Highways Financing Structure and SourcesArticles > Highways Financing Structure and Sources
Countries in the developed world are faced with high maintenance cost of aging transportation highways and replacing them in the face of budget deficits and cuts are no longer automatic options. Further, funds for transport highways have to compete with compelling priorities. In developing and growing economies, the demand made on highways with the growth in motor vehicles and accompanying economic growth have ensured the insatiable demand for better, safer, less congested highways and increase in personal travel. Growth in commerce also imposes growing demands on the highway network.
Traditionally given the public goods nature of highways the financing structure and sources of finance are closely related to the role of government. Many of these attempt to minimize risk to the government. These are discussed briefly below:
- Toll financing
- Equity financing
- Subordinated loans
- Senior commercial bank loans and debt securities
- Institutional investors/highway investment funds
- Initial Public Offerings (IPO)
- Asset securitization
- The portfolio approach
- Pinpoint equity with indexed highway bond issues
- The option concept
- Value capture
Advantages and Disadvantages of Toll Financing:
The advantages and disadvantages of toll financing of highways as compared to financing from other sources such as fuel taxes or fiscal instruments depend on the nature of the economy. Toll highways are predominant in Northern Europe, North America, and Australia. The decision of whether to toll a particular highway or not is important where traffic levels are relatively low or generated traffic has yet to be realized in the immediate future. The decision should be justified by economic and financial analyses since the perceived objectives (e.g., raising additional revenue, fairness in terms of the user-pays principle, optimal pricing and resource allocation) are seldom achieved. Also, the costs of establishing a toll system, the collection costs, and the diversion of tolls by collectors can be high. For example, the case studies and other evidence indicate that additional construction costs can range between 2 to 8% of initial costs and that operating expenses can range between 5 to 20% of toll revenue, depending on whether an open or closed tolling system is employed.
Toll highways in France has resulted in increased construction costs of about 10% and increased operating cost equal to 10 to 12% of revenues, which are considered comparable or lower than the collection costs and economic distortions of alternative revenue sources. Tolls have not resulted in misallocation of traffic between toll highways and parallel untolled highways. An estimated 6 to 7% of potential toll highway users diverted to parallel routes as a result of tolls. The economic costs of raising revenue by tolling in Vietnam suggest (including capital costs, collection costs, leakage and traffic diversion/suppression cost) should be lower than the cost of raising revenue by alternative means, and these economic costs should not be higher than 15 to 20% in the case of captive traffic. Leakage in one African country led to the introduction of a fuel tax because the collection rate through tolls was only 60%.
It is relatively easy to attract domestic capital of both debt and equity for smaller projects, if the capital cost is less than $100 million. Moreover, it is very beneficial for a toll highway project to obtain domestic financing to avoid the exchange rate risk between local currency toll revenues and foreign currency debt. However, in many countries, local capital markets are not sufficiently developed to provide the long-term capital required for toll highway projects. The financial crisis in the late 1990s in Asia followed by the recession has worsened the situation.
Malaysia has been successful in domestic financing of the North– South Expressway, a mega-project which cost a total capital cost of $3.192 billion. Out of this $755 million (25% of the total capital cost) comprised of shareholders’ equity and convertible preference shares issued to the contractors, industrial groups, and institutional investors in Malaysia. The project was financed entirely on domestic markets; a generous government-support package and the capacity of domestic institutional investors, to take large preference share issues, played an important role in the successful equity financing of the project.
Thailand’s Second Stage Expressway (SSE) and China’s Guangzhou –Shenzhen Super Highway involved foreign equity and debt financing. Good project structure attracts foreign equity and foreign commercial bank loans. Although both of these projects faced serious problems, the SSE structure was backed up by the equity participation of the Asian Development Bank (ADB), major commercial banks in Thailand, and the Royal Property Bureau of Thailand, together with revenue sharing with the First Stage Expressway. The Guangzhou –Shenzhen Super Highway Project secured a firm repayment guarantee of bank loans by GITIC and obtained a government support provision including the acquisition of all necessary and at no cost and commercial development rights at interchanges.
Another important issue is the treatment of equity in a contractor-driven project in which the contractor tends to limit the amount of equity, and to sell down its equity as much and as early as possible after the completion of construction. Lenders generally limit such actions in the loan agreement with the concessionaire, but it is always an issue as to how much equity should be injected in the beginning and how long and to what extent the concessionaire should hold it.
There are two important roles for subordinated loans:
- to fill the gap between the equity and the senior loans in the original finance structure, and
- to provide stand-by financial support in case of revenue shortfalls and cost overruns.
They may address to the difficulty of procuring equity (due to equity’s slowness in recouping the investment through dividend payments) by providing astable cash payment stream with a higher interest rate than senior debts from the beginning years of the project. Because of the subordinate nature of repayment to senior debts, second to the equity injection, government’s support and sponsors’ support in the form of subordinated loans should be more acceptable to the senior debt providers than ordinary loans. This approach, while common, should be applied carefully since an excessive use of subordinated loans may considerably increase the capital costs and impair the sponsor’s commitment to the project.
Senior Commercial Bank Loans and Debt Securities:
Procurement of long-term bank loans for a privately financed toll highway projects is a critical issue in developing and transitioning economies. The longest tenure that a toll highway project company to recoup the investment, whereas in many developed countries such as in the United States and United Kingdom, the tenure of commercial bank loans may extend to 15 to 30 years, i.e., matching the concession period.
To address this issue, various measures have been implemented in toll highway projects in developing countries. A straightforward, but difficult solution is to have a sufficiently sound contract structure with a hedge mechanism for foreign exchange risk to attract long-term off-shore debts. Alternative solutions that have been tried include:
- long-term loans of government controlled banks,
- shareholders loans from an off-shore parent company that raises funds on off-shore capital markets,
- domestic bond issues underwritten by government controlled institutional investors,
- credit enhancement with respect to domestic fundraising and direct loans from donor agencies,
- securitization of existing toll highways, and
- credit enhancement through revenue sharing with existing facilities.
There are many examples where the approaches set out above have been successfully applied. Indonesia used long-term loans of government-controlled banks in many of their toll highway projects. China has used shareholder loans from an off-shore parent company that raises funds on off-shore capital market, as well as asset securitization of existing toll highways. The North–South Expressway in Malaysia and the M1/M15 in Hungary adopted domestic bond issues underwritten by government controlled institutional investors. The M1/M15 and M5, the Linha Amarela in Brazil, and the Cali –Candelaria –Florida toll highway in Colombia have adopted credit enhancement of domestic fundraising and direct loans from donor agencies, and credit enhancement through revenue sharing with existing facilities.
Institutional Investors/Highway Investment Funds
Institutional investors can be a good source of financing for toll highway projects since the long-term maturity of their funds matches the duration of a toll highway concession. The Employees Provident Fund has invested in Malaysia’s North– South Expressway and insurance companies in Hungary have invested in M1/M15. However, since institutional investors in developing countries are not active in the highway sector in general, foreign institutional investors from developed countries can play an important role in filling the gap. Institutional investors, especially insurance companies and pension funds in the United States, have been actively pursuing investment opportunities in privately financed highway projects in Latin America and Asia. They have invested in toll highway projects directly, through various investment funds (the Asian HighwayFund [AIF], and the Asian Highway Development Company, Ltd [AIDEC]), and have purchased debt securities such as 144a bonds in private placement (this is a kind of global bond that is regulated under [the United States] Securities and Exchange Commission Rule 144a). The procedure for issuance and underwriting was simplified in 1990 and limited only to investors termed “Qualified Institutional Buyers (QIB)”, who are professional institutional investors such as insurance companies and pension funds.
Initial Public Offerings
An IPO of a single asset company with a Build Operate Transfer (BOT) arrangement can be difficult as the duration of future cash flow is limited by the fixed concession period and the enterprise is affected to a great
extent by general stock market sentiment at the time of IPO. On the other hand, an IPO based on multiple assets with a portfolio of stable cash-generating toll highway projects may become an appropriate solution to funding raising issues in developing countries. China has gone into IPO, often for multi-asset companies; in many instances, both expressway and holding companies listed their shares on the Hong Kong and Shenzhen Stock Exchanges. Examples include: Anhui Expressway (Hong Kong,11/96), Guandong AShare (Shenzhen, 1/96), Guangdong BShare (Shenzhen, 8/96), Jiangsu Expressway (Hong Kong,6/97), Sichuan Expressway (Hong Kong,10/97), Zhejiang Expressway (Hong Kong,5/97), Shenzhen Expressway (Hong Kong,3/97); Holding Companies: Cheung Kong Highway (Hong Kong,7/96), NewWorld Highway (Hong Kong,10/95), and Highway King Highway (Hong Kong,6/96). In Indonesia Jasa Marga, the public toll highway company, planned an IPO but it was postponed due to the Asian financial crisis.
One innovative approach is the leveraging of existing highway assets to raise new funds in capital markets. This approach can be attractive to private investors since they need to take only limited construction/completion risks and the transactions offer the prospect of high returns. The approach is also attractive to governments, since it permits them to obtain additional financing with relative ease, including for financially less attractive but economically viable projects.
China, the pioneer of this approach, by securitization of existing highway assets, including highways financed with World Bank assistance, has been able to raise large sums of additional capital from foreign investors. Major developments with respect to asset-based capital markets toll highway financing in China have included the following:
- the raising of $100 million in 1994 by Sichuan Province through the private placement of equity shares in off-shore markets to finance the development of the 90-km Chengdu –Mianyiang Expressway;
- an equity offering of B shares on the Shenzhen Stock Exchange by the Guangdong Provincial Expressway Company in 1996;
- completion of a $200 million Euro bond issue by Zhuhai Highway Company Ltd of Guangdong Province in 1996 and
- the listing of at least nine China-related highway stocks on the HongKong Stock Exchange by 1997, including Chueng Kong Highway and Highway King.
The portfolio approach adopted by Road King Infrastructure Limited (RKI) of Hong Kong may provide a solution for developing countries where the procurement of foreign debt is difficult and both domestic debt and equity for the financing of the country’s toll highway development are scarce. RKI leverages the credit worthiness and the track record of their projects in China, thereby diversifying its investment portfolio into various regions (high growth centers) and risk profiles, and attaining favorable income distribution and a minimum income undertaking from local partners for most projects.
RKI’s portfolio approach contains very specific elements such as: (i) its location in the Hong Kong SAR, a quality international financial center; (ii) its parent company’s credibility, engineering know-how, and long involvement in the Chinese market; and (iii) its ability to diversify geographically into its existing assets throughout China. RKI’s toll highway projects in China are financed through a combination of IPO, the cash flow from the existing portfolio, a note issue-2 and a transferable loan certificate (TLC) issue-3. At its IPO, the company had interests in ten highways in China, of which eight were in operation and six at different stages of negotiation. The company’s interests in these toll highway projects were held through wholly owned subsidiaries, which, together with the relevant Chinese joint venture partners, established various cooperative joint venture (CJV) companies for investment in different projects. There are no green-field toll highway projects in the company’s portfolio. As of June 1998, its toll highway assets were diversified in eight provinces in China, totaling 974.6 km of highways.
Highway Management Group Limited (HMG) in the United Kingdom has adopted another form of the portfolio approach to toll highway development. Two concession companies, Highway Management Services (Peterborough) Limited for the A1(M) and Highway Management Services (Gloucester) Limited for the A419/A417 — entered into Design, Build, Finance & Operate (DBFO) contracts with the Secretary of State for Transport to widen and improve the highways and to operate and maintain them for 30 years. The financing for the two highway projects was raised through Highway Management ConsolidatesPlc, a newly created special purpose financing entity, 100% controlled by HMG, which provides funds to the individual RMS companies through back-to-back onloans. In March 1996, Lehman Brothers and SBC Warburg underwrote a £165 million, 25-year, fixed rate bond issue to partially fund the two projects, and arrange a £111million, 25-year European Investment Bank (EIB) loan facility to provide the remainder of the required senior debt financing.
This structure allowed cross-application of dividends so each project could support the other. It enabled projected interest coverage levels to be tighter than they would have been otherwise, thus lowering the cost of financing. Combining two different highways diversified the lenders’ risks. It eliminated the need for two separate financing, minimized the duplication of documentation and negotiation with financing parties, and created a public bond offering large enough to be liquid and to meet demand at the long-end of the sterling bond-market. Although the issue here was not the difficulty of fund raising as in the previous example, the approach gave HMG a better risk-profile for their business as a whole by having two different DBFO highway projects and formed a base for evolving into a large toll-highway operating company.
Pinpoint Equity with an Indexed Highway Bond Issue
Pinpoint equity (high debt-to-equity ratio) coupled with inflation-indexed bond issues may be used to relieve investors of the problem of slow returns on their investment through dividends. The issues here are: (i) the need for the investor to flexibly recoup its investment without hindering the opportunity of private financing; (ii) lowering the capital cost to achieve a more affordable toll rate; (iii) the need to provide the investor with incentives that lead to higher returns; and (iv) the need of the investor for liquid investments.
This concept was created in United Kingdom. The project company of the Second Severn Crossing, Severn Plc, was formed with the minimum allowable equity capital for a private limited company, £100,000, of which the ordinary stock amounted to £50,000 and the preferred shares amounted to £50,000. The debt component comprised £131 million in indexed-linked debt, £150 million in EIB loans, with £150 million in a standby letter of credit, and a £190 million of floating rate bank loan. Although the project company has succeeded in the operation of the existing Severn Crossing, mitigating the start-up risk of the new project, the debt – equity ratio of the newly constructed portion of the project is only about 0.02%. This pinpoint equity approach frees investors from the problem of slow recoupment through dividends and also may lower the cost of capital. This in turn lowers the debt – equity ratio to 0.02% ¼ £0.1million/(£131 m þ £150 m þ £190 m) required toll rate to facilitate an earlier transfer of the bridge back to the government. In the case of Second Severn Crossing project, this approach was coupled with an RPI-indexed bond-issue. The bond was listed so that investors were able to access immediate liquidity in order to address to the drawback of the project financing approach of tying up investor’s capital over the long-term. Although this is a good practice for addressing these issues, it requires a very mature financial market to succeed.
The option concept is applied in many aspects of toll highway financing, e.g., convertible preference shares and bond issues. It has also been used to provide liquidity for shares held by the contractors and the sponsor companies. It gives flexibility to the financing structure and may broaden the horizon of fund providers for privately financed toll highway projects. The North–South Expressway (Malaysia) and the M2 motorway (Australia) projects involved application of the concept to provide liquidity for shares held by the contractors and the sponsor companies.
The value-capture concept is an approach by which the increase in real estate values created by a transport project, such as a toll highway, are “captured” to help pay for the transport highway. The approach is risky because it relies on favorable trends in the real estate market. The concept has been planned or actually applied in a number of contexts, for example, the Guangzhou –Shenzhen Superhighway in China, the Hopewell Bangkok Elevated Highway and Track System in Thailand, and the Malaysia –Singapore Second Crossing in Malaysia, with the experience indicating that over-dependence on real estate investment earnings to structure a transport concession is risky given the volatility of real estate markets.
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