This is just a quick update on a previous story. A few months ago I wrote about a major highway project in Colorado (between downtown Denver and Denver International Airport) that was planning on using a public-private partnership (P3) very similar in structure to that of the now-failed I-69 Development Partners selected to develop I-69 Section 5: Major Public-Private Partnership Highway Project Under Consideration in Colorado: Sounds Like Deja Vu All Over Again. The most interesting aspect of the $1.2B project is the lowering and covering of the interstate at one point, and the creation of a 4 acre park that connects two formerly disconnected neighborhoods on top of the cover.
Recently, Kiewit Meridiam Partners was selected to design, build, finance, operate, and maintain the Central 70 project. You can find the press release here.
It will be interesting to monitor the progress of this P3, and compare performance vs. the failed I-69 Development Partners. During the debate here in Indiana, while many blamed the selected contractor, others blame the very nature of a public-private partnership for road construction. The Central 70 project will serve as a useful comparison.
Dear MoCoGov readers, I am out in the Denver area for work, as I am frequently, and wanted to take the opportunity to bring to your attention an Interstate highway project out here that will, I think, remind you more than a bit of our own I-69 Section 5. In particular, the state of Colorado appears to be on the verge of going down the very same path that Indiana did not only in using a public-private partnership (P3) to build the road, but in using the very same type of P3. I have written about P3s before here.
The setting is a 10-mile segment of I-70 between downtown Denver and the Denver International Airport, a segment that sees over 200,000 vehicles per day. I myself have driven on this segment dozens of times.
The Central 70 project proposes to reconstruct a 10-mile stretch of I-70 east of downtown, add one new Express Lane in each direction, remove the aging 53-year old viaduct, lower the interstate between Brighton and Colorado boulevards, and place a 4-acre cover park over a portion of the lowered interstate. Construction begins in 2018.
From an engineering perspective, the most fascinating aspect of the project is the creation of a 4-acre park over a lowered section of the highway (referred to as a “partial cover” in project documents). Here is a rendering from the environmental documents:
As you might imagine, resistance from many residents to the highway expansion, which has been estimated to triple the highway’s footprint, has been stiff. See here and here for examples. The slogan “Ditch the Ditch” has been adopted by the opponents to the project.
The Federal Record of Decision (ROD) for the Central 70 project was issued in January of 2017, allowing Colorado Department of Transportation to move ahead with the project. The ROD and other environmental documents are available here: http://www.i-70east.com/reports.html.
But while the project is superficially quite different in many ways, the procurement vehicle will seem quite familiar to southern Indiana residents. Colorado has decided to pursue a particular form of public-private partnership: the Design-Build-Finance-Operate-Maintain model, the very same model used (and in the process of being abandoned) for I-69 Section 5. In this model, the private contractor not only designs and builds the road, but also finances the project, operates the road (and in the case of Central 70 the tolling component), and maintains the road for the entire period of the agreement. Some of the more cynical among us refer to this model as a construction project hidden inside a maintenance contract, that allows politicians to do big projects while being able to say that they are not taking on debt. Supporters say that it is the only way to close the “infrastructure gap” and maintain a sustainable debt load (I mentioned that argument a few days ago here).
The private contractor will be compensated through a toll concession (of course not part of the I-69 Section 5 deal) along with so-called “availability payments”, periodic payments for having the road open to the specified level of service (which is a central feature of the I-69 Section 5 project).
The Central 70 project is also using a (seemingly identical) multi-stage process, in which four teams have been selected to submit final proposals. The following chart from the project Web site shows the four teams selected to submit proposals. You can see a similar chart for I-69 Section 5 here: I-69 Section 5 Actual Proposers.
Fortunately Isolux-Corsan does not appear on this list! But many of these company names will sound very familiar. Plenary Group was one of the proposers for I-69 Section 5, as was Meridiam. AECOM and Parsons Brinckerhoff were on I-69 teams as well as design contractors. And Spanish infrastructure giant Cintra will be familiar to local readers as one half (along with Macquarie, who did the financial justification for the P3 for the Central 70) of the now bankrupt Indiana Toll Road Concession Company.
Per the Request for Proposals, the High-Performance Transportation Enterprise (HPTE), the public entity that will actually be awarding the contract, is willing to issue up to $725M in private activity bonds (PABs). Per the Federal Highway Administration, PABs are:
…debt instruments authorized by the Secretary of Transportation and issued by a conduit issuer on behalf of a private entity for highway and freight transfer projects, allowing a private project sponsor to benefit from the lower financing costs of tax-exempt municipal bonds.
These bonds do not obligate the state or pledge the “full faith and credit” of the state.
I-69 Section 5 used a similar financing method, having issued almost $244M of PABs to I-69 Development Partners (the prime contractor). These bonds have been continually downrated, and were most recently downgraded by Standard & Poor to a CCC- rating. Recently, as the partnership has been collapsing, it has been reported in the media that the State of Indiana has been negotiating with bondholders to buy back the bonds and take over the financing of the project; thus far the bondholders have rejected the state’s offers.
At this point, it appears that the intention is to make the award during the summer of 2017, with commercial and financial close by October 2017, and construction beginning in 2018. This is an important project of regional and even national significance. I love the partial-cover/park concept that reunites neighborhoods long split by I-70. And I really hope the project moves forward (though I don’t look forward to the airport traffic during construction).
But I also hope that the good folks at the HPTE and the Colorado Department of Transportation talk to their friends at the IFA and INDOT. Surely there are some lessons learned?
In today’s global finance news, the highway in Bloomington, Indiana that was being built by a Spanish corporation with Netherlands in its name is now owned by a Canadian pension giant.
Isolux Infrastructure Netherlands B.V., the equity member of I-69 Development Partners, the company hired to design, build, operate, maintain, and finance the construction of I-69 Section 5 (from south of Bloomington to Morgan County), has been sold to Public Sector Pension Investment Board (“PSP Investments”), a large pension investment manager with over $112B in assets under management. Isolux Infrastructure was formerly part of Grupo Isolux Corsan.
The newly acquired business will be called ROADIS.
Word is that all of the subcontractors have now been paid, and it is obvious around town that construction on I-69 Section 5 has resumed in a big way!
The full press release on the acquisition can be found here.
This posting is going to be a little bit different from my typical blog postings, in that I’m going to write about a more general analytic concept that is particularly important to keep in mind when trying to understand projects that are either paid for or receive revenues over a period of time — a concept that is often called the “time value of money“.
This posting is prompted by many comments that I have heard from friends, colleagues, fellow public officials, and other community members in reaction to the controversial decision by the Indiana Finance Authority to award a 35-year contract to design, build, operate, maintain, and finance section 5 of I-69, a 21-mile segment of I-69 from south of Bloomington to south of Martinsville — a so-called Public-Private Partnership, or P3.
Please note that the following discussion does not in any way address the issue of whether building the highway at all is a good investment by the state. All it does is address the issue of paying for a large project like this over time vs. paying for it with current revenues/cash on hand.
Without getting too far into the weeds on the specifics, the arrangement is that the State of Indiana will pay a contractor $21.8M per year for 35 years for the design, construction, operation, maintenance, and financing of the 21-mile section of highway. The government estimate of the cost of the design and construction of the highway was around $350M. However, if take the $21.8M per year times 35 years, you get a total of $763M. The claim that has been made, therefore, is that by using this P3 financing vehicle in which payments are made to the contractor over time, that the government is paying more than double for the highway than it would if paid through conventional means (i.e., up front, with cash).
However, this conclusion ignores the time value of money (TVOM). The basic principle behind TVOM is that a given amount of money today is worth more than it is at some future point. When you think about it, this should be self-evident; just ask yourself: given the choice, would you prefer $100 to be given to you right now or in a year? Once you accept that premise, the next question is how much more is that given amount of money worth today than it is at a future point? The answer is: a given amount of money is worth more today than it is at some future point by the amount you could earn by investing (or otherwise using) that given amount of money until that future point.
In order to compare alternative investments (or financing schemes) that are made over various periods of time, we need to make sure we compare apples to apples. One way to do that is to convert all alternatives to present value (PV) and then compare. Let’s consider our I-69 example. In that example, the state will be paying the contractor $21.8M per year over 35 years. However, the $21.8M in year 2 is not worth as much as the $21.8M in year 1, and the $21.8M in year 35 is certainly not worth as much as it is in year 1. So how do we convert the entire 35-year payout to Present Value, as though it were all being paid out immediately? And more importantly — how do we compare the 35-year payout against a $350M cost if the design and construction were paid out of cash today.
Basically, we discount future payments by the amount of money we could earn on the money we save by not having to pay it this year! How much do we discount it by — in other words, how do we compute the present value?
Quick Mathematical Interlude
I’m going to take a moment to do a little math here; however, if you want to skip to the next section, you won’t lose much of the overall argument. The actual equation is: PV = FV / (1+i)^n, in which PV is Present Value, FV is Future Value, i is the interest rate per period that you could earn on the money, and n is the number of periods that you could earn that interest rate. For a quick example, let’s consider the following alternatives:
Alternative A: I give you $100 today
Alternative B: I give you $100 a year from today
First of all, we know that alternative A — the $100 I give you today has a present value of $100.To to compare it to alternative B (I give you $100 a year from now), though, we need to compute the present value today of the $100 I pay you a year from now. In the above equation, $100 is the future value (FV) — the amount that the $100 paid in one year will be worth at the time it is paid. i is the interest rate that we could be earning per year (or per any time period) with the $100. This is where TVOM analysis gets a little squishy, and the results you get can differ a lot depending on your assumptions. How much money can you earn with $100 in a year? Depends a lot on how you invest it! If in a savings account, almost nothing — less than 1%. However many investments earn quite a bit more than a savings account. One number that is considered pretty fair to use is the average municipal bond rate. At the very least, the municipal bond rate can be considered a good proxy for the opportunity costs of the money over a given period of time.
The following Web site provides municipal bond rates for various maturity ranges and credit ratings:
Just for the sake of this example, I’m going to take a national rate for a 10-year bond with AAA credit rating (which Indiana has) — an interest rate of 2.20% per year (of course, this amount may change).
Going back to our equation, we have: FV = $100, i = 0.022 (the 2.2% interest rate), and n=1 (1 year). The present value of that $100 paid out in a year is: PV = 100/(1+0.022)^1 = 100/1.022 = $97.85. In other words, with the assumptions we made, $100 paid to you a year from now is only worth $97.85 today.
I-69 Example, Revisited
OK, so let’s apply the TVOM principle to analyzing the 35-year contract for Section 5 of I-69. For the purposes of illustrating TVOM in comparing the 35-year contract with a conventional financing (i.e. paying for the project out of current tax receipts and cash balance), I am simplifying the situation dramatically in the following way: the 35-year $21.8M/year payout to the contractor does not only include the design and construction of the road, but also the operations and maintenance of the road — money that would have had to be spent anyway in all 35 of the outyears regardless of the method of financing the design and construction of the road. If we really want to compare alternatives fairly, we would subtract out the costs of maintaining and operating the road for all 35 years — figures I don’t have close to hand. So this TVOM analysis can really be considered to be a worst-case from the perspective of the P3 scenario. In other words, the real cost of the P3 versus conventional financing is much more in the favor of P3 than it is in the following numbers.
I created the following table for all 35 years of payments (all numbers are in millions). The first column, Payment, shows the actual payment made to the contractor each year for the 35 year period of performance. The following 5 columns show how much those 35 years of annual payments are worth today (the only fair way to compare the arrangement against a conventional financing arrangement where the whole thing is paid with cash/current taxes), using 5 different interest rate assumptions (1%, 2%, 3%, 4%, and 5%). For a project of this size, given the municipal bond rates for 30 year bonds for AAA credit, the most realistic assumption is probably somewhere around 4% (from the recent past history of municipal bonds, probably a little under 4%).
So with the 4% interest rate assumption, we can see that the present value of 35 years of $21.8M annual payments is not $763M (i.e. 35 times $21.8M), but the much lower $406.89M. Obviously that number changes depending on the interest rate assumption. The higher the interest rate, the lower the present value. This should make intuitive sense: the more opportunity I have to make use of the money up front, the less valuable it is for me to have the money in the future compared to the present.
So to get back to our hypothetical-not-so-hypothetical example. We want to compare paying for a $350M highway construction project out of current dollars against the 35-year $21.8M/year P3 arrangement. With our assumption of 4% interest rate, the present value (cost) of the 35-year arrangement is $406.89M, compared to $350M if paid in cash — more, to be sure — but dramatically less than simply adding up the 35 annual payments ($763M). And again, this doesn’t even include the fact that some of the annual payments cover the costs of maintenance and operations of the highway, which would be paid out anyway, regardless of how the design and construction are financed.
None of this discussion should be taken as an endorsement of the P3 process, or the fact that the P3 financing model basically guarantees that the winning contractor will be a large multinational corporation with deep access to finance. But I do want to make sure that as we move forward with an arrangement that by all accounts will only become more common, discussions of these kinds of arrangements are based on facts. And the fact is that a given sum of money is less valuable in the future than it is today. Most certainly we will be paying more for the privilege of stretching out the payments for the road over 35 years. But we won’t be paying double…not even close.
Today, the Indiana Finance Authority released the winning proposal (well, most of it — some parts are redacted) on its Web site. The proposal is in a number of separate files. To find it, go to the Indiana Finance Authority I-69 Web site and scroll down to “Selected Proposer”.
Right off the bat, based on a very quick read, I would think that the parts of the proposal most interesting to the public include:
This section describes the history and capabilities of all of the team members, including the equity member (i.e., the owner) Isolux Infrastructure Netherlands, B.V., and the local subcontractors, including the following. Note that no Bloomington/Monroe County subcontractors were part of the winning proposal.
The section labeled “Type and Purpose of Each Funding Source and Facility” details the sources of funding used for the project as well as the overall costs of building and financing. I’ve included a screen shot below.
The equity member (prime contractor), Isolux Infrastructure, is committing $44.75M of its own investment to build the highway. They also plan to raise $253.51M through private activity bonds (PABs). Commitment of PAB funding by the underwriters is provided in this volume as well.
The “Uses” column on the right outlines how the funds would be spent. The first three items (Construction Costs, Construction Oversight Costs, and Operations & Maintenance Costs during Construction) add up to the $325M in construction costs that has been quoted in press releases.
This section details the team’s approach to construction, design, operations and maintenance of the highway. A lot of this volume is very high-level and not particularly specific. Most of the pages consist of required letters of authority, certifications and representations, references (the contents of which have been redacted!), responsible proposer forms, etc. However, there are a couple of factors of note in the volume:
Page 7 includes a high-level Gantt chart (which I screen-shot below) outlining the design and construction schedule, indicating a construction start in mid-late 2014 and a finish by the end of 2016 (Volume 2 of the technical proposal, page 20, refers to a deadline of October 31, 2016 as the”Baseline Substantial Completion” deadline).
Rehabilitation of the pavement is scheduled for years 15 and 30.
Volume 2 contains a wealth of information about the proposed approach to all aspects of design and construction, including pavement, bridge structures, bicycle and pedestrian access, drainage, lighting, traffic signals, etc., as well as communications and public outreach — far too much to summarize here. There are just a couple of elements I quickly wanted to call out.
Page 43 provides a more detailed schedule of key completion milestones:
Page 47 indicates that the proposal design specifies that the construction will be asphalt, rather than concrete. Both were acceptable in the Request for Proposals; sections 1-4 are being constructed using concrete. Per this proposal, bridge structures, retaining walls, and noise walls will be constructed using concrete. As mentioned above, rehabilitation of the asphalt pavement is scheduled for years 15 and 30. Assuming that the asphalt pavement has a 15-year useful life, the rehabilitation at year 30 will mean that the pavement will have 10 years left of useful life when contract is completed (year 35).
Undoubtedly there is much more to comment on in the thousands of pages of this proposal; however, I wanted to get a couple of quick highlights out to the public as soon as possible.
You have probably already heard in the media about the selection of a winning proposal to design, build, operate, maintain, and finance Section 5 of I-69. However, you probably haven’t seen all of the winning and losing teams yet!
This past Wednesday, the Indiana Finance Authority preliminarily announced the winning bid to design, build, operate, maintain, and finance the construction of Section 5 of I-69, 21 miles of highway from Bloomington to Martinsville. I-69 Development Partners, led by prime contractor Isolux Infrastructure Netherlands B.V. from Spain, was selected as the preferred proposal.
The winning proposal would design and build the highway for $325M. The state will pay $21.8M per year over a period of 35 years (minus any penalties for non-performance), which will cover not only the design and construction, but also all maintenance and operation, including snow and ice removal, repair, resurfacing etc. for the entire 35-year term of the contract. In the form of public-private partnership used for this contract, the contractor provides the financing for the project. However, unlike most arrangements in which the contractor provides the financing for an infrastructure project, this project will not be a toll-road.
The full press release from the Indiana Finance Authority can be found here:
More interesting than the press-release, however, is the full list of proposing teams, including all of their subcontractors. In all, there were 4 teams proposing, all with very generic names: Connect Indiana Development Partners, Plenary Roads Indiana, WM 1-69 Partners, LLC, and I-69 Development Partners. Each team consists of an “equity member” (essentially a prime contractor) and over a dozen partners and subcontractors, including construction, design, environmental, operations and maintenance, etc.
The actual contract has not yet been released to the public; however, according to the Indiana Finance Authority, “portions of the preferred proposal” will be posted on its website next week. You can be sure that MoCoGov will be watching!