Bonds

Officials still wrestle with troubled Kentucky internet project

Kentucky officials are still struggling with how to handle a troubled internet network project nine years after bonds to fund it were sold.

Analysts say the KentuckyWired project has lessons on how public-private partnerships should be structured.

The political wrangling in-state stands in contrast to rating agencies, who since September have issued the bonds an upgrade and positive outlook revision citing strong operational performance since the much-delayed completion of construction.

Kentucky Senate President Robert Stivers’s proposed budget would have redeemed the KentuckyWired bonds, but the proposal didn’t make it into the final spending plan.

The bonds that provided most of the construction money were sold by the Kentucky Economic Development Finance Authority in late 2015.

The wisdom of the project and its financing have been questioned for years and as recently as March top state officials were wrangling about what to do with the bonds.

As of March 3, there was $222.6 million long-term liabilities in 2015A bonds, $55.6 million long-term liabilities in 2015B bonds, and $15.2 long-term liabilities in 2015C bonds. Additionally, KentuckyWired Infrastructure Company, Inc. said it had $3.7 million in accrued interest current expense.

As part of this spring’s budget process the state Senate’s plan proposed allocating general fund money to pay off most of the bonds’ balances. The debt payment schedule extends to 2045, but they can be called at par beginning on July 1, 2025, according to offering documents.

However, when leaders of the Senate and House of Representatives met to hash out a consensus budget the payoff was stripped out. The budget sent to and signed by Gov. Andy Beshear in late March didn’t have the immediate payoff of the bonds. The annual appropriation was made.

“The Senate may have had the right idea to pay off the KEDFA bond but they took the absolute wrong approach by proposing it in the final days of the budget process,” said Andrew McNeil, president and senior policy fellow at Kentucky Forum for Rights, Economics and Education. “KentuckyWired was brought about through back room deals with virtually no public scrutiny. We see where that got us.”

The consensus budget was negotiated between Senate President Robert Stivers and House Appropriations Chair Jason Petrie. Stivers, Petrie, and Beshear didn’t respond to Bond Buyer requests for a comment.

The bonds are “availability payment” bonds with the Kentucky Economic Development Finance Authority legally responsible for paying them. In practice, each year the Kentucky government uses general funds to make the payments.

According to Moody’s, twice in recent years the state’s working proposed budget didn’t include funds for payment of the bondsfor payment of the bonds until a week or two before the governor signed it. In a September 2023 report, Moody’s said “negative attention” during the budget process was one risk for a bond downgrade.

The Series 2015A and 2015B bonds are rated Baa1 with a positive outlook by Moody’s rates and BBB-plus with a positive outlook by Fitch Ratings.

Moody’s upgraded the bonds from Baa2 in September and Fitch lifted the outlook to positive in January.

“We expect sound operating performance to continue given the consortium’s experience and strong operating performance with no deductions to date,” Moody’s analysts wrote.

Fitch’s positive outlook “reflects the project’s brief yet strong performance since reaching substantial completion in August 2021,” according to the rating agency. “Should the project continue to perform well, as assumed under Fitch’s cash flow cases, the rating would likely be upgraded.”

While the state is being paid some revenues from public and private entities paying to use the network, state taxpayers will continue to have to cover bond payments because the system will not bring in enough money, said Johnny Kampis, director of Telecom Policy for the Taxpayers Protection Alliance.

“Kentucky Wired has been an unmitigated disaster,” McNeil said. “Hundreds of millions of dollars have been wasted. The legislature should examine any and all options available to shut the program down.”

“A discussion of ‘what’s next?’ has to be conducted out in the open so the taxpayers know exactly what is being asked of them going forward,” McNeil said.

In 2015 Kentucky was among the five slowest in the country for internet speeds. With the KentuckyWired project state government decided to build a “middle mile” fiber-optic internet network throughout the state to raise internet speeds and internet availability. The network is 3,393 miles consisting of several loops, which allow for backup service if one part of the loop goes down.

The network was aimed at initially connecting 1,097 government sites, to be followed by access to private entities.

While the bond’s official statement in late 2015 predicted the network would be completed by summer 2018 it wasn’t in fact finished until summer 2023. The project’s timeline was “impossibly ambitious,” McNeil said. In the OS the Kentucky Economic Development Finance Authority promised to do an internet “system refresh” after eight and after 18 years had passed. In practice this means Kentucky’s government had made this promise.

In 2018 Kentucky Auditor of Public Accounts Mike Harmon released a 125 page report on the KentuckyWired project. It projected the system refreshes would cost Kentucky $87 million.

“Typically, [with bonds based on availability payments] the availability payments are made for infrastructure that is available and operational,” Harmon said. However, Kentucky agreed to make the payments before the network was constructed.

Harmon said because of unanticipated costs Kentucky will have to pay at least $110 million more than projected.

Kentucky had projected total project revenues of $1.9 billion over 30 years with the state being able to receive $1.3 billion of this. Some of the revenue was to go to a nonprofit Center for Rural Development. However, Harmon said there was “scant support” for these projections.

Harmon said Kentucky officials were given three types of warnings about the project’s failures before they went through with it and all three warnings have proven prescient.

“The Kentucky Department of Education warned that a significant portion of needed project revenue would not materialize because the bidding for K-12 services on the network would not be E-rate eligible.” E-rate is a federal program aiding schools to connect to high-speed internet.

“A private contractor warned of the potential for problems with pole attachment agreements which have led to major issues with the project schedule and resulted in additional compensation claims made by contractors,” Harmon said.

Finally, Kentucky officials were given written advice by outside counsel that was ignored, “the full extent of which is still unknown due [to] a claim of attorney-client privilege,” Harmon said.

Among other things, Harmon found the structure of the KentuckyWired deviated from typical public-private-partnership arrangements and from the original design, significant terms favorable to Kentucky were changed during procurement, the role of the private sector in financing the project had been overstated publicly, the public was misled about revenue streams available to finance the project, and the Kentucky Communications Network Authority had inadequate financial analysis and monitoring of potential costs.

In 2019 the Kentucky Legislative Research Commission said the failure of KentuckyWired to get a contract to serve K-12 schools left a shortfall of about 45% of the funds needed for availability payments. The state might have to fill a gap of $500 million during the term of the contract.

Harmon’s 2018 report projected the KentuckyWired project would be a net negative on the state’s general fund every year through 2045 without K-12 migration to the system and this hasn’t happened.

“With a P3 as complex and expensive as KentuckyWired, the private sector partner must bear the lion’s share of the risk,” McNeil said. “Their willingness or reluctance to do so will reveal what they really think about a project’s potential viability.

“The contract with [the private sector head company] Macquarie did the complete opposite and, consequently, the state of Kentucky has had to bear the enormous costs associated with the program’s failure to deliver,” McNeil said.

“Proponents of P3s always claim that one of the benefits is that they shift risks away from the public,” said Donald Cohen, executive director of the group In the Public Interest. ”But then lots of the road deals started to go bankrupt so they shifted guarantees (and leaving all the risk to the public.)

“Bottom line — Macquarie did a no-lose deal with very favorable contract terms and I’m sure equally favorable return on investment,” Cohen said.

Macquarie Group Limited declined to comment.

The sort of problems KentuckyWired has is very common among public-private partnerships though this one seems particularly incompetent, Cohen said.

Cohen said there were five lessons of KentuckyWired for public-private partnerships. First, “realize there’s no such thing as free money.” The public will pay costs one way or another. Second, “Ask really hard questions. These are complicated long-term projects.”

Third, “What is the public giving up in making long-term decisions?”

To explain this issue Cohen said in 2008 Chicago sold the right to parking meter revenues for 75 years to investment firms. But now to remove metered parking spaces the city has to buy the spaces back. The city government made the decision in four days, he said.

Fourth, do one’s due diligence and fifth, think about the long-term implications, Cohen said.

Access to the internet is a modern necessity, Cohen said. While it might make sense for a private entity to construct internet networks, the government should control and regulate them.

The Bond Buyer awarded 2015 Deal of the Year award to the KentuckyWired deal citing the newness of using a P3 to expand broadband connectivity and a “novel tax exempt governmental purpose bond structure that achieved full risk transfer.”

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