Public Private Partnership Contracts Financing by Covered Bonds

Abstract

1. Introduction Sovereign entities of the western world rely the provision of public services (defense, public health, education, public infrastructures etc.), when tax revenues are not adequate, to a large extent on the financing through a considerable amount of unsecured public debt via issuance of unsecured senior bonds. In that way, by running controllable and scheduled public deficits, they can meet the needs of the general government extra financing as well as the required financing of public investments, and public services. On the other end, the States traditionally have on their considerable amounts of real assets (real estate and related infrastructures, as well as monopoly companies and special resources monopolies), many of them being potentially income generating assets. Recent experience has shown that, the government is not always the best manager of its on balance sheet real assets, let alone the managing of its public debt obligations. Also it is widely accepted that the private sector is usually more efficient in pricing, developing, managing and operating business (and therefore managing the related risks) in a competitive environment, with limited resources. As a consequence, Public Private Partnerships evolved as an alternative form of asset exploitation, between governments and competitive private companies, where each of the two partners brings to the contract its comparative advantages, in order to make the final partnership viable and profitable for both participants. Such structures that efficiently exploit assets and monopoly structures of the government through appropriate management from private sector companies, produce efficiently public services and manage to their full income generating potential, public assets, utilizing therefore the public property with private sector competitive standards. The appropriate pricing of the expected cash flows of the contract from both sides, taking into consideration all the possible aspects of the project is very important for the negotiation process, and selection of the preferred private partner. Optimal pricing and efficient selection of the private entity are significant parameters for contract's viability and profitability for all related parties. Once a PPP is initiated on an existing asset or an asset to be built and run by a private company, this contract is the base of a stream of future expected cash flows, as well as residual value, and subject to many kinds of pricing risks, having an overall net present value as any other real income generating asset, priced in the market. Thus far, using the example of many European countries, the issuance of public debt for the financing of government deficits was by the issuance of senior unsecured bonds. In case of default or partial default of the issuer country, the investors have full recourse against the assets of the issuer but only on theory. In practice investors will experience a loss in interest income or redemption amount or even both, depending on restructuring type. After the Global financial crisis of 2007-2008 the market has shifted its focus in more efficient pricing of default risk and especially in pricing the Sovereign default risk, of many heavily indebted countries, including Greece among others. The subsequent result was a general widening of yield levels of many sovereigns and in many cases in levels where the traditional market channel of funding became unavailable to the State. Sovereign States were in the midst of a crisis where due to the economic downturn, fiscal consolidation was needed while public investments and services needed also a boost in order to compensate for the deterioration of private investments and consumption, and all these in an environment with higher credit spreads, less liquidity and more risk averse investors. On the side of these, as history has shown, the private sector, and especially private banks in many countries around the world, were able in similar situations, of credit squeezes and illiquid markets, to refinance their balance sheet by the issuance of covered bond schemes, achieving market acceptability and substantially lower cost of funding, when the senior unsecured debt was prohibitively expensive for them to consider. …