Dollars and Sense
Infrastructure project financing success with lease-option evaluations
Infrastructure project planning and financing is never easy. Whether it is for a community or a commercial operation, several questions must be addressed before any real work can begin. When dealing with new water and wastewater projects, municipal government and industry decision-makers are faced with many of the same challenges.
The key questions they must address include:
• How do we identify and install the best compliant system that meets our needs at the lowest cost?
• Do we upgrade our existing facility or build a new one?
• What kind of system do we choose—established and familiar or a new emerging technology?
• How do we finance the project so that the community or organization can afford it?
Most municipal and commercial organizations are familiar with the technical process of determining their needs, evaluating technology options and selecting the final project design. Many of these organizations have less experience in identifying and evaluating the financing options that get the project started and completed in the shortest possible time.
A poorly planned or poorly chosen technology can lead to cost overruns, higher operating costs or the non-performance of an installed system. A project that cannot be financed will never be built. This wastes resources and leaves the original need for the project on the table. Decision-makers must identify both the engineering and financing solution for a project to be built successfully.
When tackling a new project, teams often operate in a linear manner. Technical topics of capacity, performance requirements, technology options, construction costs and annual operating expenses are addressed first. Then with the technology selected, the question of "How do we pay for it?" is finally addressed. This means that financing decisions often are made in haste without considering all appropriate options.
The project's ultimate success or failure depends on the answer to this final question. The linear approach extends the project lead time and wastes precious organizational resources if, in the end, the project is not funded.
A better road to the success of a project entails adopting a dual-path evaluation process where both engineering and financial teams evaluate options in the same time frame. With performance requirements established, the engineering team evaluates a technology on its expected operating performance, construction costs and operating expense profile. The financial team evaluates each option from the standpoint of financing alternatives, cash flow and payment requirements (see Table 1).
Financing Options Beyond the Conventional
The structure of a project's financing will almost always determine its viability as well or more so than the engineering or regulatory requirements. The process can be complicated because buyer-operators have a large and complicated set of needs and because there are a broad range of options available to structure project funding. These facts alone require that the owner-operator work with a strong advisor who has significant project financing experience and who will work to present and evaluate all possible options.
Municipal governments typically look to grant financing and/or loan guarantees as their first financial alternative to offset a community's financial commitment. In present economic times, there is a reduced chance that this funding will be available for infrastructure projects. If it is available, it might take a protracted period of time to be awarded and thus impact the project's usefulness.
This process is lengthy and time consuming but worth pursuing, when possible, to limit impact on a local community. Many projects, however, fail to materialize because of a false assumption that these funds are easy to obtain. They are not. Loan guarantees can be used to help secure bond financing, but they do not eliminate the expense and time required to conduct the process.
Alternatives to this process exist in the form of a bond issue or lease-purchase arrangement. Bond initiatives are expensive, have long lead times and must win the approval of an uncertain voter base. They also can create vendor issues by requiring municipalities to work with pre-approved vendors who must provide their own financial history to be part of the project. Due to the underwriting costs, a bond issue only is appropriate and used for $5-million-plus projects. It is not unusual for a simple bond offering to have more than $100,000 of legal and underwriting costs.
The municipal lease purchase option is a cost-effective financing solution for small- and medium-sized projects ranging from $25,000 to $5 million-plus. Municipal leases usually can be approved by government officials without voter approval. This minimizes both the time and expense typically associated with a bond initiative. As with any financing, the lender's approval is based on the past and projected financial performance of the community. Some of the items that are critical to underwriters include:
• Three years of financial performance, as shown in the financial statements of the municipality;
• The absence of prior loan, lease or bond defaults;
• Other non-appropriation commitments or the lack thereof;
• Cash flows shown by the current year's projected operation budget; and
• The critical need or utility of the equipment or project.
Commercial, industrial and agriculture decision-makers typically think of using internal cash or company borrowing to finance their infrastructure projects. In today's uncertain times—in which cash conservation is a paramount objective—purchasing a system outright can be a poor use of the company's cash resources. Traditional capital loans are harder to obtain in today's market, but they are still available to credit-worthy entities. When available, these loans generally require a significant upfront investment and can be encumbered with onerous performance covenants.
Even when they can afford it, a purchase or loan option only can be considered by larger or cash-rich organizations. For larger projects or smaller mid-sized organizations, these options can kill any project. Like the option for municipalities, capital leases and operating leases offer commercial organizations options that have several advantages of their own.
Municipal and capital leases can offer several advantages over the bond or loan process (see Table 2). Knowing these options, public leaders can make better decisions for their communities. When considering project financing options, leaders must answer questions specific to the needs and situation of their own organization. One size never fits all.
Infrastructure project challenges for decision-makers are real, and these individuals often find themselves between a rock and a hard place. The need to build and operate compliant and cost-effective water and wastewater projects is one of the greatest challenges. The issue is not one of avoiding or being delinquent in their role: The issue is how to pay for the system they need.
Traditional financing options exist but typically only work for a select few. Fortunately, market lease alternatives exist that allow both communities and commercial organizations to move forward with confidence.