New Mexico Housing Summit

Creating Affordable Housing Through Public- Private Partnerships

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Disclaimer

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Various definitions

Public Private Partnership (PPP) describes a government service or private business venture which is funded and operated through a partnership of government and one or more private sector companies

PPP involves a contract between a public sector authority and a private party, in which the private party provides a public service or project and assumes substantial financial, technical and operational risk in the project

Private involvement in projects already

Private construction

Private investors buy municipal bonds

Covers a broad spectrum of Private involvement in US

Design Build (DB)

Design Build Operate/Maintain (DBO)

Design Build Finance (DBF)

Design Build Finance Maintain (DBFM)

Design Build Finance Operate/Maintain (DBFOM)

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What is a PPP?

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Brownfield v. Greenfield

Brownfield

Gives governments ability to raise needed funds, for example to fill budget deficits or to undertake new infrastructure projects

Government leases existing asset to private entity in exchange for large upfront payment

Private entity gets right to collect tolls or other revenues generated by asset for life of the lease, called a concession

Private entity operates and maintains asset during concession

Government retains legal ownership of asset

Greenfield

Same concept as above regarding existing assets, except that private entity also constructs asset (usually no upfront payment)

Revenues may take the form of availability or similar payments from government

Government gets control of asset at end of concession term

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Revenue Risk v. Availability Payments

Revenue Risk

Private entity and lenders take risk that project revenues and user fees will be able to service debt and provide sufficient equity return

Toll roads, managed lanes, airports

May have revenue sharing over certain levels between government and private entity

Availability Payments

Private entity receives periodic payments from government during operating period as long as project is properly operated and maintained

Used for roads, bridges and tunnels that cannot generate sufficient cash flow to service debt and provide equity return

Used for assets that do not generate cash flow (courthouses, schools, hospitals, etc.) or other reasons

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Sectors Suitable for P3s

The sectors that are suitable for P3s differ across countries

Roads and Bridges

Tunnels

Airports and Ports

Parking Facilities

Mass Transit Systems (high-speed rail, light rail, bus)

Water Treatment and Waste-Management Facilities

Housing (affordable housing, military housing)

Hospitals

Prisons

Courthouses

Sports Facilities

Schools

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Update on U.S. P3 Market – Status and Trends

The market is beginning to witness a shift away from:

Brownfield transactions

Politically challenging

Movement towards greenfield transactions…

Trend is moving toward:

Construction based greenfield projects

Delivery of new public infrastructure

Transaction Profile

Growing acceptance of Private Public Partnerships (“P3”) – albeit each state is a different market

Knowledge migration from Canada, Australia and UK into the U.S. P3 market

Growing acceptance for availability payments transactions (however appropriations / authority credit risk is a key issue)

Remains a transportation centric market

Greenfield and real toll/volume based transportation projects will provide a steady source of new transactions

Observations

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P3 Project Structure

Procurement Process

Step 1 – Request for Qualification (RFQ)

Step 2 – Shortlist (if applicable)

Step 3 – Request for Proposal (RFP)

Lenders get involved; design-build contract price and pricing of loan have largest impact on bid price

Shortlisted bidders comment on Concession Agreement and Instructions to Proposers (ITP)

All bidders submit bid on same Project Agreement and ITP

Step 4 – Naming of Preferred Bidder

Step 5 – Execution of Concession Agreement

Step 6 – Financial Close

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P3 Project Structure

Fundamental Principles

Party best able to manage specific risks should assume such risks

Risk allocation based on interwoven documentation that must fit together

Risk allocation starts with Project Agreement between Authority and Private Entity (special purpose company or SPC) and is further allocated to other project participants, including design-builder

SPC accountable to Authority and Lenders (in addition to other project participants such as design-builder)

SPC will need to get consent from Authority and Lenders for specified amendments, waivers and change orders

Limitations on what SPC can do (i.e. negative covenants in financing documents, restrictions in Project Agreement)

Lenders’ recourse is to Project, the SPC, SPC assets and Lenders’ collateral

Lenders’ debt is not guaranteed

Equity needs to wait for operating period to get their return

Design-Builder to get paid monthly from draws under financing documents

Equity to be funded upfront or during construction period but in any event would be funded upon an Event of Default under Financing documents

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Why use Project Finance?

P3’s typically use non-recourse Project Finance

Project Finance is complex, slow and has a high upfront cost! But…

Benefits for P3 projects

Low funding cost due to high leverage

Increases investors’ financial capacity, so creating more competition for projects

Enables public sector to assess and monitor project-specific data

Third-party due diligence helps to ensure project deliverability

Benefits for investors

Non-recourse

Greater leverage, which may be off-balance sheet

Hence higher return on investment

Enables partnerships with different financial strengths to work together

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Risk Transfer – The Fundamental Basis For P3

P3s All About Risk Transfer or Risk Sharing Maxim is Risk is Passed to the Party Best Able to Mitigate or Manage It

Public sector always has inherent strengths

Legislative power

Ability to obtain site

Tax exemptions

Liability exemptions or caps

Ability to “self insure”

Private Sector Can Optimize & Mitigate Risk is Managed, Assessed, and Priced by Private Sector

Design risk

Completion risk

Counterparty credit risk

Maintenance risk

Interface risk (interactions between above risks)

Skilled specialists with necessary expertise and experience

Whole life cost

Patient Equity and active management

Fixed price turnkey

Insurance

Contingencies/ Concessionaire Equity

Role of Equity

Equity provides a buffer over third party debt funding (typically 10-15% in Availability Payment deals) and takes the first loss

Equity upside is limited Availability Payment deals - some upside unused contingencies but little organic growth as there is no volume or demand based payments

Long term investment horizon - no distributions pre-completion

Compensation for development / construction risk is received over entire project term

Ultimate investors/holders of PPP equity (usually via infrastructure-funds) are pension funds etc – relatively risk averse

Tends to be priced tightly compared to corporate finance target returns (20%+)

Equity’s most material exposure is contractor non-performance

In a well structured and diligenced deal, the probability of this risk should not be high, however, if it occurs impact can be catastrophic (total loss of investment)

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Investment Criteria for Equity Providers

Potential for upside from unused contingencies …

… but also for severe downside since take the first loss on a limited basket of risks including

Cost increases, e.g. insurance, lifecycle or taxation

Replacement of subcontractors

Refinancing, etc.

Similar due diligence requirements and expectations as senior funders vis a vis risks

However, will also be looking for least restrictive funding agreements possible

Allow them to manage the business

Allow them to distribute cash

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P3 Project Structure

The Role of the Special Purpose Company

The Special Purpose Company (“SPC”) is the vehicle through which P3 projects are delivered

Main responsibilities include:

Act as a single point of contact with the Authority (through the Project Agreement) and lenders;

Enter into project documents and financing documents;

Raise project financing;

Governance, controls and monitoring; and

In the case of this project, to manage maintenance obligations

Few assets and efficiently resourced

Key decisions typically made by a board (representatives of the key stakeholders)

SPC to be properly staffed to handle responsibilities

May manage maintenance and operating obligations – may do so by competitively procured subcontracts

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Typical Project Structure

P3 Project Structure

D&B contractor (CJV)

O&M contractor

Authority

SPC

Lenders

Shareholders

Project Funding

Operations & Maintenance

Contract*

Design-Build contract

Project Agreement

*Not uncommon for SPC to self perform O&M i.e. no O&M subcontractor, as is the case in this transaction

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Milestone Payments

DebtInterest & Principal

Equity Distributions

Milestone / Availability Payments (User fees, if

applicable)

Simplistic Payment Structure

SPC

Lenders

Public Sector

Equity Investors

“Sponsors”

CJV

Debt to equity ranges from 50:50 to 90:10 depending on risk profile

i.e. brownfield / greenfield, availability / toll risk, etc.

Debt is provided on a non-recourse basis

Contractor(s) typically contract as part of a Design & Build Joint Venture

Contracts supported by guarantees / bonding for construction risk

Availability payments commence at the start of service delivery and are subject to performance regime through the Project Agreement

CJV Guarantors

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Principal Documentation

Concession Agreement

Design-Build Contract

Back to back with Project Agreement

Design-Build Contract Guarantees

Operation and Maintenance (“O&M”) Agreement (if necessary)

Operation and Maintenance Guarantee (if necessary)

Interface Agreement (if necessary)

Limited Liability Company Agreement

Financing

Loan/bond documents; Security documents

Direct Agreements/Consents to Assignment

Lenders’ Direct Agreement for Project Agreement

Lenders’ Direct Agreement for Design-Build Contract

Lenders’ Direct Agreement for Design-Build Contract Guarantees

Authority Direct Agreement for Design-Build Contract

Lenders’ Direct Agreements for O&M Agreements (if applicable)

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Project Agreement

Project Agreements in Traditional Markets Follow Common Form

UK: Tend to follow Standardization of PFI Contracts (“SOPC”)

EU Countries: Often have their own national standards

Canada: Varies by province but British Columbia and Ontario broadly modeled on SOPC

Australia: National guidelines which provide a range of options at State level. Again, broadly modeled on SOPC

United States: Wide range, no standard contractual framework

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Investment Criteria for Senior Lenders

Contractor Security / Lender’s Requirements

Senior lenders’ return is limited with no upside

Very high gearing with no recourse to shareholders

Hence senior lenders’ focus is on minimizing their risk

Due Diligence

Technical: Design, timetable, cost budget reasonable, construction methodology and appropriateness

Legal: Contracts give the risk allocation, protections and control required

Insurance: Requisite insurances are in place

Contractor: Experience and capability to execute the contract

Financial strength: Net asset value, credit rating

Surety / Guarantees

Levels of third party support given

Other

Size of investment vs. time required

Market conditions

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What can go wrong?

Lender’s Risk & Mitigations

Construction Cost Over-Run or Delay

Contract under-priced Too aggressive timetable Unexpected complications, e.g. site conditions worse than expected Senior lenders and equity protections:

Technical Advisor (“TA”) sign-off of contingencies in cost and timetable

Contractor held to fixed price turnkey contract Contractor liable for Liquidated Damages during delay In worst case scenario Contractor has Termination liabilities

Senior lenders in addition have buffer of equity return

Operating Performance

Contract under-priced Unexpected cost increases above indexation Inability to meet required performance standards Senior lenders and equity protections:

TA sign-off of performance standards and contingencies in costs Contractor held to fixed price contract Benchmarking/market testing for soft services Performance deductions passed through to operator (whole fee at

stake) In worst case scenario Operator has Termination liabilities

Senior lenders in addition have buffer of equity return

Insolvency of Major Project Party

Example: Jarvis situation in the UK Senior lenders and equity protections:

Financial strength of subcontractors assessed upfront Parent Company Guarantees required Third party support required for weaker contractors

Senior lenders in addition have buffer of equity return

Cost Over-Runs at SPV Level

Management costs Lifecycle costs if risk held at SPV level Insurance costs Senior lenders and equity protections:

TA sign-off of adequacy of lifecycle budget Insurance premia sharing with Authority General SPV contingencies

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Security required by Funders and Equity

Security Package

CJV Security Package

Cap on General Damages Percentage of Contract Sum

Cap on LDs Percentage of Contract Sum sufficient to cover 100% of the Availability Payment

abatement or unmitigated costs out to the Long Stop Date

Liquid Security Percentage of Contract Sum in the form of a letter of credit from suitably rated bank /

institution with refresh provisions

Parent Company Guarantee Required from creditworthy entities

Example Security Package Required by Funders for Similar Transactions

Where project finance is used, the security normally required by the financiers (funders and equity) includes:

Security over all the project cashflows and assets (including contractual rights) and equity in the project company;

A direct agreement with the Authority, providing rights for lenders to step into Project Agreement in the event of insolvency or other default;

A direct agreement with the subcontractors, providing rights for the lenders to step into subcontracts in the event of insolvency or other default; and

Guarantees or bonding of the subcontractors’ obligations under the subcontracts (which may be provided to the project company and secured in favor of the lenders);

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Control & Monitoring

Lenders exercise varying degrees of control over project finance borrowers

Covenants – general undertakings requiring compliance with terms of project documents, consents etc

Representations and Warranties – requiring borrowers to periodically certify that they have been in compliance (considered a more active mechanism of control as borrower has to take positive action to certify)

Agent (on behalf of syndicate) in a bank deal or Trustee in a bond deal will require the following to monitor project performance:

Monthly report from the technical adviser (TA) during construction, certifying construction costs to be drawn down and compliance with program

Periodic TA report during operations monitoring operating performance

Periodic update to financial model to calculate key financial ratios (to permit equity distributions)

Monitoring of insurances by insurance adviser to ensure insurance remains in place

Annual audited and monthly/semi annual management accounts

Typically a ‘sweep up’ provision requiring Borrower to provide any other information that the Agent/Trustee reasonably requests

Regulation of flow of funds through Depositary Agreement

Controls & Monitoring Requirements

Control & Monitoring

Operations and Maintenance Expenses

Principal on Debt

Interest on Debt

Other Reserve Accounts

Project Revenues Project Revenue Account

Debt Service Reserve Account

Maintenance Reserve Account

Equity Distributions

Project Revenues

Priority of Payments Cash Waterfall (Representative Simplified Illustration)

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RBC Capital Markets – Albuquerque Staff

Paul J. Cassidy Erik Harrigan Loretta BrushManaging Director Director Associate Vice President(505) 872-5991 (505) 872-5992 (505) 872-5994paul.cassidy@rbccm.com erik.harrigan@rbccm.com loretta.brush@rbccm.com

Andrew Stricklin Marlo HoukAssociate Administrative Assistant(505) 872-5996 (505) 872-5999jeremy.landrum@rbccm.com marlo.houk@rbccm.com

RBC Capital Markets, LLC6301 Uptown Blvd. N.E., Suite 110

Albuquerque, NM 87110(505) 872-5999

Fax: (505) 872-5979