After a long skid> into financial distress, the Southern Connector, a $300 million toll road project in Greenville, S.C., filed for bankruptcy at the end of June, adding to the list of unsuccessful projects backed by municipal bonds.
Conceived in 1998 as a nonprofit toll road, the Southern Connector was designed to improve access to a slew of industrial sites in the area, including the North American headquarters of Michelin and the only BMW manufacturing plant in the United States. From its debut in 2001, the road failed to draw enough traffic to keep up its debt service. The shortfall was clear by 2003, when the annual report of the Connector 2000 Association, the nonprofit entity formed to manage the toll road, said "it is apparent that the actual results of operations are substantially less than what was projected in the study."
Owners of the approximately $300 million in tax-free municipal bonds will be at the head of the line for repayment after bankruptcy reorganization, but bond experts say the project's long, drawn-out failure underscores the need for investors to understand economic fundamentals, not just chase yields.
"It's been a pending issue for well over a year or so," said Stanley McGuffin, bankruptcy attorney for the Connector 2000 Association. "The situation with this is that the traffic on the toll road has been lower than expected since inception."
The bonds, initially offered at price range between 90.03 and 95.71, with yields of 5.25% to 5.38, last traded at 22 cents on the dollar, with zero yield.
While the idea of a toll road as a self-financing project made sense in theory, a 2009 study by Stantec, a design and consulting firm in Edmonton, Alberta, showed that the 16-mile highway needed to boost toll rates by 50% to 75% just to maximize its revenues. From 2007 to 2008, the last period covered in the study, traffic fell 3.4% and revenues fell 3.9%. The operator sought and received permission from the state transportation department to boost tolls, and got approval for three 25-cent increases on its top fee of $2.50, with the final hike scheduled for 2016.
It was too little, too late.
"The revenues from the Connector have been less than originally forecast and insufficient to pay the scheduled debt service on the bonds," bond trustee U.S. Bank wrote in its notice of default.
Toll road bond defaults accounted for about $1.6 billion of the estimated $23 billion in muni defaults on the book in the first half of the year, according to data from research firm Municipal Market Advisors.
Richard Saperstein, managing director and partner at HighTower Advisors, said his Treasury Partners group doesn't own any Connector bonds, but advised prospective investors to do their due diligence.
"We stay away from a lot of special purpose projects," he said. "It's easier to stay out of trouble than get out of trouble."
While it wasn't immediately clear the Connector was a road to nowhere, Saperstein said his analysts will pick over a project's financials, model the best and worst case for its revenues and generally stick to conservative issues that get repaid through essential services.
"Most of our investors are in this asset class for safety, and the incremental return for a riskier bond doesn't compensate for the larger incremental risk."
Peter Samuel, editor of the web site TollRoadNews, likened the project to the subprime mortgage crisis, which was, in part, a major factor in the bumpy road to bankruptcy.
The Connector project and the Pocahontas Parkway, another troubled project in Richmond, Va., proved to be too much road for the actual pace of development, and were victims of belt-tightening among the drivers who were projected to supply revenue, he said.
"In the recession, the traffic goes down," he said. "A lot of the costs are fixed costs, regardless of the traffic volume, so when it drops, there's a lot of trouble."