The Canadian PPP market has steadily matured and Partnerships BC and Infrastructure Ontario have benefited from a combination of good timing and politically sensitive strategies in developing a palatable procurement method. Their working practices have allowed their home provinces to move out of the shadow of the UK and Australian markets, and export their methods not only to other Canadian provinces, but also to the United States.

In the past three or four years, sponsors and lenders have come to view the Canadian market as relatively safe because it has enjoyed political stability and the provinces have refrained – with some unfortunate exceptions – from sending complex deals to market. Sponsors may have griped at some of the provincial responses to the crisis, but turbulence in recent deals, including projects being pulled from procurement, the implementation of wide equity and sponsor difficulties in raising required debt, can be attributed by and large to factors beyond the control of the provinces.

But the crisis has had a profound effect on the competitive landscape of the PPP market, with knife-edge competition between bond and bank debt options, increased competition between established and newer sponsors, and the growth of a domestic infrastructure fund sector.

Sources of credit

Sponsor financing preferences are in transition, as capacity in the bank market is increasing and margins on bank loans are realigning with bond debt, giving sponsors more options. Towards the end of 2009 and in early 2010, there was a decided shift towards bond debt for Canadian PPPs, determined in part by favourable ratings, a lack of bank capacity for large projects and the inflated margins on debt as a result of the credit crisis. But the Canadian bond market is a cosy oligopoly, and some sponsors have chafed at the lack of responsiveness of the Canadian life insurance companies to the improvement in conditions.

“We’re not back to the old days of multiple sources of capital just yet,” says a British Columbia-based sponsor, “but banks are back in the game and bond markets are under pressure to compete. Bank debt terms are more acceptable now than this time last year, the rates are more competitive, and swaps are becoming more secure.

”We don’t have a particular preference for any one type of debt,” he continues, “but there are a few factors that we consider aside from pricing: The bond market is easier to work with because you’re just dealing with one agent as opposed to a whole group of banks. On the other hand, bank debt comes with certainty, it’s just a question of the rate. There is no guarantee with bond debt that the pricing will be locked in.” And for sponsors, in a time of multiple uncertainties with procurements and market fluctuations, some are willing to pay a premium for defined pricing.

Bank spreads are not completely responsive to fundamental risk factors, either. Hochtief achieved 250bp over CDOR for its C$92 million bank financing for the second of the Alberta Schools packages. The construction for the project involves modular units, which are prefabricated and interchangeable between schools. According to a source close to the deal, construction did not have a significant impact on the pricing, which is only marginally slimmer than on other recent deals with more complex construction requirements.

The price of bond debt has also come down in recent months, “a compression of about 25bp over two quarters, sub 300,” he says, “and bond debt is simpler to put in place, depending on the size of the project and its rating.” Bank debt is pricing at around 285bp over CDOR (or, according to a bank lender, about equivalent to 225-235bp over Government of Canada bonds).

For bond financings, buyers usually require a rating, and market appetite has suggested that an A- rating is the minimum requisite for Canadian dollar infrastructure bonds. Bank debt does not require ratings, and bank lenders like to point out the disparities between the ratings for Canadian hospital bonds and those of deals with comparable risk profiles in other regions such as the UK, where the bonds for PFI hospitals were often rated in the BBB ballpark. Defenders of the agencies usually point out that construction risk is usually more strongly mitigated in Canada or, if they are feeling provocative, that the UK bond market, until recently in thrall to the monolines, had artificial downward pressure on ratings. The disparity between the spreads on PPP bonds and similarly-rated corporates cannot, the banks rejoin, be blamed on illiquidity alone.

Other parts of the banks’ pitch are more easily verifiable. Though negative carry has always been a consideration with bond debt, sponsors on Canadian projects are particularly sensitive to its implications. “There’s no grace period with bond debt,” says a sponsor, “and for projects where there is a significant construction period, it’s preferable to have a staggered draw-down. You’re looking at 50bp plus on top of whatever you’re paying for your debt in terms of reserves and swaps and fees which, if the construction is chunky, say, seven years, really clocks up.

”In these cases, bank debt may have a slight competitive advantage and banks are increasingly offering soft mini-perm loans that sweeten the refinancing risk of a short-maturity hard mini-perm, while still allowing the sponsor the option to refinance in the capital markets after construction. Provinces have reacted to this offering with varying degrees of enthusiasm.

Other sources of long-dated debt are also beginning to emerge. The Ontario Pension Board is developing a plan to lend directly to the infrastructure market and Deutsche Bank is in the process of pitching pension plans and infrastructure funds to form a direct-lending consortium. Pension funds, which have dipped their toes into the more liquid end of the project bond market, could be the next big presence.

British Columbia steps back

According to one investor, “BC was previously the leader in this market, but that has changed. The province has spent a lot of money, and they’re going to have to take a breather before they can find the resources to continue. There were larger budgets before the Olympics, but it’s dried up.

”Though deal flow has slowed, there are a few deals set to close in coming months and some of the earlier project financings in the province are coming to fruition, holding up to their base case scenarios. The construction of the Richmond-Airport-Vancouver mass transit project for example, financed in 2005, is now complete and opened recently to good ridership numbers, though it is operated under a design-build-finance-operate concession that allocates revenue risk to the province. The monoline-wrapped financing for the Golden Ears bridge, also a DBFO, has required equity top-ups, though its difficulties stem mostly from its choice of lenders and wrappers, a cast that includes Depfa, Dexia, XL and Ambac.

Provincial funding constraints may inhibit BC’s PPP ambitions, but its problems in procuring two major projects in 2009 – the Fort St John hospital and the Port Mann bridge and highway – have left both lenders and borrowers cautious about pursuing opportunities in the province.

Though originally issued as a PPP, the Fort St John hospital deal was ultimately executed with wide equity, meaning that the sponsor, a consortium of Acciona and Innisfree, increased its contribution to the project and the province contributed higher completion payments to eliminate the need for debt funding. The project had presented some technical challenges and is geographically remote, but its timing, and the concession structure’s sensitivity to high debt costs, forced the province’s hand. The province followed the C$250 million Fort St John deal with a second, and it hopes last, wide equity deal for the BC Cancer of the North, a C$60 million DBFO concession with Plenary.

The Port Mann highway project also caused consternation when the province terminated the concession after it had been awarded to a Macquarie-led consortium. The province benefited from keeping the terms of the EPC contract and is procuring the road under a conventional construction contract, but the sponsor and the syndicate of bank lenders backing the deal were left high and dry. “The problem is, nobody wants to commit time and resources to a bid that’s not going to result in a deal,” explains a Canadian bank lender, “and sponsors are just as sceptical.

”BC is continuing its PPP programme and signs are that banks, newly-flush with fatter lending budgets, are prepared to forgive and forget. An ACS-led consortium has been chosen as the preferred bidder for the South Fraser project, with a low bid for the construction of around C$640 million. It beat bids from SNC Lavalin and PCL/Kiewit-led consortiums or C$890 million and C$990 million respectively, and is thought to be looking at a bank financing package.

The extreme price difference of the bids has raised eyebrows across the market. “It’s a very aggressive bid,” says a sponsor from a company that opted against bidding for the project. “We can’t see how ACS is going to make any money on it, although it has got low pricing committed for its bank debt.”

The Federal government has made more progress in closing a headline deal for a new asset in the province, the first federal pure PPP financing ever. A consortium of HSBC and Bouygues has closed a C$195 million 27-year bond financing for its Royal Canadian Mounted Police headquarters in Surrey, BC, arranged by Scotia Capital. The sponsor achieved a spread of 285bp, a respectable showing for a new customer and an unfamiliar asset.

Ontario now the master

The Ontarian PPP market continues to produce the most deals, with a seemingly relentless stream of projects coming to market and closing successfully. “There are some promising prospects in Ontario,” says a sponsor who has worked on a number of projects in the province, “and the procurement process is straightforward. Infrastructure Ontario has produced a stable model which more or less guarantees procurement.” Upcoming projects include the South West Detention Centre, the Women’s College hospital and the Windsor-Essex Parkway, which will be the province’s first PPP road project under the current model.

A sign of the province’s increased confidence came with its willingness to highlight a report supportive of PPPs in Canada, although it still prefers to use a more politically palatable term, alternative financing and procurement, to describe its DBFM deals. The province’s unions decried the contents of the report, from the Conference Board, though it marked Ontario’s coming to terms with PPP, after a troubled birth and a subsequent change of government.

Although the Ontario procurement process is well tested, the challenges with Plenary’s financing for its Niagara hospital project in 2009 demonstrated that the province was not immune to financing difficulties. When Plenary’s institutional relationship with Deutsche Bank came under strain and it was reassessing its debt solutions, the province stepped in and offered an increased contribution to the project in the form of extra milestone payments, which might be charitably described as a soft loan, assuming the province can get the payments back in a refinancing.

Ontario has strict rules in its procurements, pertaining to how bids are written and structured and what financing methods its sponsors present in their proposals. Infrastructure Ontario penalises mini-perm bank financings for its projects, believing that their implicit refinancing risks are not manageable. However, sources close to the Women’s College project, which is due to be awarded imminently, believe that the financing for this deal may signal a change of approach for the province.

Alberta's blunt offer gets accepted

Despite the strict rules, some bidders in Ontario claim that domestic sponsors are favoured and that diversions from bid rules are sometimes overlooked. “Ontario protects bids against rate changes, and has a benchmark mechanism that protects sponsors from changes in margins between bids going in and financial close,” notes a sponsor with experience in a number of the provinces. “Quebec offers similar protection on a project-by-project basis, but Alberta is more complicated in that respect. It protects against base rate changes but doesn’t immunise against changes in spreads, which can be problematic if a project takes a few months to close.

”This added risk may be irksome for certain sponsors, but is characteristic of Alberta’s PPP procurement ethos. “Its approach is straightforward to the point of blunt,” says one lender familiar with the province. “It puts the onus of risk to the sponsor, and asks for a C$10 million letter of credit to secure the bid and give the sponsors a monetary incentive to get their act together,” he says. Once all the due diligence is in place, he continues, “There are no arduous requirements about how bids are written, no worries about refinancing risk etc, or how the sponsor arranges its debt. They want the best value for money, the best NPV, and a guaranteed date certain for financial close and construction. And that’s it.

”Alberta recently closed the second package of schools with banks, as well as shepherding Acciona and SNC Lavalin to close a C$157 million bond for the Stoney Trail SE road, without difficulties. “Alberta is the province to watch,” says a sponsor with assets in several Canadian provinces. “So far, it has produced a couple of deals per year, but the real tell-tale sign that it has potential is if it gets into the healthcare sector. It could be a very appealing market then.”

Quebec falls back

The Quebec PPP market has been patchy. Macquarie's A25 highway project closed when the market was still robust, though its debt included some market flex provisions. ACS and Acciona’s A30 highway deal coincided with the fall of Lehman Brothers, and was the last of the province’s PPP successes to date. Although construction has proceeded well on both projects, there is speculation that the sponsors had to deleverage by increasing equity during the worst days of the crisis.

Since then, Quebec’s PPP progress has been hampered by financing constraints as well as political and public ill-will. Its two super-hospital projects were issued almost simultaneously for procurement, in part because of the sensitivies of tendering the Francophone before the Anglophone project, or vice versa.

The procurement of the first of the projects, the McGill hospital development, has been protracted. When bids from the remaining two prequalified bidders – SNC Lavalin and OHL-led consortiums – went in, the province decided that the costs were too high, so reduced the scope and asked the bidders to resubmit best and final offers. The agreed financing solutions had to be reassessed, and the SNC Lavalin consortium was eventually awarded the deal. Financial close is expected in June 2010, with a bank-bond hybrid debt. Fiera and Meridiam hope to close a smaller bank/bond deal for a C$470 million research centre at CHUM within weeks, while the main CHUM PPP concession will probably close in 2011.

“Quebec doesn’t know whether it’s coming or going at the moment,” says one lender. “The CHUM project is back from the dead now that McGill looks set to close, but the awarding authority has too much on its hands and not enough staff or capital to deal with the procurements.” PPP Quebec has been renamed Infrastructure Quebec, part of an effort to refocus it away from PPP. It recently lost its well-regarded CEO, Pierre Lefebvre, and has adopted a new policy towards project procurement that makes PPP concessions less of a certainty.

Federal, regional and municipal deals offer some welcome diversification from the troubled provincial mega-projects. The federal government is set to choose a preferred bidder for its Communications Security Establishment Canada headquarters, which would house an intelligence body analogous to the UK’s GCHQ, on which Plenary, SNC and Carillion are bidding. The PPP Canada fund is set to contribute towards an effort on the part of the Maritime provinces jointly to procure a new radio system as a PPP. Meanwhile, the city of Winnipeg, capital of Manitoba, has quietly closed with Plenary on its Disraeli Bridges PPP.

Box: The rise of the home-grown funds

Over the past three years, a number of Canadian infrastructure funds and boutique equity fund managers have set up shop, looking to take advantage of fatter PPP deal pipelines. Fengate Capital Management, Gracorp Capital Advisors, Fiera Axium and now Concert Properties’ infrastructure venture, are among the market players.

Gracorp Capital is part of the Graham Group and has invested in a number of infrastructure projects in Canada including both of the Alberta Schools deals, through its Conor Clark & Lunn GVest Traditional Infrastructure vehicle. Tim Heavenor, president of Gracorp Capital, says that there are strategic advantages to these kinds of domestic investors, and that its partnership with Graham’s construction arm gives the company an edge in bidding. “A lot of European companies are attracted to the Canadian market, but some have the money to invest but can’t execute projects in Canada.

Gracorp’s investments come from a variety of sources, including high net-worth individuals, small to mid-size institutional investors, and from Graham Group companies’ employees, who can make annual contributions or put some of their pension funds to work in the infrastructure fund.

Fengate raises its funds from small- to mid-size private pension plans, such as the labourers’ unions, and seeks to invest in PPP across Canada. According to George Theodoropoulos, senior vice-president at Fengate, it seeks dividend returns in the low teens for its investors and notes that the Canadian market is small, so all opportunities are worth pursuing. Though Fengate, unlike Gracorp, does not have a corporate alliance with any given construction company, it does have a number of strategic relationships with: EllisDon, Kiewit and Walbridge (construction); and with Honeywell, Johnson Controls and SNC-Lavalin (facilities management; though not with their respective equity arms).

Unlike the larger Canadian funds such as Ontario Teachers’ and OMERS’ Borealis, these boutiques favour keeping their investments domestic. Heavenor explains that, for Gracorp’s investors, it is important to see how their money is spent, and they understand the Canadian construction risks implicitly as many of them are directly affected through their employment.

The rise of these funds suggests a move towards Canadian investors sharing in returns generated by Canadian infrastructure and construction, heading off a common criticism of P3 – that it has been too often a boon to foreign sponsors, and thus foreign tax-payers. The market might be small, but these Canadian investors do not want to see the PPP equity premium heading offshore.