality, and thus itsrating, at thecore of our analysis is the question whether the facility is or will be self-supporting.Market Risk is considered the major input factor in analyzing a tollroad’s projecteconomics. In assessing the market or demand risk of a toll roadproject, MARC’sanalyst has to rely on independent traffic study report as a starting point.

The trafficconsultants appointed by the toll road concessionaires rated by MARC

include MVAConsultancy Sdn Bhd, Scott Wilson (M) Sdn Bhd, Symonds Travers MorganSdn Bhd,Hacrow Consultants Sdn Bhd and Perunding Trafik Klasik Sdn Bhd.

Independent Traffic Study Report The traffic forecast, whether reliable or not, remains a key input

in thedetermination of the credit quality. The traffic forecast may be less

critical if the

existing traffic and revenue can by itself support the financing



facilities. Trafficstudies look at regional origin-destination patterns, trip purposes, trip

frequency,and relevant employment and housing growth forecasts, motor vehicles

ownershipgrowth trend, which are good predictors of traffic growth pattern.

The trafficstudy is normally carried out by an independent traffic consultant.

MARC shallrequest for a copy of the report as well as any updates or revision of

such reportfrom the client.

o Traffic Count SurveysIn establishing the area’s traffic characteristics and existing traffic

pattern,the consultant would conduct on-site data collection as well as

reviewliterature study. Along with the roadway survey and land use

surveys, thetraffic consultant conducts a traffic count survey to gatherprimary traffic

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data. The objective of the survey is to ensure that future trafficdemand

projected by the traffic consultant are well founded and arecomparable to

the existing traffic demand. Other than relying on primary data,secondary

traffic data were also obtained from reliable sources to give theconsultant a

more comprehensive view. The traffic count arising from thissurvey will

normally be used as the base case to the revenue variable in thecash flow

projection.

o Study Area Network

The consultant’s report specifies the area network involved inthe study,

which offers the most potential in providing the necessary trafficdemand for

the Highway. Average traffic volume (normally units are inpassengers car

unit: PCU) is estimated for each travel corridor. Thealternative roads

available in the vicinity of the toll road project are also considered.Possible

deviation from other congested roads in the area wouldnormally be

analysed and highlighted in this report.

o Historical Traffic growth rates in the area The consultant’s report also tracks the historical traffic growth

rates in thearea. The growth pattern is highlighted and reasons for the

movement inannual traffic growth are cited in the report. Traffic growth

rates arenormally subject to socioeconomic factors namely the population

growth as

well as growth in motor vehicle ownership by the population in theaffected

areas.

o Service Area Demographics The population density, motor vehicle ownership trend,

employment growthrate are among the factors incorporated in the traffic study

report. Keygrowth drivers such as matured and proposed commercial and

residential



development areas which serve as the catchment areas are alsohighlighted

in the report. For example, in projecting the growth in the trafficvolume

for the SPRINT highway, Halcrow identified three main driversnamely the

growth in background traffic with the Gross Domestic Product(GDP) as a

proxy, impact of toll increases and developments along theDamansara

Perdana areas. A toll road that is heavily used by commuters orcommercial

traffic is generally stronger than a road that depends onrecreational traffic,

due to the discretionary nature of that traffic.

o Traffic forecastsUsing the assumptions and parameters derived from the

information in the

earlier factors, including growth trend, demographic analysis,inflation rate,the traffic consultant prepares the traffic forecast scenario.

Average dailytollable volume of vehicles over the tenure of the finance facility is

estimatedby the consultant. For example, KLT produced three different traffic

forecast

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scenarios; a base case for the most likely scenario, a high caseforecast for

an optimistic estimate and a low case forecast incorporatingconservative

growth scenario. Factors that may influence future scenario,include the

uncertainties on the proposed development in the region or vicinity;possible

late construction of key feeder roads heading to the toll road;or early

construction of competitive roads; implementation of measuressuch as high

occupancy vehicle lanes following the improvement to the publictransport

system and construction/upgrading of other competitive public

road. Thetraffic forecast is an important variable in our analysis of the

project’s cashflow projections.

o Toll rates and administration, flexibility of raising toll rates There are two types of toll systems; open toll and close toll

system. Opensystem is a concept where vehicles are imposed a fixed tolling

charge whenpassing through the toll plazas according to the type of vehicle.

Except forthe East Coast Expressway Phase 1 (ECE1) awarded to MTD Prime,

most of the toll roads rated by MARC are based on the open system.

ECE1 isdesigned to be operated on a closed toll system, whereby

vehicles arecharged according to the distance traveled. For the purpose of

toll rate

administration, the concession period is usually divided into sub-operating

periods and the scheduled toll rate as agreed between the

concessionaireand the government. MARC’s analyst shall assess the mitigation

factors inthe case if the gazetted toll is lower than the agreed toll. For

example, forSPRINT, toll-pricing approval risk is somewhat mitigated by the

condition in

the concession agreement that if the gazetted toll is lower thanthe agreed

toll, the Government shall compensate SPRINT for any reductionsin the toll



collections calculated based on a certain formula. The analyst shallevaluate

that in the event compensation is payable, what would be thepayment

structure in terms of the amount and timing of such payment.Cash

payment would be preferable than other means of compensationsuch as

land.

o Comparative rates for similar toll roads within the

region/areaMARC’s analyst shall review and analyse the comparative rates for

similar tollroads within the region/area and assess the consequent public

acceptance of any increase in toll rates. Generally, public acceptance and thus

usage of tollroads are inversely correlated to the presence of alternative routes.

The tollroad may have to compete with a free available alternative road,unless the

toll road offers shorter travel distance or time, less congestion ora safer

route. Alternatives also include other forms or mode of transportation.

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Last but not least, MARC shall always be alert for Government’spolicies on road

infrastructure, policy on ownership and usage of cars and politicalsensitivity

associated with toll rate increases. Toll roads are subject to regulatorypressures,

particularly given the ability to increase toll rates by the agreed quantumand time

frame as allowed under the Concession Agreements. Some CAs have beenamended

or supplemented which resulted in a lower quantum of toll rate increase,with longer

intervals than initially agreed upon due to public resistance.

DEBT ISSUE STRUCTURE

The issue structure spells out the principal terms, conditions and covenantsof the debtfacility, such as repayment, security, and designated accounts. Terms,conditions andcovenants under the issue structure are directed towards ensuring thesolvency of theproject and the requirement of the project concessionaire to manage its cashflows andservice its debt obligations. Certain structural features and bond covenantsthat may

provide additional bondholders’ protection include:

Minimum Debt Service Coverage Ratio (DSCR) The minimum DSCR is minimum coverage of debt service by toll

revenues. Theminimum DSCR set as covenant ranges from 1.25x to 1.75x for MARC-

rated tollroad projects.

An order of priority in the payment waterfallIn analyzing the cash flow projections, MARC shall look at the order

of prioritywithin the payment waterfall, which normally provides for the

payments of operating expenses, debt service and deposits to required reserve

accounts beforepayments of any other obligations, including dividends. Another

importantcovenant is the restriction on making dividend payments if the coverage

ratio fallsbelow a certain level (distribution test).



Debt repayment scheduleMARC’’s analyst shall monitor the debt repayment schedule over the

duration of the facility and whether the payments have been made according to the

schedule.

Designated Accounts The designated accounts to be opened and maintained include the

finance serviceaccount, finance service reserve account, operating account, escrow

account,disbursement account, etc. MARC’s analyst will want to obtain

a clearunderstanding of the functions and workings of such accounts, the

minimumbalance requirement in the designated accounts (if any), etc as these

serve toaddress the liquidity risk associated with the project. Normally,

there is a

requirement to maintain a minimum balance in the reserve accountequivalent to

at least half to one year of debt service.

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Maximum debt to equity ratio The maximum covenanted debt to equity ratio for toll road projects

rated byMARC’s analyst ranges from 1.50x to 3.00x. MARC shall also monitor

the trend indebt to equity ratio historically (for existing toll roads) and that

forecasted for the

entire period of the facility.

Legal structure, credit enhancements and other financialcovenants

MARC’s analyst shall analyse other features including legalstructure, any

measures which minimize cash leakage and tighter ring fencedmechanism which

may provide additional protection to bondholders. Generally, thehigher the

assigned rating, the more stringent the cash flow monitoring processand financial

covenants that have been set.

ISSUE STRUCTURE RISK ANALYSIS

Based on the issue structure given for a toll road project, MARC’s analystshall analysehow the issue structure addresses liquidity, refinancing and investment risksassociatedwith the project.

Refinancing Risk The risk of the issuer refinancing the existing debt issue. This is usually

mitigatedby the payment structure of the bonds with repayments spread

over a longnumber of years. The first serial payment would normally take effect

after thehighway has been commissioned and the base level of traffic has been

achieved.

Liquidity Risk This risk is somewhat mitigated through the requirement to maintain a

minimumamount equivalent to six months to one year of the profit or interest

in a debtreserve account throughout the tenure of the financing facility.

Investment Risk The risk of capital loss in respect of the investment of funds in the



designatedaccounts is mitigated with the requirement to restrict investments to

liquid assets,government-issued instruments or capital market instruments with

minimum ratingof AAA or AA with maturity dates matching the debt obligation dates.

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FINANCIAL RISK ANALYSIS

For pre-operational toll road projects such as KLT and KESTURI, thefinancial riskanalysis gravitated around the cash-generating ability of the project and therobustnessof the cash generated under adverse scenarios to meet the debtobligations. Foroperational toll roads, besides the cash flow coverage analysis, MARC’sanalyst shall alsoassess the profitability of the toll road companies, in particular theiroperating margins.Due to the cash-based nature of the transactions, credit risk should notbe a major

issue. The toll road project normally does not require heavy capital

expenditure,because heavy maintenance works such as road resurfacing are onlyrequired after 5 to7 years. Therefore, the main critical factors that have negative impact onperformanceusually arise from top-line items such as lower than expected trafficvolume and tollrates, resulting in lower than expected revenue.

For operational toll roads, operating profit margins are strong, rangingfrom 40% to60%. MTD Prime, MARC’s highest rated toll road at AA, achieved anoperating profitmargin of 59.6% in FY2005.

Profitability/Earnings The main profitability measures analysed include revenue, profit before

tax, profitafter tax, operating profit margin, interest paid, operating profit

interest (financecost) coverage. For example, MTD Prime (rated AA) in its audited

FY2005,recorded revenue of RM117 million, operating profit margin of 60% and

operatingprofit finance cost coverage of 5.8x. SPRINT (rated AA-) achieved total

revenue of RM66 million, operating profit margin of 41%, and operating profit

interestcoverage of 0.4x. The profitability measures are benchmarked to that

of otherMARC-rated toll road projects to ascertain the appropriate risk scoring.

Cash flow coverageMARC shall assess the earnings and cashflow projections of the toll



road projectover the tenure of the financing facility, based on the financial

forecast of theproject, including the assumptions underlying the forecast (e,g:

inflation, interestrates, tax rates and planned capital expenditure).

Based on the financial forecasts, MARC’s analyst shall sensitise the

cash flowprojections under several scenarios including worst case and best case

scenarios.

The sensitised cash flow projections are then matched against the debtrepayment

schedule of the project to ascertain the DSCR/FCSR (debt/finance servicecoverage

ratio), a key indicator of the debt servicing ability of the company. Theobjective

is to determine how much revenue is needed to cover debt service andoperating

expenses. The DSCR under each scenario and the year in which theminimum

DSCR would occur are noted and explanation obtained for the trendobserved.

MARC shall also compare the DSCR with the minimum DSCR asrequired by the

financial covenant. The higher the DSCR under the various stressedscenarios, the

lower the risk of financial default, resulting in a more favourable rating.

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In performing the sensitivity analyses, a number of variables shall besensitized.

First, MARC’s analyst shall consider the ramp-up period; the initialperiod of attracting road users onto the newly built road and the developmentprocess of user’s acceptance. The ramp-up period can be slow and difficult. In viewof this, itis better to provide for a conservative traffic volume and growth in theramp-upperiod in order to avoid a cash crunch in the early years of projectoperations.Ramp up risk may be less of a concern if the targeted users of the newfacility arealready using other toll roads, and there is traffic congestion in the area

or if thereare a few free competitive alternatives to the new toll road. It is alsonoted thatmarketing and development of public awareness can positively impactthe lengthand nature of a ramp-up.

Another pertinent variable to be considered in the sensitivityanalyses is thefrequency of toll rate increases. MARC’s analyst shall determine theeffect on thecash flow of any delays/postponement of toll rate increases as well asdelays inany compensation payments due thereafter.

The traffic growth over the period of the facility shall be discountedunder a worstcase scenario (example; discount ranging from 10% to 20%) bearing inmind the

assumptions made in determining the traffic growth given the longgestationperiod of a highway.

As mentioned earlier, for existing toll road financing, MARC’s analystshall alsoanalyse the past financials and carry out the variance analysisagainst theforecasted financial results. Time series analysis is conducted toreveal anysignificant trend. The analyst shall determine the historical DSCR,CFO interestcoverage, CFO debt coverage of the company. In particular, MARCshall requestfor confirmation of the DSCR calculation from the monitoring



accountant of thefacility, through the client and MARC’s analyst shall ascertain whetherthe DSCR isin compliance with the minimum DSCR requirement in the financialcovenant. Forexample, the CFO interest coverage for the MTD Prime highway was5.6x duringthe latest fiscal year.

Capitalisation/Financial FlexibilityFor pre-operational toll roads, the capital structure is an importantconsideration.Normal project finance cases rated by MARC are usually structured onan 80:20 or70:30 debt to equity basis. The equity requirement is to ensurecommitment onthe part of the project’s sponsors. Projects with high equity participationwill havegreater financial flexibility, because dividend payments can be

deferred duringstressful time as compared to a fixed repayment schedule for debtservice. Theissuance of subordinated debt to enhance the rating of the seniordebt of theproject company is not uncommon in toll road projects. In this case,

MARC shall

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assess the features of the subordinated debt and the extent of the credit

enhancement, if any, in respect of the senior debt of the project.Subordinateddebts including shareholders’ advances and hybrid equity such asredeemablepreference shares are usually classified as equity under the definitionof projectgearing. A favourable capital structure would comprise a relativelylower level of senior debt which should significantly reduce the probability of default riskparticularly in the initial operating years. The debt to equity ratio is animportantindicator of the capitalization structure to be monitored by MARC

against themaximum debt to equity ratio set out in the financial covenants. Forexample,MTD Prime recorded a debt to equity ratio of 0.74x in FY2005, wellbelow thecovenanted ratio of 2.5x, which is one of the main factors supporting itsrating of AA. SPRINT recorded a debt to equity ratio of 2.13x in FY2005 slightlybelow thecovenanted level of 2.33x.