The Indiana Toll Road and the Dark Side of Privately Financed Highways

This is the first post in a three-part series on the Indiana Toll Road and the use of private finance to build and maintain highways. Part two takes a closer look at how Australian firm Macquarie manages its infrastructure assets. Part three examines the incentives for consultants to exaggerate traffic projections, making terrible boondoggles look like financial winners.

Who owns the Indiana Toll Road? Well, as of the bankruptcy filing in September, Macquarie Atlas Roads Limited (MQA Australia), which is joined at the hip to Macquarie Atlas Roads International Limited (MQA Bermuda) on the Australian stock exchange, has a 25 percent stake. Macquarie’s investment bank arm brokers the various transactions related to ownership of the road, collecting fees on each one. Welcome to the world of privately financed infrastructure. Graphic: Macquarie prospectus

In September, the operator of the Indiana Toll Road filed for bankruptcy, eight years after inking a $3.8 billion, 75-year concession for the road with the administration of Governor Mitch Daniels.

The implications of the bankruptcy for the financial industry were large enough that ratings agency Standard & Poor’s stepped in immediately to calm nerves. In a press release, the company attempted to distinguish the Indiana venture from similar projects, known as public-private partnerships, or P3s: “We do not believe this bankruptcy will slow the growth of current-generation transportation P3 projects, which have different risk characteristics.”

But the similarities between the Indiana Toll Road and other P3s involving private finance can’t be ignored. And as we’ll see, even the differences aren’t all good news for the American public. Once hailed as the model for a new age of U.S. infrastructure, today the Indiana deal looks more like a canary in a coal mine.

At a time when government and Wall Street are raring to team up on privately financed infrastructure, a look at the Indiana Toll Road reveals several of the red flags to beware in all such deals: an opaque agreement based on proprietary information the public cannot access; a profit-making strategy by the private financier that relies on securitization and fees, divorced from the actual infrastructure product or service; and faulty assumptions underpinning the initial investment, which can incur huge public expense down the line. Though made in the name of innovation and efficiency, private finance deals are often more expensive than conventional bonding, threatening to suck money from taxpayers while propping up infrastructure projects that should never get built.

For the parties who put these deals together, however, the marriage of private finance and public roads is incredibly convenient. Investors are increasingly impatient with record-low returns on conventional bonds, and are turning to infrastructure as an asset class that promises stable, inflation-protected returns over the long run.

Meanwhile, governments are eager to fix decaying infrastructure — but without raising taxes or increasing their capacity to borrow. On the occasion of yet another meeting intended to drum up investor interest, Transportation Secretary Anthony Foxx recently wrote on the U.S. Department of Transportation’s blog: “With public investments in our nation’s important transportation assets steadily declining, we need to find better ways to partner with private investors to help rebuild America.”

Those investors are lining up to get in the infrastructure game. According to the Congressional Budget Office, about 40 percent of new urban highways in America were built using the private finance model between 1996 and 2006. Since 2008, that figure has jumped to almost 70 percent.

In an attempt to get even more deals done, the current federal transportation bill ramped up funding for the TIFIA program — which offers subsidized federal loans and other credit assistance, often to projects that also receive private backing — by a factor of eight.

Major private investors have stepped up their lobbying efforts to close more of these lucrative deals. Meridiam North America recently hired Ray LaHood, Foxx’s predecessor as Transportation Secretary, and Macquarie Group — which orchestrated the Indiana fiasco — hired away a White House deputy assistant to “continue strengthening our relationships with key elected officials… while also exploring new investment opportunities.”

From a PricewaterhouseCoopers report advising readers "how to become a player in the P3 (public-private-partnership infrastructure) market."
A PricewaterhouseCoopers report advised engineering and construction firms on “how to become a player in the P3 (public-private-partnership infrastructure) market.” The U.S. is considered an “emerging market,” since it accounts for only one in five P3 deals worldwide.

In the midst of all this excitement about an “emerging market” in privately-financed American road-building comes the big failure of the Indiana Toll Road. In the news cycle following the bankruptcy, pundits praised former Indiana governor Mitch Daniels for deftly negotiating the deal. Many experts seem to think that the state of Indiana will almost entirely be shielded from the fallout of this bankruptcy, since it already received its payout and retained the right to set the road’s tolls and enforce its maintenance standards. (That is often not the case in these kinds of deals. Note how Standard and Poor’s says that newer infrastructure deals have “different risk characteristics” — that is, more of the risk falls on the public, something we’ll discuss in the third installment in this series.)

At the time of its sale in 2006, the Indiana Toll Road was the largest infrastructure privatization deal in U.S. history. Investors paid $3.8 billion for the right to operate and collect tolls on the 156-mile road for 75 years. The winning bid raised eyebrows. Sure, the road is heavily traveled by cross-country trucks, but the price was twice what state officials had expected the road to fetch, and $1 billion more than any other group had bid.

But if Indiana did manage to put one over on the financier-owners, Australian firm Macquarie and Spanish firm Ferrovial, as some suggest, those owners don’t seem to be too worried. For Macquarie, an investment bank and financial services firm with almost $400 billion under management, the loss hardly even registered as a blip in its share price:

Image via Google
Image via Google

Under the terms of the bankruptcy deal approved last month, ITR Concession Co. LLC — the company Macquarie and Ferrovial formed — will either be sold at auction, with proceeds distributed among its creditors, or those creditors will themselves buy a 95.75 percent stake in the restructured company, thanks to a fresh $2.75 billion round of borrowing. ITR began its life as a P3 with $3 billion in bank debt, and ITR’s second incarnation could get up and running with $2.75 billion in debt — not exactly a fresh start.

Bloomberg, The Hill, Reuters and the other outlets covering this story all pinned the downfall of ITR on both a risky financing scheme and on faulty traffic projections. Most sources shrugged off the faulty traffic projections as an artifact of the recession, not as part of a longer-term, more permanent shift in driving behavior that has been widely documented.

Whatever the cause, the Indiana Toll Road’s traffic projections were indeed very, very wrong. Although the actual projections contained in the signed contract are proprietary and shielded from public view, the state of Indiana released an analysis they conducted prior to the sale [PDF] showing expected increases amounting to 22 percent every seven years. What actually occurred after ITR took over the lease in 2006 was closer to the inverse: traffic declined more than 11 percent.

But even if traffic levels had met the projections, that would not have been enough to save ITR. As Toll Roads News pointed out, predicted traffic growth plus profit-maximizing toll rates still couldn’t have balanced the books:

They’d still only have toll revenues of $245m. And with interest payments to be made to borrowers of $268m they’d still be losing money.

So in addition to faulty traffic projections, ITR relied on a risky financing scheme that inflated its costs.

Media outlets also noted that the ITR bankruptcy was just the latest and largest in a crop of privately owned tollway failures that now litter the land. In recent years, other privately financed toll roads that have filed for bankruptcy protection have included San Diego’s South Bay Expressway (also owned by Macquarie and the first project to receive federal TIFIA funds), South Carolina’s Southern Connector, and the Alabama and Detroit roads owned by American Roads. Many more are limping along and may well end up bankrupt, like SH-130 outside Austin or the Northwest Parkway between Denver and Boulder.

Bankruptcy or default won’t necessarily eliminate the risk of a public bailout. The 12-year-old Pocahontas Parkway outside Richmond has now failed twice, largely because projected sprawl in its vicinity just never materialized. (Instead, Richmond’s core is booming, as in other metro areas.) Since TIFIA loans account for one-fourth of Pocahontas’ debt, taxpayers will eventually take a hit if the road continues to miss its payments.

Who is Macquarie, and why did it pay so much to run this Indiana highway? What can we learn about private finance in the infrastructure industry by taking a closer look at how Macquarie handled the Indiana Toll Road?

And then, why were traffic projections so far off base in this case? There’s a lot of evidence that engineering firms like Wilbur Smith (now CDM Smith), which produced the faulty forecasts for the ITR, have incentives to inflate traffic projections.

We’ll dig into these questions in the next posts in this series:

  • Psst, buddy! Wanna buy a bridge?

  • lop

    How does the share of financing available for different road types (interstate, arterial, collector etc…) compare with the share of revenue atritubable to those roads? Chiefly an estimate of fuel burned based on VMT I guess and other user fees. I suppose it would vary heavily by states since state and local gas taxes are hardly uniform. If interstates receive a disproportionate share of user fees that would make it harder for toll roads to make sense

  • Ben Ross

    Even more financially vulnerable than toll roads that are entirely for-pay are the new fad of express toll lanes that run alongside free lanes. The only reason to pay the toll is congestion on the free lanes. So if total traffic is below forecast, the entire loss comes out of the toll lanes.

    Let’s say the road has 3 free lanes and 2 toll lanes in each direction. The free lanes have to carry more than 60^% of the traffic – otherwise the toll lanes are just as congested and there’s no reason to pay the toll. So if total traffic falls below forecast by 10%, the entire shortfall comes out of the toll lanes’ (less than) 40% share. Thus a 10% shortfall in total traffic yields a shortfall in toll payments of greater than 25%.

  • 42apples

    I think that this serves as caution to those who say (transit advocates included) that driving charges should be used as a stable revenue stream. Maximizing social benefit is not the same as maximizing revenue. It can easily be the case that parking meters, HOT lanes, and toll roads do not raise a lot of additional revenue. What they are useful for is reducing congestion and avoiding or delaying new road or parking lot construction.

  • jeff wegerson

    Indiana in infancy went bankrupt over a canal deal that went south. Not a scenario here just an interesting aside.

  • Wewilliewinkleman

    First off, my knowledge of high finance is nearly zilch. But how these deals are financed may not be in traditional sense that most of us know like corporate bond and long term debt, but through more archaine structures like credit default swaps. Short term borrowing, betting on the come that interest rates would stay low, which they didn’t, with the hope that the long term debt can be converted to to low interest rate at a later date, which so far hasn’t happened.

    Politicians don’t like to raise taxes, but like to promise the sky to their constituencies. Ten + years of Middle eastern wars have robbed us. The World Bank financed private sales of 3rd world water systems that haven’t turned out so well. Privatization isn’t always the best, but it sure sounds good.

  • Chris Chaten

    This is cautionary from an investor perspective, not the government or citizens. Indiana struck a deal that netted taxpayers multiples above projected income, while maintaining control over the price. A better cautionary tale is the Chicago parking meter lease, which ended on the wrong side of both points. Most city bike shares are P3s of a different form. P3s are an instrument, just like bonds offerings. The latter can go poorly as well – see Chicago Public Schools.

  • Who are the investors in this case? That’s something we’re going to talk about in part 2. (Also, who are the investors in a typical P3 toll road deal, and more importantly, who assumes the risk?)

  • Jim

    It depends on the infrastructure asset. A P3, in its truest form, is about exporting risk to a private sector. This risk includes construction risk, operational risk, and revenue or future performance risk (in the case of a revenue risk concession). In some cases, these risks are best left with the public sector. In other cases, some of these risks might be best left with the private sector. (There is no one size fits all approach to building infrastructure).

    Additionally, a P3 is about bundling of contracts. A full blown P3 involves the design, build, finance, operate and maintain of a facility. The benefit of combining these features into one contract is that you can have designers work with developers to create a facility that is cost efficient and cheaper to operate and maintain in the long term (i.e., there is an alignment of incentives).

    In the case of a DBFOM, the private parties involved are usually construction firms, operating firms, and long term investors often capitalized by other long term investors (such as pension funds). The investors are not usually interested in a short term investment play. These concession agreements are typically 30 + years because it takes a considerable amount of time for investors to recoup their investment, which is usually very substantial.

    One final note – the contracts for these projects are fairly extensive and detailed. The idea that P3s involve a “profit-making strategy by the private financier that relies on
    securitization and fees, divorced from the actual infrastructure product or service” is not true. Concessionaires can be hit with penalities and even lose the project if they fail to “perform”. In the case of an availability payment (in which the public sector makes payments to the concessionaire to make the facility “available”), the concessionaire’s return is contingent upon the facility being available, open to the public and meeting many detailed specifications.

    Thanks,

  • Availability payments and maintenance of the road by the operator are what you can see on the surface. In many cases, including this one, ownership of the asset and its revenue streams are sliced and diced in a way that is completely divorced from the public-facing management and finances. There is more about this in part two, coming soon.

  • Andres Dee

    When public infrastructure, paid for by taxpayers, is sold off to investors, is the pool of investors wide enough that the public gets a decent price, or are these “fire sales” to a small group of potential buyers at depressed prices?

    When private investors take over public infrastructure and raise fees, why are these not recognized by a conservative electorate as effective tax increases?

  • neroden

    Because in this country’s political world “conservative” is a code word. It doesn’t mean “conservative” in any normal sense.

    In politics, “conservative” means “shill for people trying to steal public goods for private benefit”. Some analysts use the word “corporatist”, others the word “thief”, others call it “lemon socialism” (privatize the profits, socialize the losses). But this is what “conservative” means in politics today. Weird, isn’t it?

  • neroden

    So, an example of a REAL, honest PPP would be the 19th century contracts where the city authorized a privately financed streetcar company to build tracks and overhead wire on its streets, and gave it a “franchise” to operate.

    Or the very similar contracts with electric companies, which evolved into the “regulated utilities” of today.

    If so, an honest PPP is nothing new — we’ve had them since before the 18th century!

    In contrast, what Macquarie is up to is obviously not that. Macquarie’s business model (as explained in part 2) is, in fact, a profit-making strategy by the private financier that relies on securitization and fees, divorced from the actual infrastructure product or service. In other words, it’s dishonest.

  • The dark side – sophisticated asset stripping. Convinced that government can’t do anything, though the foundation of infrastructure we have was done by municipal corporations and development oriented States and Federal government, the foundation deteriorates. If you build it, you must maintain it. The “no new taxes” mantra has led to more an more tricks to pay the necessary costs. The world of finance makes its money on these tricks – promising relief, but delivering greater and greater levels of debt. The notion of living within one’s means went out the window in the 1980’s. We have a highly indebted society in the States. Private debt far exceeds anything that is payable. Much of the risk has been transferred to the public via the Fed’s QE. The planning horizon for government should be 300 years, focusing on perpetual maintenance of what exists now. Techno-optimism comes with even higher maintenance costs. Like lottery payouts, government windfalls don’t last that long. The private sector has a great market for project management and construction services for projects where there is no long term demand for a government, local, regional, State or Federal to have that expertise in-house. Governments can, however work together and develop cooperatively, such experience. Government in this “We the people,” country is the mechanism community built to serve itself in perpetuity. There is a responsibility to be prudent when the future is endless. This, I would say, is truly conservative.

  • Bazata

    Do you have information on how Indiana spent the money? What a windfall for any administration to have several million more to buoy their priorities or balance their budget.

    Thanks for the great research.

  • thinkisnotis

    Ah, Ha! Jusy as I figured! I’ve noticed significant traffic declines on these toll roads that are going broke. I drive an 18-wheeler and as C.W. Mc Call sang in his song “Convoy”, “we just ain’t going to pay no toll”, andtrcukers are doing exactly that. We’ll find an alternative way to get through Indiana. Even the rest areas are a disgrace on the Indiana Toll Road. I’ll take US-20 through Ft. Wayne and reconnect with I-80/90 at Toledo, thanks to the new US-24 FREEway Ohio built.

  • thinkisnotis

    That’s indiana for you, doing things on the cheap. When a company starts selling its most valued assets to stay in business, they are having serious financial problems.

  • thinkisnotis

    Governor Mitch Daniels told the people a half-baked lie when he said the tolls would not go up. True, the rates did not go up for cars, but they were more than doubled for big trucks.

  • xvet

    Privatization of public services is a scam.

  • R.A. Stewart

    Well put. I may steal your concise analysis.

    Hey, if I steal your analysis, which you made freely available to the public, and find a way to make myself rich by making taxpayers pay to read my version, I’m a “conservative,” aren’t I?

  • I am concerned about SH-130 outside Austin or the Northwest Parkway between Denver and Boulder ending up bankrupt.