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You Can Work It Out! Valuation and Recovery of Private Debt with a Renegotiable Default Threshold

Majid Hasan and Frédéric Blanc-Brude
The Journal of Fixed Income Spring 2017, 26 (4) 113-127; DOI: https://doi.org/10.3905/jfi.2017.26.4.113
Majid Hasan
is a senior research engineer and head of asset pricing at EDHEC Infrastructure Institute in Singapore.
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  • For correspondence: majid.hasan@edhec.edu
Frédéric Blanc-Brude
is a director at EDHEC Infrastructure Institute in Singapore and EDHEC Asia Pacific.
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  • For correspondence: frederic.blanc-brude@edhec.edu
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Abstract

Large infrastructure projects are often financed through limited-recourse project finance (PF) vehicles with a high proportion of senior debt. PF is a unique form of corporate governance that creates extensive creditor rights when certain covenants are broken, most notably the option to “step in” upon a credit event, and to restructure the firm to maximize either expected recovery or expected payoff, depending on the nature of the credit event. These options significantly impact the outcome of credit events, and credit rating agencies report anecdotal evidence of very high recovery rates in project finance debt compared to comparable corporate debt. However, data paucity forbids robust reduced-form modeling of expected recovery rates. In this article, we extend the structural credit risk model of illiquid debt developed by Blanc-Brude and Hasan [2016] to incorporate the step-in option of senior creditors in PF, and model its impact on the valuation and risk profile of senior unsecured project debt, taking into account the bargaining power of creditors and borrowers in investment projects that are relationship-specific. Step-in options also can be understood as trading off credit risk and duration, depending on creditor risk preferences.

TOPICS: Project finance, credit risk management

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The Journal of Fixed Income: 26 (4)
The Journal of Fixed Income
Vol. 26, Issue 4
Spring 2017
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You Can Work It Out! Valuation and Recovery of Private Debt with a Renegotiable Default Threshold
Majid Hasan, Frédéric Blanc-Brude
The Journal of Fixed Income Mar 2017, 26 (4) 113-127; DOI: 10.3905/jfi.2017.26.4.113

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You Can Work It Out! Valuation and Recovery of Private Debt with a Renegotiable Default Threshold
Majid Hasan, Frédéric Blanc-Brude
The Journal of Fixed Income Mar 2017, 26 (4) 113-127; DOI: 10.3905/jfi.2017.26.4.113
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  • Article
    • Abstract
    • NON-RECOURSE PROJECT DEBT
    • VALUING ILLIQUID PRIVATE DEBT: THE BBH MODEL
    • A RENEGOTIATION MODEL OF NON-RECOURSE PRIVATE LOANS
    • ILLUSTRATION
    • MODEL EXTENSIONS
    • ENDNOTES
    • REFERENCES
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