What The Financial Meltdown Means To The DRIC Bridge

Believe it or not, Brian Masse and I may actually agree on something respecting P3’s but perhaps for different reasons.

I believe that I am even more opposed than Brian about the value of what is proposed to take place here by building a P3 bridge based on my own experience as a corporate lawyer. I have watched organizations following the latest gimmick resulting in major losses. I have seen companies become “conglomerates” by investing in businesses they did not understand and not sticking to their core business. I was there when companies started using their pension plans as a means of generating revenue and profits for the Corporation by having the plans investing in riskier investments in order to reduce corporate contributions. I have seen the horrible results of those failures.

P3’s are not the salvation for financing a new border crossing in Windsor. P3’s will become the newest disaster in waiting as we shall find out down the road. P3 collapses in future will risk the financial well-being of people at the most fragile time of their lives, their retirement years. Pension funds, mutual and infrastructure funds are hearing the Sirens’ call of high and stable returns and will get more deeply involved with them as the latest financial gimmick.

Of course, no P3 investors will come here while the Ambassador Bridge is owned privately since it provides competition to them and would mean that they would not get a satisfactory return on their investment or perhaps no return at all. P3 investors like a monopoly and that is why the Government needs to force the owner of the Ambassador Bridge to sellout cheaply. That is what DRIC is really all about.

Brian opposes P3’s from a philosophical perspective. He wants total "public" with no private involvement at all. PERIOD. As for me, while the use of private funds should be encouraged, I oppose P3’s because they are impractical in our situation. All that would happen would be more delay in providing financing for a border solution and more devastation to our region because of the lack of funding due to the financial meltdown in our economy today. If one is actually built and it goes broke because the amount of money used in the the financing cannot be satisfactorily serviced or the rates of return are too low, then what would happen? Let me explain.

How could it happen? They hire the best and the brightest and pay them very well. The cream of the crop from the best schools. Businesspeople with unmatched pedigrees and running businesses to huge successes, at least in the good times.

And yet they are all failing. Major companies like the auto companies are verging on bankruptcy. The money boys at the major investment houses have been literally wiped out overnight. The banks around the world are requiring massive bailouts.

If you think the financial crisis is over, you ain’t seen nothing yet!

In my opinion at least, the subprime mortgage market chaos is nothing more than masking for now the real problems that banks, pension funds and private equity investors will be facing in the very near future. I take some comfort in that point of view by this story in the Globe and Mail:

• “Why LBOs will be the next thing to go pop
  
  Leveraged buyouts, the lifeblood of the private equity industry, are set to unravel. Even private equity says so. "There will certainly be dozens of LBOs that won't make it and it doesn't take a lot of imagination to get into the hundreds," said John Moulton, founder and managing partner of Alchemy, a London-based private equity firm.
  
  Like real estate in the United States and Britain, private equity and LBOs were bubbles waiting to burst. Highly leveraged deals, in which a pebble of equity was buried under a mountain of debt, are already a thing of the past; thanks to the credit crisis, banks have no appetite for risky lending. The new world of lower leverage will inevitably translate into lower returns. In the meantime, more than a few top-of-the-market LBOs are cracking…
  
  While the partners of private equity firms were built up as swashbuckling captains of capitalism, the reality is that their business model was dead simple: Goose investment returns by buying an asset with as little equity as possible.
  
  They could do so because loans were cheap and plentiful, and rising markets kept the credit spigot open. Typically, private equity firms financed LBOs with one-quarter equity and three-quarters debt, though many were done with much thinner equity layers.
  
  As the good times rolled, the LBOs, measured by their cash flow cushions, became riskier. A strategic buyer would make sure the target company's debt was no more than three times EBITDA - earnings before interest, taxation, depreciation and amortization. The first wave of private equity deals were done with debt equivalent to five times EBITDA. During the credit boom of the past two or three years, that multiple rose to eight times or higher.
  
  The higher the ratio, the higher the risk, because cash flow is used to pay down debt. "If your operating profit goes down even a fraction in these highly leveraged deals, you're up [a] creek, to use the technical term," said Alchemy's Mr. Moulton…
  
  Private equity managers say things will get a lot worse before they get better. Some truly big LBOs could blow up, spreading wreckage everywhere. "

Do you think Governments are any better off? Take a look at this story:

• “California may need emergency $7 billion loan: report
  
  California may need an emergency loan of up to $7 billion from the federal government within weeks, the Los Angeles Times on Friday quoted Gov. Arnold Schwarzenegger as saying in a letter to U.S. Treasury Secretary Henry Paulson.
  
  In the letter dated October 2, Schwarzenegger called for the passage of the $700 billion financial industry bailout plan which the U.S. House of Representatives is expected to vote on Friday, the Times said.
  
  "Absent a clear resolution to this financial crisis, California and other states may be unable to obtain the necessary level of financing to maintain government operations and may be forced to turn to the federal treasury for short-term financing," Schwarzenegger wrote in the letter, according to the paper.”

Pension plans are not immune from shocks either as you will recall from the OMERS balance sheet several years ago that required huge contributions from all of the municipalities around Ontario thereby causing tax rates to increase dramatically. OMERS is very fortunate. They have you and me, dear reader, who have deep pockets to make up their losses. Other pension funds are not as lucky.

Here is another scary story if you are a teacher:

• “The Ontario Teachers' Pension Plan is cutting back on inflation protection for some future retirees to eliminate a $12.7-billion funding shortfall reported earlier this year.
  
  Instead of the present 100 per cent adjustment for the cost of living, inflation increases for pension credit earned after 2009 will range between 50 and 100 per cent, depending on the financial health of the plan, officials said Wednesday.”

I’m telling you all this because I’m not sure where P3 investors are going to get the money to pay for a border crossing in Windsor, especially if the owner of the Ambassador Bridge decides not to sell out. I am absolutely disgusted with the disingenuous arguments used by MDOT during the transportation budget debate:

• “Shreck wanted to correct any perception the new DRIC bridge would drain funds from other Michigan road projects: "Any bridge that is built will be financed with bonds and paid for by tolls, not state and federal gas tax funds, so it will not affect any other road projects."

What a facile comment that is so misleading that it is a disgrace. He did not say who would provide the bonds and how much higher the tolls would have to be in order to pay those bonds back given the amount of traffic that the DRIC bridge would actually have. That assumes that there is fair competition between the crossings. But what is most disgraceful is that it appears that it is the intention of MDOT to have a P3 for the DRIC bridge even though it is not yet permitted by legislation. After all, why did MDOT speak with the “Australians?”

In this light, I found a very interesting article on P3’s that MDOT should find very troubling. Where Brian and I may have some agreement is on the outrageous sums of money that P3 investors want to earn in order to invest in the first place. If MDOT believes that money will come from tolls, than just imagine how high they will be. If on the other hand, tolls are kept artificially low, as it appears to happen at other public bridges, then taxpayers will have a considerable amount of subsidization that will be required. Of course that will not be easily be apparent to the public so that few will know about it. Examples are the plaza costs at the Peace and Blue Water Bridges and at our Tunnel. We know that the Soo bridge will have to be bailed out by taxpaers soon too.

Here are some excerpts from the article:

• Infrastructure funds seek $100bn
  
  Banks and asset managers are currently raising $100bn (€69bn) to plough into infrastructure projects around the world, twice as much as last year, as investors seek double digit returns from investments lasting 10 years or more…
  
  He warned some funds might not hit their goals, due to tougher capital-raising conditions in the economic downturn.
  
  Jane Welsh, a senior investment consultant at Watson Wyatt, said infrastructure funds were typically aiming to make inflation-linked returns of about 12% a year after management fees of 1% to 1.5% and performance fees of 20%.
  
  The riskiest opportunities, such as those involving the building of a tunnel for a tollroad, may aim to generate returns of more than 20% a year. Most funds require their investors to lock in minimum investments of $10m for 10 years, with some demanding 25-year lock-ins.
  
  She said: “There has been a ramp-up of new entrants in the past three years and we are concerned about the number of funds looking for capital. Are the opportunities out there?”
  
  Sadek Wahba, head of the Morgan Stanley Infrastructure team, said: “The answer is not 100% clear. Some projects that are desirable from a social perspective are not interesting commercially and there may be political considerations…
  
  Philippe Taillardat, head of infrastructure investments at Crédit Agricole Asset Management Capital Investors, which is also fundraising, said: “The emergence of many new investment groups will increase competition for quality assets, making manager selection a critical factor.”
  
  He said credit was being made available to help finance infrastructure deals, though under more stringent terms than last year.
  
  Investment consultants said large pension schemes had increased their allocations to infrastructure to 5% as part of a broader investment in alternative investments. One recommended an allocation of 10% to infrastructure, but warned: “It is an onerous job to get comfortable with this kind of investment.”
  
  Some investors said that while they liked the idea in theory, finding a way to invest could be a problem.”

You can see the problem about to develop again. Infrastructure funds are going to be set up by smart operators to lure pension funds’ money as they diversify their portfolios into infrastructure investing. The pot of gold for them supposedly will be high and stable returns over a long period of time to match their pensioner payouts. That is the theory going around.

Increased buyout amounts will be offered for the prime investments since the number of "quality" ones are relatively few. In many cases, amounts paid will be a premium to the market value of the asset in order to get the asset in the first place. And someone--probably you and I-- will ultimately have to pay for that premium too, say by increased tolls or subsidies if we are talking about the DRIC bridge.

Not only are these type of investments illiquid in themselves, the funds will require the pension funds to lock themselves in for long periods of time. It will not be like trading on the stock market where if things go bad an investment can be sold immediately.

These transactions are not immune from disaster as we in Windsor should know from the OMERS’ investment in DRTP and the write-downs that they took on infrastructure a number of years ago. Infrastructure managers are not infallible. Who knows the future traffic volumes of a DRIC bridge as transportation needs change. The so-called experts were unable to figure them out a few years in advance, never mind 75-99 years out!

The troubling part in all this however is the kind of return that is expected: “returns of more than 20% a year” in some cases. If that is the rate of return expected on the new DRIC bridge, then who would ever use it and those who did would not be very happy at the tolls.

So what do we see right now? A financial meltdown supposedly because of the subprime mortgage market to be followed by disintegration of the private equity market that was also supported by the banks and some pension funds. Governments themselves have their own financial problems as tax revenues decrease and costs increase because of the loss of jobs and industry resulting in higher unemployment. Huge demands on government to bail out the marketplace to prevent a depression.

Our salvation…the money boys leading us to our next financial disaster, P3’s. Why an assistant professor of geography and planning at the University of Toronto in a Toronto Star opinion piece just told us:

• "Public-private deals can pay for new transit projects
  
  But between privatization and traditional public-sector funding, there is the possibility of many different forms of private-public partnership. These range from the sale of public lands or zoning rights adjacent to new facilities, to the bundling of infrastructure design, construction, operation and financing into a single long-term contract.
  
  While more than 1,100 transportation infrastructure projects worth more than $450 billion were delivered through private-public partnerships worldwide between 1986 and 2006, in Toronto, such mechanisms have been highly controversial.
  
  Critics contend that private-public partnerships are a backdoor path to full-fledged privatization, that projects paid for through upfront private investment are more expensive because of higher private-sector borrowing costs and the need to cover corporate profits, that worker pay, job conditions and service quality suffer when projects are operated by private companies, and that transparency and public input into decision-making is limited.
  
  Each of these concerns has a basis of truth. But it is also the case that as the experience with delivering projects through partnerships has grown, approaches have been developed to mitigate some of the downsides."

Careful Professor, it is those downsides that can destroy you!

The money boys are not operators of the business but they are financial whiz-kids who will recommend an investment as long as their financial spreadsheets show rates of return that will make their investors happy. It is interesting that Michael Nobrega of OMERS as an example is not only interested in being an investor but he also wants to be a manager because that will be where nice money can be with a minimum of risk:

• “Few pension funds or merchant banks in the world match the depth and breadth of expertise that we have assembled at Borealis Infrastructure. In the next stage of Borealis Infrastructure’s evolution, we will partner with other like-minded pension funds in the pursuit and acquisition of trophy infrastructure assets around the world.
  
  The nature of this partnership could take several forms:
  • Creation of a North American infrastructure fund, managed by Borealis Infrastructure, in which OMERS would be the lead and largest investor; this fund structure is particularly attractive to smaller pension funds without the resources to pursue and manage an in-house infrastructure program.

I am sorry but I do not see P3's as our answer. I'm not sure that a P3 is even possible here unless the Ambassador Bridge is wiped out and that will lead to a decade or more of litigation, something that also is not good for our region.

Even if some arrangement could be made with the Bridge Company that would not result in litigation, the amount of money involved would not be insignificant just based on the DRIC traffic projections themselves. Why would the Bridge Company accept a low amount when the Governments are saying that the DRIC figures of the traffic volume doubling make sense!

There is no doubt that the Governments would expect a private P3 operator to include those costs as well as the costs of a new bridge, Plaza and perhaps even a new road to the Bridge along with the Tunnel rolled in the amount to be financed. Remember, the Tunnel has to be bought out as well and rolled into this project because it is competition.

Can you imagine the amount of the toll for all of those amounts as well as a rate of return in excess of 20%! That would kill traffic-- business, tourist and commuter-- for this region forever.

Given the demands on Governments, how are they going to subsidize this crossing in order to keep the tolls of manageable? If the Draft DEIS is correct, and traffic will be drawn from the other crossings, they will suffer financial problems which the Governments will have to subsidize also.

Where are these pools of capital going to come from with all of the infrastructure needs around the world that have to be met? Bank loans or government... don't be silly. If you don't think that Governments are going to start to impose on their pension funds the obligation that they invest only in their own country, then you are deluding yourself. Don't you find it despicable that Canadian pension plan money is being used overseas to fix the infrastructure of other countries!

Just wait until some of these Infrastructure Funds start having their own meltdowns as well as investments go sour. Just watch as money flows away from them. No wonder they require long-term lockins.

We are at least fortunate here that the Bridge Company is prepared to risk its money to build its Enhancement Project. Don't forget that they have already spent about a half a billion dollars of their money over the last decade to get to where the project is today.

The nature of their "partnership" with the Government is not the same as the P3 partnerships that we are being encouraged to enter into. The Ambassador Gateway project is a good example of the Governments of Michigan and the United States doing what they are required to do... build interstate connections... while the Bridge Company does what is required to do... Plaza improvements in making the connections.

It is not a financial partnership as a P3 would be but rather a partnership where each of the parties performs their function as they have been doing for almost 80 years.

It is time that the games playing with Governments stop and some sanity be brought to this region. We need a proper border solution that can only be arrived at if the Governments and the Bridge Company sit down and discuss what must be done in a cooperative fashion and in a respectful one as well.