In the most basic terms, project developers are corporate holding companies that typically finance their investments through non-recourse, or ring-fenced, debt at various operating subsidiaries. The project developer also has recourse debt at the holding company level, which is serviced with distributions from its operating companies. There is renewed interest in this asset class as these companies are globalizing their operations and financing this growth on a non-recourse basis to the holding company. Project developers are among the fastest growing asset classes in our rated universe.

Over the past two years, however, there have been instances where companies rated under our project developer methodology did not act consistent with our expectations, and this has resulted in a re-assessment of these companies under our corporate methodology. In this commentary, we discuss these instances to emphasize that it is not always possible for a project developer to walk away from its non-recourse obligation. The unwillingness to do so can have credit implications.

What type of corporation does S&P Global Ratings view as a project developer?

We define a project developer as a corporate entity, structured as a holding company that owns, develops, and operates assets mainly in the energy and infrastructure sectors.

Typically, a developer conducts its business through operating subsidiaries. The operating subsidiaries are generally financed with non-recourse debt, either on a corporate- or project-finance basis. At the holding company level, developers usually have few, if any, operations of their own. The developer relies on distributions such as dividend and fee income from a diversified portfolio to service its recourse debt and other operating expenses.

Developers are distinct from conglomerates in that they mainly use non-recourse financing at the subsidiary level. We do not see extraordinary support to the subsidiaries, although our group rating methodology applies to developers. Subsidiaries are typically nonstrategic or, at best, moderately strategic to the developer. The subsidiaries usually do not receive substantial support from the developer, who also will not support any distressed debt at the project or subsidiary level. However, we can decide to rate the developer under our corporate methodology and fully consolidate all subsidiary level debt if the developer later decides to support the subsidiary's non-recourse debt.

How are project developers different from developers?

The word project developer is perhaps a misnomer because these companies are neither developers, nor projects. Project developers are entities that have little to no construction or development risks, and whose portfolios typically have all its assets operational. YieldCos, in particular, are examples of project developers that purchase assets, or have assets dropped into them from affiliate development companies, after they have commenced commercial operations.

How do project developers differ from project finance?

For an entity to be rated under our project finance criteria it must comply with a framework that meets certain minimum requirements. That is, the project is structured as a limited-purpose entity (LPE); provides senior lenders a senior secured ranking through a security package to the key project assets; and contains covenants to limit a range of actions including asset disposal, incurring more debt, and financial maintenance covenants. The framework also includes cash management covenants and establishes a cash management system that prioritizes the payment of senior debt service ahead of other project obligations.

Transactions that fall short of a project finance structure are often rated under the project developer methodology. From a practical perspective, the main distinguishing feature between a project developer portfolio and a project finance portfolio is whether the portfolio is close-ended or open-ended. If the portfolio is close-ended (no sale or additions to the portfolio), then it usually falls under our project finance methodology. If the portfolio is open-ended, even with project finance-like covenants, we would likely use our project developer criteria because project finance usually doesn't permit material sale or additions of assets.

Why did we feel the need to identify a select group of corporates as project developers?

We felt that the methodology is required because some companies organize themselves under a structure that gives them the flexibility of walking away from distressed investments. By not comingling the subsidiary debt obligations and cash flow, they effectively insulate the parent company from the subsidiary's default risk. Financing this non-recourse debt is often more expensive than financing the debt on the parent company's balance sheet. The incremental cost of financing represents the option cost of walking away from a distressed asset.

The project developers' legal structure has been tested. During the 2002-2004 financial slowdown, companies like The AES Corp. avoided corporate-level defaults by having no cross-guarantees or cross-defaults with distressed subsidiaries.

Which project developers do we rate?

There are 15 companies rated under our project developer methodology (see table). Although the number of project developers is small, their size is growing because many of them are expanding into global operations. Putting regional risks in their respective silos through non-recourse investments appears to be one path for such growth.

What type of financing support to a subsidiary do we consider acceptable and what is not?

In deconsolidating the debt of the subsidiaries in the parent's credit assessment we make the inherent assumption that the subsidiary is not strategic to the holding company. We assume that if the subsidiary is distressed, the parent would chose to walk away. Not doing so would imply that the parent is unwilling to abandon its investment in the subsidiary, which would subsequently result in the consolidation of the subsidiary's debt with the parent's, even if the subsidiary's debt is legally non-recourse to the parent.

From a capital allocation perspective, we expect excess cash flow at the parent to be used for its own debt repayment, for dividends and/or share purchases, and to finance growth investments in its subsidiaries. While we expect the developer to make capital investments relating to net present value positive growth projects at the subsidiaries, any material equity infusion to assist the subsidiary's ongoing business activities is considered as support that would result in the consolidation of the subsidiary with the parent.

Have there been instances where a company was reassessed under our corporate criteria after being rated a project developer?

We have seen instances where a project developer sold businesses and lost the minimum diversity needed to be rated under the project developer methodology. An example of this is InterGen N.V. When InterGen sold its Mexican portfolio in 2017, it lost the minimum diversity requirement to be rated under our project developer methodology and was reassessed as a corporate entity.

While the criteria allows a company with as few as three subsidiaries to be rated as a project developer, we view any company with less than ten subsidiaries as one that could support its investments. In smaller portfolios, we have noticed that even as the parent company has the ability to walk away from distressed investments (i.e. its non–recourse obligations), they are sometimes unwilling to walk away because of too much equity exposure to the subsidiary (i.e. "skin in the game").

A recent instance of our reassessment of a project developer as a corporate issuer was Macquarie Infrastructure Corporation (MIC). We assessed MIC as a low diversity project developer, as it had only five subsidiaries with non-recourse debt. However, when subsidiary ITT Holdings LLC (IMTT) required substantial funding to undertake a major overhaul of its storage assets, MIC cut its dividends and sold assets to raise funds for IMTT's capital spending. We saw this as meaningful support of the subsidiary, consolidated all subsidiary debt with MIC, and reassessed the company under our corporate methodology.

Can a reassessment of the developer under our corporate methodology have a rating implication, all else being equal?

Yes, it can. However, the potential rating change would not stem from the application of a different methodology but because of our view of the company's perceived intent. Although we don't expect to see any difference in business risk under either methodology, our assessment of the company's financial risk could change based on the holding company's posture towards its investments.

For project developers with low diversity (i.e. less than 10 subsidiaries/assets), we assess the developer on both a consolidated basis (i.e. we consolidate all subsidiary debt with the holding company debt) as well as on a deconsolidated holding company only basis. While the consolidated ratios inform our financial risk assessment, we still give the developer a benefit, through a financial risk adjustment, for having the ability to walk away from the non-recourse subsidiary debt. However, if the developer decides to support the subsidiary, we would remove this adjustment to reflect the fact that even though the developer can walk away from its subsidiary, we believe that it won't. In such instances, we will rate the company based on its consolidated financial ratios, potentially resulting in a weaker financial risk assessment.

What are other instances where S&P Global Ratings has revised its debt imputations on a project developer?

Recent examples of reassessments of our debt imputations have been underscored by utility Pacific Gas & Electric Co.'s (PG&E) bankruptcy.

We rate NextEra Energy Partners LP (NEP) and Clearway Energy Inc. (Clearway) under our project developer methodology. Both NEP and Clearway own solar projects—Genesis Solar and California Valley Solar Ranch (CVSR), respectively—that have long-term offtake contracts with PG&E. Clearway also has ownership in Agua Caliente, another solar project with exposure to PG&E. These contracts are in-the- money for the owners, as market prices have fallen substantially since these contracts were inked.

All projects have intermediate holding companies (HoldCo) that have debt serviced from distributions made from the operating projects (OpCo), which, in turn, have debt at the OpCo level. The OpCo and HoldCo debt documents have a technical default in the event of an offtaker bankruptcy, a covenant considered moot given that these offtake contracts were signed when the utility was investment-grade.

However, with PG&E defaulting in January 2019, cash was trapped at the OpCo level. This resulted in increasing prospects of the HoldCos defaulting when interest payments came due in September 2019 (or March 2020 if debt service reserve LC's were drawn). Because PG&E continued to make payments under the offtake contract, both NEP and Clearway had equity value at these projects.

In order to protect that equity value, NEP chose to buyout the OpCo and HoldCo debt, resulting in the consolidation of all the erstwhile non-recourse debt at Genesis Energy LP into NEP's financials. Because the company had some cushion under its financial ratios there has been no rating impact.

Clearway also chose to support these non-recourse obligations. Clearway paid off the HoldCo debt at Agua Caliente. We now consolidate debt at the HoldCo level at CVSR (which Clearway is servicing) with Clearway's debt obligations. This consolidation has resulted in elevated leverage and has resulted in the company's current negative outlook.

Related Criteria

• Group Rating Methodology, July 1, 2019
• Criteria | Corporates | Industrials: Methodology For Rating Project Developers, March 21, 2016

Only a rating committee may determine a rating action and this report does not constitute a rating action.