Canada's debate over public-private-partnerships (PPP, or P3 as it is known locally) rages not just over the whether, but also the how. While in several countries that have been experimenting with PPP, the choice is usually presented as public versus private, Canada's ongoing debate over the level of private involvement in public services tends to spill over into the nitty-gritty of concession structures.

This malleability, while frustrating for both sponsors and lenders, can be taken as a sign of the sophistication of government and unions. Or, it could be a sign that Canadian banks, long assumed to be destined to stay on the sidelines of P3 development, may be offering the provinces an alternative game to play. And this game may be much more friendly to P3 opponents.

The fact that alternatives exist is a product of the extended gestation period that P3 has enjoyed. Between the 407 financings, oft-cited (search www.projectfinancemagazine.com for examples) but never replicated, and two recent deals ? Vancouver Ambulatory Care and Sierra Yoyo Desan ? nothing closed. And the two most recent P3 deals total C$150 million ($120 million). This pace is one of the clearest indications yet that progress in developing P3 is not divorced from the state of provincial and municipal finances.

Michael Nobrega, chief executive of Borealis Infrastructure Management, says that ?the background to P3 was when Canada was about to hit the wall financially. The response was to push more discretionary spending down to the provincial and municipal level. Now, Canada has a C$10 billion surplus, and debts of less than 40% of GDP, but this has left pension funds looking for assets.?

Borealis, which manages the infrastructure investments of OMERS, the state employees' pension provider, would be one manifestation of this search by the funds for risk-adjusted returns. It also, in the wake of upsets in US and Canadian equity markets, left them looking for more stable investments. These will not necessarily be on the equity side.

No-share's market share
While P3 projects take steps forward and backwards, there has been a less heralded increase in the numbers of structured debt issues for non-profit, or at least no-share, borrowers. These involve much less risk transfer, a low coupon, and a semblance of off balance sheet treatment. The most recent of these, BC Ferries, was a $250 million issue of 6.25% senior secured bonds with a maturity of 13 October 2034. The deal was led by CIBC, joined by TD Securities, BMO Nesbitt Burns, Scotia Capital, and RBC Dominion Securities. It partially repaid C$355 million in debt that BC Ferries closed in May, and followed a C$250 million issue, led by the same group minus Scotia.

BC Ferries was a crown corporation for the 60 years up to 2003 when it became an independent regulated company, in which British Columbia owned the majority of economic capital and the BC Ferry Authority owns the single voting share. It has a monopoly position, with an exclusive 60-year contract to provide ferry service, and can raise fares as approved by the BC Ferry Commission. As such, it provides solid revenue streams, and garnered ratings of A- and A (low) from Standard & Poor's and Dominion Bond Rating Service, respectively.

According to Cliff Inskip, managing director in debt capital markets at CIBC, ?most of what we've called P3, except perhaps recently, has had limited risk transfer, is close to the government credit, has involved at most completion risk. Those entities with fee-setting autonomy, or at least the ability to match revenues to costs, have a lot of appeal to investors.? The structure, pioneered by NAVCanada and copied by most of the airport authorities and the University of Toronto, leaves procurement up to the borrower.

Municipal debt preferred
Canada's decentralised political system also encourages the use of such structures, much as municipal-level debt has provided a viable alternative to PPP in Europe in some instances. The Ontario School Boards Financing Corporation (OSBFC) has issued C$2 billion in notes since 2000 backed by grants from the province, with a rating, albeit tied to that of Ontario, of AA (DBRS). The 2004 series consists of 14 boards that have raised $500 million in debt.

Ontario's current liberal government, which ran on a promise to scale back P3, is exploring the use of such pooled funding structures with enthusiasm. It tried to prevent the owners of Highway 407 from raising tolls on the road, but was rebuffed in its court challenge. The episode (for some detail, and background, search ?407? on www.projectfinancemagazine.com), reassured some foreign investors, but reminded them that Ontario, while pursuing two legacy P3 projects, remains opposed to the process.

The Ministry of Public Infrastructure Renewal, set up by the liberal government and headed by David Caplan, has a mandate to centrally run and plan the province's infrastructure development. Its first major programme is the Ontario Strategic Infrastructure Financing Authority (OSIFA), part of the ministry of finance, which will issue bonds later this year, and then lend the proceeds on to smaller projects. The plan owes a great deal to the OSBFC, and the Ministry of PIR's Caplan was formerly a school board trustee.

The no share-capital structure has its adherents, particularly at the banks that lead the bond issues. ?I think it can be applied very effectively to certain situations, such as natural or legislated monopolies?, says Rick Byers, a managing director at BMO Nesbitt Burns. ?The structure can access capital at rates very close to those of most governments which it makes it appealing to public sector officials, especially in the ?post-Enron? environment.?

Byers also notes that a lot of the impetus behind these structures was the realisation that public finances in Canada are on a much more solid footing. But, on current predictions, and at least in Ontario, this situation is likely to change ? predictions put together in the wake of the May 2004 budget put the Ontario budget deficit at roughly C$6.9 billion. That compares to a projected requirement for investment in health of C$7-8 billion and a federal infrastructure requirement of between C$100 billion and C$200 billion, according to Borealis' Nobrega.
Borealis, in part because of its roots in Ontario's pensions system, thinks that a more widespread use of P3 structures is ultimately likely, if only because of the deficit, and the likelihood that the other provinces will produce some workable hospital projects in the near future ? a variation of the ?PPP momentum? argument.

William Osler ? persistence pays
The William Osler Hospital financing may provide a workable example, and is set to close on 19 November. Borealis is the 75% sponsor of the hospital, with the remainder of the equity in the hands of Carillion. The C$465 million deal, to be placed by CIT, looks like being oversubscribed. This despite a two-year lead time, project documents laid open to public debate, and an ongoing opposition to the project from the health unions. One partner at a firm that has advised on several transactions, notes that ?unions canvassed voters in the last elections by suggesting that patients would have to bring credit cards with them to hospitals. The fear of what we call US-style healthcare is powerful.?

Nevertheless, while maintaining a rigid separation of clinical and maintenance functions, the hospital has a structure that would be familiar to European observers. It is also apparently palatable to the private placement market where CIT, the heir to Newcourt Capital, which had deep local roots, has had a degree of success. CIT sold the C$40 million Sierra Yoyo Desan financing, for a Ledcor-led road concession in British Columbia, down to Sun Life Assurance.

Osler will have to be taken up by a wider audience, and has, apparently, procured a rating from DBRS. But those life companies that Project Finance has contacted have said that they do not anticipate assigning large numbers of people to conducting P3 due diligence. One advisor active in the market has said that the role of capital markets gatekeepers that the big five banks have assumed has not been hard to maintain: ?most fund managers will keep their door open, but are not scouting far and wide in search of new opportunities.?

The private placement market will be at best a marginal source of finance, but the alternatives are not all convincing. ABN Amro, which has put up C$110 million in 32-year bonds for the Access Health Vancouver financing, will try to sell this commitment down to the institutional buyers at a later date. Few Canadian banks even look like providing bridge debt for a PPP concession.

?Canadian investment dealers are not willing to take spread risk for projects that have a long negotiation period between proponent selection and closing?, notes CIBC's Inskip. ?It is not clear whether Provinces will want sponsors to provide a bid that is underwritten at a specific interest rate. If so, sponsors and lenders need a way not only to hedge interest rate risk, but also to ensure that between preferred bidder stage and financial close the spread over the underlying Canadian rate does not change.?

Given the uncertainties currently attached to a P3 concession, it is difficult to see the Canadian banks providing a reprise of the 407's bank to bond solution. The Canadian withholding tax system, which penalises lenders whose debt largely amortizes within the first five years of its life, is one factor that has discouraged such bridges.

Assuming that the monolines, still in the process of negotiating licences with the authorities, do not play an immediate part in the market, the European banks are the next most likely candidates. The prospects for the Europeans, which have said that they will likely be able to offer debt for 25 years in the 150bp range, should be good. Depfa, Dexia, Bank of Ireland, SG and RBS are among those looking for arranger mandates.

One arranger looking closely at the market says that ?we're not sure that the hospitals will be the key new financings. We'll be looking forward to the Richmond Airport Vancouver [RAV] financings, and the roads. Unlike the 407 deal, and most of the US deals we've seen, they look like having a largely availability-based regime.? Or, to paraphrase some of the syndication bankers acting in New York, the Canadian P3 financing should be more attractive to accounts operating out of New York than the US deals, which went straight to Europe for consideration.

All dressed up and nowhere to go
Nevertheless, one disconcerting possibility remains ? that those P3 financings that do go forward will be dress rehearsals for a performance in Ontario that is ultimately cancelled. The process of bidding for concessions in British Columbia and Alberta has been characterised by dealing with administrations that, however politically committed to the private model, are in good enough fiscal shape to drive a very hard bargain.

Alberta, which planned to use the P3 route for a 30-year Calgary courthouse project, abandoned the DBFO route after the projected costs grew to over $500 million, and will now publicly fund the work, while subcontracting construction and maintenance. Ontario's Durham courthouse, which suffered from an imprecisely designed concession, was described by one adviser close to the process as ?how not to do P3?.

Alberta's pipeline initially consists of the Edmonton ring road, which will largely consist of availability payments. The C$300 million extension to the Anthony Henday drive (from which the concession derives its name) could be the model for further concessions in the province, but does not, at present, form part of a strong pipeline in the province.

Likewise, once Vancouver, and the larger Abbotsford financing, which ABN Amro is also working towards financial close, are complete, the remaining big-ticket P3 opportunities will be in transport, which has proved to be much less amenable to pressure from Canada's public sector unions. The Sea-To-Sky highway project will feature an element of shadow tolling, equal to roughly 15% of revenues, but will mostly use an availability regime.

At least one sponsor that has looked at the project has questioned whether the concession regime features sufficiently healthy revenue streams to be attractive to private bidders. Nevertheless, Black Tusk Highway Group, led by Cheung Kong and AMEC, S2S Transportation Group, featuring Vinci and Macquarie, and Sound Highway Development, led by Borealis, are all in the running.

The RAV project, described by one adviser close to the process as ?essentially similar to the London Underground,? is likely to be highly bankable, especially in the absence of monolines. But its debt requirement has drastically dropped from an original C$1 billion. RAVxpress, a consortium of Bombardier, AMEC, Bouygues, and Bilfinger Berger, and an SNC-Lavalin and Serco venture have submitted best and final offers, which are now being evaluated. The project has a storied history (see Project Finance, September 2004, p.36 for details), but given the levels of subsidy available, the ultimate financing will not fill any bank budgets, unless the BAFO stage yields considerable cost increases.

And the willingness of the private sector to pursue P3 may be wearing even thinner than at some of the banks. While complaints about the cost of bidding are as familiar to P3 as public sector comparators and union opposition, such complaints can seem more reasonable when the list of cancelled projects is as almost as large as the list of preferred bidder projects. The provinces have thus far been willing to provide defeated or frustrated bidders with some compensation.

Running from risk
The Canadian construction industry has become largely content to leave the heavy lifting to financial partners, and there is some evidence that service providers are still resistant to performance-based contracts. According to one adviser to the government, the private sector providers have demonstrated patchy enthusiasm: ?government found that using the private sector to manage the Central North Correctional Centre at Penetanguishene worked very well, but it has encountered resistance to more modern procurement methods at some providers, such as in healthcare.?

Working round the financial weakness of Canadian contractors is one element where the financial sector may be able to help. Conor Kelly, managing director at Depfa Bank's infrastructure finance unit in New York, suggests that his institution may be able to provide construction completion enhancements in support of a commercial paper or bond issuance. And there seems little opposition to signing fixed-price construction contracts at sponsors, even if the majority of existing government contracts have contained sizeable loopholes.

Tying in the sponsors
More daunting will be finding sponsors that will stay committed to concessions for the full term, since several provinces have suggested that they would be opposed to sponsors flipping equity stakes in the short term. The BC government has apparently been fairly accommodating, but Ontario is considering prohibiting the flipping of equity stakes on some deals. But this would reduce the pool of available bidders significantly, and only Borealis, pension fund investment manager based in Ontario, shows any great enthusiasm for the requirement.

This assertive public sector is driven by a lingering fear of a repeat of the 407 privatization, which it was unable to renegotiate. According to Mark Adams, a senior vice president at DBRS, ?there is evidence that in the wake of the 407 privatization the public sector felt it did not get the best bargain. As such, there is now a tendency to defray as much risk onto the private partner as possible.?

But at the same time, the province will not be getting any balance sheet benefit from the use of P3 structures, even if construction and life-cycle costs are assumed by the private sector. ?We don't see a 1.1 million square foot hospital serving one million people as not the province's problem,? says Adams. State auditors general have also taken the view that P3 investments will be on balance sheet, wiping out any schadenfreude that sponsors might experience on learning that the non-share structures will also be counted as government obligations.

?We need to point out the four main benefits of P3s ? on time, on budget, life cycle costs taken care off, and certainty of budget planning,? says Borealis' Nobrega. Quebec, which has two large hospitals, Montreal and McGill, up for grabs, and ambitious plans for a total of 11 P3 projects. It hopes to get three of them done before the next provincial elections. After that, as in other provinces, the bets are off again.