How does your credit risk model work?

Answer

Credit events are rare in infrastructure debt investments. Observable default events are too few to calibrate a ‘reduced form’ credit risk model because the data is too thin and highly biased in space and time (e.g. California merchant power, Spanish toll roads, etc.). Instead, we use a structural model à la Merton to model default events within infrastructure borrowers i.e. when they run out of cash to pay next year’s senior debt service.

Thanks to 20 years of cash flow and valuation data we derive a robust suite credit risk metrics including default frequency but also loss given default and expected loss.