Assessment of Credit Risk in Project Finance

Abstract

In project finance, raising sufficient funds via the debt channel is a key task for all project companies and sponsors. Before furnishing a loan, lenders typically need to ascertain the ability of the project company to service principal payments plus interest. This paper aims to establish a quantitative model to analyze default risks and loan losses in infrastructure projects. Acting as an assessment system, the model will help lenders evaluate their exposure to default risk by monitoring the changes in credit quality of the project company. The model uses a conditional credit rating transition matrix to predict the probability of default and the net present value technique to estimate the maximum default loss. The Hong Kong-Canton highway project is used as a case study to illustrate the techniques and output of the proposed credit risk model. The model can be used to assist lenders and investors in making sound investment decisions, price contracts, and allocate capital. Similarly, it can also help project sponsors evaluate those critical measures that they must control in order to secure favorable loan terms by minimizing the risk of default and improving the bankability of a project.