All About the Leverage

One of the principal reasons, I think, to integrate an impact tranche into a larger Alternative infrastructure financing is to achieve some leverage on the social and environmental impact of the project. Each aspect of impact might be individually small (relative to project size), but the aggregate potential value, in comparison to an impact tranche that is also small (relative to project size) might achieve decent results.

I did some rough (and highly hypothetical) numbers on this, really to start to get a sense of scale. The Excel model is in the Download menu — sans goal-seek macros and not at all user-friendly anyway. But the on-open results in the impact tabs illustrate the ‘aggregate and leverage’ idea.

EIB Risk Allocation?

From what I’ve seen so far, the few and highly-publicized environmental impact bonds (EIBs) completed recently really allocate most risks to the funding source (the issuer), not the investor. When the press release smoke clears, the EIBs are pretty much high-credit quality loans with a lot of interesting packaging.

Below is a chart I sketched out for another project that shows where they might fit on a spectrum of various types of ESG project capital types. The EIBs are all in the upper left quadrant — in contrast to investors who take real risk on unproven green tech (lower right) or even project finance non-recourse lenders in renewable energy deals (in the middle).

To be fair, EIBs are still very much in the small bench prototype stage. At the least they need to get a lot of bigger. Since publicity value doesn’t really increase with size, they’ll need to develop more substantive features (something that larger size also makes more worthwhile). My guess is that their development path will lead to about the middle of risk allocation — in effect, a kind of specialized project finance — which is not a bad market precedent.

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2018 Federal P3 Conference

I was involved (behind the scenes) in developing a panel for the Federal P3 Conference here in Washington a few days ago. The theme was ‘deconstructing’ and ‘demystifying’ P3s — the real focus was to prompt a discussion on the New Alternative Framework. Which, after playing to a full house, is what happened.

Extended Accrual

The prior post outlined the concept of a ‘ramp’ to achieve full cost recovery for infrastructure that relies on regulated rates. At the core of the ‘slow and certain’ approach is very long-term debt that can accrue in the early years (strictly in accordance with a plan) but is cost-effective overall.

In effect, that means a private placement with a pension fund or insurance company — or, sometimes even better, a loan from a federal infrastructure loan program that offers concessionary rates. Not quite available as yet though — what would the extent of required legislative changes? Perhaps small and technical enough to happen?

Maybe. The following is a short thought-experiment about what changes would be required for Cost Recovery Ramp financing to be sourced from a water loan program.

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Cost Recovery Ramp

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When you’ve kicked the can on asset maintenance and replacement for many years in order to keep rates low, how do you dig your way out of the hole before the system really starts to implode? (yes, I know — mixed metaphor — but the images just go together so well…)

What you can’t do (as matter of political feasibility, economic efficiency and basic fairness) is just spring higher rates on everybody. But if you do it slowly, won’t that lead into can-kicking temptation all over again — while things get increasingly worse?

I think the answer has to be in a combination of (1) getting the real-world work done as quickly and efficiently as possible, (2) telling people they’ll be eventually paying for it, so get ready, and (3) and enforcing the commitment with the necessity to repay very-slowly (but relentlessly) amortizing debt.

A Subtle Tax Impact

Here’s a short summary of an analysis I did recently on the potential impact of a federal infrastructure loan program on federal revenues due to the displacement of other forms of financing. Very preliminary — more like a “thought experiment with some numbers” at this point — but the results show that the impact might be worth further research if loan programs become (as I think they will) a larger part of the infrastructure solution.

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A New Alternative Framework

Here’s a ‘cut to the chase’ version of the evolving functional approach to P3s discussed in the previous post.

One of the most important things that the New Alternative Framework clarifies is highlighted in Concept 4: Ownership and equity Alternatives are not really necessary for most basic infrastructure deferred maintenance and delayed investment projects. The focus should be on construction, O&M and debt financing Alternatives.

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A Focus on (Actual) Function

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A project I’m doing for the Water Infrastructure Resiliency and Finance Center (WIRFC) at the US EPA involves developing a learning module for ‘P3s’. Not incredibly exciting in itself, but I’m thinking of it as an opportunity to start demystifying the topic using Value for Funding principles — by definition, an effective learning tool cannot be mysterious.
Here’s where I’ve got to so far:

Half the mystery in P3 land is the lack of clear definitions in the terms used – not the least of which is the (over-exposed) handle ‘P3’ itself.

More fundamentally, all P3 concepts can be unpacked and anchored in some clear function associated with the infrastructure project. The functional parts of an infrastructure project aren’t mysterious, especially to the public sector folks who deal with this stuff all the time. I think there’s four big categories:

  1. You have to build it.
  2. Then you have to operate and maintain it.
  3. Almost all larger projects will need debt financing to spread out the capital cost.
  4. And someone has to own it. For public infrastructure, this functional category is rarely considered since the owner is almost always the ‘public sector’. But that changes when a P3 is being considered – and it’s where most of the cognitive dissonance arises.

Each of the four functional categories have a ‘Traditional’ and an ‘Alternative’ approach. The Alternative approaches might be new to the US public sector, but mainly they’re pretty well established in the private sector or elsewhere – so again, no mystery.

Finally, this framework supports a clear and easy way to define the elusive ‘P3’ – regardless of whether a ‘partnership’ is actually involved, a ‘P3’ really mean some combination of two or more Alternative approaches.

All this – and more – summarized in the presentation above.