INVESTMENTS IN WATERPPPs and Public Investment

Thursday, December 10th

Daniel BouskelaEugene Chao

Molly WhitehouseSterling Wilson

Agenda

• Introduction: Need for Infrastructure, Spectrum of Funding Options

• PPP model• How does it work?• How have they performed? How do they price?• Pros / cons

• Public funding mechanism• How does it work?• A Philadelphia Example• Pros / cons

• Conclusion

The Need for New Infrastructure Funding

Water infrastructure investments are badly needed

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Public Funding PPPs Private Funding (not approached in this ppt)

# of water systems (in the US)¹

Source: ¹EPA

1,343 (6%)10,800 (~44%) 12,145 (~50%)

Description Contractual agreements between public and private sector, in general with private capital and private operation.

Water systems held completely by private companies. In general, in smaller municipalities

What are the possible funding structures for water infrastructure?

State or local government issues debt, which it uses to fund the design, construction, and operations of the facility.

Funding Sources

Several models of agreements can be drawn to invest in infrastructure

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Spectrum of Public vs. Private Involvement

Water investments are essential in most of the world. With lack of capital to invest, governments have been adopting new forms of investing.

• According to the WHO/UNICEF, 32 % of the world’s population – 2.4 billion people – lack improved sanitation facilities.

• 663 million people still used unimproved drinking water sources in 2015

Name of Presenter 7

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• Public debt has reached one of the highest levels in the history

• Governments are adopting other mechanisms to invest in water infrastructure

PPPs are

Overview of a PPP

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• Government designs the project

• Auction is set to find potential interested partners

• Partners invest / operate the contract

• Partners recover investment through service fees paid by the public or the government.

“In an infrastructure-intensive sector, improving access and service quality to meet the SDGs cannot be done without massive investments. Around the developing world, the water sector appears chronically under-funded and inefficent.   In this context, Public-private partnerships (PPPs) can be viewed as one of the tools (among others) available to governments for improving the performance and financial sustainability of the water sector. “ World Bank

PPPs - Public Private Partnerships

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Gov. Offtaker

Infrastructure Service

Revenue

Construction Contractor (EPC)

Senior Debt

Shareholder Equity

Water Infrastructure Asset SPV

Free Cashflow

Residual Cashflow

Proceeds from Commitments

Management Service Provider

Feedstock/Fuel Supplier

O&M Services Provider

Insurer

Payments to Service Providers Services

Asset Construction

1. http://www.eib.org/epec/resources/epec-capital-markets.pdf2. “How Banks Price Loans to Public-Private Partnerships:Evidence from the European Markets,” Journal of Applied Corporate Finance, Vol. 19, No. 4, Fall 2007.

Project Finance: Typical PPP Financing Structure

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▪ From 1990-2013, the ten-year cumulative default rate for PPP/PFI was 3.9%, compared to overall project finance (6.4%).2

▪ In the event of a default, 10-year cumulative recovery rates for PPP average 81.5%, slightly higher than project finance overall (80.3).2

▪ Moody’s default and recovery rates imply that for a $100 million project, an average loss over 10 years would be $3.18 million.

▪ Transactions de-risk over time, with regular amortization, cash sweeps, reserve accounts, and “lock box” formats as typical features of the asset class.

▪ Moody’s tracks 5,308 project finance loans, 1,293 of which they designate as PPP/PFI.

Historically, PPP/PFIs have been uncorrelated with other major markets, exhibiting low volatility while generating inflation-linked cash returns.1

1. “Default and Recovery Rates for Project Finance Bank Loans, 1983-2013,” Moody’s Investors Service, (2015).2. Figures are based on the Basel II definition of default, which incorporates a higher number of defaults than the Moody’s definition of default. “Default and Recovery Rates for Project Finance Bank Loans, 1983-2013,” Moody’

s Investors Service, (2015). Implied losses calculated by multiplying defaults by losses (i.e. 1 minus recovery).3. Calculated based on data provided in “Default and Recovery Rates for Project Finance Bank Loans, 1983-2013,” Moody’s Investors Service, (2015), Exhibit 11.4. For project finance default rates: “Default and Recovery Rates for Project Finance Bank Loans, 1983-2013,” Moody’s Investors Service, (2015), Exhibit 11. According to Moody’s, the initial three year period of elevated

marginal default rates is strongly linked to construction phase risk and/or the commencement and ramp-up of operations. For corporate default rates: Moody’s Special Comment, "Corporate Default and Recovery Rates,1920-2011,” (2012), Exhibit 34, “Average Cumulative Issuer-Weighted Global Default Rates by Letter Rating, 1983-2014”.

Marginal Annual Defaults According to Moody’sMarginal annual default rates are broadly stable for the initial 4 years post financial close, overlapping with an approximate 3-4 year development and construction period, and decline thereafter to marginal annual default rates consistent with those of corporate issuers in the Baa ratings category or better.

Defaults & Recovery

Project Finance Loans Weighted Average Spread (bps)1

1. Compiled from database queries in Thomson ONE Banker.2. “How Banks Price Loans to Public-Private Partnerships:Evidence from the European Markets,” Journal of Applied Corporate Finance, Vol. 19, No. 4, Fall 2007.

As in Many Things, Coupons are Cyclical

LIBOR 1996-Today

1. http://www.eib.org/epec/resources/publications/epec_market_update_2013_en.pdf

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The Size of the Market in Europe

Costs & Benefits of the PPP Structure

Benefits

Harness private sector expertise & efficiency● Risk mitigation

Government bears risks that might be unpalatable or too expensive in the private market.

○ E.g. guarantees of debt / debt service reserves, exchange rates, ability to convert local currency, offtake purchaser obligations, tariff collection, a minimum level of demand for services…

● Efficiency Private investors are more efficient, e.g. by keeping down construction and operating costs and delays, which is believed to more than offset the cost of risk-pricing by private financiers.

● Low necessity of public funding ○ The government does not incur debt

○ Costs either born by end-user or taxpayer, depending on the government’s goals

+ - Drawbacks / Criticisms

Higher cost, lower service● Hides government debt

By transferring costs to private sector in favor of an ongoing payment agreement and sometime certain government guarantees, some accuse that it hides government debt.

● Undermines servicesThe private sector has financial incentives, which sometimes conflict with the whole public interest, and won’t be addressed (e.g. in a huge draught, private sector wouldn’t be happy if had to invest in extra infrastructure).

● More expensive Private sector will, in theory, demand a higher ROI.

● Government still needs to control (insure water quality and access)

The Perception of Public Sector in Financing Water Infrastructure in the United States

A well designed infrastructure investments can raise economic growth, productivity, and land values, while also providing significant positive spillovers to areas such as economic development, energy efficiency, public health and manufacturing. …..………..…The Department of the Treasury with the Council of Economic Advisers October 11, 2010

Operators

Public Sector

Tools for Public Financing Water Infrastructure in the United States

Grants

Loans

EPA Environmental Finance Program

Information Access

Fees & Special Charges

Bonds

Subsidies

Grants from federal, state, and/or local sources, often disbursed on the basis of a competitive, merit-based process, are one source of funding. Ex: USDA rural business enterprise grants, EPA Drinking Water State Revolving Fund

Short or long-term commercial loans, typically with fixed interest payments.Ex: Water Infrastructure Finance and Innovation Act (WIFIA),Clean Water State Revolving Fund (CWSRF)

Subsidies to an operator to cover operating losses (which may include interest on debt financed projects) are another funding source. Ex: Interest Rate Subsidies

Electronic services Ex: Catalogue of Federal Domestic Assistance (CFDA) and Grants.gov

The program provides leveraged financial outreach services through advisory board (EFAB), finance center (EFC), and information network (EFIN). Ex: EFC is a system of 9 university-based centers to provide the public and private sector with training and educational, technical, and analytic assistance on environmental finance.

The price pays as remuneration for services or financial charges for activities undertaken.Ex: Connection fees, Septic system inspection fees, water and wastewater utility user fees

A bond is a written promise to repay borrowed money on a definite schedule, and usually at a fixed rate of interest for the life of the bond.Ex: Advance Refunding Bonds, Anticipation Notes, Special Tax Bonds

Source: U.S. EPA Guidebook of Financing Tools: Paying for Environmental System, August 2008

Water Infrastructure Finance and Innovation Act (WIFIA)

WIFIA could provide credit assistance to large water infrastructure projects that otherwise have difficulty obtaining financing.

WIFIA would access funds from the U.S. Treasury at Treasury rates, the mechanism is able to lower the cost of capital for borrowers.

WIFIA assistance would have much less of a federal budgetary effect than conventional project grants that are not repaid, because only the subsidy cost of a loan (representing the presumed default rate on loans) would be scored. Thus, if only an average 10% subsidy cost is charged against budget authority, a $20 million budgetary allocation theoretically supports $200 million in loans.

To be eligible for assistance, projects must be determined to be creditworthy with a revenue stream for repayment, thus limiting the federal government’s exposure to default and also encouraging private capital investment.

The WIFIA concept is modeled the Transportation Infrastructure Finance and Innovation Act (TIFIA) program. WIFIA may include the following benefits:

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Source: Water Infrastructure Financing: WIFIA Program, Congressional Research Service, August, 2015

U.S. Treasury

WIFIA

Water Projects State Revolving Loan Funds

Principal Interest

The Structure of WIFIA

Clean Water State Revolving Fund (CWSRF)

CWSRF authorized by the Clean Water Act, provides low-cost financial assistance for planning, design, and construction of wastewater infrastructure. Eligible applicants include cities, counties, districts, river authorities, public bodies, and private entities proposing nonpoint source or estuary management projects. Enhance Infrastructure System

✓ Treatment• Projects to install or upgrade facilities to improve drinking water quality to comply with SDWA regulations

✓ Transmission and distribution• Rehabilitation, replacement, or installation of pipes to improve water pressure to safe levels or to prevent

contamination caused by leaky or broken pipes✓ Source

• Rehabilitation of wells or development of eligible sources to replace contaminated sources✓ Storage

• Installation or upgrade of finished water storage tanks to prevent microbiological contamination from entering the distribution system

✓ Consolidation• Interconnecting two or more water systems

✓ Creation of new systems• Construct a new system to serve homes with contaminated individual wells• Consolidate existing systems into a new regional water system

Source: U.S. EPA Drinking Water State Revolving Fund (DWSRF)

- provide the largest capital assistance today

The Structure of Public Finance- Bonds

➢ A Bond is an agreement in which an issuer is required to repay to the investor the amount borrowed plus interest over a specific period of time.

➢ A Bond is a debt instrument issued by governments, corporations and other entities in order to finance projects or activities.

Principal borrowed by government from the investor.

Principal and Interest returned to the investor

Principal

Interest

Government/ Bond Issuer Investor/ Bond Buyer

Philadelphia: Funding & Pricing Regimes

Philadelphia Facts

Source: Wikipedia

PWD Facts

Source: PWD

PWD History

Source: PWD

PWD Operations

Source: PWD

PWD Progressive Solutions: CSO

Source: PWD, Phila.gov

PWD: Combined Sewer Overflow (CSO)

Source: EPA

PWD: Green Stormwater Infrastructure

Green City, Clean Waters

Source: PWD Website, Interview with PWD staffer, Erin Williams

PWD: Green Stormwater Infrastructure

Source: Commons Images

PWD Regressive Pricing

Source: PWD

PWD Regressive Pricing

Source: PWD

PWD Financing

Source: Treasury.gov, Alpha Publications

PWD Financing

Source: Treasury.gov, Alpha Publications

Agenda

• Introduction: Need for Infrastructure, Spectrum of Funding Options

• PPP model• How does it work?• How have they performed? How do they price?• Pros / cons

• Public funding mechanism• How does it work?• A Philadelphia Example• Pros / cons

• Conclusion

Conclusion and Takeaways

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Government should dedicate to prioritizing infrastructure needs, creating a streamlined investment process and a competitive arena to galvanize investors’ creativity and innovation.

Government should devote to maximizing efficiency gains and mobilizing private capital.

Environmental planning, funding and financing decision has to be made before EIS reviews.

Unnecessary restrictions given by BAB, etc should be unlocked. Otherwise, receiving public funding will be a less desirable option and may cause unnecessary delay on projects.

Water pricing calculation should internalize administrative cost, link with inflation, and provide saving incentives.

It is hard to directly compare whether PPP is better than Public Finance or the other because it varies. But, Leadership and Governance are equally important and indispensable for all infrastructure project.

Questions?

We (may have) answers!

Thank you for your time and attention.

-Daniel, Eugene, Molly, Sterling

Appendix

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Where can I get the money? Should we try PPP or wait for federal financial support? It’s grab a coffee first.

Time is money. It’s all about efficiency gains. Return of Skill. Return of Speed. Return of Fund Size. Return of Impact Investing

Public Sector

Private Sector

The Efficiency and Project Delivery Process

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Source: The World Bank Public-Private Partnerships Reference Guide: Version 2.0

How PPPs can help infrastructure delivery process

The power of private sector

U.S. EPA Guidebook of Financing Tools: Paying for Environmental System, August 2008

Appendix

Key Decision-Makers Goal-setting Funding/Financing Decision Criteria

Public Sector

GovernmentFederal State Municipal/Regional

❑ Maximizing public benefits❑ Minimizing negative

externalities ❑ Risk of project default

Political level • Funding availability • Pricing• Public benefits (economic

impacts) justify investment • Project size/ risk profile• Public support• Financing capacity and ability

to attract grants

Administrative level• Budget/funding availability • Necessary approval (EIS,

Procurement process)• Political power• Pricing and regulatory policy

Public Water Operations ❑ Achieving mandated public policy objectives

Access to funding

Private Sector

Private Water Operations ❑ Profitability ❑ Other investment

opportunity (network expansion)

• ROI • Risk profile• Optimal capital structure • Shareholder support

Shareholders/ Capital Markets

❑ ROI (Share prices, dividends)

• Consistence with portfolio landscape

• Resistance to macroeconomic risk

Lenders/Banks/Bond Market ❑ Return on loans • Creditworthiness to borrower • Securing risks• Resources to assets in

default risk

Suppliers ❑ Business growth❑ Profitability

• New business where margins can be generated

• Risks associate with revenue stream

Contract durations vary considerably – from 3 years (management) to 20 years (delegation contract)

Name of Presenter 53

Works Cited

Bibliography

Bibliography

http://www.eib.org/epec/g2g/annex/1-project-finance/

PWD: Sources