The first two true concession financings under Ontario's latest infrastructure programme have reached financial close. The two deals, for a courthouse and a hospital, have been several years in the making, and should not be treated as templates for the province's latest attempt to harness private sector capital in building social infrastructure. But they are part of a wave of more than 40 projects set to come to market at an impressive pace, with a variety of financing structures.

The deals are, in the main, hospitals and healthcare facilities, though there are also a number of courthouse, prison, archive and rehabilitation centre projects underway, with plans for transport systems in the coming years. The province's history of public-private partnership (PPP) is relatively patchy, but it has both its own precedents and those from elsewhere in Canada, particularly the British Columbia and Alberta experience, to draw upon.

The programme, which Ontario calls alternative financing and procurement (AFP), falls under the McGuinty government's C$30 billion-plus ($26 billion) initiative entitled ReNew Ontario, which involves 37 construction projects announced to date. All of the construction and developments are in the social infrastructure domain, with healthcare facilities dominant. The unannounced projects are believed to be justice facilities. AFPs will only be considered for projects greater than C$50 million.

The agency responsible for the projects is Infrastructure Ontario, a crown corporation created by the province to manage all aspects of ReNew concessions and contracts. This agency is very similar in operation to Partnerships BC in British Columbia, which oversees PPPs in that province.

Of the 37 identified deals, four are under construction, teams are selected for six, proposals have been requested for four, another four are at the shortlist stage, and 19 more are pre-tender. Most of the projects are build-finance, though there are also a number of longer-term design, build, finance and operate (DBFO) projects. Even with the larger DBFO projects, to date, the design was determined by the public sector, though the private sector is likely to assume greater design risk on the forthcoming DBFOs.

How to stop history repeating

Ontario uses the term AFP interchangeably with PPP. For a market flush with acronyms, one more may seem innocuous. However, re-dubbing a now-familiar concept with a less controversial and equally ambiguous moniker says a lot about Ontario's earlier experience with PPP. The term is designed to reinforce the administration's message that it will partner with the private sector, while at the same time appearing to maintain control of the process. The McGuinty administration took office amid public unrest over the concession terms of the 407 toll road and union disquiet at two PPP hospitals, which closed financing shortly after the October 2003 elections and are rarely discussed (Search "Royal Ottawa" and "Osler" for more details.)

Sources familiar with the market are willing to discuss the politics of the programme, though few on the record. A recurring opinion is that hospitals win votes, and McGuinty is up for re-election in the third quarter of this year. Says one source involved in a project that has already closed; "the administration ran on a platform opposed to private sector involvement with public service provision. However, the infrastructure was in need of an overhaul, and the private sector could provide services on time and on budget, so the u-turn is inevitably contentious."

The dispute between the government and the Cintra-led Highway 407 consortium still casts a shadow over the AFP programme. The previous administration faced criticism that it did not maximise both proceeds and control over the road's operations. After a protracted and acrimonious legal wrangling over toll increases, the Ontario Superior Court found the contract to be watertight. The province does not have any further transport projects planned until 2011, but since clinical services are not provided by the concession holders, hospital projects do not engender the same levels of opposition.

Infrastructure Ontario must now prove that it can achieve value for money, and plans on issuing value-for-money (VFM) reports with a similar format to those produced by its counterparts in British Columbia. Infrastructure Ontario (IO) is wary of releasing all the financial details of projects until this document has been produced. Four of the projects have reached financial close; two DBFO, and two build-finance, with a further build-finance under construction pending financial close.

The Montfort hospital was the first of the ReNew projects to be procured, and reached financial close in May 2006. Ellis Don is constructing the C$173 million build-finance project, which has been funded through a bank loan led by BMO Nesbitt Burns and also arranged by Caisse Centrale Desjardins and RBC Capital Markets. The Sudbury hospital, another Ellis Don build-finance project, also used financing from RBC. Construction has already started, with the contractors taking on the risk, until financial close is attained. The final build-finance, C$72.2 million Qunite healthcare/ Belleville hospital, was awarded to M Sullivan and Sons contractors with financing from the Stonebridge Group.

So far only Montfort has a VFM report out, and this report has been several months in the making. In addition to the total costs, the report also outlines the projected savings to the public using the AFP. It does not, so far, provide a break-down of sources and uses of funds, and largely tries to give an idea of the savings from a date- and cost-certain contract over a conventional public procurement process.

What price DBFO equity?

While a probable majority of the hospital projects to go ahead under AFP will be build-finance, a substantial minority, including two of the first five to close, are DBFO. Ontario prefers to use the acronym design-build-finance-maintain, or DBFM, since this also minimises private sector involvement. The choice of words is significant, however, since soft facilities management will not be included in concession, and maintain describes the hard FM and life-cycle maintenance a lot better; IO's line is that its preferred acronym better reflects "the spirit of what services are included in the contracts". No clinical or soft services will be provided under the hospital concessions, and though the hard FM is open to negotiation, the basic government rule of thumb is that it will continue to provide any service which has a direct impact on patient care.

The first of the new DBFO projects to reach close, on 19 March, was the North Bay hospital. The North Bay regional health centre concession is for 30 years, and is held by Plenary Group, which the province will pay C$551 million over the term of the contract. Deutsche Bank provided the financing for the deal by underwriting a bond issue. The total funding is C$420 million, with a senior bond issue of C$374 million, and C$46 million in equity and subordinated debt. The term of the debt is 33 years, with the average life of the bonds at 22 years. The weighted average cost of capital (WACC) is particularly low on this deal, a feature believed to be due to the level of risk transfer to the contractors, PCL, as EPC contractor, and Johnson Controls, as facilities manager.

The debt pricing is understood to be marginally higher than that of the Durham Courthouse financing, which closed two days later. The City of North Bay has committed to pay C$1 million per year for 20 years towards the hospital project, as part of the funding sourced by the province from the community. Plenary Group and the same set of contractors have also been awarded the DBFO concession for the York University archives in Ontario, a C$50 million project which is pending financial close and is due to be completed by 2009.

Plenary's approach to financing DBFO hospitals draws heavily on the structure that ABN Amro developed for two hospitals, Vancouver Ambulatory and Abbotsford, in British Columbia. The similarity of the bond-financed, tightly subcontracted financings for the two provinces is in part the result of an exchange of ideas between the two provinces, and in part the result of Plenary's principals hailing from the ABN Amro team that financed the two earlier projects. Most recently, and subsequent to the close of North Bay, Mike Marasco, formerly vice president at Partnerships BC responsible for the hospital procurements, has joined Plenary in Toronto. Babcock & Brown's principals also hail from ABN Amro in Vancouver.

The 30-year concession for the Durham Courthouse is held by Access Justice Durham (AJD), a consortium led by Babcock & Brown Public Partnerships, which holds 100% of the project's equity. AJD issued C$213.7 million of senior secured amortising bonds, with a 32-year maturity. The average life of the bonds is 21.5 years, and they are priced at 72bp above the comparable government of Canada long bond. They have a coupon of 5.051%, and were priced above par at $102.78 with a yield of 4.827%. TD Securities was bookrunner, and RBC and Scotia acted as co-managers on this deal, which was rated by Moody's as A1 with a stable outlook.

The Durham Courthouse project company's equity shareholders are based offshore, in Guernsey, and so do not pay tax to the Canadian government. The offshore structure allows project companies to set their availability payments lower than domiciled competitors that must factor in the tax rate. As the VFM does not consider the loss of tax revenue, the tax quirk may flatter the AFP process' efficacy. Some of the US States have recently imposed restrictions on the bidding for PPPs requiring that proponents have their equity shareholder domiciled in the US, which may reflect protectionist sentiment as much as a VFM consideration. Whether Canadian authorities will follow suit remains to be seen.

The way for wraps

Despite the similarities between DBFO financing structures, IO is actively encouraging alternatives at the bidding stage. As well as bank debt and bonds, the use of monoline wrapped debt has been mooted for some of the deals, though IO stresses that it does not favour an option, and leaves it to the preference of bidders. In the procurement of the Sault St Marie hospital, bidders have been encouraged to provide both wrapped and unwrapped options. The concession for this hospital is almost exactly the same in structure to the North Bay project, and the pre-qualified proponents are also the same.

Scott Northey at TD Securities notes that there is "not a lot of value in having a AAA rating" at least for bond debt, but suggests that the project companies could "find a way of wrapping BBB to AAA during the construction phase." Monolines are still forbidden from operating directly in Canada, but have found ways of enhancing PPP deals in the country, either by acting through or broker or wrapping debt offshore. XL, Ambac and FGIC have provided guarantees at financial close to two Bilfinger Berger-sponsored DBFO roads in British Columbia and Alberta (search "Golden Ears" and "Stoney Trail" on www.projectfinancemagazine.com for details). Other monolines are understood to be providing wraps to bondholders post-financial close.

For instance, although the Durham Courthouse did not feature a monoline wrap, ABN Amro provided a guarantee on the debt which brought its rating to AA-. On the North Bay project, Deutsche is believed to be considering wrapping the debt with a monoline outside of Canada, although Jonathan Yellen, an MD at Deutsche, would not confirm this. While market participants have waited for several years for news that monolines can formally operate in Canada, the current suite of insurance products, which include credit default swap-based structures, has taken a substantial hold on the PPP financing process.

The upcoming DBFO St Catharine's hospital project will be one to watch, not only in terms of financing structure, but also with regard to risk transfer between government and concessionaire. It will be first of the full concessions where the design aspect is controlled by the project company and not the government, and may have a perceptible impact on financing costs. Some bidders have suggested that this might, by more cleanly incorporating risk in the construction process, actually reduce the complexity and cost. Three consortiums have been short-listed for the St Catharine's project, with the request for proposals expected to be issued in mid 2007. The teams are Hospital Infrastructure Partners comprising Carillion and EllisDon; Plenary with Deutsche, PCL and Johnson; and Infusion Health comprising Bilfinger Berger, John Laing and Vanbots.

Who pays the piper?

Project developers in Ontario must also contend with a degree of decentralisation in the province's hospital system. Moody's, in a December report, noted that Ontario's public hospitals are rated at one notch below the province's Aa1. It also highlighted the fact that several of the hospitals are the subject of small amounts of debt that they incurred during earlier deficits. The procurement process in place does not factor in these inherited debts, but states that they are a matter for the province and not the private sector at this stage.

Despite the low risk rating on the projects overall, there still remains some counterparty risk. The appropriations risk is slightly increased with the DBFO hospitals as the agreements are not directly with the Ontario Ministry of Health and Long Term Care (MHLTC), the original source of the funds. The funding is disbursed to the hospital to pay for the project, while a further 10% to 15% of the funding for the hospitals in the province comes from community sources, fundraising and ancillary services.

Moreover, as Moody's also notes, a joint default system is in operation, and the probability is 80% that if the province were for any reason unable to pay, the federal government would step in and honour the payments through extraordinary support. This step has previously been taken on two hospitals in the province that defaulted on payment. Hospital counterparties will also need to reassure sponsors and lenders that they have the financial processes in place to outline funds designed for AFP repayment. The appropriations risk for Durham Courthouse, on the other hand, is theoretically lower, because the contract is between the Ministry of Justice and the concessionaire.

Hospitals, moreover, also have to contend with the possible reuse of buildings in the event of a concession termination. The risk of termination through either default or convenience is considered low, and is provided for accordingly. But the buildings are purpose built for the services they provide, and so commercial resale of any assets is not really feasible.
The province of Ontario has a Moody's rating of Aa1, indicating that the political risk is also low, and the serious risk of default is also low. Neither sponsor nor lenders on the two legacy P3 hospital projects, for instance, have indicated any default by the province, although the Highway 407 dispute indicates that the province is prepared, in select instances, to litigate its interests.

But AFP in Ontario is a work in progress. None of the projects to come to market to date were conceived under the current plan, and both in terms of financial reporting and its attitudes towards risk transfer, IO is still working towards best practice. For instance, there is room in future contracts not just for the transfer of greater design risk, but also greater operating risk transfer and thus a more complete DBFO model.

After testing the water with the less contentious social infrastructure projects, IO will be in a position to pursue more esoteric projects. From 2011, the province plans to start the procurement process for roads projects, but has neither identified concessions to settled on financing structures. If it can convince sponsors and lenders that the returns on offer in the province are priced, and allocated, properly, it should be able to maintain its current impressive pace.