THE COVID-19 pandemic is leaving a long trail in its wake, including how infrastructure projects are financed.
Catherine Doyle, a partner at Blake Cassels & Graydon LLP in Toronto, sees infrastructure projects as falling into two categories: transactions and projects that closed before the pandemic became widely known and projects within the closing stage or in procurement during COVID that may still be in procurement or have recently closed.
“For those already closed or under construction when the pandemic hit, there are a few things” to consider, says Doyle. “Whether the pandemic has caused construction delays . . . is top of mind for funders, and how sponsors of those projects are managing those delays is very important to funders.”
Second, she says, the additional time to complete projects and increased financing costs due to construction delays “are important questions that financiers are looking at with respect to all of the projects in their portfolios right now.”
Many existing infrastructure projects now need the project sponsor to request relief from the lender if COVID-19 is causing delays, she adds, which means increased requests for waivers and for some relief under existing finance covenants.
“The question is who’s paying for any increased cost? And the lenders’ view is always [that] it’s not them,” she says. Supply chains may be disrupted, key pieces of equipment may be unavailable and projects coming into service later than expected means that the project is not generating cash flow, which lenders look to in order to service their own loans.
For transactions in the market now and looking for funding, where those are public facilities — roads, bridges, hospitals, courthouses — and projects are being built in the public interest, both lender and equity sponsors are actively seeking relief from their public-sector counterparties, says Doyle. That relief can take a variety of forms, she adds: It can provide for the government to make up the missing cash flows in terms of debt service or construction where COVID has in fact caused a delay.
Governments are prepared to open their pockets and to spend money in the public interest, and the burden should not be left on the private sector and proponents of projects, she adds, ”because the private sector does not control either whether a pandemic is announced by the government or how and to what extent that pandemic is controlled. Those are public-sector responsibilities.”
In June, Prime Minister Justin Trudeau announced that the federal government would be offering cities an advanced transfer of $2.2 billion in infrastructure money to help cover COVID-19-prompted budgetary shortfalls. And governments in all jurisdictions across Canada are working through how to address impacts on existing projects and future ones, says Samantha Cunliffe, a partner at McCarthy Tétrault LLP in Vancouver.
“Each jurisdiction is taking a unique approach and working through it in real time with the interested parties as they’re figuring out what the effects are and as they continue to evolve,” she says.
“But from a financing perspective, it seems that, across the board in pretty much all jurisdictions, the COVID-19 relief that’s being offered will at the very least protect the lenders’ interests . . . the principal and interest repayment to the lenders, which should ensure continued finance ability for infrastructure projects.”
We are still in the early days of the COVID-19 pandemic, says Morgan Troke, a partner at McCarthy Tétrault’s Vancouver office, and people are still focused on the effects on the ground. While social infrastructure has been important over the past decade, the pandemic has highlighted other sectors, such as fibre-optic and broadband projects, as business is now more reliant on virtual connecting.
“What we’ve seen on all projects is collaboration between private and public sectors in getting them done,” says Troke.
“The project agreements that govern these projects . . . didn’t contemplate the pandemic, so there was no force majeure-style relief; that would have fallen to private developers. But what we’ve found is that public-sector agencies have an interest in projects being completed. We’ve seen developers and the public sector coming to the table.”
Although the government’s focus has been on the health-care sector, with significant upgrades to hospitals, Greg Southam also sees financing moving to broadband. Indeed, Infrastructure Canada, in announcing its support for rural communities during COVID-19, has identified “bringing broadband to all communities” as a priority.
Governments and the public “also see infrastructure spend as one way out of this, to get people back to work, to get money back into the system,” says Southam, a partner at Davies Ward Phillips & Vineberg LLP in Toronto.
“We’ve done a lot in the last 15 years, but we’re making up for 60 lost years; we had two generations that spent nothing on infrastructure,” he says. Following the push after the Second World War, from 1960 on to 2000, there was not much done, and “we’re [still] battling from behind; we have been for 20 years. The needs for the country have changed, too,” including the need for broadband.
Financing projects and shifting models
Cunliffe observes a shift in the delivery model for P3 projects, with an increasing number of projects being procured as design-build-
finance, or DBF projects, rather than design-build- finance-maintain, or DBFM projects. DBF projects have a shorter tenure of around three to five years and are financed by short-term debt that’s repaid at the completion of construction, she says. By comparison, DBFM projects are typically 30-year projects often financed with both short-term debt but also long-term debt and equity that’s repaid over the 30-year life of the project.
Once construction is completed and the project goes into the operation phase, the private-sector developer will do the maintenance, operation and system repair of the hospital or other facility over a period of 30 years. In the DBF model, the private-sector developer completes the project and then hands it back to the public sector.
“As we’ve seen more procuring agencies using the shorter[-term] model, we’ve seen more financing via bank debt rather than bonds and life insurance company investments,” says Cunliffe. “It seems to be a bit of a regional preference; so some provinces, i.e., British Columbia, appear to prefer the shorter-term partnerships — the DBF — whereas other provinces, such as Ontario, remain committed to delivering certain of their projects with longer-term concessions” — the 30-year project term.
Southam predicts that, in the current situation, refinancing mechanisms, although not often used on Canadian deals, may be used in project documentation. “You might see the public sector access the refinancing provisions that exist in the project documents in order to avail themselves after things have stabilized [to] where we were a year ago. That’s a possibility.”
For Doyle, the continuing low-interest-rate environment “has put a significant focus on long-term financing, because long-term rates have been low, so projects have been refinanced to take advantage of long-term rates.” In the wake of COVID-19, however, the credit spread pricing has increased, she says. While the lender’s cost of funds has gone down, the credit premium that the market puts on debt right now, simply because of the uncertainty, has meant that money is not as cheap as it should be.
But from a risk appetite perspective, there continues to be a high demand from lenders for investing in infrastructure projects and a continuing view that Canadian infrastructure projects are a safe, recession-proof investment, Cunliffe says.
“We’ve got a whole whack of dry power on the sidelines; there’s more money than there’s projects,” says Southam. To manage this and the increased interest in broadband development, he says, the Canada Infrastructure Bank can play a centralizing role in bringing provinces and municipalities together to develop community infrastructure.
“I’m really excited about what the Canada Infrastructure Bank will do,” he adds. “Michael Sabia just became chairman of its board, and he has a long history of getting things done in this country.”
And although Canada has been “very reluctant” to take on revenue-based, user-pay models, there will likely need to be a bit of a mix of user pay/availability, says Southam. Projects in Canada to date, for the most part, have been availability payment or payment for performance, a fee structure often used in public-private partnerships in which the public agency makes payments under the relevant agreement to the private-sector party once the project or facility is made available for use.
The United States and other larger players in the market have both availability payment and revenue-based projects. Often, the revenue-based model is used in transit projects such as roads, Southam notes, pointing to the successful model of southern Ontario’s Highway 407, a toll road.
“We need to have more education on the benefits of that model,” he says. “I do think the pathway forward is going to be needing to either have more revenue-based projects or hybrids of revenue-based with availability payment all worked into one type of project.
“I think that’s going to open up other types of asset classes [such as public utilities] and, frankly, other types of participants in the industry to help with the financing of these [projects].”