How quickly times change. Not four months ago, Canadian politicians sang the praises of public-private partnerships, or PPPs, and Canada’s provinces were top target markets for sponsors and lenders. Ontario had the most robust pipeline of design-build-finance-maintain (DBFM) concessions in procurement, with British Columbia close behind. But as quickly as they could endorse the model, politicians could scupper it.

According to various sources at Infrastructure Ontario (IO), the province’s PPP procurement agency, Ontario’s upcoming 10-year infrastructure plan will likely contain a significant number of build-finance (BF) or design-build-finance (DBF) deals, and a smaller proportion of the DBFM concessions that attract foreign sponsors and financial equity providers. These sources attribute the shift to concerns from provincial legislators over the cost-effectiveness and multi-year payment obligations associated with long-term concessions – a budgetary concern high on their list ahead of the 6 October 2011 provincial elections. The plan is due to be released next year.

“Moving back to DBF concessions would be a negative step for the province,” says one Toronto-based sponsor who has worked on a number of deals. “Without the O [operations] and M [maintenance] components, the private sector has no accountability for a project.”

The province denies that it is changing the model. “This government is pursuing the AFP [Alternative Financing and Procurement] model as an innovative way of financing and procuring large public infrastructure projects,” says a spokesperson for the Ontario Ministry of Energy and Infrastructure. They add that the province is considering ways of “transforming” the delivery, financing and management of infrastructure in the upcoming 10-year plan. The province, however, considers both BF and DBFM structures as AFP, and of late has been using AFP and PPP interchangeably.

The implications of such a shift are much more than simply a lack of accountability. The move would hurt the underwriters that arrange long-term financing and likely push pure financial equity sponsors and facilities management contractors out of the market. All are firms that have spent the better part of the past two years investing and growing their business in Canada.

“If the trend continues, it will push the pure infrastructure companies out of the [Canadian PPP] space and benefit the integrated developer and operating companies,” said a Canada-based infrastructure adviser.

Political motivations

Legislators’ main concern is the long-term cost of financing. According to sources at IO, the sentiment is that higher spreads, which are currently in the region of 250bp over the government of Canada long bond (Canada long), push the cost of debt for 30-year DBFM concessions higher than if the province were to manage the projects itself. Based on just these metrics, they are correct.

A chart tracking the spreads for Canadian infrastructure deals compared to those of generic, A-rated corporate bonds and quasi-governmental organisations, for example the Greater Toronto Airports Authority (GTAA), from 2007 through the present shows a sharp increase in pricing after the 2008 credit crunch. While the spike is hardly a surprise, the fact that spreads for the GTAA and other organisations quickly fell back under 200bp while private infrastructure pricing remained elevated is.

 

One Toronto-based banker attributes the stubbornly wide spreads to the fact that investors were burned by illiquid investments during the crisis and are still hesitant to invest in what they perceive to be illiquid or specialised issuances. Another sponsor joked that “maybe banks were just being greedy before” but, on a more serious note, they added that the market for infrastructure debt in Canada was still small relative to other asset classes.

Whatever the reasons for spreads remaining high, legislators appear to be basing their cost effectiveness assessments on “artificially low” pre-crunch pricing, according to the IO sources. In March 2007, bookrunner TD Securities, with co-managers RBC and Scotia Bank, closed on C$213.7 million ($210 million) in senior secured amortising bonds priced at 72bp over the Canada long for the 30-year DBFM Durham Consolidated Courthouse deal. The project included construction of a new 33-courtroom facility that combined the operations of the superior and Ontario courts from eight locations into one. Babcock & Brown Public Partnerships was equity sponsor and joined by PCL Contractors and Johnson Controls for construction and maintenance.

Compared to the Ontario provincial police (OPP) facilities modernisation project, which closed on 14 September, Durham was a bargain. A German club of WestLB, Nord/LB and KfW priced C$163 million in senior bank debt, including a C$53 million roughly two-year construction loan and C$110 million 30-year loan, at an average of 290bp over CDOR for OPP. Hochtief and Concert Real Estate were equity sponsors. Though the deal included some unusual construction risk associated with building new facilities in 16 cities scattered throughout Ontario, many market players consider it a relatively vanilla DBFM. While it is true that deals priced over Canada long price lower than those over CDOR, even adjusting for the difference the cost of financing for OPP would still have been around 250bp – significantly higher than Durham Courthouse.

What is clear is that the pressure to eliminate the O or M components of concessions is solely political. Numerous market participants say IO understands the lifecycle benefits of long-term concessions. The most commonly cited benefits include value for money, accountability for design and innovation in service delivery.

These benefits are not always just industry boilerplate, as one example illustrates. Simon Chapman, executive vice-president of Canadian infrastructure development at Carillion, wrote recently that by including the services provider in design discussions for a hospital project, janitors were able to point out that planned window ledges would be time-consuming to clean and harbours of bacteria. By eliminating the ledges in the design process, the team was able to produce a more cost-efficient and hygienic facility.

Party of one?

Ontario alone may be concerned about the cost-effectiveness of long-term concessions. Alberta, British Columbia, Quebec and the federal government continue to procure projects with the O and M components and there are no reports of them stepping back. British Columbia has put forward plans for the occasional build-financing, but the structure does not account for a significant proportion of its pipeline.

“We evaluate each project to determine what suits it best,” says Sarah Clark, chief executive of Partnerships BC, when asked whether the agency would be launching more BF or DBF deals. She added that the Evergreen Line Rapid Transit Project, an 11km extension of Vancouver’s Skytrain currently in procurement, was tendered as a DBF because it will be integrated with the existing system and not operate as an independent line like the Canada Line. The province, which is the most active market in Canada after Ontario, intends to tender three or four PPPs annually for the foreseeable future.

In Quebec, public opposition to PPPs, not their long-term costs, has prohibited the market from moving forward. The recently closed Centre de Recherche (CR) at the Centre Hospitalier de l’Universite de Montreal (CHUM) and McGill University Health Centre projects, as well as the CHUM hospital that is still in procurement – all DBFMs – were delayed because of questions over whether the model was a suitable one for public health facilities. Sponsors hope that with two of the three deals completed, the province will begin tendering more PPPs though many note that nothing is likely to happen until after CHUM closes, probably in the first quarter 2011.

Alberta has closed six PPPs – four road DBFOs and two packages of school DBFMs, but currently does not have any projects in procurement. Sponsors hope to see more activity from Alberta in the future.

The federal government is the player everyone is talking about. Since setting up PPP Canada, the federal crown corporation charged with promoting PPPs nationally, it has supported projects outside the usual centres of alternative infrastructure investment. In its first round of funding awards, grants were awarded to the city of Winnipeg’s Chief Peguis Trail extension and a new maritime emergency radio network in New Brunswick, Nova Scotia and Prince Edward Island. In the second round, 68 proposals were submitted including one from the province of Saskatchewan, which has not previously procured a PPP, for a new C$431 million retractable roof stadium in the provincial capital Regina.

The federal government also has projects to award directly. Defence Construction Canada awarded the Communications Security Establishment Canada’s (CSEC) C$880 million Long-Term Accommodation concession to a Plenary-led consortium in October. The 30-year DBFM is the ministry’s first and many sponsors express hope that there will be more to come from both the defence ministry and the federal government as a whole.

Downward spread

Canada’s politicians seem to be reacting after the fact. As Ontario legislators argue that the price of long-term concessions featuring O&M are too expensive, spreads are on their way back down.

According to bankers, spreads for long-term bond for infrastructure deals are currently between 250bp to 275bp over the Canada long. Long-term bank loans are pricing at similar levels over CDOR, creating the first competition between financing sources in Canada in more than two years.

“Competition is good for the market,” says one Toronto-based infrastructure banker. “Without it you can get inefficient pricing for PPP deals.” They added that after the 2008 credit crunch, the domestic bond market reached maturity and was able to provide a viable alternative to long bank deals that, for the past two years, have been absent from the Canadian market. “The McGill Hospital deal was the coming of age of the Canadian infrastructure bond market,” the banker concludes.

Now banks are competing against each other and pitting internal origination and fixed income desks against one another (with Chinese walls, of course). One source said OPP went for long-dated bank debt because it significantly beat the bond pricing on offer. Though it probably did not hurt that the primary equity sponsor, Hochtief, has close relationships with the three German banks that provided the 30-year loan. Another source said three projects recently awarded to Plenary – CSEC’s Long-Term Accommodations, St. Joseph’s Healthcare Hamilton West 5th Campus and the Thunder Bay consolidated courthouse – will all be financed with long bonds for the maintenance portion of the concessions. The source added that one would use short-term bank debt for the construction period. St. Joseph’s and Thunder Bay are expected to close before the end of the year and CSEC in January 2011.

Ontario’s 10-year infrastructure plan may be nearly a year away but the decision on how to finance it will be made soon. The IO spokesperson says legislators are watching the deals that close in the next three months very closely – indicating indirectly that the pricing they receive will weigh heavily on ultimate structure of projects in the 10-year plan.

BOX: Pan American opportunity?

When the Pan American Games open in Toronto on 10 July 2015, the city and its environs will boast more than 30 new or expanded sports facilities. Many of these will have been built under Ontario’s alternative finance programme. Just as the Winter Olympics in Whistler earlier in 2010 provided a spur to the development of PPP in British Columbia, there will be role for the private sector in Ontario.

Infrastructure Ontario is responsible for delivering all facilities related to the games. Venues include the athletes’ village, and aquatic centre and stadiums in Hamilton and York. The federal, provincial and city governments as well as the other hosting entities are providing C$1.4 billion ($1.39 billion) in funding for construction and operations and another C$1 billion for the athletes’ village.

Large projects, for example the aquatics centre and stadium, will be procured as design-build-finance (DBF) projects, according to IO. The athletes village, though structured as a DBF, will be awarded to a master developer that will also be responsible for operating and maintaining the facilities during the games before turning them over to the province. Ontario is still evaluating what structures to use for the renovation and expansion, valued at C$120 million, of another 30 existing venues.

The venues will not be procured as design-build-finance-operate or design-build-finance-maintain concessions because local municipalities and other organisations will take over the facilities after the games. Many of these bodies already have their own operations and maintenance policies. For example, the University of Toronto Scarborough will take over the aquatics centre once the games are over and the athletes’ village will be sold to a private developer to be converted into housing.

Despite the full slate of relatively risk-free projects, sponsors and banks are leery. Equity players say they will not bid on the facilities because there is no opportunity for long-term returns. This makes the deals potentially the exclusive realm of construction and engineering firms. Bankers worry that the penalties for delivering a venue a week or two late are as severe as completely forfeiting the completion payment. No tender documents related to Pan American Games’ facilities were available as Project Finance went to press.

IO intends to release the request for qualifications (RFQ) for the athletes village, the first games-related tender, in October. RFQs for the remaining projects will be released in 2011.