nick crawley, corality financial group

11 March 2014

Major Road Projects Conference

A financiers perspective of toll road analysis

A financier’s perspective of toll road analysis 2

Consulting firm specialising in the financial analysis of infrastructure projects

Involved in virtually all Australian PPP bids

Through our London office we have significant exposure to North American

and European infrastructure transactions.

About Corality


Have a sullied reputation – why?

Environmental

Public perception

Financial flops

As an asset they are an essential piece of regional and national infrastructure

so where is the industry going wrong?

Overview of todays presentation

Bankers perspective

Toll road credit 101

Patronage modelling

The outlook

Toll roads


As an Australian Project Finance banker I spent three years losing toll road bids

and looking at winning assumptions

Cross City Tunnel – losing bid

Cross City Tunnel – syndicated participant on winning bid

Lane Cove Tunnel – losing bid

Lane cove Tunnel - syndicated participant on winning bid

Western Sydney Orbital (M7) – losing bid

M5 refinancing

Introduction


There is an art to optimising a bid but fundamentally, for capital intensive projects

like toll roads, the situation is best described as a “cost-of-capital” shootout. “The

consortia with the lowest acceptable returns at the end of the day will have the best

chance, all other things being equal…”

Financially the best outcome for government is from the party who is able to

‘contribute’ to government funds the most on a comparable risk basis to other bids.

The bid that can free up enough surplus cash and achieve the lowest acceptable

return is.

For a toll road the drivers of this are:

Traffic volume

Toll charged

Cost to build and operate

The situation


From an engineering and operational perspective toll roads are fairly boring!

Tunnels and bridges make it more interesting of course…

But patronage risk is dynamite!

It is historically significantly over-estimated

‘Ramp-up’ takes longer to achieve (and that is to a lower steady state)

Alternate routes are not as unattractive as planned

Irrational negative public perception does not align with modelling

Until recently the uptake and effectiveness of e-tags was a major sticking point

Financiers perspective


Construction risk

Patronage risk

Design and technology risk

Operational risk

Environmental risk

Legal risk

How does a banker look at a toll-road?


Construction broken down into:

Earthmoving

Road surfacing

Civil works (bridges etc.)

Drainage

Lighting, safety and monitoring systems

Outcome:

Takes longer to build

Costs more to build

Built to spec

Ability for staged opening

Reasons:

Experience of parties

Cost of materials and labour

Scheduling and logistics (earth moving etc.)

Toll road credit 101 – Construction


Outcome:

Toll road users are below planned

Ramp-up takes longer than expected

Mix of commercial (heavy) versus passenger (light) traffic (higher costs/different peaks)

Congestion

Reasons:

Patronage modelling

Assumptions

• Time value of money, daily and annual profile…

• Signalling, on/off ramp gradients, lane changing…

Calibration

Network modelling algorithms

Origination/destinations

Interface with existing infrastructure

Performance of alternate route choices improve

Alternate travel options become available

Public perception

Toll road credit 101- Patronage


Outcome

Doesn’t satisfy planned volume

Costs more to operate and maintain

Tolls are not collected accurately

Doesn’t integrate with existing infrastructure properly

Can’t satisfy a staged opening

Reasons

Experience of Construction and Operating parties

Lanes, location, length and gradient of ramps

Monitoring system not proven in given

Weather conditions

Ability to recognise local plates

Interfacing with electronic tolling systems

Processing system volume, speed, interface with traffic databases

Toll road credit 101 - Design and technology


Right to access the land and operate a toll road

Control over the circumstances when Government can step in versus

trade-out

Ability to pursue users for unpaid tolls

Interface risk of Major Contracts

Toll road credit 101 – Legal


Pollution

Storm water drainage

Air quality

Impact on surrounding wildlife as a result of:

Earth moving

Major construction

Operations

Community

Displacement of people

Impact on local quality of living

Toll road credit 101 - Environmental


Patronage modelling can only interface with the financial model at a simplistic

level – especially when flexibility is needed.

A bank’s perspective is often hard to understand from a developer or patronage

consultants position.

Patronage modelling is:

Non-transparent – unfamiliar software

Complex algorithms/neural network – don’t marry well with low cost debt

Dependent on computationally intensive convergence

Tough to calibrate accurately

Dependent on rational behaviour and an individual to value utility / time.

Characterised by a wide range of assumptions

Educated unbiased independent peer review is underused

Not well documented/widely understood differences between approaches

Localised – Melbourne has a different model to Sydney…

Patronage modelling – banks perspective


Bain (2009) showed the mean ratio of actual to modelled demand is 77%. This

means that on average a given toll road attracts 23% less traffic than planned.

The same study showed a staggering 96% mean ratio for un-tolled roads.

A quarter of a sample of 183 tolled roads had errors ± 40%.

These errors are not “symmetrically distributed” – there is a strong tendency for

planned demand to be higher rather than lower than actual. A strong optimism

bias can be rationally hypothesised, why might this happen?

Short term financial reward

Political/economic pressure

Patronage modelling - the facts


Patronage forecasting

Bain R, Error and optimism bias in toll road traffic forecasts.

Figure 1, 2005 Full data-set forecast performance distribution

Under estimated Over estimated


A failure for equity investors and lenders no longer willing to invest in this asset

class without substantial changes in risk allocation

Cross City Tunnel A$300 million loss

Lane Cove Tunnel A$1 billion loss

East Link A$770 million loss

Clem7 A$1 billion loss

Airport Link A$800 million loss

A success for taxpayers

Delivered on time or ahead of schedule

At tolls cheaper than what would otherwise be expected given realised traffic

volumes and full cost of the asset

Situation


So what analysis to banks like to perform?

Run extensive, seemingly simplistic scenarios - patronage consultants

generally don’t like this.

Breakeven x% reduction

To maintain a flat DSCR of 1.00x

Minimum LLCR of 1.00x

Patronage stress on the ramp-up profile

Seemingly over-conservative cases such as six months no revenue part way

through the project and complete re-finance failure

Bank analysis


Patronage scenarios from network modelling overlaid with fairly simplistic

time based linear adjustments to Bank Base Case and Bank Downside Case

– reflecting:

Less people use it

Take longer to ramp-up to the steady growth state

Construction

Time over run (revenue delayed)

Cost over run

Macroeconomics

Base rates

CPI

Increased operating and maintenance costs

Performance of revenue (cash) realisation (monitoring to collection)

Critical analysis - Scenarios


From the outset have a financial model constructed to a standard that is in line

with the rest of the project submissions and documentation. The project needs

this to be able to make better decisions with confidence.

Tips

This is not the time for ‘my first model’ or for somebody to be learning on

the job.

Choose a methodology such as SMARTTM that favours:

• Transparency

• Flexibility

• Presentation

Work with a model auditor who can add value throughout the process to keep

the final model audit costs to a sensible minimum.

How can you have great analysis?


Work with a financial modelling partner

Design your financial model before you start building it

Layout model clearly

Separate inputs, calculations and outputs

Focus the detail and flexibility around the key drivers

Patronage

• Seasonality, daily profiles, peak / off-peak / shoulders

• Ramp-up

Toll rate and escalation

Construction cost

Operating cost

Pre-program scenarios

Build in integrity checks and commercial signals

How can you have great analysis?


Tony Abbott has declared that he wants to be “the infrastructure prime minister”.

Major projects like Badgerys Creek and high speed rail, will require extensive

road and rail infrastructure for passengers, freight and heavy commercial traffic –

over the time it takes to progress these projects credit markets cycle.

I believe we should expect to see more patronage risk style projects needed to

be financed and for the market to move slowly away from pure availability based

regimes to more innovative mechanisms such as staggered phases with different

levels of government guarantee.

Furthermore, I think international banks and credit agencies are likely to lead the

way on this.

Toll road’s – the outlook


Nick Crawley, Principal

[email protected]

02 9229 7401

Thank you

nick crawley, corality financial group

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