October 1, 2012
FOR REVIEW BY P3 EVALUATION TOOLKIT BETA-TESTERS
Public agencies pursue P3s for a variety of reasons, including sharing of risk with the private sector, access to private capital, reduced upfront costs, accelerated project delivery, design innovation and improved levels of service. However, P3s -- like traditional projects -- require revenue in order to be delivered. "Project finance" is a specific type of financing used for P3s through which an expected future revenue stream generated from a project or committed to a project by a public agency is the primary means for repaying the upfront investment a concessionaire makes to fund it.
In the project development phase, financial assessment helps establish whether or not a P3 project is affordable to the government. Initially, the public agency attempts to determine the bidder’s costs, financing structure and other assumptions, in order to determine whether the amount of public subsidies, toll revenue or availability payments required are likely to be acceptable from the public agency’s point of view.
In the bidding phase, financial assessment is used by the public agency to review the bidder’s financing and the impacts on public agency contributions. For P3s involving availability payments, a financial model is used to calculate the availability payment required to cover capital and operating expenditures, debt service and return on investment. After financial close, the financial model continues to be used to price payments to the concessionaire required by the contract due to variations from base assumptions, and to calculate any refinancing gain to be shared between the public agency and the concessionaire.
The financial model attempts to address the public agency’s constraints with regard to the term of the P3 contract and the amount of public funding available throughout the life of the P3 contract. It addresses lenders’ requirements for debt, such as interest rates and term, "cash-flow tail" and the required "coverage" ratio of cash flows available to repay debt relative to the amount of debt (both principal and interest) to be repaid throughout the life of the debt. It also addresses the required return on investors’ equity. Finally, the model accounts for taxes and other expenditures in calculating cash flows available for debt service.
While accessing private capital to finance transportation projects may help a public agency deliver needed transportation projects, it does not come without cost. As with any financing, the capital generated from private finance must be paid back with future revenue. P3 agreements often involve the commitment of a long-term revenue stream to pay back lenders and private investors. Private lenders and investors typically demand a higher rate of return than investors in tax-exempt municipal bonds. Therefore, the cost of project financing through P3s is generally greater than that of public financing. Public agencies must carefully analyze these and other tradeoffs when deciding whether to pursue private financing of transportation projects. A Value for Money analysis can assist in the decision.