Article by Rickard Warnelid for Project Finance International (PFI) in 2008

1. REUTERS PROJECTFINANCEINTERNATIONAL
PW
MiddleEast
ppps
Roundtable
PROJECTFINANCEINTERNATIONAL
26 November 2008/1ssue 398/http://www.pfie.com
Americas
BNDEStohydrofinance
Shiloh Ildealfunded
ABN AMRO underwrites
Seraya sale is off
EMEA{
Considering newoptions
SER refinanceswind
Features
Buy, buy infra funds
Brave newPPPworld
REUTERS

2. 126 Nosember2008 http•..//ww•wpfie com
NewPPPs
e brave new
orld0fPPPs
n Australia. where PPPshave been relied upon to
deliver a large amount of criticalinfrastructure,
they should be a key priorityfor government to
keep the private sector satisfiedwith risk-allocation
and corresponding returns. The AustraliaInfra-
structure Partnerships conference organised in
October 2008 by PFIin Sydney highlighted more recent
concerns expressed byboth public and private sector par-
ticipants. This article sets out to discuss these concerns
and in doing so seeks to raise awareness of the implica-
tions on the financial modelling task of the newly imple-
mented structures.
Traditionally,the PPPstructure has had mixed sue
cæsses.with private involvement sponsored by investment
banks often blamed for the aggressivedevelopment of
infrastructure, most notably the toll-mad sector.This con-
cept has been successfulin the way that core infra-
structure projects have actually been completed, but
many market participants now question the effectiveness
ofthe businessmodeldue to the high number ofprojects
strugglingto avoidfinancialdefault.
Anumber ofhigh-pmfile examplesofmispricing ofthe
equity capital component have tainted the toll-road sec-
tor and the general attraction of these investments. In
addition, with the complexity ofdeals constantly increas-
ing. the frustrations of huge bid-costshas forced gov-
ernments at all levelsto re-thinkthe risk and rewards
equation in order to keep all participants not only com-
petitive but alsofundamentallyinterested!
Impact offinancial crisis on PPPs
•me credit crisishas had a gigantic impact on the liquidity
of the global financial system that has resulted in numer-
ous negativeoutcomes for financiersand developers
>Syndication markets have collapsed and are currently
closeto being non-existent
The collapse
of financial
markets has
had a signifi-
cant impact
on the
appetiteof
privatesector
investors in
ppps,which
has forced
governments
worldwide to
discuss new
initiatives to
stimulate
activity in the
sector. By
Rickard
Wamelid
directorof
Navigator
Project
Finance.
a
>Bond markets are inactive and are regarded as
"impossible"for the foreseeable future
>Fundingcosts (inter-banking and lending)have reached
unprecedentedhigh levels
>Newsourcesof funds have to be investigated as
alternative sourcesof capital
Asa Krnctionofthese points. we are starting to see lary
er gli)ttpsofbanks (clubs)that work together to win bids
and achievefinancialclose.The impact of this isthat a
larger number of individual deal teams need to agree and
come to a consensus. which can delay decisions and
makethe team asa whole lessefficient.
This model can still be used in an efficient way,but this
generallystarts payingbenefits after a few dealshave been
worked through.Bythen, the consortium has found its
preferred financial advisers,tax advisers.financial mod-
elling consultants, engineering consultants. legal firms.
etc, and tolling out a new transaction is kick-started by
building on the experience gained in the previous trans-
actions.
The supported debt model
Oneinitiativethat has recentlybeen tested in the mar-
ket isthe supported debt model (SDM).which hasbeen
developedbased on the credit guarantee finance(CCF)
model pioneered in the UKand is basedon the ftmda-
mental capacityofthe state to raise finance at a lower cost
than the privatesector couldachieve.
lhe SDMassumes that the private sector provides 100%
ofdebt and equity funding throughout construction, but
at the end of construction an element of the debt is refr
nancedwith publicdebt.The newdebt providedby the
state is fil$t-ranking and is sized as a given percentage of
total project costs (typically70%).lhe idea isthat byusing
government-backeddebt the total cost of the project
should fall.increasing the value for money for the public.

3. S21pfi 126 No..ember2008
NewPPPs
Manyactive
banks inthe
sector have
chosen not
to
participate
in the first
roundsof
SDM
structured
deals.
Howit Impacts modelling
lhe implication ofSDMon the financial modelling of PPP
projects includesthe incorporationand analysisof the
additional government-funded debt tranche. The model
has to quanti$' the risks of the bank debt now being treat-
ed assubordinate to the government poltion ofthe debt.
Ranking lower than government-funded debt has been
known to cause issueswith credit committees in local
banks, although we have not yet seen any caseswhere
the committees have not been able to accept the struc-
ture. The credit decision will always be backed by rigor-
ous downside analysis (construction delays,construction
cost blow-out,operator default,operational penalties)and
analysis of sweep mechanics in these scenarios.
Further consideration and care needs to be applied to
the calculation ofdebt service reserve accounts (DSRAs)
and the discounting rates for key project finance ratios
(LLCR,PLCR),when the impact of the SDMneeds to be
considered.
It is still very early days for the new SDMmodel in the
market but already, as with many new controversial ini-
tiatives, many PPPprofessionals have developed strong
and often widely shifting views on the topic.The more
positive PPPprofessionals see SDMas an opportunity to
deliver more value to the public due to the lower cost of
funds of the government-backed debt. A number of
other banks. on the other hand, haveexperienced prob
lems convincing their credit committees that this isnot
simply an arrangement in which what used to be senior
debt is now subordinated to government debt.
lhe conflictingviews on the topic means that many pre-
viously active banks in the sector have chosen not to par-
ticipate in the first rounds of SDMstructured deals and
let others explore the field first. Inevitably, it will take some
time before the market anives at a consensuson this topic,
which Willhopefilllyresult in a more consistent appmach
to pridng and credit structuring issues.It willbe very inter-
esting to see at what level pricing stabilises and whether
that will represent sub or senior pricing.
Financialmodelling of PPPprojects should alwaysuse
the most up-todate financialengineering techniques due
to the extrmely competiüve nature ofthe bids.PPPtmns-
actions are commonly project-managed by debt providers
or financial adviserswhose responsibilityit alsois to devel-
op and maintain the financial models.
lhe outcome ofthe closerelationship between lender-
s' requirements and the financial model is a technically
sophisticatedfieldwhere smart use of financialinstru-
ments and modelling practices optimises bids to a level
un-matched by more traditional transaction sectors.
Optimisation of tax structures to maximise and extract
tax losses,CPI-linkedinstruments, stapled bust structures,
and multi-tranche bond or debt facilities are all common
elements ofa typical PPPmodel. PPPmodelling isan area
where inexperienced modellers will be very challenged
http•j/w•mofie.corn
dueto an enormous flow of information and the extreme
pressure for accuracy and optimisation.
Financiers and advisers are constantly trying to opti-
mise the level of debt in a transaction by ensuring that
the downsideisproperly supported by legalframeworks
and financialcovenants.lhe financialmodel captures the
legal and financial frameworks. giving the deal team a
"structuring tool" with which it can review different
fundingoptions, tax structuringmodels, maintenance
contracts and all other aspects of the project.
This puts a massive focus on flexibility in the model.
Generally, the biggest risk in a typical project financing
ofa commodity projectisthe estimation of reserves(eg,
ore, oil, gas).which gives the whole project a larger ele-
ment of uncertainty.PPPs,on the other hand, are con-
sidered less risky given stable and more predictable
operational cashflows in combination with a well struc-
tured engineering procurement contract (EPC),well bal-
anced ownership stakes and legalframeworks.
The level of accuracy achieved in PPPmodelling is of
the utmost importance. which iswhy it is common to see
modelling ofoperational metrics (delays,penalties, avan-
ability, etc) on a daily basis. This can, if not done well. have
dramatic impliations on the complexityofthe model and
corresponding fees for model audit services.
Atypical PPPmodel audit fee ranges from AS30,OOOto
AS80,000,although in recent casesthere have been finan-
cial model audits in the market where the total fees have
reached AS200,OOCplus,mainly due to the lack of under-
standingofthe underlying processesneeded in the prepa-
ration of the model. One additional issue that commonly
increasesthe fee for the model audit isan unnecessarily
quent delivery ofthe model version to the model audit teanu
lhe credit crisishas not onlyledto more complex struc-
turs. is has actuallyalso resulted in some simplifications
from the modellingpoint ofview.Giventhat the mar-
kets are not currently considered a viable option for fund-
ing. many consortia do not even go through the efforts of
modelling bank debt and bond solution into the model,
which has u•aditionallyalwaysbeen the case.lhe result is
that the modeller can, early on in the process, exclude the
bond optionalityin the model,which
the model structure and makes the work more effective.
Another heavily scrutinised ara of any PPPmodel is
the level of support from liquidated damages in caseof
adverse changes in the timing of construction. The key
question to answer is in its most basicversion whether
the liquidateddamages large enough to keep the proj-
ect out of default and to keep debt whole. but investors
are often also interested in seeing the impact on their
returns (IRRand NPV)in different delay scenarios. Arelat-
ed point of analysisis the impact of earlycompletion,
which in some casesgenerates earlycompletion bonus-
es to contractors and (more importantly for investors) an
earlier start of operational cashflows.