INFRASTRUCTURE IN BRAZIL: HOW BRAZIL’S BNDES USED PROJECT FINANCE TO FUND THE 2014 FIFA WORLD CUP

Infrastructure in Brazil: How Brazil’s BNDES Used Project Finance to Fund the 2014 FIFA World Cup S&P evaluates how Brazil is innovating project finance to fund its mega-projects. Authors Bob Durante Senior Director, S&P Capital IQ Credit Solutions Rad Lukic Director, S&P Capital IQ Credit Solutions Jorge Cláudio Cavalcante de Oliveira Lima Economist, BNDES Vicente Cardoso Economist, BNDES

Despite headlines before the event proclaiming the country’s lack of preparation, Brazil just finished hosting the 2014 FIFA World Cup with few hitches. Now the country will turn its focus to the hosting of the 2016 Summer Olympics in Rio de Janeiro – the first Olympic Games hosted in South America. Both events have counted on the funding of Brazil’s development bank, the Banco Nacional de Desenvolvimento Económico e Social (BNDES) to finance the vast majority of the stadium and related infrastructure improvements these mega-events require. These events require not only the upgrade of sporting venues but also support infrastructure projects, including subways, train lines, bus corridors, and road and airport upgrades. With more than $345 billion in total assets as of December 2013, according to its website, BNDES in one of the largest development banks globally and the Brazilian government’s main vehicle for implementing its infrastructure policies. BNDES provided most of the financing for the FIFA World Cup because it offers long term loans with below-market interest rates. As a result, S&P evaluates how Brazil is innovating project finance to fund its mega-projects | September 2014 1 WWW.SPCAPITALIQ.COM

INFRASTRUCTURE IN BRAZIL: HOW BRAZIL’S BNDES USED PROJECT FINANCE TO FUND THE 2014 FIFA WORLD CUP

few commercial banks have been involved in the financing projects for either the World Cup or the Olympics.

Authors Bob Durante Senior Director, S&P Capital IQ Credit Solutions Rad Lukic Director, S&P Capital IQ Credit Solutions Jorge Cláudio Cavalcante de Oliveira Lima Economist, BNDES Vicente Cardoso Economist, BNDES

A recent study from S&P Capital IQ explores how Brazil implemented infrastructure funding through the BNDES, associated programs, and the public-private partnership (PPP) framework in the country. The study was conducted in conjunction with the BNDES and uses Standard & Poor’s rating criteria, as well as the S&P Project Finance Scorecard model based on those, to better understand and analyze BNDES’s role and challenges in financing Public Private Partnership (PPP) projects as part of the World Cup and the Olympics preparations, which will be discussed in this article. S&P also used two BNDES PPP stadium financing projects assessments of credit from the Scorecard as illustrative case studies, which will be explored in a following article. For the World Cup, BNDES created two programs. The first is “ProCopa Arenas,” established to construct or upgrade infrastructure in the 12 cities that hosted the World Cup. The ProCopa Arenas allowed BNDES to finance up to 75 percent of the investments on infrastructure building and Arenas’ projects, limited to the maximum amount of BRL $400 million. The bank approved BRL $3.8 billion for building purposes for all arenas. Most of the financing is through intermediary banks, to which the national bank transfers the credit risk. The program financed 11 out of the 12 arenas built, the Brasília stadium being the exception. The second BNDES program, ProCopa Turismo, is to promote the construction and modernization of national hotels. This program had 17 approved loans until September 2013, which amounted to BRL 1 billion. These financings fostered the building of 4,727 rooms, in the Northeast and Southeast regions.

PPP Project Finance: The Financing Technique of Choice for Major Infrastructure Projects PPP Project Finance provides a number of advantages for major infrastructure project financing. As with other forms of Project Finance, the main advantage is that PPPs do not burden the sponsor’s balance sheet or responsibility (up to the level determined by recourse). They also allow public-sector entities to spread out payments for large projects, usually over 20 to 30 years, while keeping associated debt off the public party's balance sheet. Another advantage is the risk sharing among all the public and private participants of the project and appropriate allocation of risk and benefits. Additionally, PPP frameworks are varied and can provide different options for the design, financing, construction, and the entire operational phase of the project. Among the types of PPP are Design-Build Finance-Transfer (DBOT), Build-Own-Operate (BOO), Build-Own-Operate and Transfer (BOOT), Build-Operate-Transfer (BOT), and Operation and Maintenance (O & M), to name a few. Often the PPP model used for major sporting projects adopts the BOT formula, which means that the private entity builds the infrastructure facility and then for a number of years collects fees from the users, thus recovering the invested money together with some profit. When the S&P evaluates how Brazil is innovating project finance to fund its mega-projects | September 2014 2 WWW.SPCAPITALIQ.COM

INFRASTRUCTURE IN BRAZIL: HOW BRAZIL’S BNDES USED PROJECT FINANCE TO FUND THE 2014 FIFA WORLD CUP

contract terminates the facility is transferred to the governmental entity that initiated the 1 project . This type of cooperation needs to be legally supported by a relevant legislative act (e.g., Act on Concessions for Construction Works and Services, PPP Act, etc.) that typically outlines the risk allocation. In most cases, a larger part of the risk is borne by the owner of the concession or the concessionaire in this PPP model.

Authors Bob Durante Senior Director, S&P Capital IQ Credit Solutions Rad Lukic Director, S&P Capital IQ Credit Solutions Jorge Cláudio Cavalcante de Oliveira Lima Economist, BNDES Vicente Cardoso Economist, BNDES

Although the majority of rated and assessed projects are under construction or have had limited operations, some trends are evident. PPP projects have generally been completed on time and to budget, and they show stable income and limited operational risks. Despite this, high leverage, low debt service coverage, as well as the single asset nature of most projects, mean that the credit assessment will likely be in the low investment-grade category. Exposure to innovative and complex construction, weak sponsors, overly demanding services, onerous performance-related conditions, a high reliance on weak counterparties, or disproportionately low debt coverage levels, often leads to non-investment-grade ratings.

PPP Environment in Brazil PPPs proved they can provide assistance in bridging the infrastructure funding gap in order to develop new and rehabilitate old infrastructure. This type of project financing has proven to be an immense support for Brazil’s hosting of the 2014 FIFA World Cup and 2016 Olympic Games. The PPP model offers many advantages to the Brazilian government beyond simply attracting new investments. The model can help not only upgrade the sporting venues but also the supporting infrastructure and broadly increase the efficiency of public sector spending. This has created an opportunity for the Brazilian government to monetize these capitalintensive assets, bring in private capital, and remove the entire financing burden from the government. For investors, infrastructure generally offers better returns than the short-term interest rate because inflation risk is typically fully covered. Construction of stadiums specifically showed great potential for cooperation between the public and private sectors and to increase the participation of private investors in financing infrastructure. The regulatory landscape in Brazil has improved in the last couple of years, creating an 2 environment that fosters private investment. In the view of most analysts in the region , Brazil has led the way in Latin American PPPs over the last decade, not just because of its size and rapidly growing economy but also due to its legislative framework and a business environment that lends itself to the implementation of sustainable partnerships between the public and private sectors. Within recent years, the Brazilian government relaxed its monopoly on construction and management of key infrastructure components. This change 1

“The potential of project finance for financing public tasks”, Anna Pyka, Karol Adamiecki, Economic and Environmental Studies, Vol. 10, No. 3, Sept. 2010 2 Karla Fernandes, Deutsche Bank: “Q&A: The Public Private Partnerships Market in Brazil,” DATETK S&P evaluates how Brazil is innovating project finance to fund its mega-projects | September 2014 3 WWW.SPCAPITALIQ.COM

INFRASTRUCTURE IN BRAZIL: HOW BRAZIL’S BNDES USED PROJECT FINANCE TO FUND THE 2014 FIFA WORLD CUP

was welcomed by many because of concerns about the ability to handle the surge in visitors expected during the World Cup. Among a number of factors key to the successful implementation of PPP projects related to sports and other infrastructure in Brazil, the most important ones were the existence of core legislation that supports PPP structures together with the readiness of BNDES to provide financing.

Brazil’s PPP Framework Authors Bob Durante Senior Director, S&P Capital IQ Credit Solutions Rad Lukic Director, S&P Capital IQ Credit Solutions Jorge Cláudio Cavalcante de Oliveira Lima Economist, BNDES Vicente Cardoso Economist, BNDES

Brazil recognizes two types of PPP, according to Law 11,079/2004. The first one is the Administrative PPP, in which the public administration grants the exercise of an activity to the private sector. It comprises a kind of public concession where the earnings of the private counterparty stem solely from the public sector. The other kind of PPP is known as Sponsored PPP. In these PPP agreements, the public administration transfers an activity with unknown or low profitability but enhances the financial prospects with public resources. The law requires the creation of a special purpose company (SPC) that is responsible for the management and implementation of the projects. This helps to isolate counterparty risk. The law also specifies what kind of collateral can be used to enhance the PPP, allowing the pledge of revenue streams, among others allowed by law. The PPP must be formed through a procurement process. In terms of policies, the law sets some guidelines on federal PPP contracting, requiring that the PPP employ public resources efficiently in order to fulfill the government’s objectives. It must also respect the rights of the targeted public partners, as well as the private partners. The law calls for fiscal responsibility, transparency of procedures and decisions, and clear risk sharing between parties. And it states that projects should be financially sustainable and provide socioeconomic advantages. The same regulations set some constraints on the creation of PPPs, stating that: 

A contract must amount to more than BRL 20 million;



Contracts must be in force from 5 to 35 years;



A public compensation share higher than 70% in private partner earnings requires specific legislation;



Credits to PPP originated by public enterprises or government owned enterprises are constrained to between 70% and 90% of source of funds, depending on the location of the project being financed;



Commitment of the current net revenues with PPP expenses are limited to 1% for the federal government and 0.5% to state and local governments; and



The long term effect on public finances should be positive.

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INFRASTRUCTURE IN BRAZIL: HOW BRAZIL’S BNDES USED PROJECT FINANCE TO FUND THE 2014 FIFA WORLD CUP

What challenges exist in structuring PPPs in Brazil? Most PPP projects are less technically challenging than other infrastructure projects. This makes them inherently less risky. Additionally, many PPP projects have natural monopoly characteristics, which may be further protected by concession agreements. PPP projects in particular enjoy natural monopoly characteristics arising from a combination of limited seating alternatives and regulatory and political support. While these types of projects remain subject to demand and often price/tariff risks, they tend to have lower overall market risk than other more competitive projects. However, some of the biggest challenges in PPP project finance are: Authors Bob Durante Senior Director, S&P Capital IQ Credit Solutions Rad Lukic Director, S&P Capital IQ Credit Solutions Jorge Cláudio Cavalcante de Oliveira Lima Economist, BNDES Vicente Cardoso Economist, BNDES

a) Creating and sustaining interest in specific projects: The PPP partnership is a long-term agreement, typically about 30 years, so it is important to find multiple parties from both the government and the private sector who are both interested and committed to supporting growth of a particular project. b) Duration: PPP transactions can be complicated because they are longer deals than straightforward project finance transactions. In Brazil, a typical private project finance deal would be structured for 12-15 years, while a PPP structure is generally in place for 30 years. Within this extended period of time, the public entities will change along with the arms of the financing. c) The creditworthiness and experience of the construction contractors. Typically, the project involves a head contractor and a number of subcontractors who assume a large part of the work. Paradoxically, the experience of some of the smaller, often less complex, PPPs, such as schools and housing projects has not been as good as that of the more ambitious, larger PPP transactions. This primarily reflects the fact that weaker contractors have typically undertaken such projects, with limited, if any, third-party support for construction obligations. Better projects benefit from financially sound, experienced, contractors with good reputations, supported by guarantees from their larger, often multinational, parent companies. d) Cost and time budgets for the project. The financial and time cushions built into a construction schedule can have a significant impact on a project’s risk. The construction and long-term life cycle risks represent the largest single risks to PPP projects. Identifying and mitigating the appropriate risks so that a particular PPP project is completed on time and within budget is critical to the credit quality of the project company undertaking the development because the unitary payment receipt from the government counterparty is triggered upon substantial completion of the asset to be constructed by the PPP project company.

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INFRASTRUCTURE IN BRAZIL: HOW BRAZIL’S BNDES USED PROJECT FINANCE TO FUND THE 2014 FIFA WORLD CUP

What Evaluating PPP Projects using the S&P Project Finance Scorecard S&P performed two case studies using the S&P Capital IQ Project Finance Scorecard to gauge the level of risk of two (publicly unrated) stadium projects. These are the Mineirão – Arenas Minas in Belo Horiztonte, and the Arena das Dunas in Natal. Both projects were structured as PPPs designed to foster the risk sharing between the public and private sector. All information used in the analyses was obtained from public sources, with the website Portal da Transparência as the main source of data. Authors Bob Durante Senior Director, S&P Capital IQ Credit Solutions Rad Lukic Director, S&P Capital IQ Credit Solutions Jorge Cláudio Cavalcante de Oliveira Lima Economist, BNDES Vicente Cardoso Economist, BNDES

The website provides the PPP agreements as well as public notices concerning the procurements. It also describes the budget and time schedules, along with completion information for all arenas. The website additionally provides the financing contracts, allowing us to analyze the legal risks involved plus the measures taken by BNDES in order to mitigate construction, operations, and counterparty risks.

Assessing Project Credit Quality – Project Finance Case Study – Financing of Mineirão – Minas Arena The Minas Arena Stadium, located at Belo Horizonte, Minas Gerais, is designed to be a multi-purpose arena, ready to host football matches, live music and other cultural and religious events. According to Portal da Transparência website, it has 64,000 seats and its parking lot has 2,644 places. Restaurants, bars, stores, and a museum were built. The whole project cost BRL 665.7 million ($273.1 million), including the preparation works. The project was financed by BNDES through a BRL 400 million loan, with the remainder through public and private sources (State of Minas Gerais – BRL 40.5 million, concessionary – BRL 254.5 million). The main characteristics of the PPP agreement are as follows: A public procurement was announced in 2010, where the winner must have bid the lowest compensation requirements (based on operating margin). A consortium (Egesa Engenharia, Construcap Engenharia e Comércio and Hap Engenharia) won the procurement with a BRL 3.7 million bid. The main aspects of the contract are: 

Object: operation, maintenance, and renovation of the Mineirão Complex.



27 year contract including construction – 2 years.



Deadline: 2 years after signing of the contract.



Concessionary compensation: o

Revenues from commercial activities; and

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INFRASTRUCTURE IN BRAZIL: HOW BRAZIL’S BNDES USED PROJECT FINANCE TO FUND THE 2014 FIFA WORLD CUP



Authors Bob Durante Senior Director, S&P Capital IQ Credit Solutions



Rad Lukic Director, S&P Capital IQ Credit Solutions Jorge Cláudio Cavalcante de Oliveira Lima Economist, BNDES Vicente Cardoso Economist, BNDES



o

Public compensation: (i) fixed compensation that assures the refund of a BRL 400 MM investment in 10 years (debt service) and (ii) variable compensation based on performance.

o

The winning bid must require the lowest compensation: “lowest monthly desired operating margin.”

Concessionary Obligations: o

Perform the renovation and adequacy works of the Mineirão Complex, as specified in the Terms of Reference; and

o

Acquire the environmental licenses.

Operate the assets: o

Supply the minimum set of products and services,

o

Access and security,

o

Maintenance,

o

Information disclosure, and

o

Social responsibility.

Management and operation of the following activities: o

“Suites” and “VIP suites,”

o

Restaurants and bars,

o

Stores,

o

Parking lot, and

o

Advertising and sponsorship.

The stadium was completed on December 2012, but some issues like wi-fi Internet connection remain unaddressed.

Construction Risk The construction phase S&P ratings methodology assesses the likelihood that a project will be adequately funded for it to be built and completed on time and within budget, and that the project will be capable of operating as designed and as expected. The construction and funding assessment is critical to ensure not only that a project will be built and completed with sufficient committed funding in place but also to ensure that a project meets its operational and contractual deadlines in a timely manner and is able to produce sufficient net cash flows to meet scheduled debt service. The construction phase usually poses the greater risk to the enterprise, since heightened costs as delays could hinder the creditworthiness of the project, lowering cash flows and S&P evaluates how Brazil is innovating project finance to fund its mega-projects | September 2014 7 WWW.SPCAPITALIQ.COM

INFRASTRUCTURE IN BRAZIL: HOW BRAZIL’S BNDES USED PROJECT FINANCE TO FUND THE 2014 FIFA WORLD CUP

increasing the probability of a credit event. The risks in this particular project were mitigated by setting a certain date to the completion of the work. Also, the schedule and budget didn’t seem to be aggressive. The main drivers of risk in this phase are the credit quality of the contractors. Unlike other arenas that incurred in cost overruns and delays, the Minas Arena was completed on time. In fact, the construction phase was not very complex and the time schedule was met as expected by all involved parties.

Authors Bob Durante Senior Director, S&P Capital IQ Credit Solutions Rad Lukic Director, S&P Capital IQ Credit Solutions Jorge Cláudio Cavalcante de Oliveira Lima Economist, BNDES Vicente Cardoso Economist, BNDES

Counterparty Risk In general, the counterparty risk for PPP projects can be greatly reduced because the lead contractor or contract manager is paid for directly by the concession company. In addition, the government usually pays service and maintenance costs, although they are subject to deductions for unavailability, poor performance, and sometimes volume risk. The risk of offtakers and suppliers performing their obligations often defines the risk profile of a project. Economic incentives, business relationships, market position, and reputation take on additional importance. As previously mentioned, the state of Minas Gerais will pay a fixed compensation and a variable one based on performance. This probably reduces the risk that the special purpose entity (SPE) will lack the necessary funds to pay back the loan. However, the contractors, like all construction companies, are exposed to cyclical markets. The construction market in Brazil has been highly volatile in the last few years, which contributes to weaken the credit assessment of companies exposed to this industry.

Competitive Position The Mineirão is the main stadium in the State of Minas Gerais, and has been used to host matches from all relevant tournaments (Campeonato Mineiro, Campeonato Brasileiro, Taça Libertadores da América). The stadium used to be the home of the two most important teams in Minas Gerais, Atlético-MG and Cruzeiro. However, as of May 2014, Atlético-MG is still committed to host its matches in the smaller Independência stadium, possibly complicating the current projections of attendees. A comprehensive survey, ordered by the state of Minas Gerais, took place along with the public notice for the procurement. The survey interviewed individuals and interested companies on topics such as price sensitivity, what services the new stadium should offer, and what measures should be taken to increase the attendance. The survey concluded that, among other things, the services portfolio and quality should be improved; accessibility and security should be improved; the new arena could offer leisure and food services like tourist services, new restaurants, and space for festivals and fairs.

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INFRASTRUCTURE IN BRAZIL: HOW BRAZIL’S BNDES USED PROJECT FINANCE TO FUND THE 2014 FIFA WORLD CUP

The new stadium probably is able to offer the best services and comfort to the attendees, because it’s modern and because of its size, which give it a competitive advantage. Its location and tradition also grant it a better position than Arena do Jacaré (Sete Lagoas – MG) and Independência (Belo Horizonte –MG). The supporters of both teams attend the matches in large numbers. It should be noted that most polls put the number of supporters of the most important teams from Minas Gerais among the top ten in Brazil.

Authors Bob Durante Senior Director, S&P Capital IQ Credit Solutions

Financial Risk BNDES requires that the financial projections not breach the minimum of 1.3 for the Debt Service Coverage Ratio – DSCR (it could go as far as 1.2 if BNDES agrees). With that in mind we built financial scenarios for the financial score. We were conservative and left the minimum DSCR at 1.2 (see table 1).

Rad Lukic Director, S&P Capital IQ Credit Solutions

Minimum DSCR Average DSCR

Jorge Cláudio Cavalcante de Oliveira Lima Economist, BNDES

1.2 1.2 1.2 1.2 1.2 1.2 1.2 1.2 1.2 1.2

Vicente Cardoso Economist, BNDES

1.22 1.30 1.36 1.51 1.64 2.01 2.35 2.78 3.29 3.72

Score

Score

4.25 3.75 3.5 3.25 3.25 3 2.75 2.75 2.5 2.5

AA A A+ A+ A+ AAAAAAAA-

Table 1

Legal Risk The project is bankruptcy remote and constituted as an SPE, and the SPE is forbidden to merge or consolidate without consent of the lenders. All documents are binding according to Brazilian law, and the lender is able to foreclose the assets in the event of a default. Step-in clauses are in force, which allows BNDES to take control of the enterprise if it is nonperforming. The contracts forbid the legal profile of the project from changing without consent and intercompany loans. Funds for dividends can only be released if a project has sustainable financial performance as measured by DSCR. Additionally, the entity is constrained to issuing debt senior or pari passu to the project facility. The lack of an operations and

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INFRASTRUCTURE IN BRAZIL: HOW BRAZIL’S BNDES USED PROJECT FINANCE TO FUND THE 2014 FIFA WORLD CUP

maintenance (O&M) reserve account is a weakness, but it does not lower the assessment of the legal structure substantially.

Scorecard Output The assessment of the above risk dimensions within the S&P PPP Project Finance Scorecard produced the following assessment of credit for the stadium project that was completed in December 2012:

Authors

Project Finance Scorecard Summary Bob Durante Senior Director, S&P Capital IQ Credit Solutions Rad Lukic Director, S&P Capital IQ Credit Solutions Jorge Cláudio Cavalcante de Oliveira Lima Economist, BNDES

Sector Sub-Sector Project Name

PPP/PFI Public buildings or other Minas Arena

Country External Rating Project ID

Score (1 - 10) Market Protection and Revenue Contracts 6.00 Competitive Market Position 5.00

S&P Scale

Brazil Bank Master Scale

Market Risk Exposure

6.0

1.5

Financial Strength Technology, Construction & Operations Legal & Finance Structure

6.00 8.00 5.00

1 7 1

Implied Project Rating

7.00

bb-

BB-

Implied Project Rating after Country Risk

7.00

bb-

BB-

7.00

bb-

BB-

Vicente Cardoso Economist, BNDES

Credit Enhancements Final Project Rating

Using S&P’s Project Finance Scorecard methodology the risk dimensions were assigned scores from ‘1’ to ‘10’, with ‘1’ being the strongest score. The summary confirms that the contractors, which are exposed to cyclical markets, often represent the “weakest link” of the project finance structure, and the weak credit assessment of companies exposed to this industry in Brazil can have a major impact on the Construction / Operations risks (score of ‘8’) as well as overall strength of the PPP project.

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INFRASTRUCTURE IN BRAZIL: HOW BRAZIL’S BNDES USED PROJECT FINANCE TO FUND THE 2014 FIFA WORLD CUP

Assessing Project Credit Quality – Project Finance Case Study – Financing of Arena das Dunas Arena das Dunas was built as a multi-purpose arena, ready to host matches, shows, live events, and exhibitions. It features a 22,000 m2 square and parking lot. Its total capacity is 43,000 seats. The whole project cost BRL 400 million, of which BRL 396 million was financed by BNDES. According to the arena website, although the stadium was opened in January 2014, issues such as the roof, finishing, and facilities are unresolved. Authors Bob Durante Senior Director, S&P Capital IQ Credit Solutions Rad Lukic Director, S&P Capital IQ Credit Solutions

The main aspects of the contract are: Object: demolition of the old stadium, construction, operation and maintenance, management of the Dunas Stadium. 

20 year contract (construction – 30 months).



Deadline: 12/31/2013.



Concessionary compensation:

Jorge Cláudio Cavalcante de Oliveira Lima Economist, BNDES Vicente Cardoso Economist, BNDES

o

50% of revenues from commercial activities, the other half goes to the State.

o

Public compensation: (i) fixed compensation comprises 85% of the total compensation (BRL 9.125 MM total); (ii) variable compensation based on performance (15%).



The winning bid must require the lowest compensation: “lowest total monthly compensation.”



From the 9th to 12th year: 30% reduction in fixed compensation.



From the 13th year on: 100% reduction in fixed compensation.



Concessionary Obligations: o

Perform the demolition and removal of the old stadium. Construction of the new Arena das Dunas. Construction of a parking lot.

o

Acquire the environmental licenses.

o

Operate the assets:

o



Stadium and parking lot,



Access and security,



Maintenance,



Information disclosure, and



Social responsibility.

Management and operation of the following activities:

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INFRASTRUCTURE IN BRAZIL: HOW BRAZIL’S BNDES USED PROJECT FINANCE TO FUND THE 2014 FIFA WORLD CUP

Authors Bob Durante Senior Director, S&P Capital IQ Credit Solutions Rad Lukic Director, S&P Capital IQ Credit Solutions Jorge Cláudio Cavalcante de Oliveira Lima Economist, BNDES Vicente Cardoso Economist, BNDES



“Suites” and “VIP suites”



Restaurants and bars,



Stores,



Use of the arena for events,



Parking lot,



Naming rights, and



Advertising and sponsorship.

For each of the specific risks, the same characteristics attributable to Mineirão apply concerning Construction, Financial, and Legal Risk. The legal considerations follow the same structure since they share the same PPP framework and financing restrictions. We built the financial scenarios under the same assumptions because we do not have access to the financial projections. However, it should be noticed that the public compensation, set at BRL 7.75 million should be sufficient to cover the interest and principal payments. Nevertheless, the public compensation will be reduced to 30% after the 9th year, and to 0% after the 13th year. This poses questions about the financial sustainability of the project (See Competitive Position, below).

Counterparty Risk The State of Rio Grande do Norte will pay a fixed compensation of BRL 9.125 million to the operators, which seems adequate from a debt payback perspective. OAS Engenharia, an experienced contractor, won the procurement with the lowest compensation bid. To help fund this project, the state created a collateral fund with quotas given as collateral to the concessionaire. The financing contract featured an equity support agreement that obligates OAS to irrevocably support the project should any resource deficiency arise. As with the Mineirão stadium, an equity pledge was in place.

Competitive Position The Competitive position is rather weak because the arena is located in Natal, where no major Brazilian football teams usually host their matches. This creates significant demand risk, which is an important issue for these types of projects in the Operations phase. The arena’s financial success will need to rely, over the long run, on strong economic and tourism growth. The arena could be used to host live shows and exhibits, which could attract more tourists from the U.S. and Europe to northeastern Brazil. However, the prospects are too uncertain at this point.

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INFRASTRUCTURE IN BRAZIL: HOW BRAZIL’S BNDES USED PROJECT FINANCE TO FUND THE 2014 FIFA WORLD CUP

Scorecard Output The assessment of these risk dimensions within the S&P PPP Project Finance Scorecard produced the following assessment of credit for the stadium project: Project Finance Scorecard Summary Sector Sub-Sector Project Name

Authors Bob Durante Senior Director, S&P Capital IQ Credit Solutions Rad Lukic Director, S&P Capital IQ Credit Solutions

Country External Rating Project ID

Score (1 - 10) Market Protection and Revenue Contracts 6.00 Competitive Market Position 7.50

S&P Scale

Brazil Bank Master Scale

Market Risk Exposure

7.5

1.5

Financial Strength Technology, Construction & Operations Legal & Finance Structure

7.00 7.50 5.00

1 7 1

Implied Project Rating

7.00

bb-

BB-

Implied Project Rating after Country Risk

7.00

bb-

BB-

7.00

bb-

BB-

Jorge Cláudio Cavalcante de Oliveira Lima Economist, BNDES Vicente Cardoso Economist, BNDES

PPP/PFI Public buildings or other Arena das Dunas

Credit Enhancements Final Project Rating

Using S&P’s Project Finance Scorecard methodology the risk dimensions were assigned scores from ‘1’ to ‘10’, with ‘1’ being the strongest score. The summary confirms that the competitiveness-related risks for the project are elevated based on an evaluation of the overall project’s economics, expected benefits, and incentives to stay committed to the project for the various material counterparties. Since the stadium is in area where there are no major soccer teams, the project rationale is grounded on assumptions for other uses for the arena largely dependent on economic growth and tourism, which is a significant driver of the overall project risk.

Conclusion The increasing number of cities bidding to host the mega sporting events and the increasing funds invested in Olympic and World Cup bids indicate that the securing of such events is still perceived as an opportunity to improve economic and social aspects of a country or region through investments. While Governments have always employed a substantial amount of resources to attract major global sports events, such as Olympic Games and the World Cup, justifying these efforts based on the economic benefits seems to be always controversial. This is particularly the case with emerging markets, where the social opportunity costs can be large. While it will always be difficult to garner support for government investment in such events, we believe that sharing the investments and S&P evaluates how Brazil is innovating project finance to fund its mega-projects | September 2014 13 WWW.SPCAPITALIQ.COM

INFRASTRUCTURE IN BRAZIL: HOW BRAZIL’S BNDES USED PROJECT FINANCE TO FUND THE 2014 FIFA WORLD CUP

allocating the risks in a fair way between government and private parties within a PPP will remain the best way to capture the tangible and intangible benefits associated with hosting a FIFA World Cup and similar events. Given the potential that PPPs have for the delivery of essential public services, as well as sporting facilities, we believe the increasing interest in PPP models globally will continue, as more and more countries enact legislation to assist in streamlining the procurement process.

Authors Bob Durante Senior Director, S&P Capital IQ Credit Solutions Rad Lukic Director, S&P Capital IQ Credit Solutions Jorge Cláudio Cavalcante de Oliveira Lima Economist, BNDES Vicente Cardoso Economist, BNDES Other sources: Standard & Poor’s: "Counterparty Risk Framework Methodology and Assumptions," June 25, 2013 Standard & Poor’s: “Credit Enhancements (Liquidity Support) In Project Finance And PPP Transactions,” March 30, 2007 Standard & Poor’s: “Project Finance Construction Methodology,” Nov. 15, 2013 Standard & Poor’s: “BNDES Provides Majority Financing For The 2014 FIFA World Cup And 2016 Olympics In Brazil,” July 13, 2012 S&P Capital IQ PPP Project Finance Scorecard Methodology

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INFRASTRUCTURE IN BRAZIL: HOW BRAZIL’S BNDES USED PROJECT FINANCE TO FUND THE 2014 FIFA WORLD CUP

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