With the need for massive infrastructure investments in the US putting strains on traditional funding methods, with government entities promoting non-traditional approaches, such as public private partnerships to increase the funding mechanisms available to public authorities, and with international public market players looking over the US for potential projects in which to become involved, more PPP projects could well be on the way. The need is to convince public entities of PPP's merits.

That said, interest is growing but it will take more time and less available tax-exempt funding to give the market a push.

California dreams

The $635 million SR125 project involves the design, financing, construction and operation of a 9.2-mile toll road linking Chula Vista and San Diego in southern California and includes a 35-year concession. It also involves the construction of two connector roads with additional expected project costs of $138 million, which will be funded by the San Diego Association of Local Governments.

It is one of four projects authorized under Bill 680 in 1991 by the state legislature in California to encourage the growth of state-owned, privately funded projects. It is the only one of the four to go ahead as a full public-private partnership in the US - two of the deals are dormant now and one, the SR91, is no longer seen as suited to the approach.

The SR125 began life as a typical road project with little interest by sponsors in a true PPP approach.

But all that changed two years ago when Macquarie Infrastructure Group (MIG) got involved.

The road looked attractive to MIG - a toll project in a developed country with little in the way of restrictions on chargeable tolls, thus giving the Australian group a relatively reliable and high rate of return.

MIG bought out the original sponsors and began working on the financing in 2001. Milbank, Tweed, Hadley & McCloy acted as advisers to MIG on the original buyout and the financing and security package for the toll road.

The deal will be managed through SPV San Diego Expressway LP (SDELP), owned by MIG. "We were able to develop an integrated financing and security package incorporating private equity, bank debt and significant public investment," says Allan Marks, a partner at Milbank. "This type of public-private partnership, although common in Europe and elsewhere, is relatively novel in the US."

The deal includes between $160 million and $180 million of equity put up by MIG over the course of the deal, $321 million of bank debt with an 18.5-year tenor, and $154 million in government funding through the Transportation Infrastructure Finance and Innovation Act (TIFIA) of 1998.

"MIG's significant equity commitment, together with the banks' $321 million construction and term loan, demonstrates the international financial institutions' confidence in California as a place for new infrastructure investment," says Marks.

The lead arrangers on the bank debt were BBVA and Depfa Bank. It was originally slated to be Abbey National alongside BBVA, but when Abbey pulled out of the project finance market altogether - and thus out of the SR125 project - MIG approached Depfa, with whom they were working on another project at the time.

TIFIA takes off

The deal was groundbreaking in a number of ways.

Not only was it the first true PPP project within the US, but it also was the first deal using primarily private financing to receive TIFIA support.

This is significant in that TIFIA loans are generally subordinate to the project and require no interest payment for five years. As a result, projects receiving TIFIA funds must ensure that senior debt is investment grade, which is the case with the SR125.

Mark Sullivan, chief of the TIFIA Credit Program, US Department of Transportation, says it was very different than a typical TIFIA deal. "Clearly having a set of banks in the transaction managing their own syndicate added a layer of complexity to the deal," he says.

"There is certainly more inherent flexibility in the financing structure than in typical transportation projects that we are involved with, simply in terms of what the senior banks are willing to consider. One of the things that was new to us was seeing how the deal was structured to take out the banks at a certain point." They will be financed out of the project after seven to 10 years.

In addition, the investors in the deal have very different goals than those in a typical road project.

Sullivan says: "Seeing how a deal like that was structured was enlightening. The level of scrutiny that was applied to the project was impressive, and to a certain extent went against some preconceived notions that there would be less transparency in a deal done in the private sector than in one that was strictly publicly funded. It was interesting to be working on a transaction that represented a different financial model."

Sullivan says that TIFIA is open to more projects of a similar nature. "The more options that are available to project sponsors the better. It is certainly good in the long run to see some other options in the US."

There are no other projects now underway in the TIFIA roster following the full public-private partnership approach, although Sullivan says there has been some interest expressed in partially privately funded deals.

Munis still king

The biggest inhibitor to further deals following the SR125 model is the availability of tax-exempt financing.

"On the financial side the biggest holdback is the cost of capital," says Sullivan. "The tax-exempt bond market provides for very inexpensive financing, and has been around since 1896, so it's ingrained in the system. The whole transportation finance market has developed around that method of financing.

"But if that changes, without that inexpensive access to money we may see a completely different development."

Many market players believe that this must change. And soon. There is a large and growing funding gap between what is available and desirable through tax-exempt financing and what is needed for essential infrastructure investment.

Connor Kelly, managing director and head of infrastructure finance for North America at Depfa, says this gap is causing an enormous stress on tax revenues. "For example, most transportation projects are funded through gas taxes, but with the number and size of projects now in the works, those taxes will no longer cover that need," he says. "Most states do not want to increase those taxes, so this gap in funding must be filled somehow."

In addition, revenue bonds used to support most road transactions have a tarnished image within the capital markets. "Recent performance on some of these bonds has not been as predicted," says one project financier. "And the revenue bond is not as flexible as the senior debt option so there is a genuine need for other financing structures that are more flexible."

Kelly at Depfa says the problem is that most public authorities are not yet willing to consider alternate mechanisms. "It is their lack of interest to try new ways of financing that is holding back the market," he says. "It is clear there is a need for alternative financing mechanisms, whether the reasoning is to find a lower cost of funding to increase available funding or for optimum risk transfer to the private sector. But it is unclear exactly what the public authorities are looking for."

Tacoma's narrow escape

That lack of interest in new financing methods can be held accountable for the curtailing of another proposed PPP deal in the US - the Tacoma Narrows Bridge project in Washington.

In 1995, when the $615 million design-build project first went forward, it was expected to involve a public-private partnership and Tacoma Narrows Constructors - a joint venture between Bechtel and Kiewit Pacific, became project sponsors.

However, in 1999 the structure was changed and by 2001 state legislators had decided not to go ahead with the PPP structure. It returned to being a typical infrastructure project supported by a state-backed municipal finance issue with gasoline taxes backing revenues.

Kelly believes that as pressure mounts on those traditional outlets, other options will be explored: "As the financing needs of the local authorities grows and traditional structures become less available, we hope, and believe, that there will be interest in new ways of doing things, such as the PPP model."

With little interest from US project banks in forwarding such structures, it is the European public banks that look set to take advantage of the burgeoning market, as with the SR125 deal, where the syndicate leaders were European names.

"US banks do not typically take long-term risk, whereas in the EU you can see tenors for as long as 35 to 40 years," says Kelly. "However, many European banks avoid the US market after have been burned in the power market, so this is really a policy decision. But some are looking for new and growing markets, such as Canada and the US."

In fact, a number of European players are now looking at opportunities in the US, and some, such as Depfa, are making a concerted push into North America.

"We are always looking for new opportunities in OECD countries, and both US and Canada provide that opportunity," says Kelly at Depfa. "The SR125 deal gave us the chance to book at least one project finance deal in the US, which is excellent as we are looking to grow in the US. We intend to establish a structured finance team in New York by the second quarter of this year, which will focus on the US and Canadian PPP markets."

He says the team's remit will be to meet public authorities and help them discover alternate routes to meet infrastructure financing needs. "It will be an educational process for us and them to find the optimum ways to satisfy their needs and get new and innovative projects going."

Those that were involved in the SR125 project, and others who have looked at such deals in the US, agree that there is an increasing need for alternatives to the tax-exempt bond. As the funding gap grows, public authorities will be forced to look for other funding mechanisms or see basic infrastructure sink further into disrepair. PPP may indeed bridge that gap.

Sullivan says the FHWA would encourage other projects to follow the PPP model. "We are absolutely in favour of the use of public-private partnerships. One of the express goals of the TIFIA programme is to attract more private funding into pubic projects, both private equity and debt.

"There are those that would argue that capital markets and tax-exempt bonds are the cheapest way to get deals done, but there are indeed benefits to having other partners involved that are willing to take more of the risk.

"Certainly the FHWA is interested in PPP. It would be good for the market as a whole to have healthy options like true public-private ventures in infrastructure."