Michigan testing P3 waters with $600 million highway deal
Michigan’s Department of Transportation will sell $600 million of private activity bonds next week as part of a public-private partnership that will allow the state to wrap up a highway project more than a decade early.
The Michigan Strategic Fund is issuer for the deal expected to price Nov. 14. It authorized a borrowing of up to $725 million. Proceeds of the limited obligation revenue bonds are expected to total $632 million.
The bonds are being to fund MDOT’s P3 with private developer Oakland Corridor Partners. After a competitive bidding process, the state agency entered into a design-build agreement with OCP on Oct. 12. OCP is a group that includes John Laing Investments Limited, AECOM Capital Inc., Ajax Paving Industries Inc. and Jay Dee Contractors Inc.
P3 financing is a relatively new arena for MDOT. The state agency said last year that it was would use the structure to accelerate the completion of Segment 3 of the I-75 Modernization Project while also transferring more risk to the private sector for long-term maintenance.
The project has been in planning and development for more than 20 years. Construction cost for the segment is estimated at $628 million.
The project is expected to achieve substantial completion in August 2023 and a maintenance term will extend for 25 years afterward. At the end of maintenance term OCP will turn the project over to MDOT.
“This is an essential project for MDOT containing necessary repairs for key routes in Michigan and accelerates project completion by as much as twelve years over MDOTs original plan for modernizations,” said Michael Fishbein, senior vice president at John Laing Investments.
In September 2017, after completing the first portion of the 18-mile-long project in Bloomfield Township and Auburn Hills, MDOT announced that it would seek lenders for a public-private partnership as a means to come up with the upfront cash it needed to put the project into overdrive and complete the work more than a decade sooner than planned.
OCP was named the preferred bidder to design, build, finance and maintain the final 5-mile segment of the Interstate 75 project between Eight Mile and 13 Mile roads, north from the Detroit city limits. OCP will complete the project and collect availability payments totaling $101 million that were originally earmarked for the I-75 modernization project over the course of 30 years. Under the original plan, the cash would have been collected from taxpayers over time and work would have been completed in five separate segments over the next decade.
OCP will also maintain the stretch of highway for 25 years after construction is finished and will receive quarterly availability payments during this maintenance period from MDOT.
Bank of America Merrill Lynch and Wells Fargo Securities are co-senior managers. Dykema Gossett PLLC is bond counsel.
The bonds have underlying ratings of Baa2 from Moody’s Investors Service and BBB from Kroll Bond Rating Agency. The outlooks are stable.
Some maturities may be insured by Assured Guaranty Municipal Corp which is rated AA-plus by KBRA, A2 by Moody's and AA by S&P Global Ratings.
Bond insurance has become a more common feature on these transactions, said Lorne Potash, Managing Director at Assured Guaranty. "Assured Guaranty’s participation helps enhance the execution of these transactions and reduce the overall interest rate for the issuer," he said.
“There is no financial risk nor financial exposure to the MSF, MEDC or the state of Michigan,” said Otie McKinley, a spokesperson with the Michigan Economic Development Corporation. “The MSF does not provide funding and does not guarantee any debt.”
All availability and milestone payments will come from budget appropriation to MDOT and represents at a maximum less than 5.6% of MDOT funding available for the project.
Michigan's 2015 transportation funding package significantly increased available MDOT funding sources. The legislation, pushed by Gov. Rick Snyder, increased state motor fuel taxes, vehicle registration taxes and redirected income tax revenue for transportation purposes. The law will eventually dedicate $1.2 billion in annual funding toward road repairs by 2022.
“As a result aggregate transportation funding into the Michigan transportation fund have grown by $715 million from fiscal 2016 through fiscal 2018,” said Patrick McCarthy, division administrator for financial operations at MDOT.
McCarthy said that MDOT also receives federal revenue through Title 23. In federal fiscal 2017, MDOTs receipts of Federal Highway Administration funding were $850.2 million. “The milestone and availability payments are subject to annual appropriation,” McCarty said. “MDOT intends to include the payments in its overall capital budget.”
The first milestone payment of $20 million will be at the acceptance of tunnel boring machine expected in May 2020. The second payment of $40 million payment will be made following the storage and drainage tunnel and pump station being in service, expected in June 2023. The following $40 million payment will be made after substantial completion expected in August 2023. The final milestone payment of $1 million will be made at final acceptance which is expected to occur by February 2024.
OCP has subcontracted the project with MI-75 Constructors, LLC which is composed of Dan’s Excavating, Ajax Paving Industries, Jay Dee Contractors and CA Hull Co. Inc.
The project consists of 1.5 miles of rural freeway, 4 miles of urban depressed freeway with service drives, a storage and drainage tunnel, and pump station, all located in Oakland County. It's a key commercial, commuter, and tourist route handling 103,000 to 174,000 vehicles daily, which is projected to increase 10% by 2035.
A key feature is a drainage tunnel and pump station to prevent flooding. In the past, heavy rains have overwhelmed the freeway’s drainage system and flooded the low-lying I-696 Interchange.
Kroll said that aside from the tunnel work, the design and construction work for the project is relatively straightforward. “The proposed construction schedule from the Design-Build Contractor includes float of 337 days -- approximately 11 months -- for the tunnel work, which is more than sufficient to absorb any potential delays,” KBRA said. AECOM is a tunnel design firm with local and international experience with similar water-containing tunnels and pump stations.
There is also the added benefit that the Design-Build contractor will self-perform 94% of the design build work, which provides significant cost certainty in the construction budget, the rating agency said.
“The Design-Build Contractor is the most experienced local contractor group for this type of project in Michigan,” said KBRA. “Its members have substantial experience working together, with MDOT, and with local jurisdictions. OCP and the Design-Build Contractor have unparalleled experience and knowledge of the corridor, especially as it relates to geotechnical conditions relevant to the tunnel work.”
KBRA noted in its report that although the subcontractor lacks experience with availability-based projects of this size, the risk is mitigated by the equity sponsors who have extensive global experience with delivering P3 projects. “The Project is likely to progress in accordance with the project schedule without significant delays or cost overruns,” said KBRA.
However construction delays or lower-than-projected debt servicing during the maintenance term could trigger a downgrade of the bonds, the rating agency said.
The deal is subject to several risks that could impact payment on the bonds, according to offering statement. The bonds being limited obligations of the state mean Michigan has no continuing legal or moral obligation to appropriate money for payments to be made or other obligation. "No assurance can be given that the state will be willing or able to take into account the interest of the owner of the bonds if an event occurs that would entitle MDOT to terminate or to take other remedial action under the project agreement,” the offering statement said.
There is also the risk that the level of federal highway appropriations, which are a significant source of funding to MDOT, won’t come in as anticipated.
A report commissioned by Snyder in December 2016 argued that Michigan is underinvesting in infrastructure by about $4 billion per year. Transportation infrastructure alone has an annual investment shortfall of $2.7 billion, the report said, that will exceed $40 billion over the next 20 years.
Term limits mean Snyder, a Republican, couldn't seek another term this year.
"The decision to choose the P3 route originated from MDOT," said McKinley. "Moving forward, the incoming governor will likely determine the frequency or future of P3 projects."
MDOT previously used P3 financing for a $125 million freeway lighting project that replaced 15,000 bulbs with efficient LED versions across bridges, tunnels and roadways in metro Detroit. The project, which closed in 2015, was the first P3 in the US to reach initial financial close using private placement debt. The state partnered with Star America and Aldridge Electric.