Are Canada’s financial markets adequate for infrastructure project needs?
Fuelled by a sharp rise in the number of big-ticket civil-infrastructure projects, some people have started asking whether Canada’s financial markets have the capacity to absorb the glut coming down the pipe. If not, the big question is, what happens next?
“What you’re seeing is the emergence of large-scale civil infrastructure projects as a dominant focus in the market,” says Chris Bennett, who leads the project finance team at Osler, Hoskin & Harcourt LLP in Toronto. “The level of activity has been intense.
“I speak to a number of senior counsel in this space fairly regularly and consensus is the first part of this year has probably been the busiest we have ever seen the infrastructure bidding market. The amount of capital required for these projects – the sheer size of them – is unparalleled in the Canadian market in the past.”
The $11.5 billion in deals that passed through procurement in a single four-week period earlier this year provides a telling snapshot, he says. These include the $5.3-billion Eglinton Crosstown LRT project in Toronto, the $1.2-billion Regina Bypass project and Montréal’s new Champlain Bridge project, which is estimated at as much as $5 billion.
As Canada’s aging infrastructure starts to crumble, highways, bridges, overpasses and tunnels across the country have to be rebuilt. At the same time many cities are finding their aging transit systems and transportation routes buckling under the sheer volume of people using them, which means they have to be upgraded or replaced as well.
Transportation and transit infrastructure is much more expensive than building social infrastructure such as hospitals, courts and schools, which has been the province’s focus over the last decade. The numbers can be eye watering. Projects already in the pipeline include monster tickets such as the Greater Toronto area’s $13-billion Regional Express Rail, the $5-billion Southwest Calgary Ring Road and the $3-billion George Massey Tunnel Replacement in BC.
The vast majority are being done as Public-Private Partnerships, or P3s, with governments offloading construction and operation onto the private sector.
Bennett says one challenge to market capacity is that governments have not traditionally worked together to stagger the projects and coordinate the timing of close. Multiple big-ticket projects strain the market “in the sense you’re typically looking at broadly marketed bond-financing solutions for deals of this size.
“The sizing of the projects, the amount of senior debt required, is something we haven’t seen before. And on top of that you’ve got multiple projects going to market within the same window of time. That raises some new issues.”
One already being tested is how underwriters working to market the bonds attached to a specific project will be affected by other projects simultaneously competing for large amounts of capital.
“I think it could affect pricing more than anything else. The reality is these are highly rated investments, and in my experience there tends to be a lot of investor appetite for them, so I don’t believe there are going to be project failures because there’s insufficient capital in the markets.
“But if you’re concerned about domestic capacity you can always look south of the border. If things continue at this rate, it wouldn’t surprise me at all if you saw people looking in first instance to the US and, if that trend continues, possibly other markets.”
Greg Lewis, a partner at Bull, Housser & Tupper LLP in Vancouver, says while they’re not seeing deals in Western Canada being marketed in the US, they are seeing a growing interest in marketing to Asian investors.
“I know Japan and South Korea have an interest and some companies from Asia are interested in participating in North American P3s. There have been events in Tokyo with North American participants coming over and talking about the P3 model, explaining it.
“The big Japanese and Korean conglomerates I think are quite interested in doing business in North America and P3 is a fairly attractive investment. While it’s not risk-free, it’s probably a reasonable return for the level of risk.”
He says one interesting question is whether the hammering that oil prices have taken, and the effect on the larger economy, will stall any of the big-ticket infrastructure projects — especially in Western Canada.
“I wouldn’t be surprised to see the P3 deal flow dropping off in Alberta and Saskatchewan, and slowing slightly in BC. The drop in government revenue is making governments pause and consider all of their spending, at least in the short term.”
Canada’s top 100 infrastructure projects in 2015 represent a healthy $157 billion in total investment, according to ReNew Canada, an infrastructure magazine that tracks projects by cost.
Bidders in each case have to have committed financing and keep it in place during the selection process. They are generally required to set aside the funds for anywhere from two to four months, and occasionally even six, says Guy David, a partner in the Ottawa office of Gowling Lafleur Henderson LLP.
“If you’ve got a $5-billion project and three bidders, you need to find $15 billion of financial capacity in the market to support that project. If you’ve got three projects that size then you’re looking at $45 billion in funds being committed. If they’re all happening around the same time that may pose a challenge.”
Ehren Cory, divisional president of project delivery at Infrastructure Ontario, says Ottawa and the provinces have formed a working group to tackle exactly these kinds of issues.
Cory, who previously led the infrastructure and public-sector practices at McKinsey & Company, says there have been “good discussions” recently about the implications of so many projects hitting the market at the same time.
“One of our big topics lately has been about the staging of construction, it’s something industry has been talking about a lot more. Right now we’re comparing notes – when is your project coming, and hmm, those feel really close together. The next step for us will be to start thinking about more coordinated scheduling, making sure there’s a bit of space in the market to make sure they don’t all hit at once. So there is that kind of conversation starting to happen.
“There’s a realization on our side, as owners, that we have to think about how this pipeline of projects – this wave of transportation projects in particular – are coming down the pipe.”
The long-term trend in financing costs for infrastructure projects has been in a steady decline since the 2008 financial crisis, partly because the debt is priced as a spread over Government of Canada bonds, whose yields have been declining as well.
As lenders around the world become more comfortable with large P3 infrastructure projects, which are only about 15 years old, the traditional financing structure of 90 per cent debt and 10 per cent equity has given way to more like 93 per cent debt and 7 per cent equity. Equity is the more expensive piece of financing, so that’s helping drive down costs as well.
When it comes to raising money, the European banks have been much less active in Canada’s P3 market than they were before the financial crisis. But the Canadian market has had no trouble picking up the slack and digesting the financing levels required, says Nick Williams, a partner in the infrastructure group at Davies Ward Phillips & Vineberg LLP.
Williams says he’d be surprised to see large Canadian infrastructure deals actively marketed and sold in the US, at least in the near term.
“There’s a huge appetite for this kind of debt just amongst the Canadian institutional investors — the lifecos, pension funds and some of the other investment funds. Obviously, when you start marketing the deal in the US you’ve then got to comply with various US securities-law requirements, and it complicates the deal. I just don’t think there’s been the need. Could that change with something like the Champlain Bridge, which has a larger debt requirement? Possibly.”
If anything, says Williams, the larger size of the massive new transportation- and transit-related projects should attract new sources of capital on the equity side.
“On a $1-billion project, which was a large PPP project in Canada, you’d probably have been looking at $100 million of equity split a couple of ways, which is not a big cheque. The work involved in that is probably not going to attract a lot of attention from the large pension funds.
“If you’ve got a much larger project with a much larger equity component dollar-wise, that may attract some of the larger pension funds. And other institutional investors may decide this is more interesting. There are certainly sovereign wealth funds I’ve talked to over the years that will come in and say, ‘We’re looking to invest in infrastructure but our minimum deal size is a $250 million.’ These projects tend not to be large enough to warrant that sort of investment.
“The big pension funds, the OMERS, Teachers, the Caisse, CPPIB, have also tended to stay away from the smaller P3s. They’ve been doing more direct investing in infrastructure — they can go and purchase and own a larger infrastructure asset rather than putting $50 million into a P3. But when you get to a larger size, if it’s a big enough ticket, I think it could certainly be more attractive to them.”