Canada’s best negotiators needed to ensure Public Infrastructure Bank doesn't replicate Ontario's $7 billion Samsung “fiasco”

Do you ever find yourself on the wrong side of an issue?

As global institutional investors from around the globe met yesterday in Toronto to discuss Canada’s proposed Public Infrastructure Bank, I find myself in that very situation.  Some of the brightest minds in Canada, not to mention our savvy and experienced Minister of Finance, see the Infrastructure “Bank” as the overwhelmingly obvious solution to repair Canada’s infrastructure deficit.  I’ve read much of what has been reported in the media on the topic, and I don’t feel any the wiser.  Sadly, the key questions appear to going unasked by the DTM, other than Paul Wells perhaps, despite all of the real estate that’s been dedicated to reporting on the topic. 

The argument “for” the McKinsey-recommended Infrastructure Bank scheme is simple, by the sounds of it.

Canada has immediate infrastructure needs that exceed the capacity of domestic government budgets.  As I understand the primary details, a $15 billion contribution by the Government of Canada is going to attract, say, $40-$60 billion of heretofore unavailable institutional investment capital.  This is, we are advised, the key attraction of the concept.  All told, the “Bank” will be capitalized with $75 billion with a focus on projects of at least $100 million in size.  Airports and ports are just two examples of high profile assets on the list of suitable investment targets.  For every Loonie the Feds invest, others will put up (maybe) three or four bucks.  Sounds sweet, right? 

Several dubious Mayors have pushed back on the entire concept, rightly pointing out that i) the Liberals made no mention of privatizing Canada’s roads, bridges and airports during the 2015 election, and ii) municipalities don’t want to have to pay the private sector to provide a public asset that was expected for to come for “free” following the new Liberal government’s promise of massive increases to infrastructure investment.

Let’s give Mr. Morneau the benefit of the doubt on whether or not the Government has the moral authority to pursue this “Bank” proposal.  The NDP are looking for an issue, and privatizing core public assets can be their angle to get back into the political game.  I’m one of those who believes that the government shouldn’t be in a business that can be better performed by the private sector.  As a political staffer in the 80s and 90s, I watched John McDermid and Greg Ebel manage the privatization of a host of then-public entities, including: Air Canada, Canadair, CN, Petro-Canada, etc.  None of which should have been owned by the Crown, and I’d be surprised if any political party would recommend that Canada get back into those industries today.

But don’t confuse privatizing an airline or rail company – an operating business entity – with a municipal water tower or the Quebec Port Authority. One benefits from being managed for profit, while the other essentially exists to benefit the local public good in a way which is divorced from economic profit in the traditional sense.  If an airline raises its prices and generates an outsized profit, a new competitor will enter the fray.  If I own the only water tower in your community, what are you going to do if I raise prices beyond your tolerance level: stop drinking tap water?

As probably the only person to Chair two Federal agencies with experience in P3 projects (PortsToronto & the WDBA), I’ve actually seen things from the inside.  I actually executed a P3 Project Agreement that came to pass without a single dollar from any level of government.  Through those two roles, I had the opportunity to meet with institutional infrastructure investors, construction companies, bankers, municipal politicians, union reps, the media….  One learns plenty by doing. 

Unlike anyone in the Liberal caucus or the media covering the topic, a couple of us have actually had ultimate fiduciary responsibility as the RFQ and RFP process played out on a real-live Federal P3 project; more than once, in fact.

That’s why the details of the Infrastructure Bank scheme fascinate me: how exactly will this “Bank” work?  What will it do that Canada can’t achieve otherwise?  Where will the line be drawn between private profit and public good?  How long will it take for the CP’s Access to Information requests on the topic to be processed (that’s an inside joke)?  Will the Canadian taxpayer be subsidizing the investment returns of foreign sovereign wealth funds?  Let’s start with the last question, given yesterday’s unprecedented meeting.

We do not yet know what the economic incentives will be to attract foreign capital to the “Bank”, but perhaps the Federal Venture Capital Action Plan structure provides some insight into how this could play out.

Under the VCAP structure, taxpayers are believed to take the “first loss” that arises under that $1.2 billion investment pool. Federal taxpayers contributed 33% of the money to the VCAP pools, while institutional investors and pension plans (such as CDP, CPPIB, Manulife, OPB, SunLife and so forth) provided the remaining 67%.  By agreeing to take the first loss, at least as the rumour mill goes, these pension plans and other financial institutions don’t lose a penny until the first $400 million (the government’s 33%) of the various investment funds (ie. the taxpayer’s contribution) has been blown. 

Whether Mr. Morneau’s Infrastructure Bank goes this route, or provides some other form of return enhancement (if any) to these foreign investment pools is unknown, at least to the public at this stage. But you can only image how weak Canada’s negotiating position is, having convened a meeting yesterday involving the PM himself to press the case to “invest in Canada”, without nailing down the fine points first.

The very idea that Canada needs to provide return enhancements to the Abu Dhabi Investment Authority, Blackrock, the Kuwaiti Investment Authority or CalPERS will confuse some, myself included.  If global investors are desperate for stable, long term, revenue-producing assets, one would assume that Canada doesn’t need to even advertise that it is open for business, let alone guarantee their investment profits.  And that’s before the recent U.S. election. 

More curious is Canada’s apparent need to attract foreign capital of any kind for attractive domestic infrastructure projects, whether or not the taxpayer has to provide a “first loss” type of safety net.  It wasn’t that long ago that Canadian pension plans were being touted as global leaders on the Davos cocktail circuit.

Between AimCo, BCIMC, CDP, CPPIB, OMERS, OTPPB and PSP, these seven local pension plans are sitting on at least $900 billion of capital to invest. If only 10% of that cash was allocated to an infrastructure strategy, this would amount to $90 billion for the very Canadian highways, bridges and airports that are allegedly going unfinanced but for the McKinsey Public Infrastructure Bank.  And that’s just from those seven domestic investment pools. 

Canada has 2,000 pension plans of various shapes and sizes. All of whom face the same investment dilemma as the rest of us, each and every day.  Finding attractive investments with the right risk/return profile.  If infrastructure investments can generate 7-10% net returns, they’ll be only too happy to send their respective cheques.

An academic will tell you that attracting foreign capital to local P3s should lower the cost of capital that is applied to these projects; but that theory doesn’t hold water if foreign sovereign wealth funds require a sweetener to commit capital to the Infrastructure Bank in the first place.

Another confusion surrounds the actual investment targets of this Infrastructure Bank scheme.

Canadian airports are mentioned in media reports, but Pearson, Dorval, Calgary and Vancouver have already spent tens of billions on their beautiful terminal upgrades thanks to passenger Airport Improvement Fees (AIF) and bond issuances.  If the GTAA needs a new terminal wing or a runway resurfaced, the $25 you already pay to depart that airport should be sufficient to finance the new capex. 

Taxpayers will soon want to know what they have to gain from selling Pearson to a Mark Wiseman Blackrock fund, for example.  The Liberal government would receive a one-time lump sum of, say $10 or $15 billion, and that would appeal to a team running a $30 billion deficit.  The trade-off is that in exchange for that lump sum, travellers will continue to pay their current $25 AIF, plus another $7.50 (?) per trip to cover the profit and debt servicing on Blackrock’s purchase price.  

In perpetuity, indexed for inflation plus. On an asset that is already world class.  If Pearson is already well run, it’s not clear why we should follow that path. 

Let’s consider assets that don’t already exist.  If you’re the Chief Planner of Toronto or Montreal, and a Federal Cabinet Minister says they’re going to invest more money in public infrastructure, you’re invariably going to say: “sign us up.”

But the devil’s in the details. The Kuwaiti Investment Authority isn’t going to plow money into your roads or transit infrastructure for free, no matter how convincing our PM was yesterday.  And that’s where the disconnect is going to arise between Jennifer Keesmaat’s Tweet-love of the concept and the reality of global infrastructure investing.

How will the Infrastructure Bank fund Toronto’s proposed Downtown Relief Line, for example? It’s the perfect example of a dearly-needed municipal infrastructure project that is currently unfunded.

Let’s say the construction cost is $5 billion, and the Infrastructure Bank agrees to fund the project as a 30 year Public-Private Partnership (or P3).  I would assume the bank would front the $5 billion (using 90% debt, 10% equity) under an availability payment model; the Windsor-Detroit Bridge Authority is planning to utilize an availability payment for the Gordie Howe Bridge, for example, and we used the same structure to finance the Billy Bishop P3 Pedestrian Tunnel, as well; over a 19-year period in the latter case. 

What that means is that the TTC would agree to pay the Infrastructure Bank, say, $50 million per annum in profit (assuming a 9.3% IRR), plus another $292.7 million per year in principal and interest payments to cover the debt (assuming the proponent borrowed 90% of the total cost at a low 5% interest rate for 30 years). And that $342.7 million annual P3 payment doesn’t include any operating costs and new rolling stock, which would be in addition to money the McKinsey Bank needs just to finance the hard asset.  The TTC would have to model 114.2 million additional trips/year at $3/passenger just to pay Mr. Morneau’s Bank; of interest, the TTC might expect 540 million riders in 2016.

The math isn’t very complicated, even if the Project Agreement will be over 2,000 pages in length.

As the total TTC operating budget runs around $1.2 billion, you can see the challenge of finding an additional $343 million per year, plus the staff and rolling stock needed to service the DRL. “Trudeau touts Canada as safe option for infrastructure investment” makes for a great headline, but I’m worried that folks think this Infrastructure Bank is a free lunch.  It won’t be, of that I am sure.

And, as we saw with the Metrolinx UPexpress, there’s often a flaw in the “build it and they will come” strategy, as I warned some years ago.  One can already imagine the complaint from Toronto Councillor Gord Perks and his pal, MP Adam Vaughan: “If only the Feds would increase the subsidy for transit, we could afford to pay Mr. Morneau’s Infrastructure Bank for the Downtown Relief Line.”  That’s far easier than finding another 115 million TTC passengers to cover the P3 availability payment.  Since the DRL is designed primarily to shift passengers off an overcrowded line, rather than serve new customers, you can imagine the challenges to the entire P3 DRL business case.  Which is likely why UPexpress wasn’t a P3 project.

The folks protesting yesterday’s P3 conference may not even yet appreciate that the DRL would require Availability Payments to the Infrastructure Bank of $10.2 billion over a 30 period – just to offload the initial $5 billion construction bill.  As for the benefit of bringing cost overrun and delivery date discipline to the project, I can share more on that urban myth another time.

Under that Perks/Vaughan Scenario, the Feds would be covering the TTC’s incremental revenue shortfall on a project where Canadian taxpayers were, in essence, also guaranteeing Kuwait’s 9.3% IRR for 30 years via the Infrastructure Bank. If you find that a touch circular, you’re not alone. 

A similar thing happened with the $550 million taxpayer-funded UPexpress, when the Toronto Star successfully lobbied Metrolinx for deeply discounted rates for Pearson Airport workers prior to the project’s completion – although in that case passenger utilization never got above 12% before the fare was dramatically cut — well below the point where taxpayers were earning a return on their investment.  Fare-cutting won’t be possible when foreign investors are involved in a DRL, for example.  The Availability Payment is sacrosanct, and that’s a good thing.

If the DRL project seems too hard a nut to crack, one has to ask what’s the point of Mr. Morneau’s proposal if Toronto’s toughest infrastructure need won’t fit “the box.”  For argument’s sake, let’s pick a smaller project, such as a bridge upgrade in West Vancouver. 

That type of P3 undertaking would likely require a toll, which doesn’t bother me a bit (see prior post “Bring on the toll roads” Sept. 20-07).  Canadians are a bit erratic when it comes to where and when we’ll pay user fees; certainly roads and maintenance-intense bridges are perfect candidates for such approaches, even if politicians say we shouldn’t pay twice for existing infrastructure.

The Bank P3 proponent would agree, say, to spend $800 million to modernize the bridge in exchange for the right to charge a toll for perhaps the next 20 years (I’m assuming no further ongoing capex for simplicity sake).  In this case, because there are other bridges to use, the proponent would be taking “traffic risk”, which would require a higher IRR than the availability payment infrastructure model.  In this example, perhaps an IRR of 10.9% would work.  There would be less debt too, given the higher risk involved.  Maybe 80/20 debt-to-equity in this example.  The higher the proportion of equity, the higher the traffic toll needed to pay the Bank its’ just desserts.

Over 20 years, the Infrastructure Bank would receive $400 million in revenue on its initial $160 million equity capital investment.  The project lenders would require $55.8 million per annum to finance the project, with an implied 6% interest rate.  All told, 103,800 folks from West Van would need to pay $2/trip (rising with inflation) every day over the course of the year for the P3 Proponent to earn its required return and service/retire the debt.  Given the cost of an average home in West Van, I suppose $2 seems like chump change; particularly when a Hudson River bridge toll runs something like $5.75 per trip.  That said, the day will soon have to come when Mr. Morneau tells the people of West Van that this proposed Bank is going to require tolls if they want the Lion’s Gate Bridge (for example) to benefit from its talents.

Nothing is free in life, particularly when infrastructure investors are involved.  The B.C. government’s recent experience with the $3.3 billion Port Mann P3 Bridge proposal is a cautionary tale.

It is cliché to say that the devil is in the details, but unless someone has already figured all of this stuff out, it strikes me that the Liberal government has rushed this proposal to market.  I’m all for Public-Private Partnerships, but now that the career-enhancing photo op is over, I hope Canada’s best negotiators are tasked to turn the Minister’s vision into a reality that won’t soon look like Dalton McGuinty’s $7 billion Samsung Green Energy “fiasco.”

MRM