Inside Public-Private Partnerships
Joe Calcara, SES, Director of Programs, USACE South Pacific Division
TME: You have a broad background at senior executive levels, including at the Pentagon in military installation programs, alternative financing delivery in the U.S. Navy and U.S. Army, and now back with the Corps of Engineers and its Civil Works missions. How have your experiences shaped your perspective regarding public-private partnerships and other creative approaches to financing infrastructure-related requirements?
CALCARA: When it comes to managing larger infrastructure and facilities portfolios, whether your perspective is owner, operator, service provider, or other stakeholder, the common thread is always the same: to effectively leverage scarce and dwindling resources to construct, sustain, restore, repurpose and/or modernize infrastructure and facilities public works as efficiently as possible.
Now in this context, efficiency is a function of two things: one, the predictability of resources (the funding streams in a public-private partnership); and two, underwriting the appropriate level of effort to meet all requirements (balancing the risk/return value proposition in a public-private partnership).
With conventional military installations or civil works infrastructure, initial construction is generally fully funded by higher visibility line item investments intended to meet a critical need for 30 to 50 years. Operations and maintenance is subject to the annual budget chase through erratic and volatile appropriations cycles, often competing with other must-fund activities and services sourced from flexible and discretionary accounts. Moreover, inside a fixed top-line spending total, funding is frequently vectored to offset emerging priorities in stressed manpower, training, equipment and systems accounts. Consequently, the end result is asset managers have sub-optimal program levels to effectively arrest deteriorating conditions in their portfolios. This spirals downward into the vicious circle of requiring even more resources than a focused and vested build-operate-maintain partnership would afford. And so, in the most ideal public-private partnership, we cobble tranches of funding for construction, operations, maintenance, services and sometimes grant permitted uses for other revenue generation, into a life-cycle business model that spreads costs over a fixed, predictable, must-fund arrangement for a multi-year term.
When done correctly, infrastructure and facilities get built at a fractional cost of upfront conventional appropriations. Operations and maintenance benefits from reduced costs as a result of prudent recapitalization and service cycles not driven by catastrophic failures or compressed, storming-market bidding periods.
TME: What is the key to reconciling the risk perspectives of the government, private entities, and third-party financiers to effectively implement public-private partnerships?
CALCARA: Risk/return parameters vary depending on the legal authority used by the government, the transaction genetics, including the type of financing, and the wherewithal of the private partner. In general, all public-private partnerships forge a dynamic balance of Performance Risk, Market Risk, and Structured Financing Risk.
Performance Risk is a very common element in virtually all larger infrastructure and public works projects irrespective of funding sources. It is usually underwritten by completion bonding from a surety or insurance company, though it may be secured by a separate reserve account or other financial guarantee to reduce costs. The government and the project lender are completely aligned in this risk element, so it is predominantly the project partner who has the full responsibility of ensuring performance.
Market Risk is generally tied to the longevity of the government requirement. But it may entertain residual value or secondary market considerations. In this element, the government and the partner are usually more aligned. The lender must evaluate conditions antecedent to obtain the optimum arrangement for refinancing, restructuring, or retiring the project.
Structured Financing Risk concerns the debt-equity mix used in the project, which generally includes multiple tranches of funding yielding different rates of return on varying terms and risk positions in the waterfall of revenues—all of which are effectively balanced to obtain optimum efficiency on the blended capital sources. This is the most critical and most complicated element of any public-private partnership as it can affect every aspect of the transaction. Moreover, if not done correctly, it can cause catastrophic collapse of the project, if not permanently destroy any future opportunities for the parties or programs involved.
To date, some of the more successful public-private partnership projects across the Defense Department use simplified applications of these elements, with Military Housing Privatization being the most advanced in terms of the government actually involved as a participating member in a single purpose entity limited liability company formed for raising capital through Certificates of Participation Public Offerings to own, operate and maintain inventory for a 50-year term.
Other transaction models such as Enhanced Use Leases, Cooperative Agreements, Concession Arrangements, Long-Term Facilities Contracts, Government Direct Loans, and Special Legislation Real Estate Transfers are often designed to engender partnering responsibilities. They, however, lack explicit authority for the government to form a single purpose business entity and share risk/return with a private concern.
TME: What are some successful alternative financing arrangements involving the private sector that you have observed?
CALCARA: Specific business structures used by the government in public-private partnerships and similar transactions vary widely. They have evolved over the years with emerging private capital markets protocol and implementation guidance from the Office of Management & Budget.
Defining success is critical. It depends on government participation and the goals for the particular project, which can range from cost avoidance to cost savings, from outsourcing to divestiture, and from partnerships to lease-contracts.
My first project, back in 1989, executed under 10 USC 2809 Long Term Facilities Contracts Authority, leveraged a government partial rental occupancy guarantee into a 30-year arrangement to construct, operate and maintain 300 transient lodging accommodations at Naval Submarine Base New London, Conn., and Newport Naval Education/Training Center, R.I. With no upfront financial participation from the government, the transaction relied on conventional short-term construction debt taken out by permanent financing at beneficial occupancy.
Similar models at the time included the Military Family Housing 801/802 Build-to- Lease/Rental Guarantee Programs. But the contingent liability of the capitalized obligation by the government later was dramatically affected by Credit Reform Scoring, resulting in the lack of a programmatic business case to pursue further projects.
I worked for Naval Facilities Engineering Command in San Diego and Pearl Harbor during the 1990s, a decade that brought a spate of different approaches and authorities using Navy Housing Limited Partnerships, Military Housing Privatization, Enhanced Use Leases, and Special Legislation Real Estate Transfers.
In 1997, we used pilot authority under 10 USC 2837 to enter into a 10-year limited partnership with a developer to build, operate and maintain 185 family housing units on private land in the vicinity of Naval Station Everett, Wash. Leveraging a modest $5.9 million in upfront government participation, $19 million in housing was constructed and operated to rent at preferred Military Basic Allowance Schedules with all government equity returned at the end of the project term.
In 1998, using Government Direct Loan Authority under 10 USC 2802, $19 million in upfront federal appropriation was leveraged into $85 million in construction and repair for the DeLuz Housing Area at Camp Pendleton, Calif.
For more than a decade beginning in the late 1990s, public-private ventures authorized under Military Housing Privatization Authority 10 USC 2837 multiplied in size and scale, securing billions of dollars of investment capital as tens of thousands of military housing units were transferred into limited liability corporation partnerships to construct new inventory, eradicate maintenance and repair backlogs, and provide what is now enhanced residences and world-class property management services at preferred rents.
In 2004, in Hawaii, 10 USC 2814 Real Estate Transfer Authority was used to bundle private market opportunities from former Navy housing and infrastructure divestiture at Iroquois Point, Barbers Point and Waikele Gulch into $84 million of privately funded, critically needed capital improvements on Ford Island—upgrades that otherwise would have been sourced by military appropriations. And in 2005, 10 USC 2667 Real Estate Out-Leasing Authority was executed to leverage concession-oriented permitted uses into market revenue that sourced $18 million for the construction of a Navy Administrative Facility, with no government participation or guarantees.
Against performance measures of cost avoidance, cost savings, divestiture, and partnering to capture private capital, each of these transactions may differ in their specific legal authority. But they all share the commonality of huge financial leverage and greater speed in reaching project outcomes than conventional government appropriations protocol.
TME: What are the biggest challenges and impediments to implementing more public-private partnerships for military and civil works infrastructure projects?
CALCARA: I would like to characterize these elements as Institutional Change, Implementing Authority and Individual Talent.
Institutional Change. From the government perspective, Institutional Change describes the inherent cultural issues found in driving transformational changes to current protocol that exists at all levels—from the delivery point up through senior policymakers. There can be no successful public-private partnership project without endorsement along all levels of the chain of command. From the private sector perspective, the relentlessly increasing pursuit of financial guarantees, credit enhancements and risk mitigation works unfavorably against the preferred contingent liabilities threshold that the sovereign can or is willing to grant. Any potential partner who makes an offer without knowing its limitations and requirements is wasting everyone’s time.
Implementing Authority. Implementing Authority concerns the very genetics of the transaction. It sets the framework for government participation and instrumentation to be used in the business structure. Terms like partner, partnering and partnership are often used interchangeably. But in fact, they have distinct and separate legal rights, responsibilities and remedies. The same goes for contractor, lessor/lessee and grantor/grantee.
Individual Talent. Individual Talent regards the human capital available with both the seasoned experience and the longevity to consummate a transaction of this nature. Stewarding these transactions requires competencies in engineering, construction, real estate, structured public financing, and versatile legal support. In my 20-plus years working in and around public-private partnerships, there has been a chronic shortage of specialized people on all sides. That is something we will have to rectify if we are going to make any inroads to the next level.
TME: What is the next evolution for public-private partnerships and alternative financing in the Defense Department and the U.S. Army Corps of Engineers Civil Works missions?
CALCARA: With constrained budgets, no major realignment decisions on force structure in the immediate future, and the uncertainty for more sequestration looming, there will be overwhelming interest to seek efficiencies in asset management of infrastructure, facilities and public works activities. While, in many cases, government participation will be needed at levels deemed too onerous or extreme for senior leadership, stakeholders and operators, projects that can buy-down government participation from long-term capital obligations and fixed guarantees into shared market or vendible uses have potential. Revenue streams that can be monetized quickly enough to amortize private capital contributions in shorter terms also would score favorably within current government fiscal law parameters.
"Any potential partner needs to decide what product/service line they are best suited to compete in, their financial wherewithal to participate, and most importantly, the hard limits and all requirements necessary to successfully execute the transaction and perform responsibilities under the partnership."
In my opinion, notwithstanding the broader powers enacted by the Water Resources Reform & Development Act of 2014 to carry out infrastructure public-private partnership pilots, there will be no larger scale, significant accomplishments without additional legislative authorities and enabling implementation guidance that promotes more risk sharing by sovereign participation for most product and service lines in infrastructure and facilities management. Still, current authorities do exist to leverage real estate privileges and other legal agreements into a feasible business arrangement that can produce an equitable value proposition for both the public and private side. Right now in California we are analyzing the ability to leverage emergent water conservation demand due to drought into an arrangement where interim risk reduction measures to upgrade a Corps of Engineers dam would be sourced by the value of the water on the spot-market.
In potential concept, the transaction would simply modify water control operations in return for in-kind construction and repair to dam infrastructure. In practice, the devil is in the details as flood risk management operations, weather probability forecasting, and real estate rights, remedies and instrumentation all need be conjoined into a workable mix that aligns within existing legal authorities.
Of course, it wouldn’t be any fun if it wasn’t challenging!
TME: What can an interested party do to prepare for seeking opportunities in public-private partnerships?
CALCARA: Begin by getting familiar with some lessons learned and best practices of past programs. Leveraging private resources in military infrastructure goes back to the Wherry Act (1949) and Capehart Act (1955). Utilities Privatization, Real Estate Enhanced Use Leases, Energy Savings Performance Contracts, even some early BRAC Economic Development Conveyances have synergies from the standpoint of risk, participation, and overall scale/scope. Many large-scale surface transportation projects for highway, transit, railroad, intermodal freight and port access have been gap-financed using government subordinate loans and other supplemental guarantees under the Transportation Infrastructure Finance & Innovation Act.
I also would get comfortable with some of the underlying principles, concepts and hard lines that will undoubtedly be involved in virtually all transactions. A short list of homework might include participating ground leases, anti-deficiency statutes, credit reform scoring policy, and the Water Infrastructure Finance and Innovation Authority on the federal side; and investment grade underwriting protocol, revolving fund water financing, and credit-debt instrumentation on the private side.
Any potential partner needs to decide what product/service line they are best suited to compete in, their financial wherewithal to participate, and most importantly, the hard limits and all requirements necessary to successfully execute the transaction and perform responsibilities under the partnership. Chasing myriad projects with newly formed hybrid teams that have no prior successful, demonstrated experience can get exponentially expensive—and usually doesn’t prove fruitful. No one wants failure in their deals. Any perceived un-mitigatible weakness in a potential offer generally cannot be overcome.
TME: Any final takeaways or parting shots?
CALCARA: Public-private partnerships can advance “win-win” desirable outcomes—but both the risk/return balance and the transaction tenets must be precisely aligned within the bounds of legislative authority and capital markets feasibility for the initiative to have merit.
In many cases, public infrastructure and government missions are in the sovereign because there simply is not enough vendible revenues and/or permissible federal participation for the private sector to amortize the profit, insurance and taxes driven by the cost and risk of ownership and life-cycle operation, maintenance, and recapitalization at a prudent business case.
That said, the opportunities are out there, albeit some larger than others. We just need to find them, engage the right folks on all sides of the deal, and drive efficient and effective outcomes to success!
[article first published in the January-February 2015 issue of TME]
Joe Calcara, SES, became Director of Programs, USACE South Pacific Division, in 2012. Before that, from February 2008 to January 2012, he served as Deputy Assistant Secretary of the Army (Installations, Housing & Partnerships). He was responsible for worldwide policy, programming and oversight of Army real estate, engineering and construction, housing privatization, base realignments and closures, energy conservation, and military infrastructure and facilities. Calcara also was the Senior Executive for the Army Residential Communities Initiative and before that served as Director of Army Real Estate at HQ USACE. From 1983 to 2006, he served in various capacities with Naval Facilities Engineering Command at its headquarters in Washington, D.C., and component commands at Pearl Harbor, San Diego and Philadelphia, and in the Office of the Assistant Secretary of the Navy. Calcara is a graduate of the University of Hartford with a degree in Mechanical Engineering.