SPI President & CEO Mary Scott Nabers
Public officials worry about what happens if a public-private partnership (P3) is not successful. And, taxpayers want to know what happens if a bankruptcy occurs. While failed public projects are not common, they have occurred. So, what can be learned from unsuccessful projects, especially those that are collaborations between public and private entities?
The first thing to learn is that the financial models must be absolutely sound. The responsibility to plan well falls squarely on both parties. There must be a “safe and stable” return on investment (ROI) model in place – one that is fair to both partners.
In the past, most P3s in the United States were financed with user fees. For example, revenues from toll roads were allocated to repay the initial capital investment from the private partner. Under this modeling structure, almost all financial risk is transferred to the private-sector partner. The model works, however, only as long as user projections are accurate. And, it is not always possible to accurately predict demand.
When private capital is to be recouped through user fees, contractors carry a very large risk. If usage projections are inaccurate, financial stress results quickly. Although public entities may be protected financially when calculations are incorrect, a governmental organization suffers in other ways if its partner is forced to find workaround strategies because user projections turn out to be wrong. Here are some examples:
The South Bay Expressway in San Diego, a public-private partnership, suffered hard times because of the housing market collapse in 2008. Although an economic downturn could not have been anticipated, the result was a steep decline in the number of vehicles using the expressway as fewer people commuted each day to jobs in Southern California. With significantly fewer vehicles using the roadway, the financial model began to fail. The project suffered because of “demand risk” – one of the more significant risk factors that public officials now work to avoid.
A private-sector contractor operating an Indiana toll road recently declared bankruptcy. That failed project was a direct result of inaccurate projections related to demand. Ultimately, the San Diego Association of Government assumed responsibility for the toll road and the private company turned the project back to the public entity. However, a favorable workout agreement was negotiated and the toll road continues to operate as planned.
The Southern Connector, a tolled portion of I-185 in South Carolina, constructed as a P3, opened in 2001. The toll road began experiencing financial strain six years later in 2007. A nonprofit operator of the toll road defaulted on its bonds and filed for bankruptcy, citing less traffic and revenue than projected in the financial model. This was clearly another example of inaccurate user projections. The nonprofit association managed to restructure the debt through bankruptcy and reported $6.9 million in revenue for 2013. Because of a rebound in the economy and increased demand, the future success of this project is likely to be positive.
These projects were all structured as fee-based repayment models. In each case, debt was restructured and another entity absorbed a failed project from the original contractor. The public entity suffered very little financial loss, but failed projects like these make it hard to find contractors willing to take on any demand risk. Most new P3 financial models are now structured around availability payments. That means that once a project is completed and all specifications have been met, the public entity accepts the project and begins a payback model based on availability.
Public-private partnerships in the UK and Canada are predominately funded with availability payments. Other countries, more experienced in P3s, learned from failed projects long ago that demand for any public facility is difficult to predict over a period of many years.
The Florida Department of Transportation (FDOT) recently used the availability payment model to close a $2.3 billion dollar, 21-mile reconstruction of the I-4 roadway. The private partner accepted all construction, operations and maintenance risk over the life of the project but the ROI is structured to come from pre-determined revenue streams not associated with projected usage.
Aside from roads, availability payments were used for the $860 million Miami Port Tunnel that was recently completed, the $495 million Long Beach Courthouse and the $1.6 billion Denver commuter rail line. The trend to structure P3 repayment models with availability payments is becoming the norm.
There is no argument about the lack of public funding for large infrastructure projects. It is simply not available – and that will not change in the near future. Because of that, public officials and private-sector contractors must study “best practices” and learn from failed projects. Success is sweet and collaboration is good when P3s work as they should.