At the mid-way point of 2011, the Australian PPP market saw close on three deals worth A$3.5 billion ($3.57 billion) – the Single Living Environment and Accommodation Precinct programme, the Royal Adelaide Hospital and the Gold Coast Rapid Transit Project – with a rosy future predicted, thanks to a billion-dollar project pipeline.

At the mid-way point of 2012, however, the market is subdued. A major PPP has yet to close (the last was Plenary Health’s A$1 billion ($1.02 billion) Victorian Comprehensive Cancer Centre in December 2011) and most activity is on the secondary market, where Bilfinger Berger Global Infrastructure bought into the Victoria Prisons concession and Plenary pulled in an A$139.2 million ($142.3 million) equity investment from Caisse de dépôt et placement du Québec in five existing PPPs.

Perhaps the biggest news of the year so far, though, was the collapse of the project company for the A$237 million ($242 million) Ararat prison, which has raised fresh concerns about risk allocation in PPPs. Ararat is meant to be a landmark deal; procured by the government of Victoria as the state’s first social infrastructure PPP. Aegis Correctional Partnership (whose equity investors are Bilfinger Berger Project Investments and Commonwealth Bank of Australia (CBA) won the contract in 2010 for the 350-bed medium-security facility under a design, build, finance and maintain model.

The facilities management contractor for the project was Programmed Facility Management, while the construction contractors were St Hilliers Construction and Hawkins Construction. Earlier this year, though, St Hilliers Construction, a subsidiary of St Hilliers Group, and its holding company for its share of the contract, St Hilliers Ararat, were placed into voluntary administration. Despite extensive negotiations, work halted in May and the AEGIS project company entered into voluntary administration, too.

Prison terms

St Hilliers placed the subsidiaries into administration after they were unable to meet their obligations under the contract. Equity investors, banks and the state failed to reach a definitive agreement for the extra funding necessary to meet cost overruns. Bilfinger said it would take a Eu15 million ($19 million) write-down on its equity investment, while the state agreed to pay the rest of the contractors to complete the project for a fixed fee.

The collapse illustrated some of the dangers to project lenders of Australia’s overheating construction sector. The costs of developing Australian PPPs remain steep and profit margins are tight and contractors are often forced to assume more construction, weather and labour risk. In this case, the contractor ran into significant cost and time overruns because, according to reports, hundreds of doors, windows and steel components for Ararat had been ordered to the wrong size.

Ararat is not the sole PPP to face difficulty, either. Reliance Rail PPP has struggled for years with delays to the delivery of its trains, not to mention the downfall of the two monolines guaranteeing its debt, and was downgraded, resulting in government intervention. Industrial action and weather problems also delayed the construction of the Victorian desalination plant, and the opening of the Brisbane Airport Link road was delayed by nearly a month to July 27, resulting in fines of A$1 million ($1.02 million) per day for the contractor Theiss John Holland.

Robust enough?

Mark Birrell, chairman of Infrastructure Partnerships Australia (IPA), believes that the private sector response to Ararat must be “to overcome such building difficulties and get the project finished”. “The PPP model has worked properly but the broader lesson is to keep in mind the strength of each participant in a consortium,” he claims. “When there is not a strong flow of work, it is small or mid-sized contractors that can be tested. The project pipeline – including for PPPs – is thinner than it was, so that affects the cash flow of companies and can put some under financial pressure. The Australian market will certainly get through this though, as our fundamentals are very good.”

The swift intervention of the Victoria government shows that authorities remain committed to helping troubled PPPs, which should reassure debt and equity investors. The New South Wales state government moved to restructure Reliance Rail by pledging A$175 million ($178.9 million) in contingent support to the project company and potentially acquiring all the equity in the company, thus allowing the project to draw on A$357 million ($365 million) in committed bank financing.

The NSW government has recently established a new body called Transport for NSW to revamp the safety and design systems for its rail infrastructure, to attract more private investors and avoid similar problems. Despite its experience with Reliance Rail, the state looks like procuring at least part (rolling stock and rail infrastructure) of the North-West Rail link project as a design-build-finance-maintain concession.

Swati Dave, executive general manager in NAB’s global specialised finance team says: “There has been a greater propensity for governments to evolve the PPP model, such as taking on more market risk – which they didn’t do before the global financial crisis – as well as look at new ways of developing projects. This is encouraging for private sector participants.”

Milka McNamara, head of infrastructure at CBA, adds that some state governments are considering paying down a significant portion of the debt financing once a project has been constructed, amid concerns around the cost of bank debt funding. The Queensland government did this once construction was completed on a school PPP package that it procured – 2009's South East Queensland Schools.

“From the governments’ perspective, this gets around the perceived issue of still paying a high price for the debt during the least risky period of the project’s life – the operations phase. Some governments have also elected to contribute to the funding upfront, such as on the Gold Coast Rapid Transit Project,” adds McNamara.

Setting sales

Political considerations have also played part in the slowdown in PPP. States have seen changes in government, which have delayed the procurement of projects as new administrations come in, with New South Wales, Queensland, the Australian Capital Territory, Northern Territory and Western Australia all holding elections between 2011 and 2013. The federal administration is also making changes.

“The federal government severely tightened its belt in the 2012/13 Budget, so there is less public funding available for projects,” comments IPA’s Birrell. “This has slowed down the tendering and procurement process. In addition, most state governments are scaling back infrastructure spending too as they reach the maximum level of debt they want to take on for projects.”

Birrell points out that governments are actively looking for other sources of capital, including by privatising key energy and infrastructure assets. This year has seen the largest privatisation ever in New South Wales; the A$2.3 billion ($2.35 billion) lease of the Sydney Water’s Kurnell desalination plant, awarded to the Ontario Teachers’ Pension Plan Board and two Hastings-managed infrastructure funds, Utilities Trust of Australia and the Infrastructure Fund, under a 50-year concession.

The winning sponsors closed a A$1.6 billion club deal in support of the Kurnell acquisition in early June. The debt, for special purpose company SDP FinCo, comprises an A$800 million three-year tranche, a A$800 million five-year tranche and a A$40 million three-year revolver. 
The club includes ANZ, NAB and Westpac with A$193 million each; Export Development Canada and Royal Bank of Canada with A$180 million each; Commonwealth Bank of Australia, HSBC and SMBC with A$160 million each; BTMU with A$105 million; Credit Agricole with A$90 million and Morgan Stanley with A$25 million.

Other assets across Australia earmarked for sale include the ports of Kembala and Botany, the electricity generators in Sydney, and the generational and grid operations in Queensland. Governments could raise A$32 billion ($32.7 billion) from the sale of such state utilities and assets over the next few years, much of which will be ploughed into additional transport and social infrastructure, including PPPs. The revenue from the sales will fund government contributions to stalled PPP projects, as well as move on proposals such as North East Link in Melbourne, the M4, M5 or F2 and Convention and Exhibition Centre in Sydney and Cross River Rail in Brisbane.

There are a small number of greenfield PPP projects in progress, such as the A$1 billion ($1.02 billion) Darling Harbour convention, exhibition and entertainment precinct, for which consortiums Destination Sydney and VeNuSW are bidding, as well as the expressions of interest in the A$500 million ($11.5 million) Airds Bradbury social housing scheme in New South Wales. “Within the Australian PPP market there are number of social infrastructure PPP’s, including plans for hospitals and roads, which is encouraging, but we would like to see a deeper pipeline,” says NAB’s Dave.

The limited number of deals currently out to market means the short-term outlook is indifferent. The pipeline includes the Bendigo hospital PPP, which has shortlisted two consortiums, Intecare (Laing/Thiess/RBS) and Exemplar (Capella/Lend Lease/Siemens/ Spotless), and the Eastern Goldfields Prison Redevelopment, which shortlisted three bidders, Assure Partners, the Aurum Partnership, and EG PathWays.

“There are not many PPP projects coming to market and this means that banks will want to get involved but, although some of the projects are not that big, so may not attract many bidders,” one investment banker observes, “this will concentrate competition for financings as there are not that many deals, so may drive down pricing.”

Refining refinancing

A battle between banks for the handful of funding mandates is not going to meet the most stubborn complaint about Australian lenders – that they refuse to offer long-term debt. Outside of greenfield financings, the existing generation of PPPs suffers from a mismatch between the duration of concessions and debt tenors on offer. Coping with looming maturities may create some new opportunities.

“Post the global financial crisis, Australian PPPs have been principally bank debt-funded,” explains McNamara. “The main issue for PPPs remains lack of tenor for the financings. Markets such as the UK are used to tenors matching the duration of the concession but that has not been the case in Australia, which means refinancing becomes a key project risk. To date that risk has been dealt with in a number of ways, including sharing of the risk between equity, debt and government.”

Dave says there is now a lot of focus on PPP refinancings, specifically the viability of bonds, which are attractive to insurance and pension funds and offer longer tenors. “There are deals that are likely to look towards the capital markets to provide longer tenors post-completion, so we expect to see more bond issues to be completed in the future,” she continues. “That said, a pure bond PPP would require developments in the market. This requires banks to work with institutional investors to enable a deeper bond market.”

An increase in bond deals would be good news for international banks. The domestic players do not have the capacity to underwrite a slew of large bonds and the Australian capital markets are not yet advanced enough. “Australia does not have a well-developed domestic bond market for specialised assets such as PPPs that offer longer tenors than bank debt, and which can help overcome refinance risk,” McNamara concedes. “The liquidity needed for a number of the larger PPPs and privatisations will be beyond the reach of the domestic banks alone, so international banks will be important. Whilst a number of European banks have pulled back from the Australian project finance market, that gap has been filled by Canadian and Japanese banks.”

Japanese and Canadian banks have followed clients to Australia, enjoy higher liquidity levels, and have been aggressive in pricing, though they have usually declined to beat the tenors on offer from local banks. They have also started to edge out more-established international players in local financing mandates. In the years up to 2008, European banks, particularly for availability-based deals, had been prepared to go far beyond domestic tenors. “Foreign banks have always been active in the domestic market but what we are seeing is a change in the composition of banks targeting Australia,” Dave says. “The region remains a short tenor market, and the changing composition of banks is not impacting this to any great extent.”

This is a boost for foreign entrants, and potentially sponsors, as greater competition could help ease pricing, which is expected to become more generous to lenders once the Basel III capital adequacy rules are in place. Even so, a fully-developed long-term PPP financing market is some way off and, in late June, infrastructure and transport minister Anthony Albanese demanded radical reforms to financing infrastructure as part of the Infrastructure Finance and Funding Reform report, including measures to slash the costs of bidding for PPPs, as well as overall project costs.

Australia has enjoyed a successful era of PPP development, though until recently projects with demand risk threw up some notable failures. However, with short-tenors, refinancing risk and state initiatives to boost the sector, the public and private sectors are aware that PPP needs to take the next step in its evolution.