TY - JOUR T1 - You Can Work It Out! <em>Valuation and Recovery of Private Debt with a Renegotiable Default Threshold</em> JF - The Journal of Fixed Income SP - 113 LP - 127 DO - 10.3905/jfi.2017.26.4.113 VL - 26 IS - 4 AU - Majid Hasan AU - Frédéric Blanc-Brude Y1 - 2017/03/31 UR - https://pm-research.com/content/26/4/113.abstract N2 - 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 ER -