Structural options for US infrastructure: alternative sources of financing
April 2013 | PROFESSIONAL INSIGHT | SECTOR ANALYSIS
Financier Worldwide Magazine
A study by the American Society of Civil Engineers (ASCE) in January 2013 puts the costs of chronic underinvestment in US infrastructure into stark economic terms: by 2020 the US stands to lose some 3.5 million jobs due to declining productivity and competitiveness from crumbling infrastructure. The hidden price of infrastructure underinvestment also manifests itself in other ways, such as traffic congestion – one recent Texas A&M study estimates that traffic costs the US nearly $121bn per year, including some $26bn in wasted time and diesel fuel used by delivery trucks stuck in traffic. According to the ASCE study, the largest shortfall exists in funding for highway and transportation related projects, which will require some $877bn by 2020. Likewise, electricity generation and transmission projects will also require investment to the tune of $629bn. In all, the report concludes that US infrastructure requires nearly $2.75 trillion in investment over the next seven years to forestall the severe economic losses that will result from a failure to maintain and expand US infrastructure. The news is not surprising, considering that US infrastructure spending as a percentage of GDP has fallen from a peak of three percent in the 1960s to approximately 2 percent today, despite the demands of a growing population and a $15 trillion economy.
The need to overhaul America’s ailing infrastructure is clear, but the question of how to fund the much-needed maintenance and expansion has proved vexing. The traditional source of funding for US infrastructure – an 18.4 cent federal gasoline tax – has not been increased since 1993. According to the Bureau of Labor Statistics, adjusted for inflation, the gas tax should stand at about 29 cents today, but American politicians are understandably resistant to the notion of raising either federal or local fuel taxes. On top of the federal tax, most states impose an additional local gas tax of roughly 27 cents per gallon. However, the gas tax is levied per gallon of fuel, and not on the dollar amount, meaning that with Americans driving fewer miles than ever before, gas tax revenues have dropped considerably. According to a 2012 analysis by Standard and Poor’s, state gas tax revenues reached a plateau at the beginning of the 2008 recession and have since fallen off, reflecting weak economic activity and the increasing use of fuel-efficient vehicles, according to S&P Creditweek 2012.
With federal and state funds in short supply, many have looked to the private sector to fund the shortfall in infrastructure investment in the United States. The ‘Public-Private Partnership’ (PPP) framework, traditionally seen simply as a way of allocating various project risks to the parties best able to manage them, has emerged as a useful financing tool for cash-strapped governments. In earlier days, when governments had money to spend, the public sector would typically engage private firms through straightforward ‘Design-Build’ contracts to construct roads and bridges. With today’s tight budget constraints, governments have increasingly engaged the private sector through more complex ‘Design-Finance-Build-Operate-Maintain’ contracts that allow private investors to achieve a reasonable profit from equity investment in infrastructure projects in exchange for not only delivering the project, but also for operating and maintaining it. Although the US is a relative newcomer to the PPP space, European governments have long looked to the PPP framework to deliver efficient, lower cost infrastructure solutions. According to a study by the Brookings Institution, the US was home to only 9 percent of all PPP projects globally between 1985 and 2011, representing some $68bn in investment. Europe, however, led the world in PPP activity over the period, accounting for nearly 45 percent of global PPP projects over the last two and a half decades, translating into approximately $353bn in infrastructure development. The Brookings analysis also yields convincing evidence in support of the notion PPPs are more efficient and cost-effective than traditional public sector-led projects. For instance, one 2009 study of UK projects determined that about 65 percent of PPP construction was on-budget, while only almost 54 percent of public sector-led projects were delivered on-budget. Similarly, a study of Australian PPPs determined that the typical Australian PPP project had cost overruns of only about 1 percent on average, compared to an average cost overrun of 15 percent for public-led projects. When using availability payments, the PPP format is additionally helpful because it allows governments to amortise the cost of public infrastructure through project-created revenue streams rather than commit to big upfront payments, which place considerable strain on public finances.
So why has the US been slow to the PPP party? First, many states have lacked the technical capacity to undertake PPPs, which in many instances require complex contracts that differ significantly from project to project. Second, political issues may stymie PPPs. Public concerns about foreign ownership of essential facilities like ports and roadways have given rise to a significant backlash against the PPP format. For example, the bid by Dubai Ports World (U.A.E.) for the management of six major ports in the United States was denied by Homeland Security in 2006 for national security reasons and the Texas legislature imposed a two year moratorium on PPPs in 2007, after successfully awarding numerous concessions to Spanish firms from the private sector. And third, until recently, many states did not have enabling PPP legislation. Today, 33 states (34 including Puerto Rico) have PPP legislation, though not all of these states are promoting private investment into public infrastructure.
The US federal government has taken some significant steps to promote infrastructure PPPs, most notably through the 1998 Transportation Infrastructure Finance and Innovation Act (TIFIA). The program, which is implemented by the US Department of Transportation, Federal Highway Administration, is designed to foster PPPs by providing gap funding for up to a third of total project costs through low interest loans, loan guarantees and lines of credit. The TIFIA program has provided approximately $8.6bn in credits since it began lending in 1999, directly supporting some $33bn in infrastructure investment. Due to what then-Transportation Secretary Ray LaHood last year termed “overwhelming demand” from state governments for TIFIA funds, the Obama administration significantly expanded TIFIA budget authority outlays from a mere $122m to $1bn in 2014. Underscoring Secretary LaHood’s point, the US Department of Transportation reported in January 2013 that it is currently processing 27 new TIFIA project proposals, accounting for nearly $39bn in infrastructure investment. However, with US infrastructure requirements running at a rate of $160bn per year to 2020, the TIFIA program may not be enough to bridge the gap in funding. Proposals to create a national infrastructure bank have been many and the latest iteration, to be proposed in March by Representative John Delaney, a Democratic Congressman from Maryland, is in the form of an American Infrastructure Fund, which will be overseen by a new federal office called the Office of Infrastructure Investment. As proposed, the Fund will make low-interest loans to states for projects that include private capital procured under a PPP process, or will guarantee junior loans or bonds issued by states for infrastructure projects.
A handful of states and municipalities have experienced considerable success in financing infrastructure through PPPs. Chicago was among the first to leverage private equity investment for large infrastructure projects. In 2005, the state concessioned the $1.83bn Chicago Skyway toll road through a partnership with a pair of Australian and Spanish firms. Since then, many states have moved to pass legislation sanctioning PPPs. Virginia has had an active PPP program since 1995, when it passed the Public Private Transportation Act. Since then, the state has been able to complete a number of high-profile transportation infrastructure projects, including the 495 Capital Beltway and I-95 Express managed lanes projects. Both of these projects make use of an innovative dynamic toll pricing system to reduce traffic congestion and both projects were funded by equity from Australia’s Transurban and the United States’ Fluor, as well as over $800m in TIFIA loans. Florida, Texas and California have also attracted considerable private investment into their transportation sectors.
Alternative sources of financing
One possible source of alternative financing could be pension fund investors seeking the long-term, stable returns typical of infrastructure projects in the United States. Global institutional investors piled some $214bn into infrastructure-focused funds between 2004 and 2013, with over half of that amount going to North America. Yet an increasing number of pension funds, dissatisfied by poor performance and high fees, are circumventing fund managers and making direct investments into infrastructure projects. Led primarily by Canadian funds, pension investors are attracted to the highly predictable, inflation linked revenues associated with infrastructure projects. The Ontario Teachers’ Pension fund began investing in infrastructure as early as 2001, and by 2012 had over $8.7bn in direct infrastructure investments, specifically in regulated utilities, power generation assets, airports and container terminals. The Ontario Municipal Employees Retirement System (OMERS), which holds roughly $55bn in assets, has also moved aggressively into infrastructure and has plans to expand its infrastructure holdings from about 15.5 percent of assets in 2010 to 20 percent over the long term. Through its Borealis Infrastructure investment arm, OMERS has over 20 direct investments in surface transport, rail, ports and airports, as well as energy assets ranging from generation to transmission and distribution.
US pensions have been slower to wade into infrastructure, but there has been a noticeable uptick in interest in infrastructure in the past several years. In 2008, the largest US pension, California’s CalPERS, indicated that it would allocate roughly three percent of its $230bn portfolio to infrastructure assets, and in 2010 made its first direct investment in infrastructure, when it acquired a 12.7 percent stake in London’s Gatwick Airport. Other US pensions, including the Kansas Public Employees Retirement System, the Teachers Retirement System of Texas and Washington’s State Investment Board, have also indicated that they will allocate more of their portfolios to infrastructure. Most recently, the New York City Teachers Retirement System promised $1bn for New York infrastructure in the wake of Hurricane Sandy in late 2012. If recent trends continue, pension funds could prove to be a critical source of patient capital to fund US infrastructure needs.
Going forward, another possible source of US infrastructure financing is the huge pool of Sharia-compliant investors in the Middle East and Asia. In search of safe, long term assets, many Islamic investors are beginning to look seriously at US infrastructure opportunities. Sukuk, which are asset-backed bonds that are structured according to Sharia principles, have recently been used to fund major infrastructure projects in the Middle East and Asia. Most recently, Malaysia financed upgrades to its main airports through a notable issuance of approximately $980m worth of Sukuk. The market for Sukuk is currently estimated at $130bn, having grown by 24 percent from 2011 to 2012 and with a compound annual growth rate of 27 percent for the last five years. The demand for Sukuk instruments far outpaces supply and is estimated to reach $600bn by 2015, compared with the potential issuance of $200bn. There are clearly opportunities to develop Sukuk finance solutions to target US infrastructure projects, including infrastructure Sukuk backed by US assets and marketed to international Sharia-compliant capital markets.
Financing for the future – are we ready?
The meaningful involvement of the private sector in the infrastructure market in the United States has been in the final countdown for take-off for nearly a decade. As a result of the current economic climate, the deteriorated state of US infrastructure, and the massive liquidity in the market, it seems the moment has finally arrived for the private sector to become a real partner. But are all of the stakeholders ready to get this sector moving? Does each of the separate entities – the public sector, the private developers and funders, the users of this infrastructure – understand the importance of its role in this complex process? And, most importantly, is there enough momentum to keep the stakeholders moving in the right direction? Unlike in other jurisdictions, where a federal government has provided a mandate for moving this process forward, the United States is a country of many jurisdictions, each with its own timeline, stakeholders and needs. Private sector investors will go where there is a transparent framework, good projects and a proven return on their investment. The US transportation infrastructure sector is ready for investment by the private sector.
However, we cannot expect this process to move quickly because capital intensive, multi-jurisdictional infrastructure project developments rarely do. However, the increase in funding for TIFIA, the fact that more of the states are finally realising the important role the private sector can play in delivering their infrastructure needs, and the attention the industry is getting in the media – from the White House and the Europeans and Australians – seem to be moving the process along a little faster. Hopefully, with the addition of the pension funds and the Sharia-compliant sources of financing, the United States might just bridge the gap.
Jennifer L. Hara is vice president at Taylor-DeJongh. She can be contacted on +1 (202) 777 2116 or by email: firstname.lastname@example.org.
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Jennifer L. Hara