Many new public-private partnership transactions are now springing up around the United States to bring private sector dollars to help upgrade roads, airports, public transit, ports, hospitals, courthouses and schools. After several high-profile missteps in the last decade, the US may now have found two workable templates. Project finance lenders seem eager to get involved.
A panel of industry veterans discussed developments at the Chadbourne global energy and finance conference in June. The panelists are former three-term New York Governor George Pataki, Nasir Khan, a managing director with Bank of Tokyo-Mitsubishi UFJ Trust Company, Victor Paulo Saltao, executive director for North America with Brisa Auto-Estadas, Karl Reichelt, executive vice president of Skanska Infrastructure Development, and Cherian George, a managing director of Fitch Ratings. The moderator is Doug Fried with Chadbourne in New York.
MR. FRIED: The projects we will be discussing fall into two categories. There are “greenfield” projects that involve new construction and “brownfield” projects that are privatizations of existing assets. In both cases, the private party also has a responsibility to operate the project for a period of time.
Another way to classify projects is to separate them into availability payment deals and demand risk deals. Availability payment deals are transactions where the government will pay a set sum of money periodically to the private party for keeping the project open or “available” for public use. In a demand risk or traffic risk deal, the private developer is fully exposed to demand or traffic risk.
Some deals that have been done recently in the market include the Midtown Tunnel project in Virginia on which Skanska and Macquarie closed. Virginia also just announced that it is considering 22 more PPP projects.
The international airport in Puerto Rico is under procurement as a brownfield project. The government of Puerto Rico will sell a concession to a private entity to operate and maintain the airport. Ohio State University sold a brownfield concession recently for its parking facilities for about $500 million.
There is procurement underway by the Port Authority of New York and New Jersey for a new Goethals Bridge. The Port Authority put out a procurement to build a new Goethals Bridge between Staten Island and New Jersey and to demolish the existing one. There was a recent procurement for a courthouse in Long Beach. There are many different types of projects currently in the market.
A few months ago, the economic recovery in the United States was gaining momentum. The employment numbers seemed to be going the right way. The stock market was up. Recently, things have not looked so good. Karl Reichelt, what effect does the economy have on this market?
MR. REICHELT: PPPs are a tool that governments can use to create jobs and drive economic development when times are tough. They are a way to provide needed infrastructure when there it too little money in the budget. A government can leverage its limited public funds three to four times by bringing in a private party. There are roughly $80 billion in infrastructure funds waiting to be invested in this sector.
GOV. PATAKI: PPPs are becoming far more acceptable and far more common. Of course, I said the same thing five years ago. (Laughter.) Five years ago, I was talking about how people were beginning to be more open-minded about having government work cooperatively with the private sector and how governments do not have the money to build new infrastructure on their own. As Karl Reichelt said, there is this enormous need both to create jobs and build infrastructure, so it made sense. But then 2008 happened, which was followed by the federal stimulus of $837 billion for shovel-ready infrastructure. All of a sudden, the idea that the private sector had a critical role to play in this was pushed aside.
I think we have now come full circle and governments have no choice but to pick up again with the private sector. There are three or four good reasons why PPPs will be back in vogue.
First, the federal stimulus is over. Unfortunately, it has not made the slightest dent on the infrastructure needs of this country. We still have trillions of dollars of short-term infrastructure needs in transportation alone, let alone the trillions we need to upgrade the electric grid and so many other items that are in crying need of capital. The federal government is not going to be there. There is no consensus at the federal level that a government that is borrowing $1.3 trillion a year just to keep moving should go into further debt to help states through these projects.
Second, if governments were running out of money in 2006, they are flat broke today. Just look at the projected deficits in California and other states. You are not going to be able to look to the federal government. You are not going to look to the state governments. Traditionally, the state would raise taxes or borrow money. States are no longer in a position to do that for infrastructure, which from a political standpoint is the easiest thing to defer because the bridge will not fall down until the next guy is in office.
Third, there has been a change in the political climate. I worked to do a lot of PPPs when I was governor. We did the air train at John F. Kennedy Airport with Skanska. We privatized the only airport thus far that has been successfully privatized in the country, although Puerto Rico should be happening very soon. The political climate was always very difficult. The results in the gubernatorial recall election recently in Wisconsin are a sign that things are changing. Governors may be emboldened by the results not to defer to public employee union objections to things that are necessary to move a state forward.
When I wanted to do the PPP for the Tapan Zee Bridge, it ran into opposition from the public sector unions. There are private sector unions and public sector unions. It is not surprising to me that Wisconsin Governor Scott Walker got between 33% and 35% of the private sector union vote. Private sector unions want jobs. They want the ability to have their kids follow in their footsteps. A shift in the political climate is limiting the ability of public employee unions to insist that everything has to be done by government, through government or with government.
Finally, Karl Reichelt said there are $80 billion in infrastructure funds looking to invest. We saw massive investment in the mid-last decade in paper assets — mortgage-backed securities and CDOs — and they bombed. The virtue of a road or bridge for a pension fund manager is you can see it. It is a tangible asset. There is growing interest on the capital side in being able to invest in assets one can see.
Brownfield Versus Greenfield
MR. FRIED: Victor Saltao, talking about future projects, do you expect to see more greenfield or brownfield projects?
MR. SALTAO: Both. That said, greenfield projects are more likely to go through politically. They also take more time, since they require new permits, environmental studies and the like. They fill a need. Managed lanes on existing roads are also becoming more popular. They will have congestion pricing. The lanes add 20% to 40% more capacity to an existing highway. Some 15 to 20 states are considering managed lane projects currently. They are faster to implement and find greater public support since they give drivers the option of arriving downtown faster by paying a toll during rush hour.
MR. FRIED: The amount of the toll varies depending upon the level of traffic. If there is heavy traffic in the managed lane, then the toll will be higher to discourage people from using the toll lane. If traffic is light, then the toll will be less to encourage people. Cherian George, do you expect to see more availability payment deals or more demand risk deals in the future?
MR. GEORGE: Most state departments of transportation are looking at demand risk projects. Demand risk projects, particularly of the greenfield variety, are challenging to finance. There are lots of risks, and lenders have been taking hits on many occasions with these projects. This means that they need some public money to make them more viable. For that reason, I think the market will move eventually to availability payment projects. If the government is going to have to spend money in either case, it may do better to take back some of the risk.
MR. FRIED: Nasir Khan, given the departure of various European lenders from the US project finance market, who do you expect to fill the void? Do you think that Canadian and US banks might get more involved? Where will the money come from to finance these deals?
MR. KHAN: The European banks have not fully departed. You may see tenors shorten. You may see slightly higher pricing. Perhaps the appetite is a little bit lower, but the European banks are still very much there.
As a Japanese bank, we are very happy to fill some of the gap, but frankly, we are also glad to see the European banks still active because we need them to have a healthy market. They have been sophisticated project finance lenders for a very long time.
When you look at a PPP bank deal with revenue risk, the market is probably capped at a little over $500 million. The Ohio State University parking deal and San Juan Airport project are both within that range.
The Midtown Tunnel deal ended up having a very strong execution in the private activity bond market. The banks looked at it, but being north of $600 million would have made it challenging from a capacity perspective. Some national US banks, like Wells Fargo, have come into the market. Other US regional banks are also starting to show an interest.
The fact that Cheniere is able to finance close to a $4 billion LNG export terminal with bank debt is encouraging. The lender capacity to handle large deals is much greater when there is the potential for cross sales and follow-on business.
There is a very strong private activity bond market in the US. It is a tax-exempt bond market. In addition, you have TIFIA funding as another source of capital. The bottom line is that this sector can tap multiple deep pools of capital.
MR. FRIED: TIFIA is basically a special form of lending from the US government at very low rates with long tenors.
Governor Pataki, I hope you don’t mind, but I want you to talk about politics for a minute. (Laughter.) We were talking about brownfield versus greenfield projects. The Chicago Skyway privatization was a brownfield project that got a lot of interest. Everybody expected an avalanche of deals to follow, but politics intervened. Do you think brownfield procurement is more politically charged than greenfield procurement?
GOV. PATAKI: Yes, and the Chicago Skyway and the Indiana Turnpike are perfect examples of what can go wrong. Governor Daniel ran into enormous public opposition when he tried to privatize the turnpike. A hundred years ago, the country bumpkin would come to New York City, sit under the Brooklyn Bridge and look in amazement, and the city slicker would say, “You like that bridge? I’ll sell it to you.” And the bumpkin would buy it. Now the city slicker goes out to the country and says, “I see that bridge you have. Will you sell it to me?” (Laughter.)
It is a harder sell to take an existing asset that people use every day and say that it will no longer be your neighbor plowing the snow or filling holes and the government running it, but it will be some foreign entity. Brownfield sales elicit a more emotional reaction than greenfield projects do.
I remember sitting down with Governor Corzine when he was governor of New Jersey. He was going to privatize the New Jersey Turnpike. He sat down and said, “I have this great plan. We are going to bring the private sector into the New Jersey Turnpike.” I said, “What are you going to do with the money?” He said, “Well, we’re going to pay down debt, and we are going to do this and that.” And I said, “You will never get it through.” He asked, “What do you mean?”
I said, “You are taking an existing public asset that people are used to using, privatizing it, and they will not see anything tangible in return.”
The difference with a greenfield project is that you can tell the public it will have a new road or new bridge soon that is impossible to build without help from the private sector. There is less of an emotional reaction. Greenfield projects are an easier sell politically because people see something tangible in return.
Politics by Asset Class
MR. FRIED: Karl Reichelt, do the politics vary by asset class — for example, a road, parking facility or courthouse?
MR. REICHELT: To do a public-private partnership effectively, you have to have strong political will. That means that the governor has to be willing to put his or her credibility on the line to work that project. The math must make sense. Strong political support is a must because there is always opposition in this market to bringing in a private partner to make improvements.
Take the Midtown Tunnel project. It is a $2 billion project. The financing is $695 million in tax-exempt private activity bonds, $422 million in a low-interest federal loan, $300 million from the state and $320 million in cash from the private sector. The way I look at it Governor McDonnell took $300 million of state money and leveraged it into a $2 billion dollar project that was both nationally and locally significant. The project had been in the works for 20 years, and it will be now built in five years taking advantage of 2012 prices. It took a strong will on his part to push it through under huge political opposition at a time when he was hoping to be considered as a vice presidential candidate.
We need a new mindset where governments focus on delivering services to taxpayers rather than owning bricks and mortar. Companies like ours are really good at doing the building, financing, operation and maintenance for extended periods and being held accountable through performance-based contracts.
When I was in government, we tried to do huge projects and always struggled with delivering them on time and on budget. The experience with public-private partnerships is that 85% of projects are done on time, on budget with high efficiency and typically with good results for the government. The inverse is true of state or federal projects: 85% are over budget, over time and obsolete by the time they are completed.
GOV. PATAKI: Our audience tends to think rationally. Politics are a combination of the rational and the emotional. Karl mentioned asset classes. People do not tend to identify closely with a road. But schools and hospitals are another story. I was amazed when I first went up to Ontario, Canada and saw that they were doing everything privately, including schools. It is like pulling teeth even to get transportation projects done here. So as you look at those asset classes, the garage is easy. No one lies awake at night saying, “What a wonderful garage we have here in Albany, New York.”
MR. FRIED: It depends upon the type of car you have.
GOV. PATAKI: It depends on your car. My cars don’t even make it into the garage. (Laughter.) But when you’re talking about your neighborhood school, it is a different story. It is a mistake when dealing with the public to lose sight of the emotional part of the equation.
MR. FRIED: We have been making progress on the transportation front. What else is holding back the social infrastructure?
MR. GEORGE: There has been a lot of bad press associated with PPPs. This is, in large part, because there has been no big picture thinking about public policy on how this should work and why it can provide better service to the public over time. What we have seen instead is a gradual shift, state by state, of people making individual decisions that lead to one project here and another project there.
We at Fitch monitor about 175 public authority ratings in the transportation sector. We also monitor privately managed project finance ratings. The one thing that you have in the private sector is clear contracts that say you will do “X” and meet “X” and “Y” standard and, if you do not, you will not be paid. The very people who are imposing those requirements on the private sector do not hold themselves to those standards. There is an opportunity to have disclosure on public performance to hold both parties accountable so that the level of service on every asset improves.
MR. SALTAO: When you try to compare turnpike numbers with roads, bridges, whatever, you are comparing apples and oranges. It is difficult. There are professors and commissions trying to make such comparisons. The only way to sell a road project is to inform the public about the benefits and what it costs to have a turnpike at an acceptable service level.
GOV. PATAKI: Another difference between public infrastructure and PPPs is you have a contractual relationship. If one side does not perform, you sue and get justice. However, when a project goes wrong, the government may have legal rights, but it does not matter if you are in public office and the people say, “What in God’s name have you done here? The road is half done.” Just to be able to say that we can hold private parties legally accountable does not cover the risk to the governor. Success breeds success, and failure breeds contempt. Legally you can collect, but in the meantime it is an enormous public embarrassment. That difference makes politicians very cautious before going into this type of arrangement.
MR. FRIED: Educating government officials and the public about the benefits of PPPs takes time. We have made considerable headway, but a lot remains to be done. Nasir Khan, what further action do you expect at the federal level to encourage PPPs?
MR. KHAN: On the federal level, there are two major topics of discussion. One is reauthorization of the transportation bill. It is expected to include more TIFIA. The other big topic of discussion, which seems to have lost momentum, is creation of a federal infrastructure bank.
At the state level, we are seeing a lot more acceptance. There are more than 30 states with some form of PPP legislation. The states and municipalities have little choice. They have relatively limited access to funding at a time when the private sector has deep pools of capital to invest. A project like the Midtown Tunnel is an excellent example of where a state was able to leverage its funds into a much larger investment. Virginia has been very good at doing that.
MR. FRIED: How do you see the 2012 Presidential race affecting PPPs?
GOV. PATAKI: I think Governor Romney would be far more inclined than the current administration to be open to private sector involvement in what traditionally has been a government activity. Virginia Governor Bob McDonnell is leading the way and, before that, Texas Governor Rick Perry was leading the way. These are states that have conservatives in charge who believe in limited government, but that is not always the case. The Daleys in Chicago have been very aggressive on this. Pennsylvania Governor Ed Rendell was very aggressive about involving the private sector.
MR. FRIED: How do you think a Romney administration would feel about increasing TIFIA funding?
GOV. PATAKI: I would like to think that it could be done with bipartisan support. These things really do make sense, and infrastructure is something that can cross the political spectrum. It only got started under Abraham Lincoln. It is not as if this is a new development. Unfortunately, there are some people in my party who believe the federal government has no role. TIFIA should be viewed as a catalyst to mobilize the private sector.
When I was governor of New York, one of the interesting things I saw was that it was not as much a partisan issue as it was geographic. It was big state versus small state. It did not matter if you were Republican or Democrat. If you were from a relatively urbanized state, you supported mass transit funding from the federal government. If you were from a rural state, you wanted more for highways and less for mass transit.
MR. FRIED: Victor Saltao, we have seen a socialist president elected recently in France who does not support wider use of PPPs. Will this create more interest in the US market?
MR. SALTAO: We have worked over the last 10 to 15 years on PPP projects with various socialist governments in Europe, like Spain, Portugal, Italy and Greece. We are paying now, and we will pay in the future, for the socialist policies on transportation. There were a lot of availability projects that did not make economic sense and that became very expensive later. They were good politically when they were completed, but the traffic volumes were much less than forecasted, making the projects burdensome to carry. Those are the lessons.
My company is operating roads in India, and it has been active in Latin America, Europe and the US. We expect to remain active in the US market. The opportunity is here.
MR. FRIED: We are coming to the end of our session. I would like each of you to tell me your view of the current market.
MR. REICHELT: We are very optimistic. Five to seven PPP projects will close in 2012. That is a high volume for this market. In the past, the pace was two to three projects a year. By comparison in Chile, the number is eight to 10 projects a year. We are seeing that projects in the US can still get done in a tough political and economic environment. This is really good for the market. The Midtown Tunnel project in Virginia was four times oversubscribed. Investors are interested. Governors are catching on.
The uncertainty at the federal level is having an effect. We are in the same boat as the renewable energy developers. I do not think the politicians in Washington understand what uncertainty does to the market. The Senate and White House coordinated on wanting to create jobs and build infrastructure, but they are killing PPPs, which are a great way to create these jobs and infrastructure.
All of that said, I am optimistic about the US market. We are currently tendering three big multi-billion dollar projects.
MR. KHAN: For a long time, we have been a transactionconstrained market, not a capital-constrained market. What we have seen in the first half of 2012 is very encouraging. The Midtown Tunnel and Presidio projects have already closed, and the Ohio State University parking and San Juan Airport projects are expected to close very soon. This compares to last year when you had just one project close, the PR-22 toll road deal. So already we have seen four times what was accomplished last year, which is encouraging.
MR. SALTAO: The authorities need to look over the current pipeline and prioritize projects. They should push forward with the ones that are truly ready. The capital is ready to be deployed.
MR. GEORGE: No pun intended, but the rubber meets the road on TIFIA. It provides around 33% subordinated debt and really enhances the credit quality of these projects. There is talk of increasing the funding, which would be an exciting development. However, the process for tapping into TIFIA is highly politicized. The program lacks the right level of staffing and, at every step of the way, the Office of Management and Budget and the Treasury have to agree on everything. The program does not follow any kind of market precedents.
This makes it difficult and expensive to execute deals. The organization and structure of TIFIA have to change to make the program more useful. I have one cautionary thought on funding, though: my concern with a large funding increase is that unless the staff is geared up to deal with a larger volume of projects, the government will end up funding projects that should not be funded and that will bring a full halt to the program when a big blowup takes place.
GOV. PATAKI: I am more than optimistic about the future for infrastructure and PPP projects domestically. Politicians like to think that they are leaders, but they are really herd players. For the longest time, nothing was happening. As Nasir Khan said, last year there was only one project. This year, there have already been four. As more successes happen, states and municipalities will find more courage, as will their elected officials. The capital is there. The need is there. The public lack of capability is there, and the political climate is becoming more receptive. I am extraordinarily optimistic about the next five years. I think this is the place to be.