Connecting P3s, bond ratings, and debt calculation.

• Author: Huge, Dan
• Position: Cover story

As public-private partnerships (P3s) have become an increasingly popular method of funding large capital projects, much discussion has focused on the choice between financing a project the traditional way (using tax-exempt bonds) and using a P3. Two factors should influence that decision: How rating agencies analyze P3s, and the subsequent impact those analyses have on bond ratings.

The difficulty that comes with analyzing P3s is that financing is often supplied by the concessionaire; therefore, associated costs cannot be determined so easily, as they would be in a typical governmental entity's bond structure under conventional debt financing. How are ratings for the bonds themselves determined, and how do rating agencies decide what, if anything, to add to an entity's debt burden?

BOND RATINGS

Jurisdictions will need to make important financing decisions in determining whether or not to pursue a P3, as well as the type of P3 to be executed. When the financial component of any deal under consideration becomes part of the concessionaire's responsibility, the effect on an entity's bond ratings must be considered.

P3 participants may earn a rating that is substantially below what they would expect if they were to pursue traditional funding via tax-exempt bonds. The current bond rating of any governmental entity considering a P3 becomes part of the rating process for any related debt issuance, and such a benchmark rating typically serves as the ceiling for any rating related to P3 borrowing. A jurisdiction's rating will often remain significantly higher than any final rating assigned to a P3, rendering any such perceived ceiling a moot point. (This is because many risks--such as completion risk, cost risk, debt structure, and securitization --are borne by the concessionaire.) When combined, these additional risks usually put the ranking into in the Baa/ BBB to Ba/BB category.

These ratings gaps may create a sizeable difference in financing costs, but that doesn't necessarily mean that a government entity should finance a project using traditional means. Financial losses might be offset by increased efficiency, reduced risk, and other benefits that the right P3 project can provide. Jurisdictions, including all relevant stakeholders, need to conduct cost-benefit analysis to evaluate the risks and rewards of a proposed P3 project, and they should do so early in the decision-making process. For further guidance, the Government Finance Officers...