Risk Management in Public-Private Partnerships: The Finance Perspective By Laurene B. Mahon Session 648 January 14, 2009 Transportation Research Board 2009

The forgotten word in P3 PARTNERSHIP implies sharing of risks and rewards PARTNERSHIP implies sharing of risks and rewards Risk should be assigned to the party who can best manage it Risk should be assigned to the party who can best manage it

Who takes what Lenders inherently take certain financial risks but shy away from project performance risk Lenders inherently take certain financial risks but shy away from project performance risk Equity investors’ risk envelope is larger, but not all-encompassing Equity investors’ risk envelope is larger, but not all-encompassing Project sponsors own the risks not transferred to others Project sponsors own the risks not transferred to others Developers and operators typically limit their risks contractually Developers and operators typically limit their risks contractually

Lenders Lenders expect timely payment of principal and interest; therefore require transactional structures to provide security Lenders expect timely payment of principal and interest; therefore require transactional structures to provide security Leverage limits Leverage limits Reserve accounts Reserve accounts Cash traps Cash traps Payment waterfalls Payment waterfalls Liens on physical assets Liens on physical assets Step-in rights as last resort Step-in rights as last resort

Lenders’ risk management tools limited to foresight and diligence Initial and ongoing credit rating requirements Initial and ongoing credit rating requirements Financial covenant maintenance Financial covenant maintenance Quarterly financial reports; annual audits Quarterly financial reports; annual audits Third-party engineering and feasibility assessments Third-party engineering and feasibility assessments Regulatory compliance Regulatory compliance

Equity The truest “at-risk” partner The truest “at-risk” partner Long-term horizon means capital appreciation can be part of return Long-term horizon means capital appreciation can be part of return Total return investors Total return investors “Patient” money a bit of a misnomer “Patient” money a bit of a misnomer Stand to loose all if debt defaults Stand to loose all if debt defaults

Sponsors invest, but usually only to further their main business lines Strategic investors add significant value and services, and expect repayment Strategic investors add significant value and services, and expect repayment Can be in cash, carried return, or profit share Can be in cash, carried return, or profit share Usually best to assign to them risks they can manage…revenue control, maintenance and staffing plans and costs Usually best to assign to them risks they can manage…revenue control, maintenance and staffing plans and costs Contractors a special case Contractors a special case

Good contracts make good risk partners Taken as a whole, the documents package should leave no identified risk uncovered Taken as a whole, the documents package should leave no identified risk uncovered Lenders especially fear “pin-hole” risk…that which no one had identified but can blow up a deal Lenders especially fear “pin-hole” risk…that which no one had identified but can blow up a deal The more uncovered risk, the higher the cost of financing…at some point, just none available. The more uncovered risk, the higher the cost of financing…at some point, just none available.