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Caitlin Devitt (00:04):
Hi and welcome to another Bond Buyer podcast. I’m Caitlin Devitt, Infrastructure Reporter for The Bond Buyer. Joining me today, my guest is Karol Denniston, an attorney with Squire Patton Boggs and the firm’s global projects partner, where among other things, she’s responsible for global infrastructure projects and is part of the firm’s P3 work in the U.S. and globally. Outside of P3s, many in the muni market might know Karol from her work as a restructuring attorney, where she’s worked on high profile distressed government project cases, representing clients of major bankruptcies like Puerto Rico’s PROMISA and COFINA restructurings. She’s based in San Francisco, is that right, Karol? You’re in San Francisco?
Karol Denniston (00:48):
Yes, I am in San Francisco.
Caitlin Devitt (00:50):
All right, cool. Well, thanks for joining us.
Karol Denniston (00:54):
Thanks so much for inviting me.
Caitlin Devitt (00:57):
So we’re hearing more about pre-development over the last couple of years. I would say we’ve been hearing more about pre-development, also called progressive, agreements with P3s. This is when a city or state or whoever’s sponsoring the projects brings in the private partner earlier to collaborate with planning, usually before pricing or financial structures are finalized, and also usually with the promise of a long-term contract to follow. So they’re becoming popular alternatives to more traditional models like design, build, finance, operate and maintain, where the government or the sponsor outlines the project price and all the risks and contingencies and the private developer bids on it. So my first question to you is what are some of the specific and unique legal questions for cities or states that are considering a PDA that would be different from a traditional P3?
Karol Denniston (01:50):
I think the initial question is the allocation of risk and timing because all the governmental entities that are involved in using a pre-development, a progressive P3 structure, they don’t know when they start down the road what the actual cost is going to be. So it’s difficult to manage approvals, it’s difficult to manage disclosures. It’s difficult to manage when you have to get regulatory compliance or you need voter consent. It works well on many levels, but it’s very hard to manage from a public sector perspective because the pricing commitment isn’t reached until potentially 6, 12, 18 months after they’ve been working on the project pursuant to the development agreement. On the flip side of that though, the upside is that the project, if it’s managed carefully, can be much more efficient because some of the challenges the private sector faces in the interface with the public sector on P3 transactions is the need for technical assistance in developing the project. So if you get your developer and your public entity under a pre-development agreement, there’s a huge opportunity to improve the planning process and make sure that through that collaboration, the planning, feasibility design and approvals can be staged, but are certainly considered before you get to any kind of financial close.
Caitlin Devitt (03:40):
So there’s certain types of projects that are more suited, do you think, to PDAs and others that aren’t?
Karol Denniston (03:48):
I think that, yes, I would say the ones that we have long experience with that we can begin to predict cost or the number of stages that a project’s going to go through are probably going to be easier to use a pre-development agreement and this progressive structure, the challenge for everybody is managing is going to be managing the progressive process because you’re not really, until you get to the end of the process, you don’t know what it’s going to cost, and that creates a series of, I would say, challenges. The first is that the developer doesn’t know if he’s going to get the deal until you sort of get to the end. And so the market’s going to have to have a conversation about how do we deal with that process because it’s, I think, unrealistic to expect developers to be happy to do six to 24 months worth of work and then arrive at a situation where there’s no project or the developer in the city don’t get, or I should say the private sector entity don’t get along.
The challenge is there’s no commitment because the terms haven’t, the terms from payment haven’t been established, and it creates a real challenge for both the developer and the public sector entity in terms of contractors, because the contractors are not part of this process. So they’re not locked in, and that means them with tremendous leverage in terms of negotiating once they’re ready to move to the stage where you need to attract and retain contractors. Part of the challenge that the industry faces today is the fact that contractors are really not willing to be locked into pricing given the challenges that we face in the market with supply chain fluctuation, pricing and interest rates. So there’s another dynamic that progressive can bring out that everybody’s going to have to figure out how to manage is the contractor piece. The other piece is that the model itself, some people think encourage low ball billing or low ball bidding in an effort for people to win work, and then that puts the project success in jeopardy.
If it turns out that the party that’s doing the low ball billing is bidding is either unwilling to continue to do the project at that price or they just don’t have the skillset to do it. So the challenge with the whole process, I think you can just sum it up and say that we don’t have, we moved through a series of stages which are necessary and I think could improve the whole project process, but you’re doing it before anybody’s got a reasonable estimate of overall final cost, and that’s a big challenge for the project owner. I think it’s also a big challenge for the project developer because you can arrive at a point where it becomes clear that there either isn’t the liquidity to do the project or the developer’s not willing to do it from the amount the public sector partner can pay.
Caitlin Devitt (07:37):
Interesting. Yeah. So it sounds like a lot of risks there as well as even them hammering out risks early, A lot of pros and cons.
Karol Denniston (07:46):
Yeah, I think there are pros and cons, but I also think that the market’s moving in this direction out of necessity because a lot of the variables when you were doing D-V-F-O-M that made it easier to get to certainty on pricing. We’re dealing with a lot of market volatility now, particularly from contractors and instilled from supply chain and volatility of pricing. This model does address that, but it requires a much higher level of collaboration and coordination between the public sector, the developer, and the rest of the folks that are going to be involved.
Caitlin Devitt (08:26):
Yeah, so it’ll be interesting to see if we ever get back to a more normal environment where construction costs inflation, interest rates start to come down if this remains popular and people will continue to pick it up. Or if we see sponsors returning a little bit to more traditional models.
Karol Denniston (08:44):
Well, if we take a page from what’s happening in Europe and in Australia and in the Middle East, all of them, were moving toward a collaborative model, even more collaborative than what we think of as a progressive P3 things that I think culturally we’re not quite ready to address, but where everybody is working together in a model from consensus building and people come into the collaboration with the agreement not to sue each other. So we are going to see changes. I think the U.S. is going to lag behind because culturally we tend to, when there are problems, we tend to turn to litigation as opposed to negotiation. It’s just the way we’re wired, but elsewhere in terms of big projects, we’re seeing our clients and participants in their transaction are moving toward what is loosely referred to as collaborative planning. There’s no agreed definition is just a movement that we’re seeing in the marketplace, but one that suggests for the U.S. that there’s a new set of skills that the public sector and the private sector are going to need to develop to manage projects, particularly when we look at the amount of foreign investment into U.S. infrastructure projects.
Caitlin Devitt (10:14):
Yeah, I mean, you sort of anticipated my next question, which was you guys have been hosting these, a series of webinars, I think four of ’em on best practices and a recent one focused on lessons the US can learn from other countries. And I was going to ask you some of the big takeaways. So it sounds like this is one of ’em, and that’s really interesting, that kind of provision against litigation because yeah, that’s really a big deal in the US and also is known outside for stalling a lot of infrastructure even when it’s not an internal agreement, but it’s coming from outside opponents, environmental opponents or whatever. So that’s interesting. What are some other takeaways from what other countries that have more mature, which I think most of ’em do that do it have more mature three markets?
Karol Denniston (11:09):
I think, yeah, they are more mature and they’ve been using the model, the P3 model for decades, at least in some of the European, middle East and Australia. But the biggest difference is that in each of those countries, there’s one entity that’s sort of in charge of the P3 process and contracts are standardized. There’s very little to negotiate. Process is predictable. People know what to expect and when there are issues, you’ve got one sort of overarching entity, governmental entity that’s basically created the set of process and procedures for the parties to follow. The U.S. is struggling on one level because we have 50 states and each state has sort of a different approach to P3. And one of the things that we’ve been doing in conjunction with AIAI is monitoring the state legislation that addresses P3. Some states are much further along in the process by developing P3 offices beginning to sort of lay down expectations and put laws in place as to how we’re going to use P3, what the limitations are and the like.
Colorado is one that’s at the cutting edge. I think Illinois is going to join ’em, their legislation, hence just some legislation governor was pushing for is just gone back, I understand in front of the legislature. But our biggest problem in the U.S. is the fact that we can’t commoditize the parts of the project that the rest of the worlds have been able to do. We have sort of bespoke contracts for every single project, even though you begin to see cut and paste provisions and there’s sort of no one anchoring agency at the state level. And then we have you look to second level that makes our process kind of complex and difficult to navigate is the federal aspect because with the funds available under the IIJA, the IRA, the federal funds and then the other funds that have been available for quite a long time under TFIA for roads and WFIA for water, they all have their own set of requirements that have to be dovetailed into whatever’s going on at state level. So when you look at a P3 project in the U.S. picking a conventional project, you have to have in mind where you’re going to fund it as you start through the process because there are federal requirements if you want to access federal funds that you need to think about and building out your structure. So our environment is about as complicated as an environment can get in terms of navigating a process.
Caitlin Devitt (14:13):
Yeah, I mean that’s why I think why we have that saying where they say you’ve seen one P3, you’ve seen one P3.
Karol Denniston (14:22):
I always kind of laugh when people say that I believe that there’s one set of P3 documents docked that are circulating that keep getting cut and pasted. We’ve obviously had more than one P3, but I think the other thing that’s happening is as we move through the expansion of infrastructure transactions, people are getting better at documenting them. And that’s both for the public sector, the private sector, and in our webinars, we’ve been encouraging the public sector to think about the documentation process as they go through procurement because it’s their project. And to the extent that they were to lay down the documents at the inception, that is one way assuming they’ve had sufficient technical financial legal advice. That is one way to shortcut some of the inefficiency that happens on the backend. The more developed an RFP is, the more efficient is for the private sector and the greater opportunity there is to get quality responses that are actually going to work. One of the challenges I think, for the public sector is accessing the resources needed to put a good project into procurement and investing the time in getting the procurement process developed and far enough along so that the private sector actually knows what it’s dealing with.
Caitlin Devitt (15:57):
Okay. We’ll be right back after this short message. And we’re back talking with Karol Denniston of Squire Patton Boggs about P3. You mentioned the IIJA, we’re coming up in the second anniversary of it. The law does encourage or at least legitimize P3s and sort of encourages them in various ways, including by requiring value for money analysis for certain projects, offering technical assistance to governments that want it. So one quick question. When you’re talking to the Build America Bureau, aren’t they putting together some type of standardized value for money analysis?
Karol Denniston (16:49):
Yeah, they are. They are. And I think the other thing is Build American Bureau has been providing a number of public entities technical assistance in connection with projects, but the technical assistance piece, and I wrote a blog on that not too long ago go kind of talking about what the White House had announced. There’s a long list of places where public sector entities can go for technical assistance and it includes the governmental entities that you would think, particularly the ones that are providing some kind of funding in connection with the IIJA and the IRA. But they’re a list of private sector entities that are involved in supplementing or providing technical assistance. And I’m not sure that the word is out to the extent it should be as to where people can go for technical assistance.
Do you think that the law in general has spurred more deals? I think that the best way to answer that is to say the more predictable the law gets in each state, that there are more transactions you’re going to see. It’s hard to make a general statement in the US given that we’ve got to look at both the federal and the state level to sort of assess that. But I think the one thing that has happened is that people are quite focused on being able to access whatever funds may be available. And we’re seeing that play out in the attention in the broadband space with the BEAD program, which is both federal and FCC. But the states have to produce a plan. I think that’s due sometime at the end of this year, first part of January that says how they’re going to use what the plan is for deployment of the bead funds and getting broadband to places that we think of as the broadband desert, what the plan is, and then the matching fund situation.
The broadband is one that I do think that there’s sort of a lot of encouragement on folks to look at what the federal opportunity is and for states to get their broadband offices organized and in place and get a plan. There’s a tremendous amount of private sector money interested in investing in broadband if there’s a mechanism to make it efficient. And as you probably have read, the president’s very focused on getting broadband out to places that don’t have it. Looking at broadband as something that’s like electricity and water. It’s a necessity for this day and age. So the challenges getting it to the most expensive sort of users which are in places that are not connected up. And that’s why you read so much about Middle Mile Last Mile and why I think we’re going to be looking at some interesting financing opportunities. And I’m waiting, we’ve had some conversations, but to the extent a state was to say, look, here’s a piece of legislation.
This is what we’re going to do for broadband, getting it to these smaller communities is if you work our program, we’ll deal with the financing, we’ll deal with the structure, we’ll put it all together essentially like we do a mortgage, you your forms and we’ll get your broadband project up and running. And one of the reasons I think there’s an opportunity for the states to do that is if they were to provide a legislatively mandated program that says, if you want to access federal money or state money, you use this program because that would make the private sector much more interested in investing. The challenge that we’re facing is we’re seeing RFPs come out that are technically developed. In other words, we need to build out whatever, but not fully fleshed out if at all, in terms of managing costs and looking to where the investment is going to come from and testing feasibility.
And that’s a huge part of the broadband challenge is that we saw a number of broadband projects default in the go back sometime between 2010 and 2012. And I worked on a number of those defaulted bond deals for broadband. And the challenge was taking it to smaller communities created intense pressure to be sure the projections made sense. And when you don’t hit your projections, there’s no cash flow to maintain your system. And that’s why we saw so many failures. So I think that the more the states are willing to engage and get involved, I think the more the private sector will be interested in partnering up.
Caitlin Devitt (21:55):
Yeah, that’s what I’ve heard just from a little bit of work we’ve done and we’re watching closely to or waiting to see those first deals is that it doesn’t sort of solve that problem.
Karol Denniston (22:05):
I think that people have done what we always do. We run toward the easy deals and these are harder deals. And California has a huge challenge with the significant chunk of the eastern part of the state, but we also have all of our reservations that need broadband. And in conversations that we’ve had with a number of folks, the idea of putting together some kind of standardized program to make it easier for the smaller users makes a lot of sense. And then the last piece on broadband I find fascinating is for years I’ve been following impact investors. I think this is a place that the impact investors could be quite active because of the importance of broadband to individuals in everyday life. It truly is a big piece of social infrastructure, and we haven’t really seen that much engagement. And I suspect the impact investors are as challenged as everybody else is trying to figure out how to engage.
Caitlin Devitt (23:12):
So you mean that they would be kind of labeled and a little bit more attractive as social bonds.
Karol Denniston (23:18):
Yeah, and I think that the other thing is taking a page from Europe, again, impact investing in Europe is also tends to cross it over into impact and charitable, the terms tend to can be quite attractive. And you can also look at some circumstances when you’re talking about social projects like broadband, you can look at charitable contributions to help fill in gaps. Yeah, there’s a lot that could be done to address and meet the president’s goals on broadband, but right now everything’s kind of disconnected.
Caitlin Devitt (23:55):
Yeah. Are there any states working on the type of legislation that you’re talking about that you were talking about?
Karol Denniston (24:02):
I wish I could say yes to that. We’ve talked to a couple of states about it, but the challenge is there is as challenges the rest of us in terms of the complexity, and I think that it’s going to take time. And then the other factor is that are some things in the FCC regulations that make it difficult for everybody given the deadlines are next to impossible. And I imagine if we had the private sector participating in this podcast, they’d have plenty of things to comment that they wish could be changed. But I think it is like everything else, it’s going to take time. It’s just unfortunate that we can’t get a roadmap that makes sense because everybody’s fear taking a page out of the 2010 timeframe is that they’re going to put the money into the structure, get it set up, and then the residents using it is such a small pool, it’s not going to be enough to sustain it, which is why I think it’s an opportunity and a discussion for the impact investors and probably some of the charitable folks that are very focused on social infrastructure
Caitlin Devitt (25:25):
Or if you make it too expensive, even if people aren’t going to do it. So yeah, it doesn’t solve that kind of longer term revenue target problem. Any other sectors besides broadband that you see as being particularly active right now?
Karol Denniston (25:39):
Yeah, we’re really busy in connection with airports. There’s a ton of investment chasing airports, but there’s also a huge interest in all the sort of deferred maintenance and opportunity to sort of, what do you want to say? Pretty up our airports, and that’s both the medium and large size airports. So we’re busy with airports and we’re also globally very focused on and working on a number of energy renewable transactions with a real high interest in green hydrogen and the buses. We have projects in Europe on that. And then a number of projects that are sort of in the planning stages in the US and Mexico. So I would say those would be the two most exciting ones. But then we come back to, we do a lot of work in the healthcare space. We do a lot of work with Higher Ed, we do a fair amount of work with water, which is also a market that needs to be brought along on a P3 model because we’ve seen more privatization of water systems where the public sector is willing to privatize, but that may not be the only option available to them. So that’s kind of the view. I think that I will say that coming at this from a restructuring perspective, I think the Higher Ed sector is going to not be as active until we see what happens and what shakes out with the performance on the Higher Ed piece of the equation. I think that sector is getting pretty beat up right now.
Caitlin Devitt (27:32):
So you mean the challenges that it’s facing?
Karol Denniston (27:34):
Yeah, I think, yeah, and I think those challenges are likely to continue, and we have worked on a number of restructurings and refinancings in the Higher Ed sector, but we’re also beginning to see a number of schools just basically close. They fit mostly I think small private schools. But you pick an example in terms of Higher Ed and do we have faulting model? The University of Iowa litigation is kind of the highlights the problem given the way the cost of capital was done and the fact that they funded an endowment, but that endowment may not be sufficient to make the payments that are required under the documents.
Caitlin Devitt (28:25):
Well wait, let’s just pause here a little bit. And so far our listeners who might not be familiar with it, and we’re talking about the University of Iowa, which earlier this year was hit with a lawsuit from the private developer that I think a couple years ago I should have these numbers in front of me, but I don’t signed a 50 year concession to operate and maintain the university’s energy system. It’s was a big deal and sort of emblematic of some of the P3 activity in Higher Ed and in energy, both of those are sort of active sectors. And so then the private developers earlier this year for not making the payments, and that’s kind of winding its way through the court system right now. So anyway, yeah, continue. I mean, talk about lessons or how that’s going. If you could talk about that specifically, then maybe any lessons we might learn from it.
Karol Denniston (29:31):
Yeah, I would love to know how it’s going. Unfortunately, it was filed in federal court and it ended up being refiled in state court and you to live in the state to get the pleadings.
Caitlin Devitt (29:44):
Karol Denniston (29:45):
Well, I told my folks we could pass the action in Congress faster than we can get the pleadings. But the question that the universities need to think about is as they look at these deals, is the cost of capital, does it make sense? Because the cost of capital for this Iowa transaction is one that has been estimated at between 6% and 7%. And typically you could somebody with a reasonably good investment rating could get 2% to 3% cost of capital. And this comes out, this is kind of the one that says, are you looking at a model that takes advantage of your ability to issue tax exempt bonds? Because one of the questions I’m always asking people is your thought about how to structure your debt stack so that you’re taking the best advantage of the lowest cost of capital. And I think for this is headed, just common sense says it’s a cost of capital issue and feasibility over time and that the universities recognized it’s gotten into a formula that’s too rich and they’re going to end up trying to renegotiate it, which is why I think they just basically stopped making the payments is to get everybody to the table.
But you look at the upfront transaction, the upfront payment was reported to be sort of $1.16 billion.
That’s crazy money when you think about it. I get it was a 50 year deal, but that’s kind of a high wire act for everybody when you look at that amount of payment and then what the expectations are. And you got to ask the question, is there another structure that would be easier to manage given that it’s a 50 year deal? And the thing that we have trouble with when we get into these longer term concession agreements and projects is that we don’t have any idea what kind of volatility we’re going to be facing. And I think the last year has been a good example of how that impacts everything we finance in terms of interest rate and just inflation has made a lot of transactions that made tremendous sense when they were put together. Make not so much sense now.
Caitlin Devitt (32:23):
Yeah, and I think I’m just looking at this at the university’s annual payments started at 35, but with annual 1.5% increases that are boosting the fee of $68 million after 50 years. And the lawsuit quotes, the president said the contract terms were so carefully negotiated that the university’s president likened the process to writing the U.S. Constitution. Well, I guess that’s freaking down. Yeah, we’ll have to keep an eye on it. I mean, maybe I’ll have to, I’m in Chicago, maybe I’ll have to jump in the car and make a road trip to try to get those documents or something. I think a lot of people in the industry are definitely keeping their eye on it.
Karol Denniston (33:03):
Well, everybody’s very interested because I think the lessons learned coming out of that will be lessons learned about how to structure and manage the embedded risk in a 50 year deal. I also think the private sector’s going to learn from this about how much money you released in a front end payment. Because the question you got to ask, it’s look in all the variables, is that the best way to manage that kind of payment is to make a payment to a university to put an endowment? Is there some other structure that would help better manage the risk? But I don’t think this yet. Our sense is this has not steered people off of P three in the Higher Ed space, but it has made ’em smarter in terms of asking questions.
Caitlin Devitt (33:56):
Yeah. Yeah. Okay. Interesting. Well, we’ll keep an eye on it. Is there anything else going on in Washington or Congress that you’re keeping your eye on in the infrastructure sector?
Karol Denniston (34:08):
I’m laughing if we say anything else going on. I mean, it’s a new day in Washington every day. I think we keep an eye on closely on what the agencies are doing with the funding under the IRA and the IIJA. And we also, because of our transportation projects, keep a close eye on what’s going on with the Department of Transportation. But overall, the global projects team is pretty hunker down into the financing coming out with the IGA and the IRA and also looking at implementing regulations and things like that for clients from specific projects we have during our global projects call. We always get a report about what’s going on in Washington, which always kind of is one of those mind blowing experiences where I’m just glad that we have a sort of a compact focus,
Caitlin Devitt (35:14):
Right? Yeah. I mean, all the things that are going on adjacently could affect it, but we’re still to find out, for example, we’re still waiting for the Build America Bureau to come out with some stuff. There’s a lot of stuff that even though the IIJA is two years old, we’re still waiting for some of those final rules and the IRA as well, which is some of those tax credits and all that that’ll, there’s a huge amount of things that we’re waiting on.
Karol Denniston (35:39):
But the best example of our policy team helping out our project finance global projects team, I shouldn’t say was what it looked like. We were going to have a government shutdown, and we had people pushing 24 7 to get deals closed that involved federal government parties because of a concern if we didn’t get ’em closed and there was a shutdown that deals would die. And so there’s a lot of attention paid to things that could affect transactions. And that’s one example of while it’s right now it’s history, but who knows it might happen again. Well
Caitlin Devitt (36:23):
That November 17th next week, it’s going to threaten rises,
Karol Denniston (36:30):
Refocus really closely on that to be sure that transactions that could be impacted, we got closed to the extent we could get them closed.
Caitlin Devitt (36:42):
And that’s because the federal employees would then not be,
Karol Denniston (36:47):
Well, you probably know from watching the space, if a transaction lags, the more it lags, the less likely it is to close. And we’ve seen that play out in a couple of projects that haven’t gotten to commercial and financial close and then have sort of died due to changes in political structure and other risk. So one of the things I think that the parties to a transaction have to think about now is they go through the process. There’s sort of a desire, I would think, to expedite the timeline rather than to go through procurement and let these projects sit until the procurement’s about to expire. And I think there’s a huge interest in the private sector being able to move your projects along. It manages the risk that the project’s going to die. And I think that political risk when you have a change in leadership, has a huge impact on P3 transactions.
Caitlin Devitt (37:55):
Yeah, we’ve seen that on the state level for sure. Yeah. Trying to get that momentum going through the same political, the same administration to skirt some of that vertical risk. Well, great stuff. Karol Denniston of Squire Patton Boggs, thank you very much for being with me today.
Karol Denniston (38:16):
Well, thank you so much. It was a real pleasure.
Caitlin Devitt (38:19):
Thanks again. And thanks to the listeners, this latest Bond Buyer podcast. Don’t forget to rate us, review us and firstname.lastname@example.org buyer.com/subscribe For the bond buyer. I’m Caitlin Devitt, and thanks again for listening.