Project finance gets innovative as markets turn tricky

Although it is only a few years since the public private partnership (P3) projects were first financed in the public bond markets, the sector is growing quickly and is becoming one of the most innovative in the world. Nina Flitman finds out how much capacity remains for growth and the likely challenges the sector will face over the coming year.

  • 28 Sep 2011
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The Canadian infrastructure bond market has developed rapidly since Access Health Vancouver first tapped it in 2005 in what was the country’s first P3 bond deal. From a total bond issuance of C$714m that year, the market hit C$2.057bn in 2010 and had reached C$4.138bn by the start of September this year.

The first big challenge for the P3 bond market came last year with the McGill University Health Centre transaction in Québec. Scotia Capital underwrote a C$764m long term bond, the largest the sector had seen, and marketed the transaction like a corporate bond transaction with roadshows in Toronto and Montreal. In doing so, they attracted more than 50 investors to the bond, most of whom had never invested in the P3 market before.

"On the McGill P3 transaction, we were concerned bringing a C$750m transaction when there hadn’t been a deal over C$300m in the P3 space in Canada," says Greg Lawrence, managing director, head of investment grade debt at Scotia Capital in Toronto. "We made the offering eligible for US investors, but in the end we only had four US investors of the 53 that participated in the transaction. To date the P3 market can be served by Canadian investors. We have not had the need to go beyond our borders."

The McGill transaction opened up the investor base for the P3 bond market, and the available liquidity has been growing ever since. As P3 transactions now make up 7.6% of long corporate bonds in Canada, investors cannot afford to avoid the sector for much longer.

"The pool of investors in Canada has been broadening consistently over the past few years," says Eric Beauchemin, managing director, public finance at DBRS in Toronto. "In the early days, there were 10-15 investors in a typical rated transaction, but now we see more than 50 on the big deals and the names are much more diversified than before. Lifecos used to account for a big share of the demand, and while they are still very active and very influential, now there are many more takers too."

Scotia Capital’s Lawrence believes the market is reaching maturity.

"This is the third year that P3 deals have been offered in the Canadian capital markets, and so investors now understand how to look at the sponsors, at the various structures and the overall credit underwriting," he says. "We now have a large audience to sell P3 bonds to that we did not have three years ago."

While the investor base looking at the P3 bond market has grown in size, it has also grown in reliability. In August this year, Halton Infrastructure Partners priced a C$543.5m 34 year bond backing the development of the Oakville Hospital in Ontario at just 205bp over Treasuries. This set a new benchmark for low pricing for P3 bond transactions in Canada and came at the end of the longest drought in the market since 2008 as macro-economic turmoil took its toll. The bonds, which will be used alongside a C$474m short term bank loan, were 2-1/2 times oversubscribed. Scotia Capital underwrote the paper.

"Halton was issued at 205bp in the middle of a wacky, volatile period," says Sean St John, co-head and managing director, fixed income and head of debt capital markets at National Bank Financial in Toronto. "There was a crisis going on in every other part of the market, but that was priced at a very good level, and the spreads have hardly moved. I think it defined the stability of the P3 market in Canada."

Along with this stability, Canadian P3 bond investors have also become more sophisticated. In September, underwriter RBC challenged the market by bringing the first long dated bullet bond as part of the C$1.004bn of senior paper issued to back the C$1.25bn Humber River Regional Hospital P3 project in Toronto. The deal was split between a C$482.1m short term construction tranche, a C$373m amortising long term bond and a C$419m bond with a bullet maturity.

"As the market matures, we want to find more efficient ways to fund and to expand the universe of investors," says Duncan MacCallum, managing director of infrastructure, Canada, at RBC Capital Markets in Toronto. "And there are some investors that can only invest in bullets. Certainly with this deal we are finding that there is a lot of new demand."

Banks versus bonds

Advisors still see the bond markets as the most reliable source of funding, especially for larger projects where the requirements would outstrip capacity in the private placement market. Not only are sponsors able to avoid the issues of inter-creditor negotiations through the bond markets, some have also found that bond financing is cheaper than funding with bank facilities.

But this is not to say that the bond market is the only funding solution available for P3 in Canada: there is no shortage of equity financing for infrastructure projects, while the private placement and bank loan markets are also available. Jim Cahill, senior vice president of AFP services at Infrastructure Ontario in Toronto says that sponsors must consider all financing options to match the exact requirements of each individual project and the issuance environment.

"There’ll always be a role for the bank market and private placements, especially on the smaller transactions where it doesn’t really make sense to do widely distributed bonds," he says. "During the crisis in 2008, the underwritten bond solution dried right up, but we closed six projects over 2008 and 2009, relying on bank syndicates for short financing and private placement club deals with the lifecos."

Although it is important for sponsors to explore every opportunity when financing projects, especially when volatility can close the public markets, many bankers expect that there will be a general move away from a reliance on bank financing and an increasing acceptance of the usefulness of the bond markets.

"Canadian banks are not big project finance mini-perm lenders, so the transition is a lot to do with the health of banks outside Canada and them wrestling with the most recent volatility," says Peter Hepburn, head and managing director of the infrastructure finance group at National Bank Financial in Toronto. "We are sensing less appetite and anticipating widening spreads, and it seems that this is not a reliable and viable alternative."

But as the appetite of non-domestic banks for Canadian P3 fades, proportionately the capacity in the bond markets is increasing. Cahill is optimistic that the P3 bond market will be established as a stable and flexible investment product.

"With wider distributed bond solutions, you can do larger projects — and there are a number of those on the horizon," he says. "And if we get more widely distributed bonds out there, a secondary market will develop. That’s what we’re really hoping to see, as that would be a sign that the market is really maturing."

CHUM plumbs the depths

The benefits of turning to a wider investor base was best illustrated in July, when Collectif CHUM closed the largest transaction brought to the market, a C$1.371bn senior secured bond for the Centre Hospitalier de l’Université de Montréal. The deal was also the first infrastructure deal rated below A in the Canadian market. Although the deal came at a cost, with the bond priced at 325bp over, the CHUM transaction presented a real test case for capacity in the sector. The infrastructure bond market passed with flying colours.

Although this was the largest bond deal to have been completed in Canada, market participants are confident that there is room for even larger deals with a less exotic structure (CHUM has a two-phase construction period, which is atypical for the region).

"The CHUM deal may not have tested the absolute depth of the market, but they would not have wanted to go much deeper because the project was not as simple and straight forward as investors were used to," says Grant Headrick, vice president of public finance at DBRS in Toronto.

However, it is not yet clear whether investors in the P3 bond market will ever have their appetite for new paper fully tested, as there are doubts about the volume of large projects still in the pipeline. Although some argue that there has long been an infrastructure deficit across Canada, others note that many of the largest transactions that are more likely to be brought to the bond market have been worked through the system already.

"We’re now at the stage where much of the low hanging fruit has already been plucked," says Headrick. "The Canadian market as a whole has over 100 projects in various stages of operation: construction, procurement or consideration. So, many of the usual suspects have been dealt with, primarily from the social infrastructure side."

But others are more optimistic about the outlook for supply. Although there are some projects that are not suitable to be financed through the bond market — for example, the infrastructure required for the Pam Am Games to be held in Ontario in 2015 — there could be a good flow of transactions from the transportation and energy sectors.

While most of the activity so far has been concentrated in Alberta, British Colombia, Ontario and Québec, deals could also come from other provinces. Saskatchewan has several energy projects coming up that may be procured through the P3 markets, while smaller provinces may follow Alberta’s lead and package together a number of projects into one P3 deal to generate some size and efficiency in their infrastructure financing.

There are also likely to be more projects being brought to market at the federal and municipal levels. There have, of course, already been several transactions from the federal government, including the C$1.3bn Plenary Properties’ Long-Term Accommodation Project for the Communications Security Establishment Canada earlier in 2011, which saw the issuance of C$840m in long bonds and C$167m in short bonds underwritten by RBC Capital Markets.

The introduction of a federal screen, whereby every capital project of more than C$100m has to be considered for its suitability for P3 status, could increase the number of transactions coming through the market from the government.

Similarly, increased supply is also expected on a municipal basis, with many bankers carefully eyeing the upcoming P3 deal for Ottowa Light Rail Transit as a potential model for large scale city projects.

  • 28 Sep 2011

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