Corzine received $30 billion proposal for "monetization" of NJ Turnpike with management contract
By Peter Samuel
Mid-February the Director of the Office of Public Finance in New Jersey, Nancy Feldman received a 15 page proposal from a major financial group offering to raise around $30 billion from the New Jersey Turnpike (and its subsidiary Garden State Parkway) based on the state retaining the business, and being in control. It would install a private sector management company to run Turnpike operations, and it would raise $30 billion for the state in an upfront fee by "securitizing" the future toll revenues.
The plan claims to be able to get the best of both worlds - the big upfront bucks available in a lease-concession, the efficiencies and customer orientation of a private operator, while retaining state government control and ownership of the business.
We were given the document on the condition that we don't identify the financial group making the proposal (hence the blackouts on reproduced documents nearby.) We got the proposal document in the course of asking around: "What kind of deal might the Corzine administration be considering that gets the equivalent upfront fee to a concession but retains state control?"
The Governor and his senior officers have said they are not doing a private lease concession in which an investor group own the business of the Turnpike for say 75 years, as on the Indiana Toll Road and Chicago Skyway. They have spoken of using a state sponsored public benefit corporation, but haven't provided any more detail.
The proposal titled "Monetization of the New Jersey Turnpike and Garden State Parkway: An Alternative to the Concession Structure" may give clues as to what they have in mind.
One of those involved in the "monetization proposal" as we'll call it told us he isn't privy to the scheme being shaped within the Corzine administration, but he thinks it is likely to have many similarities to theirs.
They use the term Management Contract/toll revenue Securitization structure and MC/S as a descriptive acronym. The essence of the scheme is to provide an upfront payment of $30 billion ($30b) to the state approximately equal to what they say it would receive in a lease concession.
The payment would be funded via:
- a $6b revenue bond transaction, and
- $24b of bank loans with a 10 year term
The proposal begins with a criticism of the concession model as employed on the Chicago Skyway and Indiana Toll Road. Echoing critics it says a concession "effectively represents a sale of an existing asset to a private group." They say the Turnpike is too central to the economy and life of the state to justify loss of planning flexibility. A concession will also be too difficult to "sell" politically.
Their MC/S proposal would put operations of the Turnpike "under private management by an experienced toll road operator" for a term initially of 15 years. Private operation is the key to a "market-based tolling protocol," and managing the turnpike efficiently and profitably enough to realize its "full value" of approximately $30b, the proposal says.
"The operator would be given the responsibility to develop and recommend toll rates for the turnpike and the parkway with the flexibility to implement:
- highspeed tolling
- time of day tolling, and
- dynamic pricing (varying toll rates based on real time traffic conditions
"Based on the debt structure that the state determines best meets its financial objectives and that is consistent with what the operator believes is achievable in toll revenues, the operator could contract to meet certain annual revenue targets."
They say the tax code allows an operator to be granted a one-time bonus for performance at the end of the contract.
"With an incentive bonus, the operator can be compensated in a manner that aligns the role of operator with the financial objectives set by the state."
They propose an operator contract for five years with the initial procurement every 15 years providing for two five year renewals.
"The selected operator should be prepared to take the risk of a relatively short contract based upon industry knowledge which will give them a reasonable assurance of earning adequate compensation through the incentive bonus and that the state will want to renew their contract after its initial term."
The MC/S proposal like a concession depends for its value on operating efficiencies and technical sophistication but primarily on market driven toll rates, the proposal says.
"If the political will exists to effect relatively significant toll increases, the state through the MC/S structure could replicate virtually the same revenue stream as a private concessionaire while still maintaining ownership and control of the Turnpike and the Parkway. With a state toll rate setting protocol that approximates the rates that would be imposed under a concession structure, the bond investor community would then evaluate the integrity of the revenue stream and arrive at an allowable debt capacity... similar to the approach taken by lenders to concession bidders."
The proposer says that they have allowed for a coverage of 1.7 times annual debt service to the net revenue stream in arriving at a MC/S value of $30b. They add: "Additional proceeds could be extracted if subordinated debt were to be added to the plan of finance."
They continue: "The MC/S structure with continued state ownership has the additional advantage of allowing the state to retain excess cash flow that would otherwise inure to the benefit of equity investors under the concession structure. Moreover the MC/S structure would provide the state with the ability to adjust toll rates as necessary when an increase in toll rates results in a disproportionate use of the free local road network adjacent to the Turnpike or the Parkway subject to the rate covenant."
The proposal contests the view that bond investors won't lend to the full value of cash flows of a government entity. It says there is an appetite for "quasi-equity" from high yield funds that would give a government authority access to the kind of funding being tapped by concession bidders. This would involve below investment grade subordinate debt. The proposal sees this as a potential source of funds beyond the $30b for the Turnpike.
Higher toll rates
The proposal notes that toll rates on the Garden State Parkway (2.2c/mile or 1.3c/km for passenger cars) are the lowest in the in the country while the Turnpike and the Atlantic City Expressway at 5.5c/mile (3.3c/km) and 5.7c/mile (3.4c/km) are in the bottom third of a ranking of toll rates around the US.
"Revealed toll elasticities for the Turnpike and the Parkway suggest that the Turnpike's projected 2010 toll revenues of $650m could increase to $1,000m ($1b) with toll increases and the Parkway's $224m in 2010 toll revenues could be increased to $300m to $400m (range."
The proposal says toll rates vary greatly along the Turnpike from 3c/mile (1.8c/km) in the southern stretch to 20c/mile (12c/km). The Parkway and the Turnpike have some toll-free stretches. Adding tolls to these and adjusting toll rates "based on revenue optimization and non-impairment of the local road network" could lead to a new toll rate structure.
The proposers argue that diversion to local roads is not a major issue in the southern portion since parallel I-95 and I-295 both have spare capacity. However north of Trenton diversion is a serious problem. Higher tolls north of Exit 7A would result in diversion, especially non-fleet commercial traffic onto US-1 and US-130. US-1 is already heavily congested. North of Exit 11 the problems get worse while the Parkway and the Turnpike compete. US-1/9 is the competing free highway liable to get toll spillover. US206 could also suffer from overhigh toll rates diverting traffic.
"The resulting (spillover) impact on local mobility will have a direct impact on the economic health of the region."
The proposal says the Parkway's conversion to one-way tolling at most mainline locations and free stretches crate distortions. The Bergen barrier's abolition of northbound tolling has been considerable. It says it is difficult to build minimization of diversion to local roads into concession structures, especially at the outset of a longterm concession.
"It would appear to be an impossibility to establish a concession contract that would permit a fair and competitive bid process and, at the same time, to be flexible enough to allow the state to unilaterally lower toll rates to facilitate local mobility."
A private management contract would provide flexibility in adjusting rates to minimize diversion problems, the proposal says.
The proposal is somewhat vague on controls over toll rates:
"Toll rate setting can either remain with the state or be transferred to he operator under this proposal, although as a practical matter both parties would share responsibility. If toll rate setting becomes a primary responsibility (of) the private manager under the management contract, the state still will have the ability to adjust specific tolls if local mobility is found to be impacted to an unacceptable level. The Turnpike Authority's toll covenant and its enforceability within the existing general bond resolution is the ultimate protection for bond investors to ensure that toll rates will be high enough (over) the entire network to ensure timely (debt service)."
The upside of refinancing debt at present attractive rates, while benefiting from toll rates appreciating with inflation could produce a "dramatic" upside to profitability of tollroads, the proposal says, and the state can benefit from this under a management contract, whereas the concessionaire benefits in the case of a concession.
The proposal says the latent value of the Turnpike and the Parkway lies not in operating efficiencies as much as in the potential for higher toll rates.
The financial model assumes a one-time jump in toll rates in 2009 to 6c/mile (3.6c/km) on the Parkway. (That's a 2.73 fold or 173% increase on the present 2.2c/mile. TRnews) Otherwise increases in tolls on the Turnpike and the Parkway would be based on the concession formulae of the maximum allowable tolls on the Chicago Skyway and the Indiana Toll Road (generally the greater of 2%, inflation or GDP/capita each year.)
Operational and maintenance costs of the private operator are assumed in the plan of finance to start at $400m, about a 10% saving from the public toll authority cost. So-called take-out or replacement financings would be spread over five years. Since interest on the bank loans accumulates the "total par amount" of the borrowings is put at $33.4b.
The proposal adds: "While the takeout financings are scheduled to occur during the first five years of the bank loan, there is inherent flexibility in this approach as the Authority will have the full ten years to determine the most advantageous market conditions for the issuance of permanent debt for the MC/.S structure."
They say they have run the MC/S debt moel and found coverage to be 1.7 times based on a level coverage and assuming all tax-exempt borrowings, providing investment grade ratings.
About $150b promised in surplus
The model projects approximately $150 billion in surplus cash flow over the term of the financing to 2054. The proposers say they recognize some potential uses of the upfront funds may not permit tax-exempt financings and they ran the debt model with taxable debt - getting debt service coverage of 1.25 times. That would apparently get less than investment grade bond ratings - though the presentation doesn't spell that out.
A formal "Indicative Terms and Conditions" provides for the New Jersey Turnpike Authority to be the state agency for the $30b deal. The operator of the Turnpike and the Parkway is to be selected by competitive procurement, and will contract for toll operations, roadway maintenance, toll system upgrades, customer service and "ongoing system wide toll rate recommendations."
The operator will be compensated with an annually negotiated fee plus an incentive bonus at the end of a five year term consistent with the IRS limitations on management contract remuneration. The contract will provide for two five year renewals.
Uses of the upfront fee of $30b will include tax-exempt purposes such as defeasance of debt and capital projects eligible for tax-exempt funding. Taxable financings will be funded with a taxable bond component.
On plan of financing the terms and conditions state: "Initial issuance of senior insured current interest bonds and uninsured capital appreciation bonds in combination with a commercial bank term loan facility. Commercial bank loans to be taken out or replaced with four additional bond issues of $6b plus bank interest payable via Turnpike revenue bonds. Commercial bank loan anticipated term of ten years, expected to be retired within four years. Future issuance of capital appreciation bonds may be reduced and replaced in the plan of finance by current interest bonds, convertible capital appreciation bonds or other debt instruments depending upon market conditions and operating performance of the pledged toll facilities among other factors."
Bond covenant changes will include eliminating the present requirement to cover maximum annual debt service within five years and a test for additional bonds.
Here toll rate setting is "to be assumed by the operator under the terms of the management contract, subject to approval of the (Turnpike) Authority who will be bound by the toll covenant."
Ratings of Baa2/BBB/BBB are expected.
The financing will be done via a municipal bond issue done through competitive bidding for senior current interest bonds and assuming a premium of 70 basis points.
The $33.4b raised is to be split into five $857m tranches of current interest bonds issued early September each year from Sept 3 2007 through 2011 amounting to $4.3b total plus $29.1b total of capital appreciation bonds issued annually and ranging between $5.1b and $6.5b per year. The closing is to produce the immediate $24b under a ten year arrangement with banks.
(see reproduced provisions below for more detail)
TOLLROADSnews 2007-07-16 added more 2007-07-17 12:00