The Indiana Toll Road: How Did a Good Deal Go Bad?

What happens when the wave of the future files for bankruptcy?

That’s what they’re asking in Indiana now that its toll road concession, lauded as a new era in public/private infrastructure partnerships, is facing a Chapter 11 filing.

Now, after years of low traffic volumes and a debt explosion, the Indiana Toll Road is facing major financial restructuring and likely new management.

What went wrong? And what does this mean for Indiana and for the use of public/private partnerships for American infrastructure?

Some background: In 2005, newly elected Gov. Mitch Daniels needed a couple of billion dollars to help fund “Major Moves,” his 10-year plan for building and fixing roads throughout the state. His idea was to solicit bids for the 157-mile Indiana East West Toll Road that directly connects the Chicago Skyway to the Ohio Turnpike. In exchange for managing and operating the road the private partners would receive the tolls paid by motorists—though the road would remain owned by the state.

On June 29, 2006 the Indiana Toll Road Concession Company—a joint venture between Cintra, a Spanish construction firm, and Macquarie Atlas Roads, an Australian toll road company—was awarded the right to operate the road for 75 years. The consortium got the contract due in large part to their $3.8 billion upfront payment, which was nearly a billion dollars higher than their closest competitor.

Unfortunately, the economic and financial fundamentals of this multi-billion dollar investment faced challenges right from the start.

For one, the Indiana Toll Road, as well as many others, experienced dramatic drops in traffic due partly to the Great Recession. In 2010 it was estimated that the road needed nearly 11 million toll-paying trucks each year just to break even, but only half as many traveled the highway.

While the revenue situation improved in 2012, the road’s financing structure may have had an even bigger impact. Using a common project finance tool called an accreting swap, the consortium hoped to exchange low debt service costs early on with higher costs later, and then eventually refinance.  However, the swap strategy fell apart due to the Federal Reserve’s aggressive efforts to lower interest rates, which ultimately increased the consortium’s debt from $3.4 billion to $6 billion.

Fortunately, the debt restructuring should have no negative impact on the toll-paying public due to the legal and contractual arrangement the state negotiated up front. The original agreement includes specific limits on the amount of toll increases and the financial impact of the restructuring is limited to the debt and equity holders.  As the chief operating officer of Macquarie Infrastructure Partners recently put it, “it’s a private-sector risk at the time the transaction was financed… and the equity and debt holders have to live with that.”

Plus, Indiana gets to keep the initial $3.8 billion payment it is using for Major Moves. The public also benefits from the improvements made by original investors, such as the installation of an electronic toll collection system. With more than 66 years left on the lease there is still time for the project to generate a profit. In fact, recent reports show strong increases in heavy truck traffic. So it will probably be refinanced by other private debt and equity groups.

The implication for the public/private infrastructure market is unclear. Private investors are still interested in finding ways to invest in infrastructure as evidenced by the bids for projects like the Bayonne’s municipal water authority, Pennsylvania’s bridge replacement project, and the Port of Miami’s freight tunnel.

But states and cities need to get more sophisticated in order to get deals done and protect the public. Many countries as well as states like Virginia have established governmental units that support efforts to procure projects through a public/private process. The Obama administration’s Build America Investment Initiative should help with technical assistance. We also like the nascent West Coast Infrastructure Exchange which is working to develop standards for contracts, transparency, labor and risk allocation.

Even though the agreement on the lease of the Indiana Toll Road insulated the public sector from risk, the restructuring will inevitably lead to a lot of confusion and misinformation. What it should not do is derail the growing momentum for similar deals between the public and private sector for investing in the nation’s infrastructure.

This opinion was originally published by Forbes.