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Annex 2

RISK CATEGORIES FOR SPECIALISED LENDING

Table1 ─ Risk criteria for project finance exposures

Risk category 1 / Risk category 2 / Risk category 3 / Risk category 4
Criterion/assessment / Strong / Good / Satisfactory / Weak
Financial strength
Market conditions / Few competing suppliers or substantialand durable advantage in location, cost,
or technology. Demand is strong andgrowing. / Few competing suppliers or betterthan average location, cost, ortechnology but this situation maynot last. Demand is strong andstable. / Project has no advantage in
location, cost, or technology.
Demand is adequate and stable. / Project has worse than averagelocation, cost, or technology.Demand is weak and declining.
Financial ratios
(e.g. debt service coverage ratio (DSCR), loan life coverage ratio(LLCR), project life coverage (PLCR), and debt-to-equity ratio / Strong financial ratios considering thelevel of project risk; very robust
economic assumptions. / Strong to acceptable financialratios considering the level ofproject risk; robust project economic assumptions. / Standard financial ratios
considering the level of projectrisk. / Weak financial ratios
considering the level of projectrisk.
Stress testing
(project analysis in extraordinary conditions) / The project can meet its financialobligations under sustained, severelystressed economic or sectoralconditions. / The project can meet its financialobligations under normal stressedeconomic or sectoral conditions.The project is only likely to default
under severe economic conditions. / The project is vulnerable to
stresses that are not uncommonthrough an economic cycle, andmay default in a normal downturn. / The project is likely to default
unless conditions improve soon.
Financial structure
Tenor of the loan compared to project duration / Project duration is much longer than tenor of the loan. / Project duration is longer than tenor of the loan. / Project duration is longer than tenor of the loan. / Project duration is not longer than tenor of the loan.
Amortisation schedule / Amortising debt. / Amortising debt. / Amortising debt in general, but with significant repayment at the end of the loan term. / Amortising debt as a whole or largely at the end of the loan term.
Political environment and legal certainty
Country risk, including transferrisk, considering project type and mitigants / Very low exposure; strong mitigationinstruments, if needed. / Low exposure; fair
mitigation instruments, if needed. / Moderate exposure; fair mitigationinstruments. / High exposure; no or weak
mitigation instruments.
Force majeure risk / Low level of risk / Acceptable level of risk / Customary hedge / Significant risk which is not entirely mitigated.
Government support and
project’s importance for the country over the long term / Project of strategic importance for the
country (preferably export-oriented).Strong support from Government. / Project considered important forthe country. Satisfactory level of supportfrom Government. / Project may not be strategic butbrings unquestionable benefits forthe country. Support fromGovernment may not be explicit. / Project not key to the country. Noor weak support from Government.
Stability of legal and regulatoryenvironment (risk of change in the law) / Favourable and stable regulatoryenvironment over the long term. / Favourable and stable regulatoryenvironment over the medium term. / Regulatory changes can be
predicted with a fair level of
certainty. / Current or future regulatory issuesmay affect the project.
Acquisition of necessary
supports and approvals for such relief from local content laws / Strong / Satisfactory / Fair / Weak
Enforceability of contracts,
collateral and security / Contracts, collateral and security are enforceable. / Contracts, collateral and securityare enforceable. / Contracts, collateral and securityare considered enforceable even ifcertain non-key issues may exist. / There are unresolved key issues inrespect of actual enforcement ofcontracts, collateral and security.
Project characteristics
Design and technology risk / Fully proven technology and design. / Fully proven technology and design. / Proven technology and design – start-up issues are mitigated by astrong completion package. / Unproven technology and design;technology issues exist and/orcomplex design.
Construction risk
Permitting and siting / All permits have been obtained. / Some permits are still outstandingbut their receipt is considered verylikely. / Some permits are still outstandingbut the permitting process is well
defined and they are consideredroutine. / Key permits still need to be
obtained and are not consideredroutine. Significant conditions
may be attached.
Type of construction contract / Fixed-price date-certain turnkeyconstruction contract. / Fixed-price date-certain turnkeyconstruction contract. / Fixed-price date-certain turnkeyconstruction contract with one orseveral contractors. / No or partial fixed-price turnkeycontract and/or interfacing issueswith multiple contractors.
Completion guarantees / Substantial liquidated damagessupported by financial substance and/or strong completion guarantee from persons with excellent financialstanding. / Significant liquidated damagessupported by financial substance
and/or completion guarantee frompersons with good financialstanding. / Adequate liquidated damagessupported by financial substance
and/or completion guarantee frompersons with good financialstanding. / Inadequate liquidated damages ornot supported by financialsubstance or weak completionguarantees.
Track record and financial strength ofcontractor in constructing similarprojects / Strong / Good / Satisfactory / Weak
Operating risk
Characteristics ofoperations and maintenance (O&M) contracts / Strong long-term contract,
preferably with contractual
performance incentives, and/orO&M reserve accounts. / Long-term O&M contract, and/or O&M reserve account. / Limited O&M contract and/or reserveaccount. / There is no O&Mcontract. There is therefore therisk of high operational costoverruns beyond mitigants.
Operator’s expertise, track record andfinancial strength / Very strong, or committed technicalassistance of the investor / Strong / Acceptable / Limited/weak, or local operatordependent on local authorities.
Off-take risk
There is a take-or-pay or fixed-priceoff-take contract / Excellent creditworthiness of off-taker;strong termination clauses; tenor ofcontract comfortably exceeds the
maturity of the debt. / Good creditworthiness of off-taker;strong termination clauses; tenor ofcontract exceeds the maturity of the
debt. / Acceptable financial standing ofoff-taker; normal terminationclauses; tenor of contractgenerally matches the maturity ofthe debt. / Weak off-taker; weak terminationclauses; tenor of contract does notexceed the maturity of the debt.
There is no take-or-pay or fixed-priceoff-take contract / Project produces essential services or a commodity sold widely on a worldmarket; output can readily be absorbedat projected prices even at lower thanhistoric market growth rates. / Project produces essential servicesor a commodity sold widely on aregional market that will absorb itat projected prices at historicalgrowth rates. / Commodity is sold on a limitedmarket that may absorb it only atlower than projected prices. / Project output is demanded byonly one or a few buyers or is notgenerally sold on an organisedmarket.
Supply risk
Price, volume and transportation risk
of feed-stocks; supplier’s track recordand financial strength / Long-term supply contract withsupplier of excellent financial standing. / Long-term supply contract withsupplier of good financial standing. / Long-term supply contract withsupplier of good financial standing– a degree of price risk mayremain. / Short-term supply contract or
long-term supply contract withfinancially weak supplier – adegree of price risk definitelyremains.
Reserve risk / Independently audited, proven anddeveloped reserves well in excess of
requirements over lifetime of theproject. / Independently audited, proven anddeveloped reserves in excess of
requirements over lifetime of theproject. / Proven reserves can supply theproject adequately through thematurity of the debt. / Project relies to some extent onpotential and undevelopedreserves.
Strength of investor (main sponsor)
Track record of the investor andits country/sector experience / Investor with excellent track record and financial strength. / Investor with satisfactory trackrecord and financial strength. / Investor with adequate track record and financial strength. / Investor with no or questionabletrack record and/or financial difficulties.
Investor support, as evidenced byequity, ownership clause and incentive to inject additional cash if necessary / Strong. Project is highly strategic forthe investor (core business – long-term strategy). / Good. Project is strategic for theinvestor (core business – long-term strategy). / Acceptable. Project is consideredimportant for the investor (corebusiness). / Limited. Project is not key to
investor’s long term strategy orcore business.
Security package
Assignment of contracts andaccounts / Fully comprehensive / Comprehensive / Acceptable / Weak
Pledge of assets, taking intoaccount priority, quality, value and liquidity of assets / First perfected security interest in allproject assets necessary to run the project. / Perfected security interest in allproject assets necessary to run theproject. / Acceptable security interest in allproject assets necessary to run theproject. / Little security or collateral for
lenders; no or weak negative pledgeclause.
Lender’s control over cash flows(e.g. cash sweeps, independent escrow accounts) / Strong / Satisfactory / Fair / Weak
Strength of the covenant package (mandatory prepayments,payment deferrals, payment cascade, dividend restrictions…). / Covenant package is strong for thistype of project.
Project may issue no additional debt. / Covenant package is satisfactoryfor this type of project.Project may issue extremely limited additional debt. / Covenant package is fair for thistype of project.
Project may issue limited additional debt. / Covenant package is Insufficientfor this type of project.Project may issue unlimitedadditional debt.
Reserve funds (debt service,operations and maintenance works, renewal and replacement, unforeseenevents, etc.) / Longer than average coverage period,all reserve funds fully funded in cash or
letters of credit from highly rated bank. / Average coverage period, all
reserve funds fully funded. / Average coverage period, all
reserve funds fully funded. / Shorter than average coverageperiod, reserve funds funded from operating cash flows.

Table 2 ─ Risk categories for real estate exposures

Risk category 1 / Risk category 2 / Risk category 3 / Risk category 4
Criterion/assessment / Strong / Good / Satisfactory / Weak
Financial strength
Market conditions / The supply and demand for theproject’s type and location are currently in equilibrium. The number
of competitive properties coming tomarket is equal or lower thanforecasted demand. / The supply and demand for theproject’s type and location arecurrently in equilibrium. The number of competitive properties coming to market is equal to forecasted demand. / Market conditions are roughly inequilibrium. Competitive propertiesare coming on the market and othersare in the planning stages. The design
and capabilities of existing comparableproperties are not state of the art as compared to new projects. / Market conditions are weak. It isuncertain when conditionswillimprove and return to equilibrium.
Comparable properties in the marketare losing tenants at lease expiration.
New lease terms of comparableproperties are less favourable compared to those existing.
Financial ratios / The debt service coverage ratio (DSCR) is considered strong (or not relevant in the construction phase), while loan to value ratio (LTV) is considered low for the given type of real estate; where a secondary market exists, the transaction is underwritten to market standards. / DSCR is good or not relevant in the construction phase, while LTV is satisfactory; where a secondarymarket exists, the transaction isunderwritten to market standards. / DSCR has deteriorated and its reduction impacted a LTV increase. / DSCR has significantly deteriorated and its LTV is significantly below the standard for the extension of new loans
Stress testing
(real estate analysis in extraordinary conditions) / The property’s resources,
(including contingencies) and liability structure allow it to meet its financial
obligations during a period of severefinancial stress. / The property’s resources,
(including contingencies) and liability structure allow it to meet its financial
obligations during a prolongued period of financial stress.The property is likely to default only under severe economic conditions. / During an economic downturn, theproperty would suffer a decline inrevenue that significantly increase the risk of default. / The property’s financial strength isstrained and is likely to default unless conditions improve in the near term.
Cash-flow predictability
For complete and stabilised property / The property’s leases are long-termwith creditworthy tenants and their
maturity dates are scattered. The property has a track record of
tenant retention upon lease expiration. Its vacancy rate is low. Expenses (maintenance, insurance, security, and property taxes) are predictable. / The majority of lease contracts are long-term, and with tenants that range increditworthiness. Customary number of tenants do not renew lease after the expiry of the agreed deadline. The vacancy rate is low. Expenses relating to maintenance, insurance, security and taxes, are predictable. / Most of the property’s leases aremedium term, with
tenants that range in creditworthiness. The acceptable number of tenants do not renew lease after the expiry of the agreed deadline.
The vacancy rate is moderate. Expenses are relativelypredictable but vary in relation to revenue. / Property lease contracts are concluded on different deadlines with tenants that range in creditworthiness. The property experiences a very highlevel of tenant turnover upon leaseexpiration. Significant expenses are incurredpreparing space for new tenants.
For complete but not stabilised property / Property lease activities are aligned with projections or exceed them. Theproject should achieve stabilisation inthe near future. / Property lease activities are aligned with projections or exceed them. The project should achieve stabilisation in the near future. / Property lease activities are largely aligned with projections. The project is not likely to achieve stabilisation in the near future. / The level of market leases is not in line with expectations. Despiteachieving target occupancy rate, cash
flow coverage is tight due to disappointing revenue.
For construction phase / The property is entirely preleased through the tenor of the loan or presold to a buyer of high creditworthiness, or the bank has a binding commitment for take-out financing from a tenant. / The property is entirely pre-leased or pre-sold to a creditworthy buyer, or the bank has a binding
commitment for permanent financing from a creditworthy lender. / Leasing activity is within projections but the building may not be pre-leased; apart from a bank, there is no other lender with good creditworthiness to take out financing. / The property is deteriorating due to cost overruns, market deterioration, tenant cancellations or other factors.
There may be a dispute with the party providing the permanent financing.
Real estate characteristics
Location / Property is located in highly desirable location that is convenient to services that tenants/buyers desire. / Property is located in desirablelocation that is convenient to services that tenants/buyers desire. / The property location lacks a
competitive advantage. / The property is located in an
undesirable location.
Design and characteristics / Property is favoured due to its design, configuration, and maintenance, and is highly competitive with new properties. / Property is appropriate in terms of its design, configuration and
maintenance. The property’s design and capabilities are competitive with new properties. / Property is adequate in terms of itsconfiguration, design and maintenance. / Weaknesses exist in the property’s configuration, design or maintenance.
Property is under construction / Construction budget is conservative and entirely adequate, and technical hazards are limited.
Contractors are highly qualified. / Construction budget is conservative and entirely adequate, and technical hazards are limited. Contractors are highly qualified. / Construction budget is adequate andcontractors are ordinarily qualified. / Project is over budget or unrealisticgiven its technical hazards. Contractors may be underqualified.
Strength of investor (main sponsor/developer)
Financial capacity and willingness to support the property / The investor made a
substantial cash contribution to the
construction or purchase of theproperty. The investor hassubstantial resources (including contingent liabilities). Theinvestor’s properties arediversified geographically and byproperty type. / The investor made a
material cash contribution to the construction or purchase of the property. The investor’sfinancial strength allows it to support the property in the event of a cash flow shortfall. The investor’sproperties are located in several geographic regions. / The investor’s contribution
may be immaterial or non-cash. Theinvestor is average to below average in financial resources. / The investor lacks capacity
or willingness to support the property.
Reputation and track
record with similar properties / Experienced management and high investors’ quality. Strong reputation and lengthy and successful record with similar properties. / Appropriate management and investors’ experience and quality; successful record with similar properties. / Satisfactory management and investors’ experience and quality. Track record does not raise serious concerns. / Ineffective management and
substandard investors’ quality.Management and investor difficulties have contributed to difficulties in managing properties in the past.
Relationships with relevant real estate actors / Strong relationships with leading actors such as leasing agents. / Proven relationships with leadingactors such as leasing agents. / Adequate relationships with leasingagents and other parties providing important real estate services. / Poor relationships with leasing agentsand/or other parties providing important real estate services.
Security package
Nature of lien / Perfected first lien. / Perfected first lien. / Perfected first lien. / Ability of lender to foreclose is constrained.
Assignment of rents (for projects leased over long term) / The lender has obtained an assignment of the rents. There are upgraded records of tenants (e.g. the list of tenants with the rent amount and date of lease expiry, and copies of real estate lease contracts) which facilitate the reporting to tenants about the payment of rents directly to the lender. / The lender has obtained an assignment of the rents. There are upgraded records of tenants (e.g. the list of tenants with the rent amount and date of lease expiry, and copies of real estate lease contracts) which facilitate the reporting to tenants about the payment of rents directly to the lender. / The lender has obtained an assignment of the rents. There are upgraded records of tenants (e.g. the list of tenants with the rent amount and date of lease expiry, and copies of real estate lease contracts) which facilitate the reporting to tenants about the payment of rents directly to the lender. / The lender has not obtained an assignment of the leases or there is no information necessary for informing tenants.
Quality of the insurance coverage / Appropriate / Appropriate / Appropriate / Substandard

Table 3 ─ Risk categories for object finance exposures