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Financial Structuring and Assessment for Public-Private Partnerships: A Primer

October 1, 2012

DRAFT
FOR REVIEW BY P3 EVALUATION TOOLKIT BETA-TESTERS

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Chapter 4 - Sources of Public Sector Financing

Public sector participation in the initial funding of P3 projects could involve capital grants funded from current revenues using the pay-as-you-go approach or by bond issuance. The public sector may also provide subsidized loans, loan guarantees or tax advantages to the concessionaire. These are further discussed below.

Bonds

Public agencies and private firms can both issue bonds to finance a project. Public agencies may issue tax-exempt municipal bonds which may be paid back using general revenues or a dedicated revenue stream such as project tolls. Private firms may also issue bonds that can be paid back through corporate revenues or, in project finance, dedicated project revenues. A common financial instrument that private firms use in P3s is Private Activity Bonds (PABs).  PABs allow a private firm to issue tax-exempt project finance bonds for public infrastructure projects.  

The interest rates that must be paid on bonds are determined by market demand. That demand is heavily influenced by the  credit ratings of the underlying debt as determined by rating agencies (if the bond will be repaid through project revenues) or by the issuing government’s credit history and financial circumstances. Rating agencies evaluate a wide variety of potential risks associated with the bond issuer and the project’s projected costs and revenues before applying a credit rating. Table 4-1 shows the range of "investment grade" credit ratings assigned by the three major rating agencies. (Bonds rated below these grades are considered "junk" bonds).

Table 4-1. Investment-grade Ratings
Standard & Poor’s Moody’s Fitch
AAA Aaa AAA
AA+ Aa1 AA+
AA Aa2 AA
AA- Aa3 AA-
A+ A1 A+
A A2 A
A- A3 A-
BBB+ Baa1 BBB+
BBB Baa2 BBB
BBB- Baa3 BBB-

Figure 4-1 shows an example of how different credit ratings and maturities may influence the interest rates, or yields, demanded by the market. Typically, the longer the term and the lower the credit rating, the higher the interest rate demanded by the market.

Figure 4-1

Figure 4-1. Illustrative Tax-Exempt Yield Curves (Interest Costs)

Municipal Bonds

Funding from bonds may be used by a public agency to provide a capital investment subsidy to a concessionaire. Bonds issued by State or local governments are termed "municipal" bonds. Bond investors are often willing to accept lower interest rates on municipal bonds because they are generally exempt from Federal income taxes as well as from most State and local taxes in the state of issuance.

There are many different kinds of municipal bonds that can be issued to help finance transportation projects including general obligation bonds, revenue bonds, and grant anticipation notes. With Federal Grant Anticipation Revenue Vehicle (GARVEE) bonds, future Federal funds are used to repay the debt and related financing costs under the provisions of Section 122 of Title 23, U.S. Code.  GARVEEs can be issued by a State, a political subdivision of a State, or a public authority.

Tax-Exempt Private Activity Bonds

A concessionaire can use private activity bonds (PABs) issued by a public sector conduit. PAB allocations are made by the Secretary of the U.S. DOT and allow State and local governments to issue tax-exempt bonds on behalf of P3 infrastructure projects. Since they are typically backed by project revenue only, they are financially riskier than municipal bonds backed by broad-based taxes – if a project fails to produce sufficient revenues, bond holders may not get paid. Therefore, they typically receive much lower ratings from rating agencies than general obligation municipal bonds do.    

Prior to the 2007-2008 financial crisis, financial guarantees, sometimes called monoline insurance, could be purchased to make the issuance of project revenue bonds more attractive to buyers as well as to borrowers (who benefited from lower interest rates on the resulting higher rated debt). The collapse of the bond insurance market has made it more difficult to finance projects through project revenue bonds.

Loans

Loans are rated using the same credit rating scales as bonds. The key difference between loans and bonds is that bonds are tradable instruments (i.e., they can be sold in a secondary market) and have more liquidity than loans. Liquidity reduces the interest rate required by bondholders. Bonds offer advantages over loans such as greater capacity and longer terms. However, bonds can be less flexible instruments than loans especially with regard to drawdown of debt and repayment schedules. Loans may be drawn down according to funding needs during construction. Also, it is easier to match debt service with the profile of the project revenue stream, especially for toll-based revenue streams.  

Federal Loans through the TIFIA Program

In recent years, several P3 projects in the U.S. have been supported by loans from the Transportation Infrastructure Finance and Innovation Act (TIFIA) program. The TIFIA program can issue long-term "subordinate" loans to revenue-financed projects of national significance. The "subordinate" position with regard to "senior" debt means that the TIFIA debt service will be paid only if sufficient cash is available after senior debt service has been paid. TIFIA loans are also particularly attractive for infrastructure financing because they offer:

  • Below market interest rates, which depend on the rate on U.S. treasury debt, but are always below rates offered by private lenders;
  • Long grace period before loan repayments start, i.e., payments may be delayed until five years after project completion;
  • An very long maturity (i.e., term of the loan) that could go up to 35 years; and
  • Flexible payment schedule, i.e., payments may be adjusted according to the ability to pay depending on a project’s projected cash flows.

Federal Section 129 Loans

Section 129 loans allow States to use regular Federal-aid highway apportionments to fund loans to projects (both toll and non-toll) which can be paid back with dedicated revenue streams. Because loan repayments can be delayed until five years after project completion, this mechanism provides flexibility during the ramp-up period of a new toll facility.

Loans from Public Infrastructure Banks

State Infrastructure Banks (SIBs) authorized under Federal law enable States to use their Federal-aid apportionments to establish a revolving fund that can offer low-cost loans and other credit assistance to help finance highway and transit projects, including P3 projects. Some states also have non-Federal SIB accounts that are funded entirely from non-Federal sources.

 

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