Financing the Future

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Building Canada’s Infrastructure

The size of Canada's infrastructure deficit is growing.

While the estimates vary, the conclusion is the same: Government funding and private sector involvement in delivering and financing infrastructure projects is fundamental to revitalizing Canada's infrastructure.

In 2007, the Federation of Canadian Municipalities estimated the infrastructure deficit was $123 billion for existing municipal infrastructure and would cost $115 billion to construct new municipal infrastructure. If federal and provincial deficits were included, the Canadian infrastructure deficit could be between $350 and $400 billion. Research indicates the accelerated growth in the infrastructure deficit is due to lack of investment, poor maintenance and escalating climate change impacts.

Government has responded to the issue. With more than $100 billion of government money being funneled into new projects, infrastructure has become a top priority. However, the role of government and continued role of the private sector in infrastructure development are currently being debated.

Should government become a lender providing credit on commercial terms? Or should government provide funding in the form of grants? And will the private sector have sufficient capital at risk if something goes wrong?

On large scale infrastructure projects where private sector innovation is sought and the amount of private investment is significantly greater, the private sector takes a robust role in the delivery of these assets providing both equity and long-term lending to these infrastructure transactions. The private sector also designs, constructs, performs routine and periodic maintenance and assumes the lifecycle maintenance of the asset over the contract term, typically through a design-build-finance-maintain (DBFM) contract.

With significant funds at risk, lenders and equity investors provide a level of rigour and due diligence to assessing project risks and have a vested interest in long-term project performance. In return, lenders and equity investors find these projects attractive as they offer a long-term stable investment providing steady risk-adjusted returns.

In recent years, long-term lending by European banks has been instrumental in privately financing many Canadian infrastructure projects that are either in construction or now operating. Financing tended to have long tenors of 30 years and beyond and banks were willing to assume syndication risk. Additionally, credit spreads above government's cost of borrowing were acceptable and provided value for money for taxpayers.

Due to the current global credit crisis, which has affected many long-term European lenders, there has been a distinct shift away from 30-year debt to "mini-perm" solutions, with loan tenors of approximately seven years and debt refinancing once construction is completed or the financing period expires. Furthermore, credit spreads have increased significantly and government owners are seeking more creative ways of financing projects that deliver value for money.

Government grants, milestone payments and substantial completion payments are all being used to reduce the cost of financing but the use of a European Investment Bank (EIB) model with commercial lending terms is still being explored. There may be a short-term role for government as a lender to stimulate investment, however, in the long-term, the risk of crowding out private investment and the inherent conflict of being both lender and sponsor will need to be managed. Also, there may be increasing pressure on government to strengthen the quality of the covenant beyond "good faith" provisions used in previous transactions.

The role of private finance in Canadian infrastructure is also set to change. In the current market, "club deals" have replaced syndicated debt. And the mix of mini-perm solutions, bond issuances and private equity investments from pension funds are paving the way for creative private finance solutions for infrastructure. In particular, pension funds are revisiting their asset mix to increase their return and are increasing private market investments, including infrastructure. On the recent Niagara Hospital transaction, Borealis Infrastructure, the infrastructure arm of the Ontario Municipal Employee Retirement System (OMERS), invested equity into the deal.

The private sector is seeking well-structured deals that have a high probability of reaching financial close. Government is injecting funding into larger projects to reduce the overall cost of financing. It is also allowing for credit spread refresh and exploring refinancing risk. Lenders may have proportionally less at risk than before but as long as they have enough capital at risk, government, project sponsors and taxpayers benefit from their involvement. For this reason, the conclusion is clear: Both government funding and private finance will play an active role in ensuring Canada's infrastructure deficit is addressed.

Shamshad Madhok, CA, CFA, is a managing director at PricewaterhouseCoopers (PwC) LLP and is the leader of PwC's federal government and Ottawa Infrastructure and Project Finance practice.

This article was reprinted with permission from Building Strategies magazine. It first appeared in their July 2009 issue.