Asset-Backed Securitization for Infrastructure Financing: Models and Applications

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Abstract

This book aims to advance an emerging approach to infrastructure finance that is gaining momentum: asset-backed securitization. The idea is basically to securitize cash flows generated by infrastructure assets. Focusing on the positioning of asset-backed securitization in infrastructure financing, the book discusses the need for such a financing instrument and its advantages compared to those of other sources of financing. To assist in the design of the quantitative aspects of the process of securitization, we develop a series of analytical methods to model a project’s cash flows and allocate the risk among different stakeholders.

Cash flow modeling of securitization deals comprises both modeling of the cash collections from the asset pool and modeling of the distribution of the collections to the bondholders. Therefore, we first analyze future cash flows surrounding development of the infrastructure by using different models, including general stochastic models for common types of infrastructure and a model derived via a bi-level toll design program for toll road projects. Then based on the cash flow model, we formulate mathematical models to obtain the optimal tranching strategies for the security and the structure design. With the mathematical models, we then further impose policy constraints on the model to study the effects and applicability of securitization. We also examine the proper risk-sharing policy between the public and private sectors and discuss measures that mitigate risks for the different parties involved. For illustration, we also apply the models to several cases and evaluate their use and performance.

Overview

Facing the challenge of economic tightening, governments tend to stimulate and drive the growth of the domestic economy by committing to investment in infrastructure, hoping to spur domestic demand by such an expansive fiscal policy. Traditionally, infrastructure investment is financed with public funds, given the inherent social benefits and positive externalities of infrastructure. However, because of public deficits, there exists a significant imbalance between the need for investment in infrastructure and the ability of public budgets to meet this demand.

Budget constraints, along with poor administrative procedures, inefficiencies in the management of infrastructure, limits on resources, and the inability to deliver on investment spending, have led to a shift in infrastructure investment from the public sector to the private sector, and to the development of public–private partnerships (PPPs). Despite private involvement, however, the infrastructure gap is still considerable. In 2013, the McKinsey Global Institute estimated an accumulated need for infrastructure investment through the year 2030 of USD 57–67 trillion. Asian Development Bank estimated that Asia will need an USD 8 trillion fund for national infrastructure from 2010 to 2020. In 2011, the European Commission estimated that by 2020 Europe will need EUR 1.5–2 trillion for infrastructure investment. The American Society of Civil Engineers also put the total infrastructure gap at USD 1.1 trillion by the end of 2020. It is predicted that underinvestment in the transportation, water, energy, and port infrastructure projects will bring a deficit of USD 3.1 trillion in GDP to the U.S. economy.

It is widely recognized that alternative sources of financing are needed to support infrastructure development in order to fill the enormous infrastructure gap. In this context, not only is the private sector a crucial player in providing funding, but financial institutions and intermediaries are major participants in creating novel financial solutions that can attract more investors and capital.

Large institutional investors such as pension funds, sovereign wealth funds, and insurance companies are considered to be suitable investors, given the nature of long-term liabilities and a low risk preference. For various reasons, however, and despite the theoretically ideal match between a large source of capital and an asset in need of investment, investors perceive a lack of appropriate financing structures. Moreover, only the largest institutions have the capacity to invest directly in infrastructure projects; smaller pension funds in particular require pooled investment vehicles. Thus this book aims to propose a new approach that can accommodate the needs of different investors, namely asset-backed securitization, to finance infrastructure.

In PPPs, the private sector often takes an ownership role and is in charge of the financing. Non-recourse project finance is the most commonly used financing method for delivery of large infrastructure with significant risk exposure. In such a setting, the investor’s repayment is limited to the project itself and the project’s forecasted performance, and does not affect the overall operations of the sponsor’s parent company. In fact, there are a lot of similarities between the concept of project finance and the idea of asset-backed securitization. When an asset is expected to generate stable cash flows, it should be feasible for it to be securitized. Thus, asset-backed securitization should be a viable approach to financing of infrastructure.

Last but not least, because the equity funds for infrastructure usually come from a small number of shareholders, and the banks have been the major providers of debt funds through syndicated loans, capital funds for infrastructure are lacking in liquidity and diversity. Therefore, with the evolution of the capital market and the development of innovations in finance, the aim of this book is to show how asset-backed securitization can be utilized for infrastructure finance and to explore possibilities for such novel financial instruments and techniques.

The overall objective of this book is to explore the potential of asset-backed securitization for financing of infrastructure.

The specific aims are to:

  • Outline the relative merits and drawbacks of asset-backed securitization of infrastructure and of the securitization products available in the capital market.

  • Provide a comprehensive literature review of the market and the products, and address factors that should be taken into account by public officials and private investors.

  • Formulate a comprehensive mathematical model that integrates revenue forecast modeling and tranche design, so as to facilitate the implementation of infrastructure securitization. With the model, we will explore the behavior of the private and public sectors.

  • Propose a suitable structure framework for the security which is tailored to the cash flow distribution and matches the risk profile to the bond design.

  • Impose policy constraints on the model to study the impact of regulations on the bond design and risk performance.

  • Implement the model in several types of infrastructure cases and evaluate the performance of the bond structuring for these cases.