2006.05.27

Privatization of tollroads was the subject of hearings at the US House Committee on Transportation and Infrastructure (HCTI) May 24. It saw appearances and prepared statements from two state governors and several of the leading actors.

Indiana Gov Mitch Daniels said in his testimony that in state hands the Indiana Toll Road was worth (as net present value) somewhere between $1.1b and $1.8b (the higher figure based on major toll increases) whereas the Cintra-Macquarie venture offered $3.8b: "Just as many business units are more valuable if separated from their conglomerate parent, an asset like a highway can be worth vastly more under different management." The ITR had operated at a loss during five of the past seven years he noted, and needed expansions, repairs, and electronic tolling were postponed, "all because there was no way to pay for these necessary improvements.

"A principal reason was its antique pricing. Tolls had been completely unchanged since 1985," Daniels said. There were tolls as low as 15c when the cost of collecting that toll was 34c.

"My response was we'd be better off with the honor system," said he retored.

To bring in $3.8b with fuel taxes the state would have had to double the rate. If bonds had been issued the state would have been able to raise only a third of the $3.8b before hitting reserve limits.

"While other states are raising gas taxes and paying interest on borrowed funds, Indiana will have cash in the bank and will be collecting a half million dollars a day in interest to reinvest in our future."

The heavily debated legislation passed by the Indiana general assembly also provides for a toll concession to build I-69 Evansville-Indianapolis.

The ITR concession fee pays off outstanding ITR bonds, puts $500m in a reserve fund from which the state can withdraw interest only at 5 year intervals for other road projects and $3.1b for "Major Moves" program construction. Of this a third goes to the seven northern tollroad counties since they pay about a third of the tolls on the ITR. An extra $150m was added. The rest will be spent over ten years on road improvements in the rest of the state.

As well as paying $3.8b for the 75 year concession, the concessionaire committed to spending $400m on capital improvements to the ITR, Danels said. In net $5b of extra highway assets will be created which otherwise would not be built - what he called "the biggest infrastructure building program in state history, quadrupling new construction, and advancing project timelines by more than 70 years, all without raising the state gas tax."

The problem of transportation finance had been considered "intractable" he said: "We have found a way to close our infrastructure gap and invest in hard, permanent public assets for our future without a penny of gas tax increase or a penny of debt."

Virginia's Gov Kaine more cautious

Gov Timothy Kaine of Virginia was more qualified and cautious in his presentation. Virginia, he noted, has more experience in private financing than any other state: "Many of our sister states seek the advice of Virginia on how to create their own programs of private partnerships."

Kaine suggested that taxes will remain the mainstay for road financing and that tolls and toll concessions can address about 20% of longterm highway needs. Federal funding accounts for 75% of the funds Virginia expects to spend on its highways in the next six years, Kaine said.

$17b of projects have been engendered by Virginia's Public Private Transportation Act, Kaine said, of which:

• three have been completed

• four are "under agreement" and

• seven are under active negotiation or consideration

Of the $17b, Kaine said, about half will be private funding, the rest apparently being government funding. He noted that risk capital has only been brought forward in the state in the past two years. Kaine called the Pocahontas Parkway deal with Transurban "the first Virginia concession."

Gov Kaine's selective history and semantic games

The Governor forgets the Dulles Greenway which opened in 1995 under the first Virginia toll concession in modern times. Don't tell Michael Crane, the Greenway CEO and principal shareholder then, that risk capital only arrived in Virginia to build roads in 2003 or 2004. We reported at the Greenway's low point in 1997 Crane saying his shares were worthless. They were then, but the TR came good and he sold out his interest to Macquarie last year for several hundred million. Now that's risk capital, Governor, and committed in 1994.

While omitting the pioneering Greenway, Kaine included among "public private partnerships" Virginia's tax districts in which landowners adjacent to a new highway are taxed to finance it. Oddly he called a tax district along the Dulles Corridor "private landowners stepping forward to pay 25% of the cost of the Metrorail extension..." Louis XVI of course stepped forward unbound to the scaffold to be guillotined in the Place de la Revolution in Paris in January 1793. He knew that if he didn't step forward he'd be bound and dragged to the block beneath the knife. And by the Governor's logic my income tax payments of last April 14 are a public private partnership since I "stepped forward" to pay them, not waiting for the demands for payment, notices of delinquency, and property foreclosures, which would otherwise ensue.

Fundamental premise of investor financing is "what market will bear"

"The fundamental premise of what public-private financing, including concession agreements, are based on is tolling a facility at a price that the market will bear," said Gov Kaine. Likely true if there are no controls over toll rates written into the concession, but most toll concessions are based on controls and they usually work to keep toll rates at below what the traffic would bear. Some toll concessions (Eastlink, Melbourne for example) are awarded specifically to concessionaires who commit to the lowest toll rates, so the Governor's statement is plainly wrong as a generalization. END COMMENT MODE, for now.

Kaine calls for "ink to dry"

Gov Kaine stressed the need for investors to have a "strong, fiscally sound" partner in public private partnerships saying the existing taxes and charges going into the state's highway trust fund are increasingly unable to fund new construction.

"We cannot turn our entire roadway system into a series of tollroads or special tax districts," said the governor, suggesting a need to raise taxes.

Virginia had completed three major PPPs in the last three years and is negotiating two more.

"The ink needs to dry so that perspective can be gained on these public-private transactions. If we all immediately turn to the private sector for financing, we run the risk of losing optimal pricing for our roads. We also run the risk of not negoiating the best business terms for the public good. Reasonable time is not an enemy of public private partnerships..."

Mercator Advisers notes toll financing small still on national scene

Bryan Grote of Mercator Advisers pointed out that despite the interest in toll financing, 94% of the $750b invested in highway capital improvements 1993 to 2005 has been with grant money ($575b) or tax-supported debt ($119m) and only $49m (6%) has been toll profits, toll revenue bonds, or equity via concessions. However he said concessions are best suited to very large complex projects and they have provided some $21b for 43 major highway projects in the last dozen years. Access to new capital is not the only rationale for involving the private sector, Grote said, citing the possibility for cutting costs and improving service as well. Overseas the experience in privatizing transit has been substantial reductions in costs and improved revenue, lowering the need for subsidies.

"In essence, policy makers are finding that there can be value in separating the public funding of transportation services from the public provision of them."

Large start-up tollroad projects facing great uncertainties in their early years, but generally viable in the longterm are better financed as toll concessions than as public projects, Grote said, because of the opportunity for patient equity capital and flexibility in financing: "The more flexible and patient capital provided through private concessions may better match these project financing profiles than conventional municipal debt capital. Concession financing typically combines private equity investment and interim debt financing (in the form of bank loans and/or revenue bonds) to carry the project through construction and revenue ramp-up. During this initial period of uncertainty, the debt holders receive interest-only payments to minimize the financing burden on the cash flows. Once project performance has stabilized, permanent financing can be arranged more easily. This 'regearing' not only takes out the interim loans but also provides a return to equity investors. Increasingly, financial intermediaries are assembling mutual funds as the preferred vehicle to raise investment capital. In this way, participating mutual fund investors pool their risk based on the performance of a portfolio of projects. This contrasts with the municipal bond model, where investors face individual project risk in terms of full and timely debt service payments throughout the project financing period."

Although equity investors require nominally higher returns than tax-exempt debt,m they have other advantages of expertise and flexibility which enables them to monetize a larger sum from a given future revenue stream, Grote said. They have far less need for cash reserves and external credit enhancement than the traditional US municipal bond financing.

In many cases public toll financing subjects bondholders to equity type risks but pays them only fixed income type returns.

DJ Gribbin of Macquarie

DJ Gribbin, director of Macquarie (USA) stressed that his company's approach is active management of tollroads acquired for the longterm. He quoted his former boss US Transp Sec Norman Mineta saying in a speech to ARTBA in 2004: "Within the world of public-private partnerships, ventures can be structured to provide better incentives for innovation, cost reduction, faster project delivery, and improved management of new - and existing - facilities." (Gribbin was formerly chief counsel at FHWA). He also quoted from Hernando de Soto's book "The Mystery of Capital" which stresses the economic losses inherent in lack of secure property rights to housing in the third world, locking up capital unproductively. Dead capital in black market and hence insecurely titled housing and other assets prevents investment in job creation and increases in productivity that would lift people out of poverty. Gribbin says US highway infrastructure is analogous.

"Inadequate markets and legal systems in this country have locked up billions of taxpayer dollars in our transportation infrastructure, billions of dollars that could be used to create jobs and fuel economic growth."

However, Gribbin said, the Skyway and ITR concessions "have demonstrated that the captive capital invested in these assets can be freed."

The ITR deal "freed $2b in captive capital," he said - the difference between $3.8b the Cintra-Mac concession is paying and the $1.8b it had been estimated the ITR was worth the state if they had operated it by pushing up toll rates in line with the concession limits (It was worth only about $1.0b if they followed precedent and let toll rates stagnate for long periods.)

"Simply put, the liberated $2 billion resulted from placing the Indiana Toll Road in a market environment. The Indiana Legislature created a legal construct under which the State of Indiana was able to transfer legal property rights to whatever entity in the world placed the highest value on the Indiana Toll Road."

Gribbin said Cintra-Mac was able to find additional value in the ITR for two reasons:

"1. A debt-equity financing model allowed the Partnership to pay more for the asset than a traditional bond financing approach; and

"2. A private sector owner will be able to achieve more efficient operations through innovations and timely investment in operations and maintenance."

Gribbin said the traditional US bond financing approach seriously underexploits economic opportunities:

"The traditional bond financing approach has layers of conservatism built into valuing the asset, and that conservatism tends to undervalue the asset. In addition, bond covenants require a debt coverage ratio, i.e. that the revenues of the asset exceed debt payments by a defined percentage. This debt coverage ratio provides a cushion for investors, but it prevents that cushion from being used to help finance the asset. By contrast, a debt-equity model is able to use the equity investment as the cushion or assurance that those holding the debt will be repaid. As a result, the debt-equity financers are able to free up more capital than those using traditional bond financing, producing a greater payment to the owner of the asset."

Gribbin says sometimes the upfront concession fee makes most sense, sometimes it doesn't. Where a large lumpsum fee cannot be used productively by a state a revenue sharing concession will be better.

Other benefits from concessioning include:

• transference of financial risk from taxpayers to investors

• transference of operations costs and responsibilities to business management

• accelerated project delivery

• shielding of maintenance and operations expenditures from the vicissitudes of government budgeting

• more rational price increases in response to inflation making the real toll rates more stable

• providing a good investment opportunity for pensions funds and other very longterm investors

Gribbin talked down various criticisms:

• toll 'gouging' - but the state sets the rules in the concession contract

• concessions too long at 75 to 99 years - needed to give real 'ownership' of the toll business but, again, the state decides

• skimping on maintenance and safety - but concessionaire needs good reputation to attract users, and concession can specify performance standards and penalties for non-compliance

• disregard environmental and neighborhood concerns - on the contrary take them very seriously to have good relations with potential users

• loss of toll revenue to state - state also loses costly obligations

Gribbin described project development agreements as another public-private partnership (PPP). These research the project to determine its feasibility and to develop it to the point where a concession could be constructed. They allow either party to call of the development process if the project looks financially, technically, or politically infeasible. Project development agreements are signed for tollroads in Texas TTC35 (Cintra-Zachary), Portland Oregon (Macquarie), and Atlanta (Bechtel).

In projects with minimal federal funding, federal rules and regulations could be lifted, Gribbin said. He also urged that federal law be amended to require that all projects expected to cost over $50m be studied for toll feasibility and private sector concessions. He hailed the administration's recently announced focus on relieving traffic congestion.

"Concession agreements have the potential of unlocking capital trapped in assets and making non-viable projects viable. Utilizing improved financing and asset management techniques, the private sector can help bridge the highway infrastructure gap... We need only make modest changes to our legal,/h4>

Mark Florian head of municipal finance and infrastructure at GS said that in Europe, Asia and Australia PPP has become the primary source of infrastructure funding.

"The United States is at a crossroads in its transportation infrastructure lifecycle," Florian said. "Large capital investments have been identified across the nation, which are critical to sustaining the US's economic growth and quality of life. Traditional funding sources have not kept pace with these needs, thereby requiring local governments to search for alternative(s)..." Strict limits on leveraging (reserve and coverage ratios) limit traditional bond financing while bonding of tax revenues (GARVEEs) and government guaranteed loans (TIFIA) can help a few individual projects they can't provide enough to renew whole systems and networks, as needed.

Florian said that although concession agreements are complex they can be completed from RFP to signature in less than a year (ITR was 9mths).

GS is aiming to raise $3b for an infrastructure fund to raise investor money for TRs (principally), and the Carlyle group $1b, and, he said "numerous other groups are contemplating funds of similar magnitude."

He continued: "These funds are driven by the significant demand for the infrastructure asset class from a long list of toll road companies, pension funds, insurance companies, construction/engineering firms, private equity funds, as well as potential public entities. These investors seek steady long-term returns from infrastructure assets (and) diversification for their investment portfolios."

Investors can realize more value than state owners because they judge in private operation it will achieve higher rates of return on capital: "The private operator is more likely to be able to hold down expenses and manage the asset more efficiently simply due to economies of scale and experience."

There is mutual benefit, Florian said: "Public private partnerships are truly mutually beneficial municipalities are able to monetize assets for up-front cash payments to fund future projects or inject additional capital in others while private owners, operators and investors are able to access the steady stream of cash flows produced by infrastructure assets. The marriage of private operating efficiencies and incentives with essential public assets can only enhance our nation's transportation infrastructure."

Hedlund of Nossamans

Karen Hedlund, a partner at law firm Nossaman & others (Nossamans) which specializes in advising states on setting up toll concessions and other PPPs, said conversion (privatization) of public toll facilities (Skyway, ITR) has been the most intense, but most of the action is in concessions for building new roads. Hedlund dated modern toll concessions - as opposed to charters, usually in perpetuity like the Ambassador Bridge - to AB680 in California in 1991 and Virginia's Public Private Transportation Act in 1995. By now 21 states, she said have laws specifically authorizing PPPs. In 2006 Indiana, Utah and Alaska joined the list, and there are moves to replace the rescinded AB680 in California. Bills are introduced or proposed in NY, OH, NJ and MO.

PPP statutes generally provide flexibility as to the terms of concession contracts and provide for a "best value" rather than just highest bid selection, though that may be most appropriate for well defined projects that have been permitted. Investors are generally unwilling to take on permitting risks, she said. They are also wary of concessions which require specific legislative approval (as proposed in the new California legislation.) Most PPP processes start by short-listing to companies deemed qualified and capable.

She added: "In our experience state and local transportation agencies take great care in managing the solicitation and review process, and in negotiating final agreements. These are time-intensive undertakings, and they assign their most senior and qualified public servants to the task. Months of effort are usually required to develop procurement documents and related agreements, including consideration of comments from the public and industry. Additional months are taken up in and in the detailed evaluation of final proposals and negotiation of implementation agreements. Outside engineering, planning, environmental and legal consultants are brought in to advise on the numerous technical issues that arise, and to give the agency the benefit of their experience on similar undertakings elsewhere in the country and around the world. Many states also establish review committees made up of representatives of various stakeholders outside the DOTs, as well as seeking the approval of the states' transportation commissions." (Ms Hedlund: states are states not States. Capitalization is reserved for proper names. TRnews)

Texas PPP program is the largest, she noted, and is seen as "the primary method for delivering new highway projects throughout the state." She characterized the situation as

• ten major projects under PPP contract, in procurement, or negotiation, or in preparation for competition

• Trans Texas Corridors 35 with Cintra-Zachary selected as "strategic partner" which is in negotiation for the first concession TX130 Segments 5 & 6, with a proposal for a 1,000km grade separated rail line Dallas to Mexican border

• I-635 Managed Lanes, TTC69, Loop 1604/US281 Austin, TX121 (north of Dallas) in active procurement, TX161 (between Dallas and Ft Worth) to begin procurement this year

• procurement being prepared for "The Funnel" a TX121/114 connector, I-820/35W also Dallas-FtW for documents to be issued 2007

• Harris County comparative studies on outright sale, concessioning, public sector reform for Houston area TRs

Hedlund listed other states with active PPP programs: VA, OR, GA, FL, IN. Washington state is developing administrative rules for PPPs.

Trends

An early tendency was to see toll concessions as appropriate for marginal projects, Hedlund observes, ones which were low on the state's priority list (or like 91 Express not even thought of and hence unlisted). And they were to be self-sufficient. AB680 prohibited any state support for the concession projects. Also many early "innovative financing projects" involved no commitment to the operations or success of the project over its life - no longterm equity. They were project development efforts with the developer/constructor being paid by a development fee on opening - with a not-for-profit or the state bearing the longterm risks.

Now that is all being reversed - most notably in Texas. Concessions are being applied to the most urgent projects and use a mix of tax and investor funding.

Says Hedlund: "Today, most state laws permit public contributions to PPP projects in the form of grants or loans, and authorize the state to cooperate with the private sponsors in obtaining needed TIFIA credit support or private activity bond allocations."

She credits international companies with bringing the concession model to the US, with assistance from the $15b authorization of Private Activity Bonds in the last 6-year highway bill.

Hedlund's paper contains a useful list of PPP legislation in each state.

see http://www.house.gov/transportation/

TOLLROADSnews 2006-05-28