Delegates at Project Finance's first Canadian infrastructure roundtable reached the event's venue through a gauntlet of protestors. The gauntlet, according to those that braved it, consisted of roughly six middle-aged union members handing out leaflets. The action was not threatening, and oil and gas bankers financing controversial pipelines have probably encountered worse, but it illustrates the country's still rocky relationship with PPP.

Canada's PPP, or P3 as it is known in most provinces, has been around in a form familiar to Europeans since June 2004. In that month Ledcor closed a C$40 million ($35 million at today's rates) financing for the Sierra Yoyo Desan road in British Columbia. Since then, British Columbia has closed roughly $3 billion in P3 deals, Ontario has closed two hospital financings, and Alberta has closed a road deal.

And this does not include the numerous construction financings for publicly-owned infrastructure, the occasional privatisation (PPP as the US thus far knows it), and not-for-profit financings for infrastructure assets. To match this slate of opportunities, Canada has relatively liquid bank, bond and private placement markets.

Still looking for love

For all this, domestic opposition to P3 in Canada has continued unabated, although the terms of debate are inching – just – in favour of P3 proponents. One key reason for this is that BC has now built up a track record in deal closings, although only Sierra Yoyo is operational. The other is that projects are raising money on much better terms than the earliest deals, and in different markets.

While the earliest deals took place in the private placement market, unrated, unpublicised and led by CIT, later deals have used a mixture of bank debt, private placements and ABN Amro's integrated debt and equity model. Bank liquidity has been such that almost from the start margins were low – 110bp over the CDOR was the initial margin on Sea-To-Sky, a Macquarie-sponsored and RBS- and SG-financed road project connecting Whistler and Vancouver.

But deal participants tended to shy away from discussing the finer points of the deals' financings. In the case of the Ontario hospitals, the provincial government preferred to act as if the projects, the legacy of a previous administration, did not exist. In British Columbia, the province has preferred to wait until the publication of its own value for money report, which looks at some of the financing assumptions behind the project, but keeps the exact details of the deals private, citing commercial confidentiality.

But the public ratings for ABN Amro's Anthony Henday drive concession in Alberta and, more particularly, the success of the Golden Ears Bridge financing, have contributed to a more confident atmosphere in the province.
Golden Ears (for more on this deal, search at www.projectfinancemagazine.com) priced at roughly 70bp over the CDOR, a margin that includes the cost of monoline premiums from Ambac and XL Capital. The senior portion of the C$1.046 billion ($900 million) financing, led by Dexia and Depfa (the two shared the C$938 million senior debt and C$52 million equity bridge, while Depfa provided a $31 million mezzanine loan) was wrapped offshore to circumvent the prohibition on monolines operating in Canada.

Innovating for the margins

More significant, however, were the smaller details. Firstly, sponsor Bilfinger Berger receives payments based solely on making the bridge available, and does not receive a payment based on the volume of traffic on the bridge, even though it is to be tolled by Translink, the Greater Vancouver transit authority. Translink did, however, agree to bear the risk of interest rates rising between the final bid and financial close, based on the borrower's base rate.

Bilfinger further hedged its exposure, according to Bilfinger's Massimo Polveraccio, by taking out interest rate swaps for the senior debt and equity bridge loan, and a CPI swap that protects against the downside associated with the project receiving CPI-linked payments. Depfa provided this swap (although RBC placed it), and the monolines insured the counterparty against project risk.

The increased presence of the monolines in the bank market echoes developments elsewhere globally, since the strength of the banks in the European infrastructure market has forced monolines into diversifying from their base in bonds. As Olivier Garnier, a managing director at FSA, notes, a monoline might insure debt booked offshore for a Canadian project (London and New York are the preferred options), or could, through the use of an offshore intermediary and cross-border credit default swaps, insure the exposures of investors based in Canada.

At present the monolines' advantage lies in the appetite of the public finance institutions for AAA bank debt, and their ability, as on Golden Ears, to offer a grace and availability period of 8.5 years for a 32-year tenor. The additional structuring expense for an offshore bond issue would likely outweigh the advantages in liquidity over the domestic unwrapped market. But the Canadian banks should be nervous that their most obvious source of P3 business – refinancing short-term bank debt – is less certain.

But Canadian banks have other opportunities, in particular in markets where P3 is a game of semantics. Ontario, in particular, looks like being a much more hesitant user of the European model. It recently closed its first hospital financing under a new framework for private infrastructure development that the province calls Alternative Financing and Procurement.

Ontario's name games

Ontario, by far Canada's most populous province and with the most pressing infrastructure requirements, has also had the most fraught relationship with PPP. The province closed two hospital deals – both sponsored by Carillion, EllisDon and Borealis and led by CIT – in late 2004. But these took place under a new Liberal administration that had taken office in part with union backing and a platform that rejected the previous Conservative administration's more pro-private bent.

As such, Ontario, while ruled by the same party as BC, is much more circumspect. It has stressed, much as BC has, that assets remain in public hands, and has included, under the banner of AFP, both design-build-finance-operate (DBFO), and build-finance projects. Two thirds of the hospital programme, which makes up the bulk of Ontario's infrastructure needs, is likely to be build-finance, and will consist of expansion and brownfield projects.

The first of these projects – the Montfort project – closed in May. The C$282 million project involves doubling the size of the Hôpital Montfort to 417 beds, and includes a facility for treating members of the Canadian military. The hospital is located in Ottawa, and provides French-language teaching, and serves the Francophone community in the area. The province opted for a build-finance structure because the project was an expansion, and because the designs for the expansion were far advanced when the province bid it out.

The contractor for the project, therefore, is EllisDon alone, and the financing comes from a group of Canadian banks led by BMO Nesbitt Burns, and also including Caisse centrale Desjardins and RBC Capital Markets. The borrower for the project, however, and thus the banks' client, is the province's ministry of health. The structure is unusual – and unlikely to be repeated in the future. The construction contract – posted at www.infrastructureontario.ca – reveals limited amounts of risk transfer.

The funding for the project will come 90% from the bank loan, and repayment, which will be the earlier of substantial completion and the end of 2009, will come from a mixture of provincial funds ($185 million), federal funds (for the military facility), funds generated by the hospital and from the proceeds of a hospital parking project. While the hospital appointed the lead arranger, the contractor negotiated the financing package.

According to Michael Wolff, a managing director in TD Securities' debt capital markets group, the project company used to pursue build-finance schemes would likely use a combination of credit enhancements such as surety bonding, insurance, a debt service reserve, interest rate hedging, construction holdbacks and delayed maturity in order to raise desired financing. Moreover, both the province, by shortlisting contractors through the RFQ, and potential lenders, though their existing relationships or experience with the contractors, have a good idea of the contractors' capabilities.

Build-finance, not innovate

The build-finance structure, as it is likely to develop in Ontario, should take a form familiar to observers of the general contractor scheme in Italy, or the Obra Pública Financiada structure used to finance much of Mexico's energy infrastructure. Such structures are also used when pursuing a project with a DBFO concession is only bankable using unitary payments that are outside of what the public sector thinks reasonable. They are especially applicable to politically sensitive projects. Among the slate of hospital projects are a mixture of build-finance and DBFO schemes, with the DBFO projects used for greenfield facilities.

According to David Livingston, the president of Infrastructure Ontario, the most important priority for the province is to space bids and awards in such a fashion as to maximise contractor and lender capacity. This will be essential given the aggressive timetable the province has set for an initial slate of 34 projects, of which three, the long-delayed Durham Courthouse, the Waterloo Region Courthouse and the GTA Youth Detention Centre, are judicial and the remainder are health-related. Of the projects with an RFP out, the Quinte hospital, a build-finance concession, is the closest to being awarded and financed. North Bay Regional Health, a build-finance-maintain project, and Durham, a DBFO, are close behind.

The approach is likely to have a strong base of support. As Jim Burke, senior vice-president and general manager at SNC-Lavalin (sponsor of the Canada Line light rail and William R. Bennett Bridge projects) notes, the construction market in Canada is tight. "BC has around C$38 billion in major projects under construction and $48 billion planned, while Alberta has C$22 billion in infrastructure and institutional projects underway, with Oil Sands work accounting for an additional C$85 billion."

According to Burke, "the typical construction schedule exposes contractors to two main peaks in demand for labour. Staggering the schedule for project enables construction companies to spread their resources more efficiently, and lowers overall costs." Labour demand is expected to peak in 2010, and Canada's natural resources boom, a boon for Alberta, is having much the same effect on contracting terms as high oil prices have in the Middle East.

It has also encouraged the torpor that grips the Canadian project lenders to continue. Canadian lenders have been an occasional supporter of P3 bids, and are reasonably comfortable with construction risk, which dominates the build-finance project credits. But their contribution, aside from RBC, which has been building up a North American infrastructure group on the back of its work in London, has been limited.

This attitude is even more surprising when one of the main objections that Canadian banks have offered to P3 – that government counterparties have been unwilling to provide hedging against interest rate movements between selection and financial close. As Golden Ears demonstrated, government is now willing to provide a greater degree of certainty.

Still, the lower Canadian dollar funding and swap costs for Canadian institutions make them viable competitors in the Canadian market. As one Canadian banker present at the meeting noted, the second-placed bid on Golden Ears offered cheaper funding costs, albeit with a higher construction price.

Two to watch

The two provinces closest to following the lead of BC and Ontario are Alberta and Quebec. Alberta already has one PPP financing behind it, the Edmonton's Anthony Henday Drive (search "Henday" at projectfinancemagazine.com). Now Calgary, the province's largest city, has its own P3 project, for the northeast section, a 21km section with a design-build-finance-operate concession is currently in the Request for Proposal stage. According to Neill McQuay, the executive director for major capital projects at the province of Alberta, there are likely to be more opportunities for additional sections of the Ring Road, 19km to the southeast, 14km to the southwest, 12.5km to the west and 10.5km to the south. In all, the province hopes to build out the roads by 2016.

But Alberta is swimming in tax receipts on the back of an oil and gas boom that has made the province's oil sands reserves very lucrative. Its Progressive Conservative administration, in power since 1971, has nevertheless turned to P3 on select occasions where the province feels that risk can be transferred in a sufficiently affordable fashion. The request for proposals for the northeast section closes in November.

Quebec, on the other hand, is set to roll out a much more substantial programme. It is close to issuing a request for proposals for its first PPP concession, for the Autoroute 25, a road and bridge project in Montreal. It has already shortlisted three consortiums, those led by Acciona/Bouygues, Macquarie/ Kiewit and SNC Lavalin, and will issue them an RFP shortly. The bridge will feature real tolls, with the revenue from the concession to be split between the province and the concessionaire (for more, search "A25").

Quebec is offering a smaller but more varied slate than Ontario. Among the other forthcoming projects highlighted by Gabriel Soudry, the vice-president, projects, at L'Agence des partenariats public-privé du Québec (PPP Quebec for short), are a multi-section completion of the A30 (request for qualifications to go out in the coming weeks), a concession to operate rest stops on various highways throughout the province (RFQ of Phase 1 in summer 2006), and pilot project for a 200-bed long-term care facility (for which an RFQ will go out in September).

Most interestingly, the province has two huge hospitals up for bid – the Centre hospitalier de l'Université de Montréal (CHUM), which has a C$1.52 billion price tag, and the Centre universitaire de santé McGill (CUSM), worth C$1.58 billion. The two were originally to be procured conventionally, but the projected costs on the two have escalated to such an extent that they will go forward as design-build-finance-maintain concessions, with soft facilities management excluded. For the hospitals, PPP Quebec recently received a government mandate to consider a PPP approach. A value for money analysis should be complete in December.

The bleeding edge

What comes next depends as much on the attitude of lenders as the provinces. Canada has benefited from the attention of European banks during a time when opportunities elsewhere were thin on the ground. US dealflow in PPP is now taking off to an unusual degree.

Banks might be becoming selective about long-term lending opportunities. Andrew Cullinan, a vice-president in RBS' project finance group in New York, suggests that mini-perm style loans might allow sponsors to increase their available leverage through loan structures that include cash sweeps, and an element of refinancing risk. Such structures might allow sponsors to share in some upside and deal with interest rate risk more cheaply than paying to unwind swap arrangements.

But any dramatic increase in construction costs would erode some of the advantages of European sponsors, and would make the Canadian funding cost advantage important enough for developers to acquiesce with domestic banks' less progressive business methods. At the moment, though, as one banker noted "the widening of spreads and bid/ask risk for Canadian dollar swaps won't break a project, but it is worth considering."