The SR125 deal - the private sector financing of the San Diego Expressway - is the first application of the PPP (public private partnership) principle to the US market. It creates a meaningful challenge to the predominance of the tax-exempt municipal bond market, and marks the first time federal TIFIA funding has been used alongside private money.

The US, however, will be unable to get infrastructure programmes off the ground solely by relying on Australian equity and European debt. It will also hope that projects can take less than 44 years to come to fruition - the SR125 was included in a Californian Transportation Master Plan from 1959. Some 29 years later, the Californian legislature passed a bill, Californian State Assembly Bill AB680, designating the project a pilot public private partnership. At that time it had company - three other projects were thus designated - but by 2002 only San Diego's road had any real prospect of going forward as a PPP.

The slow progress is the result of a protracted permitting process - power developers working in California will sympathize - and financial markets that are not geared to the PPP process. Orange County bought out SR91 from Cofiroute, and legislatures and voters tend to discount risk transfer when asked to vote on financing methods. At the same time, long-dated project finance debt is difficult to raise in the US - even at the height of the US power boom, sponsors were looking for debt of less than 10 years.

The San Diego Expressway is a 9.2-mile, four-lane road that runs between State Route 905, near the Otay Mesa port of entry with Mexico, and State Route 54, in Spring Valley. An additional part of its route is made up of a 1.5-mile freeway, which is separate from the financing. The main section, however, is tolled, and has few restrictions on toll levels.

This last detail attracted Macquarie Infrastructure Group (MIG), which has been expanding rapidly in the transportation sector. It is particularly attracted to assets in OECD countries where it has freedom in pricing. It approached the original concessionaires - EGIS, Parsons Brinckerhoff and Fluor - about buying them out. Given that only EGIS has much of a background in concession operation, and the delays in planning, the offer would have been attractive. In September 2002 it bought the holder, California Transportation Ventures from Parsons Brinckerhoff and Egis Projects for $54.8 million.MIG, advised by Macquarie Bank's corporate finance division, requested proposals from interested lenders. It settled on a blend of the two best proposals from Abbey National - lead on MIG's Midland Expressway - and BBVA, a bank familiar with MIG's partner Cintra. Abbey's withdrawal from the project business forced the sponsor to approach a third bank to lead the deal.

The lenders, now led by BBVA and DEPFA, were joined by an exclusively European and Australian group of banks. As one put it "when we took the deal to credit, the first thing they asked was -'where are the US banks?' And this is unprecedented - nowhere else has a first PPP financing gone ahead without domestic bank involvement." This was a deal likely to have a very mid-Atlantic flavour.

The credit, however, incorporates funding from the US department of transport under the TIFIA programme. TIFIA money is only available to projects with an investment grade rating, and tends to improve a project's economics. It is subordinated in terms of repayment to the senior debt, but not in security. Nevertheless, the TIFIA loan's amortization profile could be sculpted to accommodate the expected ramp-up on the route.

The SR125, while running from close to the Mexican border, is intended as a commuter route, rather than one for international traffic. It will use electronic toll collection technology and will be dependent on new residential and commercial development along the route. Therefore, even if the demand predicted by the three traffic consultants, Wilbur Smith Associates, Maunsell (for the sponsor), and Louis Berger, materialised, it would take some time to grow.

The final structural challenge lay in making sure that the project had a turnkey EPC contract that was up to the standards of the European lenders. Washington Group and Fluor, the winning bidders, were able to agree a strong enough set of terms and provide the requisite guarantee - Fluor is an A credit, although Washington is a little less solid.

The TIFIA money accounted for $140 million of the project's $900 million cost, with the bulk coming from a $400 million construction loan from the leads. Sponsor equity, backed by letters of credit and to be injected at completion, is $180 million. The remainder comes from the Federal government as a grant and San Diego Association of Governments, and goes toward the construction of the free sections.

The bank debt has a tenor of 18.5 years. This includes a 3.5-year construction period, a four-year interest-only period, including an 18-month stabilization period, a partial cash sweep for three years, and then eight years with a full cash sweep. The sponsor expects to refinance the deal in the bond market before this time - the tenor of the loan has been set this long to work for the other funders.

TIFIA officials have been enthusiastic about the process, and bankers would dearly like to repeat the process. Behind the novelty of the financing lies a group of supporters that strongly believe in the boost the road will give to the economy. Moreover, a number of banks are planning on keeping personnel in the US to monitor developments. However, there will still need to be a big change in mindset among state treasurers and construction executives before PPP picks up steam in the US.

San Diego Expressway Limited Partnership

Status: Closed 23 May 2003

Size: $900 million

Location: California

Description: 11-mile toll road linking Chula Vista and San Diego

Sponsor: Macquarie Infrastructure Group

Debt: $140 million TIFIA loan, $400 million commercial bank debt

Equity: $170 million from sponsors, $132 million in grants

Arrangers: BBVA; DEPFA

Tenor: 18.5 years

Financial advisor: Macquarie Corporate Finance

Lawyers to the borrower: Milbank Tweed Hadley & McCloy; Nossaman Guthner Knox & Eliot

Lawyers to the lender: Orrick Herrington and Sutcliffe

Construction contractors: Washington Group and Fluor

Sponsor traffic: Wilbur Smith Associates; Maunsell

Lender traffic and technical: Louis Berger

Sponsor insurance: Willis

Lender insurance: Aon

Sponsor technical: Parsons Transportation Group

Ratings agencies: Moody's Investors Service and Fitch Ratings

Tax/Accounting/Model: KPMG; Mercers