Armando Rivera Jacobo is a counsel based in Debevoise & Plimpton’s New York office, where he is a member of the corporate department and finance group. He focuses on financing transactions both in the United States and internationally, including project financings, leveraged acquisition and other secured financings and structured financings. While in the past Armando represented sponsors and lenders in the development, construction, financing and operation of natural gas transportation systems and natural gas-fired combined cycle power plants, at Debevoise, he has expanded his practice to include other infrastructure sectors, and to the representation of financial guarantors. Mr Rivera has been named a ‘Rising Star’ for Project Finance by The Legal Media Group’s Expert Guides (2018).
Michael P McGuigan is a counsel based in Debevoise & Plimpton’s New York office. He regularly advises project companies, bidding consortia, developers, equity sponsors and other private-sector clients on the development and financing of major US infrastructure projects.
GTDT: What patterns are you seeing in the US PPP market? Are any sectors particularly active at the moment?
Michael P McGuigan: We continue to see the most US PPP activity in the transportation infrastructure sector, and there is growing interest in applying the PPP model to the social infrastructure sector. The LaGuardia Airport Central Terminal Building (CTB) project and the Maryland Purple Line LRT project were both long-awaited, marquee transportation infrastructure projects that achieved financial close in 2016. The UC Merced Campus Expansion also achieved financial close in 2016, and will test the viability of the PPP model for delivering social infrastructure projects.
We’ve also seen a notable increase in the airport sector, notwithstanding the limitations in the Federal Aviation Administration’s (FAA) airport privatisation pilot programme that have hindered PPPs at US airports. Financial close for the Denver International Airport Great Hall project was achieved in 2017, two PPPs at Los Angeles International Airport (the Automated People Mover PPP and the Consolidated Rent-a-Car PPP) achieved financial close in 2018, Indianapolis International Airport tendered a storm and waste water treatment PPP in 2016, and the Illinois Department of Transportation is currently evaluating a PPP structure to develop, finance, operate and maintain a new South Suburban Airport. In addition to the LaGuardia CTB Project, the Port Authority of New York and New Jersey is pursuing the redevelopment of Terminal A at Newark Airport through a modified PPP structure, which will involve multiple separate contracts for different aspects of the project, and the redevelopment of Terminals C and D at LaGuardia Airport, largely from private sector investment.
In terms of procurement structure, one trend we’re seeing is the ‘beauty contest’ procurement. In these procurements, the shortlisted bidders are asked to submit indicative proposals for a conceptual project, instead of a substantively complete concession, and the procuring authority will pick the team that it wants to directly negotiate the detailed terms and provisions of the project. Essentially, the preferred proponent wins a pre-development agreement and the right to negotiate the project with the procuring authority. Both the Indianapolis International Airport wastewater project and the Denver Airport Great Hall project were procured on this basis, and it is expected that the newly announced South Suburban Airport in Illinois will also be procured this way.
It is also worth observing that a number of recent PPPs in the United States have been (or are expected to be) structured on the basis of availability payments, where the private sector does not take demand or revenue risk. In these transactions, the governmental sponsor makes milestone payments to the concessionaire during the construction period, and continues to make scheduled payments throughout the concession, subject to deductions if required performance standards are not met. The Maryland Purple Line light rail project, the Goethals Bridge in New York, East End Crossing in Indiana, Port of Miami Tunnel and Presidio Parkway in California are availability payment transactions. This model is also being used for social infrastructure PPPs, which have recently become more popular in the United States.
A number of the earlier transportation infrastructure PPPs in the United States (eg, Chicago Skyway and Indiana Toll Road) involved demand or revenue risk, where debt service, operations, maintenance and capital expenses, and the private sector’s compensation, are payable primarily from revenues generated by user fees (eg, tolls). However, the challenges of projecting traffic and revenues with any meaningful degree of accuracy have become apparent, particularly when users struggle to find value in their direct toll payments and opt for toll-free alternatives. As a result, the actual traffic and revenues for a number of revenue risk projects have fallen well below projections.
It is worth noting that ‘shadow tolls’ allow the public sector to discreetly shift demand risk to the private sector. Under a shadow toll structure, payments to the concessionaire are determined by the usage of the asset, but the actual users are not required to reach into their own pockets and therefore are not inclined to seek free or cheaper alternatives.
“The political environment since the 2014 mid-term elections has resulted in postponement and cancellation of several PPP transactions that had reached advanced stages of procurement.”
GTDT: What are some of the setbacks and challenges that PPP transactions are facing in the United States to achieve commercial and financial close?
Armando Rivera Jacobo: Unfortunately, political risk continues to be an important factor in the US PPP market. The political environment since the 2014 mid-term elections has resulted in postponement and cancellation of several PPP transactions (such as the Houston Justice Complex, the Indianapolis Courthouse, the US Route 460 Corridor Improvements and Philadelphia’s Southport Marine Terminal Complex) that had reached advanced stages of procurement, and although the new federal administration has touted a $1 trillion infrastructure investment plan and more recently outlined some regulatory and financang programme changes to incentivise investment, many details on how new projects would be brought to the market or how closing risk would be reduced remain to be seen. The US PPP market has not yet evolved to a point where the procurement process is sufficiently institutionalised and professionalised to render it largely immune to the political cycle. Given the very high deal pursuit costs in these transactions, any delay or incremental risk of a failed procurement can operate as a powerful disincentive to participate in future procurements in jurisdictions found to be unreliable. Beyond purely political aspects, the environmental approval process has proven to be a challenge even when a project has achieved financial close. A case in point is Maryland’s Purple Line, which has encountered significant construction delays after having reached commercial and financial close, because of court injunctions that have prevented the performance of major portions of the work based on claims that the environmental approval was not properly issued.
In the current market, Transportation Infrastructure Finance and Innovation Act (TIFIA) funding remains vitally important and, historically, the TIFIA Joint Programme Office (JPO) (the office at the US Department of Transport that administered the programme) worked hard to ensure a level playing field among all bidders for any project eligible for TIFIA financing. However, in a typical US procurement with four shortlisted consortia, it would tax the resources of the TIFIA administrator to engage in full due diligence and negotiation with each bidding group. Instead, current practice entails a highly scripted and limited opportunity for bidders to submit comments on a generic TIFIA term sheet. It is worth noting that the administration of the TIFIA loan programme has now been consolidated under the new Build America Bureau with other loan and grant programmes, namely the Railroad Rehabilitation and Improvement Financing (RRIF) loan programme, Private Activity Bonds (PABs) and the Fostering Advancements in Shipping and Transportation for the Long-term Achievement of National Efficiencies (FASTLANE) grant programme under a single agency. The hope is that by consolidating these programmes in a single office, federal resources will be deployed more effectively. Because of the absence of any meaningful negotiation of TIFIA terms, it has been very difficult to adjust the proposed TIFIA terms to the particularities of a given deal by the time bids are due. To a much greater extent than committed bank financing, for example, TIFIA terms are left to negotiation after a financial proposal has been submitted and accepted by the granting authority in the PPP procurement. It remains to be seen whether the Build America Bureau will approach the negotiation of loans and grants in the same manner or will try a new approach.
“One could justifiably take the view that every US PPP project that achieves commercial and financial close is a keynote project, merely by virtue of having done so.”
GTDT: Which recent PPP transactions have stood out? What made them interesting?
ARJ: The US PPP market is still small in terms of the number of PPP transactions achieving financial close in any given year, particularly considering the size of the US economy. For example, during 2017, in total 11 PPP transactions were reported as having achieved financial close in the United States, of which only three PPP transactions with project costs in excess of $300 million achieved financial close: LAX’s Automatic People Mover and Consolidated Rent-a-Car and the Michigan I-75 Modernization projects; that would represent a significant decrease in major PPP projects from the previous year.
In light of these numbers, one could justifiably take the view that every US PPP project that achieves commercial and financial close is a keynote project, merely by virtue of having done so. That said, if forced to single out only one or two recent transactions, I would probably mention the Pennsylvania Rapid Bridge Replacement Project, which bundled over 500 bridges into a single PPP procurement, and the LaGuardia CTB Replacement project, which will require the private party to continue to operate the central terminal in one of the busiest airports in the United States while replacing all existing infrastructure.
The LaGuardia CTB Replacement project, procured by the Port Authority of New York and New Jersey, achieved financial close in 2016 after negotiations with different stakeholders took much longer than expected. The aggregate value of the transaction is estimated at approximately $4 billion. The scope of the project underwent several changes since selection of the preferred proponent, including the addition of new facilities under a separate regime from the lease of the Central Terminal Building. In addition to the challenge of simultaneous construction and complex operation of the terminal mentioned before, airport PPP transactions have the added complexity of having to consider the interest of airline users, who will be the main source of revenue, and provide a very limited universe of customers (particularly in a domestic-only airport such as LaGuardia, with flight range limitations).
The Penn Bridges project was a real test of confidence in the Commonwealth of Pennsylvania. Everyone still remembers and talks about the failure of the Penn Turnpike deal several years ago. Not only that, but by itself the deal presents great challenges in risk allocation and management, having to deal with different circumstances in multiple locations. This was not the first time that such a bundle was attempted. Several years ago, Missouri tried a similar approach with its cancelled 800-bridge Safe & Sound Bridge Improvement Program project, which gives an indication that getting Pennsylvania’s proposal to a happy conclusion was not an easy task. Pennsylvania has now named the preferred proponent for a second PPP transaction under this mode, the Northampton County bridges project, but for a significantly smaller number of bridges (33).
Finally, we would single out two general categories of transactions for keynote status – multistate procurements and broadband projects. This category includes the Ohio River Bridges, the now cancelled Illiana Corridor, the I-11 and Intermountain West Corridor, the Brent Spence Bridge improvement project and the LaGuardia CTB Replacement project itself (which is procured by a bi-state agency), among others. These projects entail an additional degree of difficulty as different states may have different policies and priorities, ranging from budgetary issues to constituency interests to political circumstances. All parties need to make sure that the development and risks of the project on both sides of the state borders are properly addressed. An imbalance on one of the sides could cause an undesired transfer of risk pricing from one portion of the project to the other, eroding value for money for one of the participating states.
Broadband network PPP projects is a new category that has attracted particular interest in the past few years. Starting with Kentucky’s KentuckyWired Project, which achieved commercial close in 2015 and was the result of an unsolicited bid, several broadband projects have come to market in the past three years. Currently, there are over half a dozen projects in or about to start the procurement process, including proposed projects by the Pennsylvania Turnpike, Riverside County and City of San Francisco in California, the Georgia Department of Transportation and Oakland County, Michigan. Each of these projects seeks to use the PPP model to either use and improve existing assets or build completely new networks that will serve the needs of the procurement authority (in some cases allowing incremental capacity to be used and marketed by the concession company) or create public access networks. The diversity in the scope of works and services to be provided, assets being allocated and goals pursued make it interesting to follow and see if and in which cases the PPP model will prove adequate for this type of infrastructure.
“Broadband network PPP projects is a new category that has attracted particular interest in the past few years.”
GTDT: How would you characterise the typical PPP agreement in the United States? Is there a tendency towards uniformity?
ARJ: Generally speaking, PPP agreements in the United States tend to be overly complex compared with those in use in many other jurisdictions. This is partly due to an accretion of overlapping, duplicative and sometimes inconsistent provisions in many US concession agreements. This can result when terms from a precedent transaction in one jurisdiction are carried forward into another. In many cases, the new procuring authority and its advisers will add new features and protective provisions to the template. However, the difficult task of paring back features that may be inapposite in the new jurisdiction, or that may conflict with the new terms added to the template, is sometimes not given the priority it deserves. There is also a natural reluctance on the part of government officials to excise seemingly protective language from precedents that may not be necessary in the new transaction. There is sometimes little perceived ‘upside’ to such streamlining.
One of the side effects of these complex models is that the task of drafting and negotiating the drop-down agreements (eg, design-build contracts, O&M agreements, etc) become correspondingly complex undertakings. Ambiguities or inconsistencies in the concession agreement are, in effect, ‘relitigated’ in the drop‑down negotiations, adding to the costs of pursuing a project.
Many developers and equity investors have come to accept the existing complex PPP model agreements, trusting that the parties understand what is meant and that, in the event of a dispute, authorities will act reasonably. However, as more stringent review by commercial lenders commences to play a role in projects in which cheap bond financing may not be as readily available, it will be interesting to see whether a change towards simplification occurs.
An attempt to create uniformity and standard practices has been undertaken by the Federal Highway Administration, which has published a Model PPP Core Toll Concessions Contract Guide to provide guidance to state governments on possible terms that could be included in model PPP agreements. However, the Federal Highway Administration has stopped short of creating a uniform model PPP agreement.
“In addition to focusing on the general categories of relief events, bidders continue to spend considerable time dissecting the precise language describing their scope, or the terms on which compensation will be granted.”
GTDT: In your experience, are there any particular provisions in recent PPP agreements that deserve special attention?
ARJ: It sounds like a project finance lawyer cliché, but risk allocation provisions are critical; in particular, the definition of relief events and the relief granted for their occurrence. Although one can observe certain trends in recent transactions, these provisions are still the subject of lengthy negotiations that sometimes may drive private parties away from the table. The most critical relief events on which developers and equity investors tend to focus include pre-existing conditions (with special attention to environmental conditions); geotechnical and subsurface characteristics; utilities and other third-party interests in the project’s land; third-party cooperation; the usual force majeure; and change in law.
In addition to focusing on the general categories of relief events, bidders continue to spend considerable time dissecting the precise language describing their scope, or the terms on which compensation will be granted. Unfortunately, this language is often vague or ambiguous. Aside from the obvious concern with entering into ambiguous contracts, this can call into question the transparency of the bidding process. A proponent who sees, analyses and quantifies a risk created by unclear language may be at a pricing disadvantage when bidding against a proponent who may not have spotted that risk. Stated otherwise, clarity of language can promote a level playing field in the procurement process.
It seems natural that government officials will try to push all of the project risk to the private party as far as possible. Such an approach can provide the public sector with a greater level of certainty about a project’s costs. Even in cases where a value-for-money analysis would suggest that the government should retain a given risk, there is a natural bureaucratic aversion to entering into a contract with significant contingencies for which the granting authority may not have budgeted. The fact that this occurs routinely in traditional design-bid-build procurements is not always a persuasive response. If the granting authority aggressively seeks to transfer too much risk to the private party, it will lose part of the economic benefit of the PPP model. Private parties will have to price all such contingencies into their proposals (and the authority will end up paying for them, whether they come to pass or not), driving up project costs and eroding value for money.
Another set of typical risk allocation provisions that deserve special attention are those providing for the rebalancing of the economic deal as a result of changes in the financing assumptions (eg, the terms that will serve as a baseline in connection with any TIFIA financing in transportation deals). The TIFIA JPO engaged in very limited direct contact with proponents and was very reluctant to negotiate many details in its term sheets. We expect the Build America Bureau to continue acting in such manner. If proponents are considering using TIFIA financing, they must make sure that the provisions of the PPP agreement that allow them to obtain economic relief because of a change in their base case model as a result of development of, or addition to, the TIFIA terms consider all those assumptions that are key to their valuation of the asset and estimation of their return.
One interesting trend in recent PPP transactions is the agglomeration of two or more PPP projects within what can be considered a single asset. Examples include multistate projects, such as the cancelled Illiana Corridor, and more recently, and perhaps more evidently, in airport projects that allocate different portions or aspects of the operation of the airport to separate concessionaires. Granting authorities and concessionaires need to consider the allocation of the interface risk created by actions of multiple concessionaires that could be outside the control of the granting authority. The upgrading of different terminals at LaGuardia Airport is a clear illustration of this point. While the LaGuardia CTB Replacement project geared towards commercial close, the Port Authority was already planning on the redevelopment of other terminals at LaGuardia. In fact, at present the Port Authority is in negotiations with Delta Airlines for the redevelopment of Terminal D. The LaGuardia CTB PPP agreement contemplated a specific regime for allocation of the risks arising from the interface with the Terminal D redevelopment, governing the conduct of both the Central Terminal Building concessionaire and the Port Authority in their dealings with the parties implementing other redevelopments to ensure that the actions of one developer do not jeopardise the other developer’s project or the operation of the airport as a whole.
“One interesting trend in recent PPP transactions is the agglomeration of two or more PPP projects within what can be considered a single asset.”
GTDT: How has the law and regulation governing PPP transactions developed over recent years?
MPM: While the US federal government provides substantial funding, the planning, development, financing, operation and maintenance of most infrastructure in the United States is largely the province of state and local governments. At last count, 34 states, including Puerto Rico, have some form of PPP-enabling legislation for transportation infrastructure, and a number of the states that do not have such PPP-enabling legislation have PPP bills in various stages of legislative consideration, but only 12 states have effectively closed a PPP. While these statutes create a framework for utilising PPPs within the applicable state or territory, there is a substantial lack of uniformity in PPP laws from state to state, which is impeding the development of a ‘standard’ PPP transaction model in the United States. The US PPP market would benefit greatly from a more standardised legislative landscape, but that is unlikely to occur any time soon.
At the federal level, the new Build America Bureau serves as the single point of contact and coordination for states, municipalities and project sponsors looking to explore ways to access private capital in PPPs. The Build America Bureau combines the TIFIA and RRIF loan programmes, PABs and the new FASTLANE grant programme under a single agency. A number of US states have followed this lead and have created centres of excellence, committees and similar resources for PPPs.
“At the federal level, the new Build America Bureau serves as the single point of contact and coordination for states, municipalities and project sponsors.”
GTDT: Are investors comfortable with the procurement process in your country?
ARJ: I have already mentioned several respects in which the US PPP procurement process gives bidders some pause. Another important consideration not always fully appreciated is the size of the shortlist. In many US PPP procurements, the granting authority reviews qualifications at the request for qualifications (RFQ) stage and prequalifies four bidding groups. In contrast, a typical Canadian procurement will have three prequalified bidders, which is generally viewed in Canada as being sufficient to maintain competitive tension in the procurement. Although the difference may seem small, the incremental probability of incurring unremunerated deal pursuit expenses in the United States (which can run in excess of $10 million on a complex project) can act as a disincentive to pursuing US projects. This is particularly important in a market where all of the major players are active internationally and can choose to deploy resources in those jurisdictions perceived to have the lowest political risk and the most efficient and transparent procurement regime.
GTDT: What are the typical sources of financing for PPP projects in your country?
MPM: The US federal government provides substantial financial assistance for infrastructure projects through grants and other appropriations. Recently, the FASTLANE grant programme was established under the Fixing America’s Surface Transportation (FAST) Act to fund critical freight and highway projects across the country. The FAST Act authorised the programme at $4.5 billion for fiscal years 2016 to 2020, including $850 million for 2017. Examples of federal assistance in recent PPPs can be seen in the Maryland Purple Line project, where the Federal Railroad Administration allocated approximately $900 million, and the LaGuardia Airport CTB project, where the Port Authority of New York and New Jersey committed approximately $1 billion of FAA-authorised passenger facility charge revenues.
The FAST Act also authorised $1.435 billion in capital over five years for the TIFIA credit assistance programme, which offers direct loans, loan guarantees and standby lines of credit. TIFIA has long been the preferred option for financing US transportation PPP projects. TIFIA credit assistance can be in the form of a direct loan, a loan guarantee or a standby letter of credit, and may be used to finance up to 33 per cent of project costs (and up to 49 per cent of project costs for certain projects).
PABs are available for most infrastructure projects where ownership of the asset remains with the state or other governmental authority. PABs are attractive because interest earned on the bonds is exempt from federal and certain state income tax, which translates into lower interest rates on the debt. PABs also tend to carry long maturities, which are sought after by large institutional investors (eg, insurance companies and pension funds). But PABs financings tend to be more complicated and time-consuming than other sources of financing, and proposed changes to the way that the Internal Revenue Code taxes investment income could compromise the attractiveness of PABs for US PPPs. PABs, however, are not available for many of the most recent categories of PPP projects being pursued, such as social infrastructure and broadband networks.
Bank debt also remains readily available for US PPPs, but the availability of long-term and relatively inexpensive debt financing (eg, TIFIA and PABs), together with the uncertainty of refinancing risk, has narrowed the demand for traditional short-term bank loans in US PPPs. However, the rise of the availability payment structure seems to be creating new opportunities for traditional bank debt in the PPP capital structure. The availability payment regime often involves a substantial payment to the concessionaire at substantial or final completion of the project, which typically occurs five to seven years after financial close, or roughly about the same time that a bank loan would mature. The concessionaire is therefore able to mitigate the refinancing risk associated with short-term bank debt, and to reduce overall project debt early in the life of the project, if it is able to complete the project on time and on budget. Further, the value of the private sector’s equity position will be enhanced by a de-risked and de-leveraged project.
On the equity side of the capital structure, a substantial amount of private equity has been earmarked for infrastructure. It is not uncommon for PPPs to have a minimum equity contribution, and private equity funds are increasingly also providing debt financing for PPPs. In the United States, the issue is not finding the capital to fund projects – it is finding projects that are ready to make use of widely available capital resources.
“On the equity side of the capital structure, a substantial amount of private equity has been earmarked for infrastructure.”
GTDT: Looking ahead, how busy do you expect the PPP space in the United States to be over the next couple of years?
ARJ: About 20 PPP projects in the United States are currently at the stage where a preferred proponent has been selected and the winner is working its way towards financial close. This includes transactions such as the Los Angeles International Airport Automated People Mover, the Florida I-395 Corridor and the Westchester County Airport. There are about another 20 or so projects for which the proponent shortlist has been issued and that have already received bids and await the award, or are scheduled to receive bids in the relatively near future. This includes the I-10 Mobile Bridge, Bayway Widening and the San Francisco Broadband P3 project. Barring issues with governmental approvals of the final PPP agreements and delays in the procurement schedules, this by itself should create a pipeline of transactions for the next year or two that maintains the current level of activity on a par with previous years.
In addition, there are currently many proposed PPP projects, in pre-procurement or RFQ stages, that by their nature should be of significant interest to private parties. This would indicate that a pipeline for an even longer term is being created. Projects of this type that come to mind include the Honolulu Rail Transit P3, and the Hudson River Tunnel Replacement (Gateway). The current administration has put forward its plan to invest up to $1 trillion in infrastructure. Unfortunately, the plan is far from taking a full shape. Furthermore, most PPP projects are the purview of the state and local governments, and it is unclear whether the federal government’s intention to flood the market with additional funds will in fact bring additional financeable projects to the table that can take the form of PPP transactions.
As previously discussed, more states continue to enact or further develop their PPP legislation, broadening the scope of potential transactions. Moreover, states that have already been successful with their transportation PPP projects continue to expand their PPP programmes to other sectors. We are seeing a growing interest in social infrastructure, water and broadband projects, not only from granting authorities, but also from developers, equity investors and financing parties. We believe that this trend will continue to the extent that granting authorities hit the sweet spot on the size of project value. States have started to pack their pipelines with these kinds of projects, many of which remain in the viability study stage, but some of which have made it to procurement, or even to commercial and financial close, such as the Kansas Prisons P3, various state university student accommodation projects, the Long Beach Civic Center and, perhaps the most salient one at this time, the UC Merced Campus Expansion.
Despite a slow start and a roller coaster of activity, the US PPP market is alive and well. We need to recognise that the PPP market is not something new in the United States; many transportation projects date back to the early 1990s. Here at Debevoise we are confident that the activity in the PPP market will continue to grow as more projects mature and provide more evidence that the PPP model both works and, if properly applied, brings benefits to both sides of the equation.