Interest Growing in US PPPs
Roughly 25 infrastructure projects have been funded to date in the United States through public-private partnerships, while the figure in Canada is roughly 150. Thirty US states now have some form of legislation authorizing use of PPPs to fund basic infrastructure. Interest in PPPs is growing, driven by increasing deal flow as more states realize that they are an effective way not only to plug funding gaps but also to transfer risk.
A group of industry veterans talked about recent developments in the US market during the annual InfraAmericas US Transport roundtable in New York in late March. The following is an edited transcript of the discussion. The panelists are Jane Garvey, North American chair at Meridiam, Nick Butcher, senior managing director at Macquarie, Marietta Moshiashvili, managing director at TIAA-CREF, John Anderson, senior managing director at John Hancock, Thomas Pelnick, senior vice president of ACS Infrastructure, and Paul Ryan, managing director and head of the infrastructure advisory group at JPMorgan. The moderator is Doug Fried from the Chadbourne New York office.
MR. FRIED: With employment on the rise and the stock market up, what impact do you think this will have on the US PPP market?
MR. RYAN: I think it is overwhelmingly positive for PPPs. On the public side, things have been tough, but as they improve, this adds confidence that projects will be able to get done. Public clients are taking the PPP alternative seriously. They are comparing PPPs on an apples-to-apples basis with traditional procurements. We did not see that as often in the last couple years. PPPs transfer risk and close gaps in funding. The ability to close gaps is dramatically improved with an improving economy and with more money flowing into the public sector.
MR. FRIED: Jane Garvey, how do general economic conditions affect Meridiam’s strategy in this sector?
MS. GARVEY: We spend a lot more time asking questions about the sovereign health of a country or state. We probably do much more due diligence around those issues. We spend more time digging into the economic health of the surrounding region. But fundamentally the market strategy for us remains the same. In the depths of the economic crisis, we had two deals. One was awarded in California and another came to a close in California. That was not only in a bad economic time, but also with a change from a Republican to a Democratic administration. I think that was a real vote of confidence, and it suggests that even in uncertain times, the stability of infrastructure as an asset class should make it very attractive for investors.
MR. FRIED: Nick Butcher, how are the states doing economically, and how does this affect the PPP market?
MR. BUTCHER: The states are facing a tough financial situation with pension deficits and long-term indebtedness. They have been taking short-term measures like cutting services and trying to manage the annual budget. We are not seeing the type of investment in new infrastructure that needs to happen.
The financial situation will force harder decisions that may not have been politically tenable five years ago. The Port Authority of New York and New Jersey is considering LaGuardia airport as a potential PPP. Nassau County is looking at granting the private sector a concession over its wastewater treatment and sewer system because it cannot raise any more debt and it is difficult to raise property taxes.
MR. FRIED: Will the economic condition of the states change how PPP deals are structured?
MR. BUTCHER: The challenge for states looking to do availability transactions is how to give confidence and certainty to the payment stream. It will force more revenue risk transactions where there is no availability payment stream.
MR. FRIED: Tom Pelnick, how will the problems in Europe affect the market?
MR. PELNICK: Companies focus on where the work is. It does not matter whether the companies are based in the US or outside the US. If there are opportunities in the United States, then we will continue to see European sponsors active in this market. Competition will remain very fierce here. As long as projects are good, there will be opportunities for work with European banks, but maybe not to the same extent there has been in the past.
MR. FRIED: Do you see a change in the number of European sponsors in the US market?
MR. PELNICK: In just about every major deal we are considering, we see quite a few European competitors. There is probably room for others to consider coming over here.
MS. GARVEY: As Canada has leveled out, some of the Canadian players are moving down to the US as well. It will be a pretty competitive marketplace.
Entry of Institutional Investors
MR. FRIED: John Anderson, do you see the pull back of the European banks from the US project finance market as an opportunity for institutional investors to get more active on the lending side of the PPP market?
MR. ANDERSON: The debt markets are very supportive for municipal credits, both taxable and tax exempt. We saw taxable municipal deals price at the same coupons as tax-exempt deals last year. The tax-exempt feature was not saving municipalities any money because there is such broad market demand for debt of infrastructure authorities.
The project finance sector saw traditional European lenders pulling their books shorter last year, and we saw a number of large deals get done quite easily with insurance companies making up the difference. In some large transactions — $400 to $600 million — the insurance companies took the long piece. That was a structure we saw frequently in the 1990s. Those long institutional pieces were well syndicated with a large roster of investors. You see Japanese, Canadian, Asian and some US institutions also within the bank market picking up some of the pull back by European institutions.
There are a lot of different pools of capital, both on the bank and the institutional sides, looking to support well-structured long-term projects.
MR. BUTCHER: For the well-structured deals, the capital is there. The challenge is when projects come to market with a big funding gap that it is uneconomic for the private sector to plug. This is more of a transaction-constrained market than a capital-constrained market.
MR. FRIED: John Anderson, what type of institutional investor do you see coming into the market?
MR. ANDERSON: Insurance companies and Canadian pension funds. US pension funds are very interested, but it is more difficult for them to staff the kind of specialized talent that the Canadians have been able to retain. I have not seen endowment money flow in, but you may see it in the future.
MS. MOSHIASHVILI: What is difficult for the insurance companies and pension funds is to participate in the bidding stages of development. It is very hard for insurance companies to dedicate their limited resources to transactions that may or may not happen.
One solution is bridge financings, but given where the rates are, it is probably more lucrative for equity investors to get a long-term private placement. We are mostly focused on equity-type investments and on mezzanine-type investments. Given where the yields have been, it has been important for us to refocus our skills as an equity investor. A lot of other companies are trending that way as well in the insurance sector, but there may be some benefit for certain insurance companies to continue to do project finance lending.
MR. FRIED: John Anderson, does John Hancock prefer to put debt or equity into PPP projects?
MR. ANDERSON: Both. Equity infrastructure is a rarer commodity. On balance, if we had two opportunities and they had the same probability of success, we would probably throw the resources to the equity opportunity first, just because of the scarcity.
MR. FRIED: Will there be a growing secondary market in the United States?
MR. BUTCHER: I would not call it a secondary market just yet, but one will develop. In the energy sector, there is a big secondary market, and that can translate to transportation if we have more projects. Infrastructure funds and pension funds are all short on US transport exposure. It is a good time to invest if you have a long view of the cycle and the recovery of the economy. Only 25 or so PPPs have been done to date in the United States. There have been 150 in Canada. There is potentially a big market. It is transparent. Equity returns are pretty clear. Developers can make good gains from developing and holding through construction and then selling in the operating phase.
Tolling v. Availability Projects
MR. FRIED: Do you prefer to invest in projects that are already operating?
MS. MOSHIASHVILI: We are not afraid to take construction risk. We will not take development risk. We know how to analyze construction risk. For us, the key is to align ourselves with experienced operators and construction companies that have good reputations and track records.
MR. BUTCHER: When we are looking at the forward pipeline, it is largely going to be new build. You can contract out construction risk and get comfortable. The demand risk is the bigger challenge. If the project opens, how do you get confident about the patronage volumes? Government sponsors will attract a deeper pool of financial capital to availability projects or to lower-risk patronage projects. At the extreme end, you have managed-lane transactions. Not a lot of financial investors are comfortable today with taking on that risk. If the project involves expanding capacity of an existing facility and collecting a toll from users, then that is an easier proposition.
MS. GARVEY: For demand risk, there is sometimes an alignment between the investor concerns and political concerns. The politics suggest that greenfield projects are a bit more acceptable and an availability payment is more acceptable because the state or public authority feels like it has more control over usage. From the investor’s perspective, the project will be more attractive if the state or authority is willing to keep the demand risk.
MR. FRIED: Would you invest in a traffic risk project?
MS. MOSHIASHVILI: Yes as long as we see a pattern to
the traffic. We are not prepared to take both greenfield and traffic risk.
MR. FRIED: John Anderson, what issues does funding during construction create for you?
MR. ANDERSON: We can underwrite construction risk, and we have participated in projects with construction risk. We do not like monthly draws, as banks do. We want to be taken down in bigger chunks up front. We have still been able to make that math work for customers.
MR. FRIED: When you invest in a project, whether as a lender or an equity investor, do you have a preference as to the type of project: a project with an availability payment or one with traffic risk? What do you look for?
MR. ANDERSON: Availability payments are a much better value for the municipality because we will bid a lower return against availability payments. We are more comfortable with that structure, and we price that comfort into the way we bid our capital. But we can do both. We can also price traffic risk for a new-build asset, but there is a much higher chance that we will not bother. There is a deeper pool of capital prepared to put money into availability projects.
MS. MOSHIASHVILI: TIAA-CREF is a long-term investor and, for us, “long term” really means long term: it is 20+ years. It is important to optimize the performance of the asset through operating it well and making sure that we align strategically with operators. We rarely would look at leverage or short-term sales to realize our return.
MR. ANDERSON: For John Hancock, it is a multi-channel strategy. We are trying to participate as a bond investor through corporate municipal bonds, as a project finance lender, as a private equity investor through funds and working with management teams, and in a direct capacity.
MR. FRIED: What impact does cancelation of the West-by-Northwest managed lanes project in Georgia have on the market?
MR. PELNICK: When a project is canceled and a contract is not awarded, nobody wins. As far as that project in particular, the agency had decided it was a fundamentally important project, and we shared that view. We were reasonably reassured that support at the executive level remained constant and strong. So it has probably just heightened the sensitivity to the potential for an executive to exert his authority and decide not to pursue a particular path.
MR. RYAN: I am not overly concerned about the contagion effect. Candidly, I am not overly concerned about it at all.
MR. BUTCHER: It will be tougher for Georgia to attract bidders the next time around.
MR. RYAN: If someone says, “We are going to do a PPP because I want to do a PPP,” you have to think carefully about that. If someone says, “I have been through the analysis and I really understand what my challenges are and I am trying to close a gap and I have identified the value in a PPP,” then that is a very different story. What do public authorities care about? They care about a bankruptcy. So when California State Route 125 went through a bankruptcy, it actually came out successfully. The documentation contemplates and can deal with a bankruptcy filing.
MR. FRIED: Marietta Moshiashvili, what issues did TIAA-CREF focus on, as an institutional investor, when deciding to invest in the I-595 highway project in Florida? [Ed. note: ACS Infrastructure, which developed the I-595 project in Florida, sold half of its stake in the project to TIAA-CREF in 2011.]
MS. MOSHIASHVILI: It was important that the state has the reputation that it does. The other very important component of the analysis was the partner, ACS Infrastructure. We felt we made similar analyses of the investment. We look at how strategic the asset is to our partner and how dedicated it is to constructing and operating the project well.
MR. FRIED: How important are public perceptions?
MR. RYAN: The outlook for federal funding does not look good, but state funding is starting to improve, which is the biggest positive at the moment. Create a project that is feasible, and capital will come. The most difficult part of creating a feasible project is the policy aspect of closing the funding gap. If the project is projected to produce a good return, then it will get done in the municipal bond market. Our focus in private-sector projects is on gap closing.
MR. FRIED: What do you think should be done with the TIFIA program?
MS. GARVEY: The good news is that TIFIA has bipartisan support in Washington. If you look at the Senate transportation bill, a number of changes have been proposed for TIFIA. The most visible one is funding would increase, which is really significant. Funding for individual projects would focus in the future on credit worthiness. Instead of relying on an allotment cycle, there would be a revolving application process. If the TIFIA funds are reduced, then you could draw on other federal funds to boost the TIFIA allocation. So all of that is pretty good news. The Senate bill would also do some streamlining. I am less optimistic about the prospects for an infrastructure bank. People have said it may be a good idea but not this cycle.
MR. BUTCHER: More TIFIA would be great. That would definitely help projects. The debate is centered around using state or federal funding to leverage private capital. At the state level, there have been some interesting proposals in the last few months. Chicago has talked about an infrastructure trust. Virginia announced a state infrastructure bank. New York has talked about an infrastructure bank. The aim of all these proposals is to provide new-build financing alongside private capital.
MR. FRIED: How will the 2012 presidential election affect PPPs?
MR. PELNICK: I am not sure it matters. The outlook for the sector depends more on whether Congress can get together and come up with a reasonable approach, not just for PPPs but also for funding in general. The debate about the infrastructure bank was terrific because the proposal had bipartisan support. The local politicians have an even more significant impact, whether it is in setting a reasonable toll rate or whether to use tolls at all.
MR. FRIED: Jane Garvey, could Colorado become a player in this market?
MS. GARVEY: I think five years ago people might not have mentioned Colorado as one of the movers. This underscores again the importance of political leadership and political will in a state for PPPs. The governor is bullish about PPPs. The executive director is very familiar with PPPs. He comes out of this community, and he understands them. Having that kind of leadership is really critical.
MR. FRIED: What other states do you see emerging in the PPP market?
MS. GARVEY: The first question is who has the right enabling legislation. That changes every day.
We focus on the first movers, the states that have PPPs like Texas, Florida and Virginia. The lesson of Colorado is that there are always new states ready to come forward. I think all of us are focused on California. There are questions about how and when it will move, but the needs are there, the marketability is there, and there is always interest in a state as large as California.
MR. FRIED: Nick Butcher, what is happening in Puerto Rico?
MR. BUTCHER: Puerto Rico deserves to be congratulated. It is not just looking at one sector. It is looking at airports, roads, prisons and schools. It established a PPP authority. It is a good example of what can happen when the government takes an active interest.
MR. FRIED: What deal flow do you expect for parking assets?
MR. BUTCHER: There have been a few canceled procurements, but I think it is an asset class that people should still be looking at. The Ohio State University process is an interesting one. Ohio State has had good response from the market, and if it is successful, then that will encourage other universities to consider granting private-sector concessions over their assets. Most universities are probably not as politically constrained as a city. Part of the challenge has been that cities, in some instances, have put together a grab bag of not-so-good assets, and have been a bit surprised perhaps when the private sector has not been keen to buy them. There have also been difficulties delivering things from a political perspective.
MR. FRIED: There was a recent bill in Florida to allow local governments to engage in social infrastructure projects. There is a procurement out for advisors for the Yonkers schools. There is the Travis County courthouse. What will it take to make investors comfortable with social infrastructure projects in the United States?
MS. MOSHIASHVILI: More education is needed before these projects can go ahead. PPPs would stand a better chance than privatization. There is a notion that certain infrastructure should be owned by a municipality. Understanding the experiences in other jurisdictions could be of benefit. Investors will want to understand how vital the asset is for a particular community, the benefits that it would provide to that community and the risks associated with the particular jurisdiction.
MR. FRIED: Jane Garvey, could you share with us what
challenges you faced in the Long Beach courthouse PPP
MS. GARVEY: You have many of the same challenges as in transportation, but facilities like courthouses are often in the center of a community, so paying attention to urban design becomes even more paramount. We put a big emphasis on the urban design. The challenge for the concessionaire and the investor is striking the right balance between a beautiful urban design and a competitive bid.
MR. FRIED: Tom Pelnick, what do you foresee for the Ohio River bridges project?
MR. PELNICK: I am very optimistic. The state has decided the project is a priority and makes sense. Governor Daniels clearly supports it. The project makes commercial sense. The state has the legal authority to do it. The team overseeing it is commercially reasonable. The state hit its target date with the release of the RFQ. Now it is up to the market to give the state at least one proposal to consider. We think it could get to commercial close this year.
MS. GARVEY: They did a terrific job setting up that bridge authority. Excellent leader, very clear view of what they want to get accomplished, and to their credit, they approached that very deliberatively and carefully.
MR. FRIED: Paul Ryan, what is your view of the I-77 HOT lanes projects?
MR. RYAN: North Carolina has shown it is open to innovation. It is acutely sensitive to what an attractive market is in terms of construction cost and has moved quickly. The state has a good track record, which is so critical in this space.
MR. BUTCHER: The Tappan Zee bridge in New York would be great if it came to a PPP model. There is a lot of interest around it at the moment. The project is in a design-build procurement, but the state will have to find the money to pay for it. If the state does not have the money, then it will have to look to the private sector for funding.
Future of the Market
MR. PELNICK: While there are tremendous needs in the market, there are also significant challenges. The availability payment model could facilitate more projects, but there is still a challenge with debt capacity. If states and municipalities make the basic PPP decision because they do not have debt capacity, then that will restrict the use of availability payment models. The need is there. We are optimistic that the United States will remain a good market.
MR. BUTCHER: There are 30 states with PPP legislation, but there are not yet 30 states doing PPPs.
MS. GARVEY: If you look at the pipeline between now and 2015, a pretty conservative estimate is about $35 billion for states that have hired financial advisors and taken the step really to move. It is important to watch the legislation. Our job continues to be education and, as often as we can, to speak to policy makers about what the implications are and also the benefits.
MR. ANDERSON: Let’s take advantage of the building pool of precedents, of successful stories that we have. Ontario is not that far away. Ontario has a big, robust PPP program. It is a bit of a blind spot for Americans not to look outside US borders. We are not as integrated in North America as we probably should be. There are some good stories there that we can share with state officials.
MR. RYAN: We are encouraged anecdotally by what we see in terms of PPPs being taken seriously and being thoroughly analyzed, which was not happening two years ago. Interest in PPPs is more systemic.
MS. MOSHIASHVILI: We all talk about uncertainties, but these uncertainties create opportunities. People are more focused in the US, and it is a pretty exciting time.