DBRS Assigns Provisional Rating to Texas Transportation Commission IH 35E Managed Lanes Project

DBRS Limited (DBRS) has today assigned a provisional rating of BBB with a Stable trend to the proposed [35.5]-year $285 million revenue loan issued under the Transportation Infrastructure Finance and Innovation Act (TIFIA) program to fund part of the IH 35E Managed Lanes Project (the Project) of the Texas Department of Transportation (TxDOT).

The payment of principal and interest is dependent upon tolls collected from motorists using the managed lanes, and the loan only has recourse to the accounts and cash flows of the Project. Furthermore, the Project is very different from a typical public-private partnership (PPP), as it does not have the rigid legal structure, strict risk transfer to a special-purpose vehicle or extensive performance requirements generally found in PPP transactions. Instead, the Project is closely linked to TxDOT, which, in DBRS’s view, greatly limits TIFIA’s risk exposure related to completion delays and aggressive traffic projections.

The Project consists of the redevelopment and operating and maintenance (O&M) of a 30.1-mile segment of Interstate Highway (IH) 35E from IH 635 in Dallas County to U.S. Route 380 in Denton County, two of the fastest-growing counties in Texas. Well over 77% complete, the construction phase has been directly contracted by TxDOT to a design-build joint venture of Archer Western Contractors, LLC (Archer Western); Granite Construction Inc. (Granite); and LANE Construction Company (LANE; collectively with Archer Western and Granite, the DBJV) under a fixed-price, date-certain Development Agreement. The work entails the widening and rehabilitation of the general-purpose lanes, the rehabilitation of adjacent access roads and structures and the addition of two reversible toll lanes (the Managed Lanes) in the south and middle segments of the highway, which will generate the cash flow necessary to repay the TIFIA loan. In contrast to standard infrastructure financing, no technical advisor has assessed the Project. However, based on the nature of the work, the types of structures involved and the fact that all federal and state approvals have been secured and the new road follows the existing alignment, DBRS believes the construction phase falls within the low-complexity bracket, although likely at the higher end because of the extensive traffic management required on the highway.

The corridor is set to open to the public on May 18, 2017, at which time electronic toll collection will start at gantries located along the highway and on access ramps. All revenues will be deposited into a blocked account held with the trustee. TxDOT will formally assume responsibility for the management and O&M of the Project once completed, with all costs related to the Managed Lanes recoverable from the revenues after mandatory debt servicing if sufficient funds remain. The maintenance standards for the Managed Lanes are understood to be somewhat more stringent than for a standard highway, but overall obligations are viewed as low complexity given the type and location of the asset.

Given TxDOT’s direct involvement in the Project, the absence of formal pass-down of construction and service obligations and risks to the Project, TxDOT ultimately remains responsible to complete construction and cover potential cost overruns in the unlikely event the DBJV fails to perform. As a result, the construction-related considerations typically incorporated in the analysis of a standard PPP are not viewed as relevant to the Project’s rating. DBRS notes that there is a cross-default in the TIFIA loan agreement to a bankruptcy event of any of the construction parties, potentially linking the Project to the creditworthiness of the contractors. Similar to other PPPs, however, the clause allows the Texas Transportation Commission (TTC) to cure the default by submitting a plan to TIFIA within 30 days of the bankruptcy event to either replace the defaulting party or to cause a letter of credit (LOC) to be provided for the benefit of the TTC securing the obligations of the defaulting party. Since each of the DBJV members have provided a guarantee that is substantially greater than what is typically provided for civil works projects, DBRS believes that should a DBJV member become insolvent, the remaining members would be adequately incentivized to effect a replacement of the defaulting party or to provide an LOC covering its obligations. The advanced stage of the construction phase also suggests that either option would be executed without significant challenges.

The waterfall mechanism mandated under the TIFIA loan agreement and guiding the disbursement of toll revenue from the trust account ranks the mandatory portion of TIFIA interest and principal payments ahead of TxDOT’s recoveries of O&M and lifecycle expenses, exposing TIFIA debt servicing to the traffic and toll-collection risks typical of toll highways, but not to O&M and lifecycle risks. In the event of unexpected maintenance needs or a cost escalation exceeding revenue generation, TxDOT would effectively have to make up for the shortfall and complete the work in order to keep the highway safe for users. TxDOT could only gradually recover its expenses over time from cash flow net of mandatory debt servicing.

Despite the limited scope of risks assumed by the Project, significant uncertainty prevails with respect to traffic levels in the early years of operation, as the widening of the general-purpose lanes will provide considerable congestion relief in the corridor, dampening the convenience offered by the Managed Lanes. This currently constitutes the primary constraint to a higher rating. According to the traffic and toll revenue study produced by CDM Smith, traffic on the Managed Lanes is expected to ramp up to its full potential over a three-year period as users gradually get used to the toll and the convenience of the Managed Lanes. Because of reduced congestion on the general-purpose lanes, only 4% to 6% of total traffic, or an average of 36,000 weekday transactions, is projected on the Managed Lanes in the first year of operation in 2017. However, this share is expected to gradually rise to 10% of total traffic, or 90,300 weekday transactions, by 2035.

The financing terms proposed under the TIFIA loan agreement are generally typical of road projects, although a few features have been added to enhance the Project’s resilience, including capitalized interest during the first five years of operation followed by a five-year interest-only period. However, the most important features of the financing platform are the cash flow waterfall mechanism prescribed in the TIFIA loan agreement and the right to defer a material portion of debt servicing during the first 25 years of operations if toll revenues prove to be insufficient. The relevant debt service coverage ratio (DSCR) for the transaction is defined as the ratio of revenue net of O&M expenses to mandatory and scheduled (deferrable) debt servicing (the TIFIA DSCR). While non-standard, the ratio is fairly conservative, as it captures O&M expenses even though these costs are only reimbursed to TxDOT once mandatory debt payments have been made. However, it excludes the optional principal prepayments forecast during years 20 to 28 of operations. Once the five-year period where interest is capitalized ends, the minimum TIFIA DSCR is projected to be [2.12]x. The minimum DSCR remains above [2.94]x if only mandatory TIFIA principal and interest payments are considered. DBRS estimates that the Project could sustain a traffic reduction of up to 44% at any point in time during the operating phase and still maintain a total DSCR of at least 1.0x. For the BBB rating, this is viewed as an adequate cushion to mitigate the considerable uncertainty pertaining to the traffic forecasts. However, should traffic break-even fall materially below 40% at the time of the finalization of the rating as a result of increased debt or interest rate movements, DBRS warns that the rating could be finalized below the provisional rating of BBB currently assigned.

Given the absence of the standard formal pass down of the O&M and lifecycle tasks to the project, DBRS does not consider the O&M and lifecycle resiliency as informative to the assignment of the rating.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

The applicable methodology is Rating Public-Private Partnerships, which can be found on our website under Methodologies.

The full report providing additional analytical detail is available by clicking on the link under Related Research at the right of the screen or by contacting us at info@dbrs.com.