Financing Surface Transportation in the United States: Forging a Sustainable Future—Now! (2012)

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25 BREAKOUT SESSION 1 Delivering Transportation Programs Through Public–Private Partnerships Suzanne Sale, Federal Highway Administration (Moderator) Geoffrey S. Yarema, Nossaman, LLP Bovin Kumar, Halcrow Consulting India Private Limited Kevin Longenbach, Transurban Sasha Page, Infrastructure Management Group, Inc. Suzanne Sale of the Transportation Infrastructure Finance and Innovation Act (TIFIA) Joint Program Office in the Federal Highway Administration moderated the session. In her opening remarks, she com- mented that public–private partnerships (P3s) are not only a method of financing transportation infrastructure but also an innovative method of program delivery— lowering costs, accelerating project delivery, and reduc- ing public-sector risk. She stated that there has been significant progress in advancing projects through P3s over the past 10 to 15 years. Lessons have been learned both at home and abroad, and insight has been gained into important issues such as the balance between the roles of the federal and state governments. She indicated that the session was designed to delve into these issues and experiences from both a national and an interna- tional perspective. tranSitioning to a Programmatic Selection aPProacH for P3S Geoffrey S. Yarema of Nossaman, LLP, discussed the evolution of P3s in the United States and how to select projects for P3 delivery. There have been three genera- tions of approaches to this issue over its 25-year history: private-sector identification, public-sector identification on a one-off basis, and public-sector identification on a programmatic basis. Transportation planning requires decisions on many aspects germane to P3s. Most agencies assume that they will use design–bid–build delivery without conducting any analysis. Several projects are deferred and incur the losses associated with delay. Now that there are mul- tiple delivery options, including design–build, availabil- ity payment and toll concessions, and predevelopment agreements, the challenge is to match the right projects with the right delivery tools. Early P3 initiatives relied on the private sector to iden- tify projects. There was friction between these choices and the programmatic decision-making process. The National Environmental Policy Act (NEPA) was also a sticking point since it involved project definition. The private-sector solutions often required backtracking with NEPA if they were advanced. Projects advanced by using this approach include the following: • Virginia Department of Transportation (late 1980s): unsolicited proposal, Dulles Greenway; • California Department of Transportation (1989): Assembly Bill 680 call for project nominations, SR-91 and SR-125; • Washington Department of Transportation (1993): call for project nominations, Tacoma Narrows Bridge; • Minnesota Department of Transportation (1995): call for project nominations, Trunk Highway 212 (city council veto); and • Virginia Department of Transportation (1994– present): Public–Private Transportation Act unsolicited proposals processed per guidelines, Pocahontas Park- way, Dulles Rail. Over time, there has been a trend away from private identification of projects, with more states now identifying

26 FINANCING SURFACE TRANSPORTATION IN THE UNITED STATES potential P3 projects during the NEPA process itself. This approach requires the public sector to develop expertise such as analyzing individual projects for P3 suitability; com- pleting preliminary engineering sufficient to secure priced bids; and issuing project-specific, competitive requests for proposals. Key examples of this approach include the North Tarrant Express and I-635 LBJ managed lanes in Texas and the Port of Miami Tunnel and the I-595 Improvement Proj- ect (including high-occupancy toll lanes) in Florida. While this approach moves away from qualifications- based selections and sole-source negotiations to capture some private innovation and create a true competition among multiple bidders, project selection decisions are still made on an episodic basis after significant invest- ments on the basis of conventional delivery. With the third generation of P3 projects, sponsors are thinking about how to deliver a whole suite of projects. This programmatic approach has included the follow- ing initiatives: Texas Department of Transportation’s P3 review of the statewide capital program; Georgia Department of Transportation’s biannual P3 screening of the State Transportation Improvement Program, LA Metro’s P3 analysis of the Measure R Capital Program, and the Metropolitan Transportation Commission’s (San Francisco Bay Area) P3 screening of the Express Lanes Network Master Plan. Making determinations on the use of P3s early in the process helps to optimize the use of conventional and alternative delivery methods, avoid overengineering, and reprogram engineering and con- struction funds away from projects and accelerate them at the same time. The components of the programmatic approach include establishing screening criteria reflect- ing the public sponsor’s key goals, identifying projects that are suitable for alternative delivery, and creating a dedicated team to guide and direct the process. overvieW of P3S in tHe road Sector in india: tHe largeSt P3 Program in tHe World Bovin Kumar of Halcrow Consulting India Pvt., Ltd., discussed the use of P3s in developing new highway infrastructure in India. India’s national highway sys- tem is highly underdeveloped, and much of it is made up of two-lane roads. In the face of exponential traffic growth—passenger traffic is growing at 12 to 15 per- cent annually, while cargo traffic is growing at 15 to 18 percent annually—the need for new roadway capacity outstrips the public resources available to build them. Highway investment needs are $70 billion in the next 3 years alone. To address its highway expansion needs, the govern- ment of India has established a seven-phase National Highways Development Program. The first two phases of the program will be funded by a combination of the government, toll revenue, support from multilateral agencies, market borrowings, and private investment. The latter four phases will be contracted on a build– operate–transfer basis leveraging toll proceeds, annui- ties, and government support. To promote the use of P3 procurements and attract private investment, the govern- ment of India has established a framework for imple- menting the program. All preparatory work will be the responsibility of the government, which will also provide capital grants covering up to 40 percent of project costs. In addition, the government is providing private inves- tors with 100 percent tax exemption for 5 years and 30 percent relief for the next 5 years, which may be spread over 20 years. Concession periods of up to 30 years are allowed. Private partners have the right to collect tolls on the highways and may import construction equipment duty free. The government has developed a model con- cession agreement that standardizes government approv- als and allows bidders to identify up-front payments for the concessions. The program has received an excellent response from the private sector, with 44 P3 projects awarded between 2008 and 2010 to develop a total of 3,890 kilometers of highway with a construction value exceeding $19 bil- lion, some 60 percent of which has been raised by private investors. Nearly 2,200 kilometers of the program had been construction as of September 2009. Moderator Sale commented that there are many par- allels between the use of P3s in India and in the United States, in particular India’s contribution of 40 percent of capital costs. In the United States, the initial expecta- tion was that the private sector would be responsible for contributing 100 percent of project development costs. Now there is more of a collaborative approach with con- tributions from both sides, as reflected by a number of P3 transactions that reached financial closure over the past year. This approach is also envisioned in the recent P3 enabling legislation passed by the state of Arizona. Another parallel with India’s approach is in the use of tax incentives. In the United States, we have also seen that tax incentives can enhance P3 programs. P3S: leSSonS from auStralia Kevin Longenbach of Transurban observed that Austra- lia has been a pioneer in the P3 industry, with a history of delivering significant infrastructure in the education, health, social, and transportation sectors. Australia con- sists of seven states, each of which makes independent transport policies. The more populous states of New South Wales, Victoria, and more recently Queensland have been the most active users of this delivery method. Australia’s first P3 roadway project was the Sydney Harbor Tunnel,

27DELIVERING PROGRAMS THROUGH PUBLIC–PRIVATE PARTNERSHIPS which opened to traffic in 1987. Other notable P3 proj- ects include the M4 Motorway (1992), the M2 Motorway (1997), and the Melbourne City Link (2000). P3 proj- ects in New South Wales are managed by the Roads and Traffic Authority (state department of transportation), while those in Victoria are managed by special authori- ties including the Melbourne City Link Authority and the South East Integrated Transport Authority. Australia’s P3 experience offers many examples of success. A study comparing 21 P3 projects with 33 tra- ditionally procured transport improvements indicated a net cost overrun of $58 million for the P3 projects ver- sus $673 million for the traditional projects. Of the P3 projects in the sample, 3.4 percent were completed ahead of schedule, while 24.5 percent of the traditionally pro- cured projects opened behind schedule. The P3 projects were also more transparent than traditionally procured projects as measured by availability of public data for the study. Not all of Australia’s P3 projects have proved to be financially viable. Five recent projects have seen equity severely affected or destroyed. In these cases, projects were viewed more as financial transactions than as trans- portation projects. This can occur when the focus is on winning the project rather than delivering transportation outcomes. Interestingly, the five failed P3 projects were all awarded to consortia that did not include a long-term operator on their team. Three of the failed projects gen- erated financing through initial public offerings, and the remaining two raised debt through private investment syndicates. Interestingly, a majority of toll roads in Aus- tralia have failed to meet revenue forecasts during the first year of operations. One recent failure was the Lane Cove Tunnel, which is located on the Sydney Orbital Highway. This project went into receivership in the first quarter of 2010. Twin 2.3-mile tunnels were built in 2007 as a demand risk toll road facility by a concession company made up of financiers and constructors at a total cost of AUD$1.6 billion, of which AUD$1.14 billion had been leveraged. The facility was sold in May 2010 to Transurban for AUD$630 million (US$560 million), resulting in an AUD$1 billion loss to debt and total loss of equity. This experience reflects poorly on state P3 practice and the ability to attract future private investment. Despite this setback, the widespread recognition in Australia that P3s can deliver value led the National Council of Government to establish the National Pub- lic–Private Partnership Policy and Guidelines in Novem- ber 2008. All Australian state and territory government agencies now apply the National Policy and Guidelines to their P3 projects. The Australian P3 sector remains healthy, with more than 50 projects under contract, 11 in the market, and 15 potential P3 projects as of Decem- ber 2009. Lessons learned from Australia’s P3 experience dem- onstrate that with the right projects, P3s are effective and deliver value. However, they are not a means of deliver- ing infeasible projects. They require a long-term commit- ment and the participation of private partners who are vested in delivering successful transportation outcomes. The potential for success of P3s can be enhanced by guidelines to shape them. When public agencies sponsor P3s, it is important to retain the services of specialists with experience in delivering successful P3 projects. As a result of the positive experience with P3s in Australia and elsewhere, interest in P3s among U.S. institutional investors is rising. evolving role of equity in tranSPortation finance Sasha Page of Infrastructure Management Group, Inc., stated that experience over the past 5 years demonstrates that trends in the equity markets are changing. Equity is an important financing source, but it has become more conservative these days. Equity is important because it cushions debt and lets private investors leverage more money. Governments like equity because it indicates that they are still in the game. In discussions of equity and P3s, it is important to recognize that there are two types of investors. On one side are strategic investors who are looking for project opportunities. They include project developers, con- tractors, operating concessionaires, and equipment and material suppliers who are interested in securing con- tracts to provide one or more of their services. On the other are financial investors who are looking for a match for their long-term needs. These investors may include private equity funds, publicly traded funds, banks and insurance companies, endowments and pension funds, and even sovereign wealth funds. Equity is repaid at the bottom of the annual cash waterfall and involves greater risks than debt. The cas- cade of payments for P3 projects begins with debt and eventually involves repayment of equity. Sophisticated investors are prepared for the possible loss of equity. Equity allows P3 developers to be rewarded for tak- ing on additional risks. Nonrecourse debt is another key element. Equity can lose value, as has been seen with the stock market in the recent past. The same is true of the value of infrastructure companies and owners like Con- cesiones de Infraestructuras de Transporte, Transurban, Fluor, and Macquarie. Typical earning levels for other infrastructure sectors are 8 to 10 percent for brownfield projects and 10 to 16 percent for greenfield projects. The pool of equity providers has evolved over the recent past. In 2005, there were five or six major pro- viders, but more recently a number of new funds and

28 FINANCING SURFACE TRANSPORTATION IN THE UNITED STATES bank-based investors have entered the market. Some are interested in the water, energy, and telecommunication markets as well as transportation, and often they look for shorter investment periods of about 10 years. Mr. Page observed that this is not a good match for the U.S. private highway market and that many investors have stayed away. Prospective investors are also requiring higher returns now, which makes implementation of greenfield P3 proj- ects much harder. The monetization of existing assets also introduces political sensitivities. If investors have to increase the amount of equity they put into projects and their equity return expectations are higher, the number of potential P3 projects is reduced. Currently, to reduce risk, investors are focused on hybrid, availability pay- ment, and some brownfield transactions. Over the past few years, pension funds and sovereign wealth funds have become investors in transportation P3 projects. Closed- end funds are preferred, with coinvestment a potentially rising option because of duration concerns, but institu- tions have been reluctant investors in the current market- place. Investors such as the California Public Employees’ Retirement System are interested in core projects with returns of 3 to 4 percent over the consumer price index, but some of their portfolio is open to riskier opportuni- ties. Interestingly, some public toll authorities such as the North Texas Turnpike Authority (NTTA) are investing equity on a project basis. This year, NTTA announced that it will commit $400 million of equity raised from its existing roads to fund new projects, including the last leg of SH-161 and potentially the Southwest and Chisholm Trail Parkways. This is similar to the approach that other toll authorities, including Florida’s Turnpike Enterprise, have taken by investing system revenues in new projects on a nonrecourse basis. Time will tell if this is a trend. For now, other transport sectors, including high-speed rail and streetcars, have a poor track record of generat- ing revenue and are not as likely to tempt private inves- tors. Perhaps new tools can be developed to join credits with public grants. queStionS and commentS Question: When investors look for financing, they always want to use robust revenue forecasts. How can we do a better job of weeding out bias in travel demand forecasts? Comment: There is no optimism bias with revenue forecasts. There is a range of possible outcomes. The real issue involves risk factors that cannot be quantified. Negative outcomes arise when a preponderance of risk factors tend to be lower rather than higher. There is no offsetting force. We need to undertake sensitivity analy- sis to quantify the range of outcomes and structure debt financings around the low end of the range. Moderator Sale commented that the TIFIA program does not rely on the initial forecasts prepared by project sponsors. Instead, as part of due diligence, a project’s credit structure is analyzed on the basis of the more con- servative forecasts prepared for the lenders. There have been instances where even the lower numbers have not been achieved in the early years of operations. Comment: State pension funds have a lot of pressure to invest in their own states. In this way, pension fund investment could offset xenophobia risk. The North Tar- rant Expressway and I-635 LBJ managed lane projects have involved direct pension fund investment. Comment: In Denver, Colorado, sales tax–backed avail- ability payments are a unique risk structure. Comment: If failed deals like the Las Vegas Monorail and the Southern Connector had been backed by more equity, they might not have run into the problems that they did.