Macquarie and Skanska closed the debt financing for the $2.09 billion Midtown tunnel real toll concession on 13 April. The financing, for project company Elizabeth River Crossings, benefitted from strong interest in its long-term private activity bond (PAB) component, resulting in a lower than expected interest rate despite rating agency concerns over toll revenues during construction. It is the first greenfield concession to close in the US since 2010, and the first US tunnel PPP to close with traffic risk.

The 58-year real toll design-build-finance- operate-maintain concession includes the Midtown and Downtown tunnels, and the MLK Freeway in Norfolk and Portsmouth, Virginia. The concessionaire is responsible for building a new 1.3km, two-lane immersed tube tunnel parallel to the existing Midtown tunnel, a 1.3km extension of the MLK to I-264 and upgrades to the existing Midtown and Downtown facilities. It will begin collecting tolls, which are initially set at $1.59 to $1.84 per car to use one of the tunnels, in September and can raise tolls by either 3.5% or the annual change in the US consumer price index, whichever is greater, each year beginning in 2016.

The project debt is split between a $663.75 million senior PAB issue and a $422 million subordinate TIFIA loan from the US Department of Transportation. The issue is split into 11 serial bonds that mature between 2022 and 2027, and three bonds that mature between 2032 and 2042. The $42.4 million in serial bonds carry an average coupon of 4.8%. The term bonds are split into a $91.8 million tranche that matures in 2032 with a coupon of 5.25%, a $209.19 million tranche that matures in 2037 with a coupon of 5.32% and a $320.4 million tranche that matures in 2042 with a coupon of 5.5%. The average life of the bonds, which were issued by the Virginia Small Business Financing Authority on behalf of the project company, is 24 years. Barclays Capital (left lead), Bank of America Merrill Lynch and BMO Capital Markets were joint bookrunners and Deutsche Bank is the trustee.

The issue was four times oversubscribed, though this was in part because institutional investors placed large orders that drove up the subscription amount – a normal occurrence for infrastructure bonds – says one source who worked on the transaction. The bookrunners were able to price the issue below expectations, which allowed the Virginia Department of Transportation (VDOT) to reduce its milestone payments to the concessionaire to $309 million, from $362 million. The face value of the bonds was $11.25 million less than the $675 million launch size and proceeds, because the leads were able to price them with an original issue premium.

The TIFIA loan has a 34-year tenor that includes a 10-year grace period, minimal interest payments during years 11 to 18 and full interest payments after that through maturity, with principal payments beginning in year 25. According to Fitch, the TIFIA debt has an all-in interest rate of 3.39%, reflecting the US government’s persistently low cost of funding. The debt features a springing lien that would remove the subordination of the loan to the bond in the event of a default.

Complementing the debt is $272.5 million in equity and $368 million in expected toll revenue during construction, as well as the grantor’s milestone payments. Macquarie Infrastructure Partners II and Skanska each own 50% of the concessionaire. They have also raised $50.6 million in letters of credit as a backstop to the toll revenue. BMO will provide the LC for Macquarie and Svenska Handelsbanken the LC for Skanska, and both of the LCs will mature at the end of construction.

The concession faces significant toll revenue risk during the ramp up period. Traffic volume on the Midtown and Downtown tunnels could initially decline by as much as 44% from its current average of 125,000 vehicles per day when tolls are implemented, according to Standard & Poor’s. The sponsors estimate an initial 28% decline in traffic through the tunnels. The rating agency cites the fact that there is little history of tolling on the region’s highways and the existence of alternative free routes, though it does note that taking a free route could add as much as 20 minutes to vehicle trips. Hampton Roads Transit, the local transit agency, also has long-term plans for a light rail line from Norfolk to Portsmouth that would compete with the tunnels.

VDOT is also considering delaying the implementation of tolls until 2016 due to local complaints. While it would make an additional milestone payment of about $100 million to the concessionaire, the delay would result in a decline of the minimum debt service coverage ratio to atleast1.15x,accordingtoS&P.Therating agency estimates an average DSCR of 1.93x and a minimum of 1.48x under the existing financial structure, while Fitch estimates an average DSCR of 1.52x and a minimum of 1.49x. Fitch and S&P both rate the debt BBB-.

The financing bodes well for other US infrastructure concessions that are in or near market. Hochtief and Meridiam Infrastructure’s $360 million concession for phase two of the Presidio Parkway in California has an allocation for a PAB issue of up to $600 million and has applied for a $309 million TIFIA loan. The bonds could win even keener levels of pricing than the Midtown deal because they would benefit from an availability payment stream from the California Department of Transportation and San Francisco County Transportation Authority. The Knik Arm Toll and Bridge Authority’s $1.08 billion Knik Arm toll bridge in Alaska, which is currently in procurement, also has a $600 million PAB allocation and is seeking a $306 million TIFIA loan.

The sponsors were the only respondents to VDOT’s request for conceptual proposals in September 2008. The interim development agreement for the project was signed in November 2009 and a comprehensive development agreement in September 2010. Commercial close was in December 2011.

The sponsors are unlikely to refinance the debt package or sell out of their equity stakes in the near term. The combination of a long-term PAB and TIFIA loan extends debt service out over 34 years, and benefits from a 24-year tail during the later years of the concession. Macquarie is unlikely to sell its stake, which is already in the hands of three of its long-term infrastructure funds, as it did with the $1.64 billion Denver Transit Partners concession in Colorado. Skanska is also expected to hold its stake at least until the end of construction.

A joint venture of Skanska (45%), Kiewit Infrastructure (40%) and Weeks Marine (15%) holds the $1.47 billion fixed-price date-certain design-build construction contract. Skanska and Kiewit are providing parent guarantees valued at 45% of the contract during construction, which is slated to begin this quarter and be complete in 2016. The project company is responsible for operations and maintenance for the term of the concession.

Structuring the concession to include revenue risk is a bold move for VDOT, because tunnels tend to be more capital intensive than roads, and thus the most sensitive to errors in traffic forecasting. The only previous tunnel PPP concession to close, Florida’s Port of Miami Tunnel, was an availability deal and featured a combination of bank debt and a TIFIA loan. The most high- profile infrastructure bankruptcies in Australia have been for tunnels.

The generosity of Virginia, by including milestone payments, and the subordination (at least in cashflow terms) of the TIFIA debt go some way to reducing the sensitivity of the tunnel financing to revenue shocks. The sponsors will hope for at least grudging acceptance of tolls from drivers, and a lack of progress for the legal challenges from the project’s opponents.

Elizabeth River Crossings OpCo
STATUS: Close 13 April 2012
SIZE: $2.09 billion
DESCRIPTION: 58-year real toll DBFOM of Midtown and Downtown tunnels between Norfolk and Portsmouth, Virginia, and MLK Freeway
GRANTOR: Virginia Department of Transportation
GRANTOR CONSTRIBUTION: $309 million
TOLL REVENUE: $368 million during construction
SPONSORS: Macquarie (50%) and Skanska Infrastructure (50%)
EQUITY: $272.5 million plus a $50.6 million letter of credit
DEBT: $663.75 million senior private activity bonds issue and $422 million TIFIA loan
UNDERWRITERS: Bank of America Merrill Lynch, Barclays Capital and BMO Capital Markets
TIFIA LENDER: US Department of Transportation
LETTER OF CREDIT LENDERS: BMO (Macquarie), Svenska Handelsbanken (Skanska)
TRUSTEE: Deutsche Bank
FINANCIAL ADVISER: Macquarie Capital
LEGAL COUNSELS: Orrick and Hunton & Williams (sponsors), Dewey & LeBoeuf (lenders)
ENGINEERING AND DESIGN ADVISERS: Parsons Brinckerhoff, COWI and Volkert TECHNICAL ADVISER: Arup
TRAFFIC ADVISER: Steer Davies Gleave
INSURANCE ADVISER: Marsh