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B.C.'s P3 projects not immune to world financial meltdown
By Jonathan Fowlie and Lori Culbert, Vancouver Sun
January 23, 2009 10:00 PM
It was early in the morning of Dec. 16 when teams of German prosecutors descended on the offices and residences of some of their country’s highest-flying banking executives. The raids were by no means the first sign of trouble, but they served to underscore the gravity of the financial crisis.
Top executives of Germany’s Hypo Real Estate had been insisting they were sheltered from the worsening financial storms — that the worldwide credit crisis had in fact “emphasized the particular strength and sound nature of our business model,” Georg Funke had said at the end of 2007, while still CEO.
But all was not well.
As investors were finding out, a multi-billion-dollar arm of Hypo Real Estate, Depfa Bank, was being suffocated by a lack of cash.
That problem has proved near fatal, dragging the stock of Hypo Real Estate — an international provider of infrastructure finance — down by about $60 per share to just under $3.
But more than just producing an army of irate investors — and sparking an investigation to determine if former members of the bank’s board had intentionally misrepresented the financial health of the company, and whether there was any evidence of insider trading — the continuing problems at Depfa have spread uncertainty around the world, including here in B.C.
As Hypo Real Estate negotiated an $80 billion bailout last year, workers in British Columbia were pressing to finish the Golden Ears Bridge, an $800-million crossing between Langley and Maple Ridge.
While the workers knew the importance of their deadline, what they likely didn’t know was that the financial foundation of the project relied in large part on a bank struggling to stay alive.
Golden Ears is not the only public-private project Depfa is bankrolling in B.C. It is also a partial lender on the $282.5 million Royal Jubilee Hospital being built in Victoria and of Surrey’s new $239 million outpatient hospital.
Provincial officials said this week they remained confident those projects will be unaffected by the crisis, primarily because the contracts remove significant risk from the government and place it on the private consortiums in charge of delivering the projects.
But a review by The Vancouver Sun has shown several of B.C.’s privately financed public infrastructure projects — both those under construction, and those about to begin building — are connected to international lenders facing serious problems due to the world financial meltdown.
With even the smartest economists scratching their heads about the future, an obvious question comes to the fore — are these new, popular P3 (Private Public Partnership) projects truly sheltered from the economic storm?
A Port in the Storm
Since its inception in 2002, Partnerships B.C. — an arm’s length government agency — has overseen 25 infrastructure projects worth $10 billion in capital value. A half dozen are complete, and the rest are either under construction or in the procurement stage -- potentially exposed to the world financial storm.
But many politicians, high-ranking officials and business leaders argue private financing is still the way to build expensive new infrastructure projects in B.C. Critics are less convinced.
Certainly, in better times, the P3 model seemed like a sure thing.
In Australia, the high-flying Macquarie Group was dubbed the “Millionaires Factory” because the company made gobs of money investing in and operating toll roads.
Like so much else in the recent financial crisis, the never-ending growth projections and the success those projections delivered turned sour almost overnight.
About one week after attending a lavish $500,000 office Christmas party in late November, Macquarie’s well-paid staff were shell-shocked to see the company hand pink slips to an estimated 1,000 employees.
Despite the shock, there had been warning signs trouble was looming.
Macquarie, which operates more than 30 roads worldwide, slashed the value of its toll-road portfolio from $10.2 billion to $6.5 billion in the last four months of 2008, according to Australian newspapers.
In a statement, Macquarie blamed “the recessionary environment” and “higher assumed financing costs.”
Like Depfa Bank, Macquarie is involved in infrastructure projects in B.C. — including the upgrades to the Sea-to-Sky Highway.
It is also leading the consortium chosen to twin the Port Mann Bridge and expand Highway 1. Macquarie is struggling to arrange funding for that project and was given an extension by the province, which has insisted the financing should now be secure by February.
But on Friday, Transportation Minister Kevin Falcon was poised to make a sudden, late-day announcement about the Port Mann. Then, 18 minutes before the press conference, it was cancelled with little explanation.
The strange on-again, off-again skirmish may be indicative of the ongoing challenges behind the scenes trying to secure funding for B.C.’s largest privately financed infrastructure project.
NDP finance critic Bruce Ralston showed up at the cancelled event, and said he could only speculate about what was going on.
"One of the areas of speculation is what seems to be on the minister's desk — the financing question,” he said.
Like Falcon, Partnerships B.C. CEO Larry Blain was not commenting Friday.
But in an interview earlier this week, Blain said he was confident funding for the Port Mann would, indeed, be arranged by February — although he added it is conceivable the deal could take until March to finalize.
“We gave one extension to Macquarie because the markets are difficult, banks are doing more due diligence, they are more picky about projects,” he said. “[But] the fact that Macquarie Bank’s stock prices have gone down does not change its commitment to the project.”
Blain won’t reveal from whom Macquarie is trying to secure the money, but trade magazine Project Finance identified four lead financiers who met with two dozen banks last month in an attempt to assemble $2.3 billion in debt that it could lend.
According to international news reports, all four of the lead lenders — BNP Paribas, Caja Madrid, Royal Bank of Scotland, and Societe Generale — have been hit by the credit crunch.
British Prime Minister Gordon Brown recently approved a $525 billion bailout for the Royal Bank of Scotland. He said he was angry it had come to that.
The official reason for the delay in financing for the Port Mann project was credit constraints, but Project Finance magazine reported that “market rumours” suggest some banks were uncomfortable with “the debt’s pricing structure,” meaning they could be looking to renegotiate the terms.
The Truth About Risk
What all this means for projects in B.C. depends on who you ask.
Eric Doherty, a transportation planner, opposed the Port Mann project from the start, fearing it would increase congestion in his East Vancouver neighbourhood as more cars headed to an expanded Highway 1.
Then he became frustrated when he tried to follow the money trail in the financing deal.
“Macquarie’s business model seems to be falling apart, and as a bank they seem to be in real trouble,” said Doherty, a member of the Livable Region Coalition, which staged a protest outside Macquarie’s Vancouver offices on Thursday.
He noted the Sydney Morning Herald reported last week that Macquarie’s toll road project in Brisbane “became the butt of jokes in the finance sector” after it appeared the project may need a bailout.
Doherty wonders what will happen if fewer people than anticipated pay tolls to use the Port Mann expansion.
The final details for toll revenue expectations for the Port Mann are not yet finalized, though Blain insists the province is not exposed to any risk if traffic volume is lower than expected.
It is a different story for the Golden Ears Bridge.
In the final deal for the Golden Ears, TransLink — which now means the provincial government — has agreed to pay the private consortium $316,198 for operation, maintenance and rehab each month once the bridge is open.
TransLink will collect the tolls from bridge users. Should the toll revenue fall short of projections, TransLink remains on the hook for the full monthly payments. That part of the risk remains with the taxpayers.
In the agreement, the government will start paying $500,000 per month in 2009, with payments rising to about $4 million per month in 2011, and then topping out at $4.8 million in 2015.
The payments stay steady at $4.8 million until the contract ends in 2041.
If not enough cars cross the bridge, the government will have to make up the difference, meaning it is shouldering the risk.
Translink spokesman Ken Hardie said Thursday he had confidence in the model.
“You go into this knowing exactly what kind of traffic you can reasonably expect,” he said, adding that the model is essentially the same as the Canada Line’s, which relies on ridership projections to be accurate. (If they’re not, TransLink will have to pay the builder-operator to make up for the revenue shortfall.)
“We’re pretty confident we’re going to do OK,” Hardie said.
With the Port Mann Bridge, some have asked what will happen if the traffic is not as expected.
Will Macquarie turn to Victoria for help? Will it be able to raise tolls until it reaches profitability?
Partnerships B.C. says no.
Blain said there is no volume guarantee, and so the risk lies entirely with the private consortium.
Partnerships B.C. added that tolling will have to comply with provincial guidelines, and that the province will always be responsible for setting the maximum tolls.
While Blain is duly cautious in his account of the financial landscape, he says he remains confident the P3 model — and its ability to shift risk away from the government — can help ensure B.C.’s major projects come in on time and on budget.
But a look around the world suggests that in the new reality — in which several governments have already agreed to billion-dollar bailouts to keep banks from failure — anything is possible.
In Britain, the government this week announced it was cancelling an $8.75 billion plan to widen a series of major highways in time for London’s 2012 Summer Olympics. The Guardian newspaper reported in October the government was struggling to raise private financing for the project because banks were reluctant to lend money.
In Manchester, new financing is being sought for a $1.3-million waste incinerator plant after four banks bailed out of the funding deal in December.
In Florida, officials are investigating whether they can salvage a plan to build a $1 billion Port of Miami tunnel after killing the project in December when the lead financier, Babcock and Brown, began to teeter on the edge of bankruptcy.
Babcock, an Australian-based investment firm, lost 98 per cent of its market value due to the credit crunch, and since Jan. 8 has temporarily halted the trading of its stock while determining how to repay its sizable debt.
A response from Babcock’s creditors is expected this Monday, a company statement says.
The troubled Australian investment firm is the parent company of London-based Babcock & Brown Public Partnerships Ltd., which the B.C. government announced Jan. 12 was an equity partner in one of three consortiums shortlisted to build the $1-billion South Fraser Perimeter Road P3 project.
That isn’t the only project Babcock and Brown was looking to fund in B.C.
Babcock was also initially the equity partner in one of two consortiums short-listed last year to build the $268-million Fort St. John Hospital P3 project. However, Blain told The Sun this week Bilfinger Berger now has joined that project — essentially bailing out Babcock — and many Babcock employees in Vancouver are now working for Bilfinger.
The second consortium bidding for the Fort St. John Hospital includes South African investment bank Investec, which is ensnared in a multi-million-dollar lawsuit that alleges wrongdoing in the selling of shares by an associated company, whose CEO was later murdered, according to a Johannesburg newspaper.
There are problems with consortiums vying to build the South Fraser Perimeter Road as well.
One group includes a Spanish company that needed a loan last year to refinance debt stemming from another road project, and the other involves a Texas company that is a defendant in a $160 million lawsuit alleging fraud in the way a highrise was built.
Blain reiterated that he remained confident, emphasizing the province does extremely thorough checks before finalizing any deal. Plus, he said, all three consortiums bidding on the South Fraser Perimeter Road are “led by very, very strong international developers” who would have been subjected to “extreme financial scrutiny”
When Prime Minister Stephen Harper was in Surrey Jan. 12 to support the South Fraser Perimeter Road, The Vancouver Sun asked if his confidence in P3 projects had been shaken by the credit crisis.
“I would actually say it’s actually the contrary,” Harper replied. “I would say that projects like this, with the involvement of both levels of government and the private sector, are exactly the kind of thing our economy needs, and our private sector and our financial sector needs, to bolster confidence.”
Harper has been touring the country to support “shovel-ready” projects, and next week’s federal budget is expected to include funding for infrastructure as a means to spur on economic growth.
News reports Thursday suggested his government could be considering running deficits of $64 billion over two years to pay for this spending.
Premier Gordon Campbell, Vancouver Mayor Gregor Robertson and Surrey Mayor Dianne Watts were in Ottawa this month looking for chunks of that funding for local projects.
Campbell, who has been a major supporter of P3s, said he also was not concerned about the economic stability of B.C.’s privately funded projects.
“I have no doubt there are additional challenges. But I also believe these are exactly the kinds of projects that financial institutions look for . . . long-term returns that are secure in terms of their support.”
Finance Minister Colin Hansen agreed, though he did leave a window open for flexibility given current markets.
“I think there are both the pluses and minuses in terms of the times that we’re in today, but I think ultimately what we always look at when any of these issues come for a decision is, is there risk transfer?” Hansen said. “It just simply wouldn’t make sense to proceed with a P3 if risk transfer was significantly diminished.”
The fact that a P3 consortium in financial trouble can either refinance a project or lose its stake is the beauty of a P3, said Tim Philpotts, a senior vice-president at Ernst & Young in Vancouver and a director with the Canadian Council For Public Private Partnerships.
“Governments are very protected in these transactions if anything did go wrong,” he said. “I think the government is a lot more secured in these than people might at first think.”
At Partnerships B.C., Blain continued to back the P3 model, but did acknowledge the current credit crunch may require some new approaches.
“Definitely in the marketplace today, the banks have equity constraints and they are not as actively lending as they were before,” he said. “Our view is that we should continue on and be flexible.”
He insists his projects do not present the same kind of risk to taxpayers as the beleaguered and high-profile Vancouver Olympic Village, which is not a P3.
In that project, the City of Vancouver signed a completion guarantee that exposed it to significant risk if the $875-million project ran into trouble — as it did when Fortress Investment, the project lender, backed away from the deal.
To save the project, Vancouver put up an initial $100 million loan, and now is considering a deal to finance the remaining $458 million.
In a P3, Blain said those problems would never have touched the government, or the taxpayer. Instead, the consortium would be faced with a simple choice: refinance the project on its own and shoulder the associated costs, or lose its stake in the entire deal.
Others are more cautious about P3s.
Thomas Ross, a senior associate dean at the University of B.C. with an extensive knowledge of P3 projects, said the current economic crisis — and the higher cost of borrowing that accompanies it — should spark a rethinking of how big public projects are financed.
“What’s kind of happened is a concern for some existing deals that might come unravelled because everybody thought the banks that were lending the money were fine, and now it turns out the banks that were lending the money aren’t fine,” he said, citing the Port Mann Bridge as a possible example.
“It may be that some of them are difficult to finance in these times, and it may be that the only people that can really borrow are governments, and so we go back to the more traditional model of procurement until financial markets settle down.”
Ross, who Blain has described as being “in the middle on the issue,” made it clear he thinks this is not a flaw in the P3 model, and that he is optimistic an improvement in the markets will return P3s to being the leading way to finance many large projects.
The NDP’s Ralston wonders how the P3 model will affect the future of government spending, pointing out that P3 deals usually entail 30 or more years of government payments after the project has been built. “It commits a government long-term in a way that is very difficult to foresee at a time when economists are saying, ‘I can’t tell you what’s going to happen next year.”
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