Articles

Close Shave

The Pocahontas Parkway was nearly a financial debacle. But the timely intervention of a company from Down Under kept the public-private partnership from going under.

by Peter Galuszka

In early 2004, former Gov. Mark R. Warner was embroiled in the most visible conflict of his four-year administration: a bruising legislative battle to raise taxes that were needed, he asserted, to preserve the Commonwealth's hard-earned AAA bond status.

That same year, outside the public eye, the Governor scrambled to patch together a deal to rescue the troubled, $324 million Pocahontas Parkway project from insolvency. Defaults on Parkway bonds would have done incalculable damage to the credit- worthiness of public-private partnerships, a lynchpin of Virginia's road-building program, and would have sullied Warner's reputation as a fiscally responsible, can-do Democrat.

To the casual observer, the 8.8-mile Parkway, which arched 145 feet over the James River, was a stunning success. It was the first project in Virginia to be financed through the innovative Public Private Partnership Act. Its sharply curving concrete bridge was a marvel of construction design, and structural engineers came from around the world to view it. The Parkway also completed the eastern Interstate bypass around Richmond, opening up large tracts of rural land for development and holding out the promise of making Richmond International airport more accessible as soon as an interchange could be completed. 

But the Parkway also was testament to the triumph of politics over financial prudence. When the toll-funded Parkway opened in 2002, usage fell so far short of projections that the project's financial viability was immediately cast in doubt. Anticipating the possibility of a financial melt-down, national rating agencies Moody’s Investors Services and Standard & Poors downgraded Pocahontas bonds to junk status.

Culminating work commenced during the Warner administration, the Kaine administration finalized the transfer of the Parkway in May to a consortium consisting of Transurban, of Melbourne, Australia, and its bank, DEPFA Bank of Dublin, Ireland, in a 99-year lease. Not only has Virginia's sterling financial reputation been preserved, but the state has gotten back $27 million in public funds invested in the project, and it has been relieved of $225 million in maintenance and operation costs over the life of the lease.

“The principal financial benefit is that it removes the maintenance burden from the taxpayers of the Commonwealth,” says Secretary of Transportation Pierce Homer, a key player in engineering the rescue.

The Pocahontas Parkway offers important lessons to Virginia as state funds for new construction dry up. The Kaine administration is aggressively pursuing new public-private partnerships as a way to jump-start critical construction projects such as HOT lanes in Northern Virginia and an upgrade to U.S. 460. Meanwhile, the leadership of the House Republican caucus has touted privatization and public-private partnerships as part of its comprehensive transportation strategy.

As the Pocahontas episode makes clear, highway mega-projects, especially those driven by "economic development" considerations, are based on traffic projections that may or may not materialize. If projects fall apart, the state can find itself on the hook for millions of dollars. Conversely, if Transurban and DEPFA turn the project around, Virginia could serve as a model for the rest of the United States of how to build and manage highways when public money is scarce.

Like its namesake, the Native-American princess, the Pocahontas Parkway started off with much promise and ended up in situations that no one could have imagined.

In the late 1970s, regional planners wanted to complete a Beltway-like loop around Richmond. They envisioned that Interstate 295 would run from Interstate 95 south of Petersburg all the way around Richmond to Interstate 64 on the west side.

Planners saw benefits to adding a connecting annex to the plan and hoped that Federal Highway Administration funds would help pay for it. By 1983, the Commonwealth Transportation Board had approved the location of the Route 895 annex (now the Pocahontas Parkway) that was to speed the flow of traffic to the Richmond airport and make circumnavigating the city easier.

Some experts, however, noted that Route 895 seemed superfluous, especially given the dire needs of such fast-growing areas as Northern Virginia. Back in the 1970s, there was little development in the area around the highway, save for the airport and some large factories, including ones operated by the Nabisco baking company and German semiconductor maker White Oak. Proponents pointed to the financially successful and well-traveled Dulles Toll Road near Washington, which has transformed dairy farms into a world-class technology corridor, as an example of the benefits that an airport connector could bring.

Siding with the skeptics, the federal government denied funding. Undaunted, regional planners and officials cheered the project on. Route 895 then got a boost in the 1990s when the state Public Private Transportation Act, one of the first such laws in the country, allowed private entities to work with the state in financing and building road projects. The non-profit Pocahontas Parkway Association was created in 1997, during the Gilmore administration, to sell bonds to pay for the project. The state contributed $27 million in public funds up front. Operations and maintenance were assigned to the Virginia Department of Transportation.

Initial studies had projected 20,000 riders daily the first year, paying initial tolls of $2 per passenger car and $1 per additional axle. The flaws in the projections became painfully apparent when the Parkway opened for business in 2002. “It was just a few months after the 9-11 terrorist attacks and people were not flying as much,” says Barbara Reese, VDOT chief financial officer. Plus, the end of the high technology bubble in 2000 had put the brakes on economic expansion. Ridership levels were only about 10,000 the first year – roughly half of what was expected. 

Traffic levels continued to disappoint and by 2004, VDOT had a major crisis on its hands, although the Virginia newspapers gave it no more than occasional, inside-the-B-section coverage. The debt covenants were structured so that toll revenues were applied to service debt first, and only then to cover the estimated $2 million annual operations and maintenance fees.

The Parkway Association was required to regularly study its debt covenants and the picture was gloomy. Not only were revenues insufficient to pay for operations and maintenance, it looked as though they could not even service the debt. “There was a potential in the next few years that reserve accounts would have to be tapped. That’s never a good thing,” says Reese.

Wall Street noticed. Moody’s and Standard & Poors dropped Pocahontas bonds to junk status. Panic spread in the Governor’s office and VDOT headquarters a short distance away in downtown Richmond. If the Parkway defaulted, state officials would be hard-pressed to pursue any future road projects on favorable financial terms.

“The Pocahontas Parkway was the first public private act project,” says Reese. “Had the road gone into default, well, that would not have been a positive event for the Commonwealth. It would give the ratings agencies pause in doing those types of projects.” 

There were major political stakes as well. Then-Gov. Mark Warner, a Democrat, was hard at work on plans to help clean up what he billed as the financial mess left by his Republican predecessor Jim Gilmore. Warner also was seeking to reform the state tax code -- raising some taxes, lowering others -- to net $1.4 billion per biennium in an ambitious plan to preserve the state's AAA credit rating. The last thing he needed was for the Pocahontas Parkway, a Gilmore-era initiative, to blow up on him.

VDOT called in DEPFA Bank for advice. The bank recommended bringing in Transurban, a Melbourne company with a decade’s experience in managing public-private toll roads in Australia.

Transurban is one of two Australian firms that are revolutionizing the finance of transportation in infrastructure in the United States. Like Transurban, Sydney-based Macquarie Infrastructure Group, has scoured the U.S. to invest billions of dollars in public-private deals.

Macquarie has concentrated so far mostly in the Midwest, with one project in Virginia. It has won deals to manage the 7.8 mile-long Chicago Skyway with Spain’s Cintra Concesiones de Infraestructuras de Transporte S.A. Earlier this year, it signed a deal to operate the $3.8 billion Indiana Toll Road for 75 years. The latter project has been billed as the largest highway privatization in the U.S. In Virginia, Macquarie has helped restructure the Greenway, a completely private expressway built in Loudoun County to expedite commuters to Washington, D.C.

Macquarie and Transurban have experience managing public-private toll roads in Australia, where the national government lacked funds to build large-scale roads and local-regional governments teamed up with private business. Both firms have special financial arrangements with Australian and Canadian pension funds, which look for secure and steady projects, such as public works, with good returns. Other countries with similar experience are France and Spain, whose firms such as Madrid-based Cintra Concesiones de Infraestructuras de Transporte S.A. have been active in the U.S.

Transurban picked Virginia to secure a beach head in the U.S. market because of the state’s reputation for highway financing innovation. Besides the Pocahontas Parkway, Transurban is working on projects to create “HOT lanes,” special controlled-access lanes that commuters can use if they pay tolls, on parts of highways in Northern Virginia, including Interstates 495, 95 and 395.

Why Virginia?

The state "has an impressive record private sector involvement,” says Megan Fletcher, an official with Transurban in New York. “We have established a strong relationship with the state. From a U.S. perspective, public-private partnerships are really just starting to emerge. Virginia was in the forefront of recognizing the part it can play.”

The Transurban-DEPFA Bank consortium entered into an agreement with VDOT in May to manage the Pocahontas Parkway for 99 years. The consortium settled all the PPA bonds and refinanced the project through a combination of equity and commercial bank financing. It also paid back the state $27 in public monies.

The Commonwealth will continue to own the parkway but the consortium will be responsible for all aspects of operating and maintaining it. In a crucial departure from the original deal, Transurban has pledged to give road operations and maintenance first dibs on toll revenues, giving the state far less exposure to traffic projections falling short. Transurban will take on the lion's share of risk.

The consortium does have the right, however, to raise tolls, and it plans to take them from $2.25 for cars at the main toll plaza up to $4 per car by 2016. Future hikes will be limited by a formula based on inflation rates and other economic indicators.

Transurban’s Fletcher says that her firm is confident that traffic flows will improve. Projections show that daily traffic should double from about 15,000 in 2004 to 30,000 in 2011.

To reach those numbers, two things must happen. An interchange must be built to connect Richmond International airport to the parkway. Final negotiations are underway, including talks to win some federal money for the cloverleaf and new road that will funnel plane passengers and airport visitors to points south. No state funds will be involved in constructing the connection.

The other major component is the successful completion of the planned Wilton development encompassing 1,185 acres on the eastern bank of the James River. Preliminary construction work has begun on the project that will eventually have 3,200 residencies and 200,000 square feet of retail space. Another interchange is expected to serve the project whose backers are expected to pay for it.

The consortium is leaving nothing to chance -- or to the vagaries of development in eastern Henrico County. It also has been advertising the Parkway in Richmond-area media, building awareness of the transportation alternative.

Transurban, with a market capitalization of $5 billion, and DELFA Bank conducted detailed marketing studies before approaching the deal and informing its investors. “We believe that the growth anticipated around Richmond and the international airport makes it attractive to us as an investment,” says Fletcher.

Besides its four projects in Virginia, the company is looking at developing HOT lanes on Interstate 285 near Atlanta and also dear Dallas and Ft. Worth. Fletcher said the firm is open to more opportunities for public-private road projects in Virginia. However, she said, the firm is not interested in a proposed four-lane road that would bypass U.S. 460 from Petersburg to Suffolk. “We just don’t think the market is there for it,” she says.

For now, the Pocahontas Parkway is undergoing a critical metamorphosis. Its success could be key to how Virginia builds roads for decades to come.

-- December 11, 2006