Fall 2009Session 3: Construction Finance and Global Financial MarketProfessor Fred MoavenzadehFall 2009 Capital Generation Distribution Recovery Current Approach Available budget drives policy This “supply constrained system” has created Large Work Backlog No Evaluation of Benefits Budgets that do not respond to needFall 2009 Owner Financing Financing Public Projects Financing of Private Projects Contractor Financing Financial Implications of Bidding and Contract Methods Lump Sum or Fixed Price Contract Unit Price Contract Cost Plus Fee Contract Target Price Plus Profit Contract Guaranteed Maximum Price Contract Typical Cash Flows of a Construction Project Pre-Bid Expenses Bonds Types of Bonds Cost of Bonds Benefits of Bonds Bond UnderwritingFinancing Aspect of ConstructionFall 2009 General Tax Revenues, Property Assessments Dedicated Tax Revenues (Trust Funds, Enterprise Accounts) Equity Investment Debt Financing (Bonds, Notes, Other I.O.U.’S) Tolls, Usage FeesCurrent Financing MechanismsFall 2009 Turnkey Projects Design-Construction Project Finance Integration Export Credits Materials and Equipment Feasibility Studies Project Finance Consumer Credits User Finance Counter Trade (Barter) Counter purchase (Buy Local Products) Compensation Agreement (Cash and Goods) Buy-Back Transaction (Buy Project Products) Equity Position Build and Operate Joint Ventures Economic RisksCurrent TrendsFall 2009 Sale/Leaseback Arrangements Linkage Payments, Development or impact fees New types of trust funds for public construction (E.G., Public Assets Preservation Trust Fund) Infrastructure banks or revolving fund accounts Innovative Packaging of financing with design/construction services (e.g. B.O.T.)New Financing Mechanisms and Ideas Broadening of scope for activities by public works authorities (e.g. involvement of transit agencies in real estate development; commercial development of air rights) Re-assertion of the private sector role in infrastructure construction and operationFall 2009Financial Issues Management IssuesGrowth record Management structureTrends in profits Management capabilitiesCredit rating Management information systemsFixed payments Management practicesBonding capacity Equipment policiesOther bank references Types of projectsPurpose of credit Countries workingSource of repayment Outlook of operationsTiming of repayment Reputation among clientsCash flow projections Reputation among subcontractorsBusiness exposurePolitical exposureFinancial and Management Issues of Interest to Commercial BanksSources: 1. The Fails Management Institute, Financial Management for Contractors, McGraw-Hill, 19812. Journal of Commercial Bank Lending, various issues.Fall 2009 When infrastructure supported by broadly based taxes Treat very large number of constituents as “investors” Not all constituents are users of facility Financing is “pay as you go” As a result Taxpayers do not perceive immediately the benefits of their taxes Tax funds may be diverted to other purposes No direct correlation between tax and benefit Once facilities are completed, they are priced essentially as a free good (no capital recovery provision) Thus pricing fails to act as a controlling mechanism with respect to either capacity or demand in public facilities (e.g., highways, transit, water)Pricing Philosophy in Public SectorFall 2009 Predicted upon balancing adequate rate of return with attraction and satisfaction of sufficient demand Market mechanisms regulate not only price but also available capacity and adequacy of services Users select desired services and quanities from set of already available options, with demonstrated track records and known prices. Users’ willingness to pay supported by readily perceived benefits, quality and reliability of service Examples; housing; airlines; freight carriers, utilities (telephone electricity); toll roadsPricing Philosophy in Private SectorFall 2009Since Depression Capital Markets:• were highly fragmented. • Government policies prevented cross boarder investment, • prevented financial intermediaries from operating in different countries,• In the United States, there was not even interstate banking until 1990. For borrowers:• Source of financing was mostly localized, • rate of return on investment reflect local financial condition and capital availability. • As a result the rate of return would vary between similar investments (with similar risk) based on availability of capital in different countries. • For equity investors, P/E ratio was very high in certain countriesStructure of Capital MarketFall 2009Supply of fundDemand forfundDemand forfundrr’K KCountry I Country IIBarrier to Capital FlowMarket SegmentationFall 2009 Financial risks were highly localized and therefore there was not possibility of risk diversification. With a large project it meant huge exposure for lenders.  In the developing countries, international financing was based on sovereign borrowing and the backing was government credit rating. Financing project (development financing) was based on borrowing from international financial institutions and multilateral agencies (such as world bank and regional development banks) by the sovereign country.  Government acted as financial intermediary. In many developing countries these investment were based on political and not effective rate of return.Fall 2009International Financial InstitutionsGovernmentInfrastructureProjectsFund FlowGovernmentInvestmentPayback:Principle and InterestForeign aidImprove in economy and creation of surplus activityFall 2009 Much of flow was from developed countries (to other developed economies or developing economies) There was very little listing of equity in market outside home country. Therefore most of the financing was done through raising debt. The system resulted in accumulation of debt by developing countries in 1980s with increase in possibility of default on their debt. In mid 1990 South East Asian Economics collapsed: Created the first financial crisis since WWIIFall 2009• Washington Consensus• Minimizing role of government• Emphasizing privatization• Liberalization of trade, investment, and capital flow• Deregulation of market• Role of