Thursday, April 12, 2007

P3 Travel Advisory: More slippery toll road schemes ahead

Roadblocks for P3 PABs

Current Laws Put Curbs on Widespread Use


by Humberto Sanchez
The Bond Buyer
Copyright 2007

Current tax law limitations on private-activity bonds, including restrictions on proceeds for acquisition of land, may make it difficult for the debt to be used to finance public-private partnerships for new privately operated toll roads, experts said recently.

There are “some concerns with utilization,” said Texas Department of Transportation deputy finance director John Munoz, adding that the restrictions make them less useful for financing new facilities, also known as greenfields, under public-private partnerships, or P3s.

Private-activity bonds, or PABs, are tax-exempt securities issued to finance various types of facilities used or operated by private entities.

In October the U.S. Department of Transportation authorized Texas to issue up to $1.86 billion of PABs to help finance the construction of State Highway 121 north of Dallas. The state subsequently gave preliminary approval to Cintra Concesiones de Infraestructuras de Transporte to operate a toll section of the highway for $2.1 billion up front and $700 million over a 50-year contract.

Cintra is currently exploring whether to include PABs as part of SH 121’s financing plan, Munoz said.

Texas was the first to receive a bond allocation under a program established as part of a massive transportation funding authorization bill enacted in 2005 to allow states to issue up to $15 billion of PABs to help pay for the construction of highways and freight-transfer facilities.

The program was set up to help facilitate private sector investment and participation in the financing of transportation infrastructure. But the restrictions, which also include limits on the amount of bonds that can be issued at a price below par, such as zero-coupon bonds, and a prohibition on accelerated depreciation, may make it difficult for the program to achieve its full potential, according to some experts.

“I think without any changes in the tax law, we are going to have a number of challenges taking advantage of the value of PABs,” Munoz said.

As a result, Texas transportation officials have been voicing their concerns to federal lawmakers in the hope of raising awareness of the issue. TxDOT officials have been in contact with the staff of the Securities Industry and Financial Markets Association, which lobbies Congress on behalf of market participants, to see if lawmakers would be willing to consider loosening or eliminating the restrictions.

“I think we are educating [Congress] in order for lawmakers to make a good decision on how to address the issue that is fair to Texas and other states and doesn’t give more than what they had anticipated and envisioned when they passed the law,” Munoz said.

If the tax law were changed to remove the restrictions “it would really elevate the ability to finance and accelerate [projects] and bring value to the states that are running theses procurement,” Munoz said. “And really, that is what the [PAB] program is pursuing, that is why the federal legislature has gone to the efforts of creating this tool. Right now it is kind of unfortunate that it can’t be utilized to the extent that those that passed that legislation envisioned.”

Others agree that changing the tax law would help make PABs more attractive for P3s.

“I do think that in order to have the full benefit of what was intended in the legislation there would need to be some change in the code or some determination by government agencies that there is another interpretation of the rule that permits you to utilize the typical debt amortization structure for a toll road under this private-activity bond” program, said David Klinges a managing director with Bear, Stearns & Co.

Under the current tax law, only about 25% of private-activity bond proceeds can be used to acquire land, which could deter some greenfield P3s from using this type of debt.

“If you are talking about a greenfield toll road financing, that could be an important factor where land [acquisition] is an important component of the cost of the project,” said Bryan Grote, a principal with Mercator Advisors LLC, which consults with state and local governments and corporate clients on infrastructure finance issues.

In addition, tax rules that require 95% of the proceeds of private-activity bonds to be used for “qualified” or capital costs essentially preclude the use of zero-coupon bonds, which P3 advocates would prefer because there would be no interest payments on the bonds during start-up of the project when cash flows are weak.

“For a lot of P3s that are used for start-up project financings it is important, sometimes essential, to have a back loaded repayment structure where you are deferring interest to accommodate your growing revenue stream and you cannot do that with private-activity bonds,” Grote said. “When the name of the game is to back-load the debt service and maximize early cash flow available for return on equity, then some of these technical limitations come into play.”

A third limitation involves a requirement that straight-line depreciation must be used in connection with private-activity bonds. P3 investors typically prefer accelerated depreciation, which allows the depreciation to be taken over a shorter period of time and provides for faster recovery of cost and tax advantages compared with straight-line depreciation.

“Property financed with PABs may only be depreciated on a straight-line basis, whereas … owners of facilities financed with taxable debt may be able to claim accelerated depreciation,” Grote said. “This tax benefit could be significant for some greenfield developments perhaps worth a few percentage points on a present-value basis.”

Grote pointed out that “none of these technical limitations by themselves are necessarily decisive,” but when you add them up, some greenfield P3 deal sponsors may decide, “Maybe we’ll stick with taxable debt and equity.”

Charles Henck, an attorney with Ballard Spahr Andrews & Ingersoll LLP here, agreed that the restrictions could make PABs a less appealing financing option for new, privately operated toll roads.

“It generically makes the [PAB] financing approach less helpful than it might be,” he said. “It will be an issue in some cases, but not all.”

One area where PABs may work is in high occupancy toll, or HOT lane, projects where new toll lanes are added to an existing highway and there is no real need for a revenue ramp up period, according to James Taylor, a principal with Mercator Advisors.

“On those [projects] you have revenue from day one, so I could see those private project sponsors saying, ‘We don’t need to defer debt, we don’t need to acquire land [because] it is in the middle of an existing right-of-way. We will forgo the depreciation because we are more concerned about getting low cost debt,’ ” said Taylor, who, prior to joining Mercator last summer, was an investment banker with Bear Stearns. “That would be a perfect example where the private-activity bonds make sense.”

He said that, once the various HOT lane projects under development around the nation reach the financing stage, “I clearly see more people applying for private-activity bonds and using [PABs] because it is almost like from day one you have an operating mature facility. All of the traffic is there and you just have to capture a sufficient share of the market.”

Others believe that it is just a matter of time before PABs find their financing niche in the U.S. P3 market.

“The U.S. P3 market is different than the international P3 market from the standpoint that there is much more experience here domestically using capital market financing techniques such as tax-exempt private-activity bonds,” said Stephen Howard, senior vice president for infrastructure finance with Lehman Brothers. “There is an education process that has to go on with the international infrastructure companies and banks as to how to marry tax-exempt private-activity bonds with the international P3 financing model.”

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