FARCE & SCANDAL:91 Express 'Sale' to NewTrac Unravels
As we go to press those lining up against the deal include the state treasurer, the state attorney-general, the chief financial officer of Orange County, the entire board of supervisors of Riverside County, former top Caltrans officials, the local newspapers... and even the IRS.
In their filing for tax-exempt status NewTrac wrongly answered No to an IRS question about whether NewTrac was an outgrowth of the seller. Paul Dostart a tax attorney in southern California says NewTrac could face fines of millions of dollars: These guys are dancing around a minefield here.
Those who supported the 91X deal have lost their voices, it is apparently so indefensible. Except for NewTracs unfortunate Gary Hausdorfer.
The supposed buyer of the toll road, Hausdorfer has looked throughout like a minor sidekick of the seller, CPTC. He had no say in statements put out jointly in the name of CPTC and NewTrac, he complained to us when we first spoke to him last spring. And since then he has depended on CPTC for lawyers, consultants, and staffwork. And he told the LOS ANGELES TIMES in the middle of the recent furore that he had never been able to look at the 91X financial accounts (12/7/99) Puts you in a great bargaining position that.
Would a lawyer call it subdued diligence?
As for CPTC its chronic dissembling about its traffic and revenue during the protracted effort to sell 91X is now documented in the fine print of the prospectus of the state infrastructure bank (SIB) to which its owners have now been forced to resort. The hefty prospectus reads like opposition research for those questioning the deal. CPTC paid these guys to blow the whistle on them. For farce thats hard to beat.
But first what is serious is that the proposed purchase of 91X by a resourceless private not-for-profit shell called NewTrac would more than double the debt burden of the enterprise, and put this important innovatory toll road in serious financial jeopardy. And this patently awful deal has managed to deprive 91X of almost all its political backing and brought down upon it a firestorm of criticism. What an utter disaster! And a shame.
NewTrac was devised by the 91X investors, Calif Private Transp Co (CPTC) from the start for the purpose of taking the maximum capital out of the project. What a silly construct! NewTrac is clearly too insubstantial to go to the capital markets by itself. So it is to be funded with $274m of debt raised for it by the California Infrastructure and Economic Development Bank (CIEDB), a state infrastructure bank (SIB). Get a state agency involved and you politicize the whole thing and invite controversy.
NewTrac for OldLanes
SIBs were sponsored and supported financially by the Feds with the loudly proclaimed objective of helping to finance new infrastructure. New as in NewTrac (though with Orwellian naming it is set up to acquire some OldLanes.)
The 91X financing, one of the largest transaction so far, by the largest SIB in the US, is not about new construction, but about enabling investors in an existing infrastructure to bail out, and in so doing to extract a much larger hunk of capital from a supposed sale than the market would support. It is about using the cover of a state institution to palm off risk to others.
That this state bank has lent its name to such a transaction dramatically fulfils predictions by skeptics of innovative finance that these state banks would be exploited for crooked political ends and private enrichment, rather than for economic development and new infrastructure.
CIEDB is controlled by three officials of the executive branch, the state sec of trade & commerce, the state director of finance, and the state treasurer. There is not even a token independent non-political representative on the board. CIEDB seems to have no procedures for public comment or review, no open meeting requirements, no rules for open access to documentation. It seems, in short, ready-made for corruption.
Still, in this 91X case the state treasurer Phil Angelides at least abstained from voting. Bank staff reporting on the 91X deal in a Nov 10 document said there was absolutely no assurance that sufficient toll revenue will in fact be received to service the proposed NewTrac debt. They said a bond default was quite likely and recommended against the project proceeding. Their assessment was disregarded by the top trade & commerce, and finance officials on the bank board, both of whom have been struck mute over their endorsement of the deal. (OCR 12/4)
Package Deal: Drop Safety Raise $s
The state banks underwriting of the CPTC bailing-out of 91X was part of a political package deal in which Caltrans (the state DOT) made a humiliating admission of wrongful encroachment on the 91X franchise and formally agreed to freeze plans for auxiliary lanes on the CA-91/CA-241 (Eastern Toll Road) merges. These extra lanes had previously been advanced by Caltrans as essential for safety, and therefore exempt from the no-capacity enhancement clauses in the 91X franchise contract with the state. They were the subject of a law suit and extended negotiation, and for months have been holding up the sale of 91X to NewTrac and its financing.
Given that Caltrans is firmly on the public record advancing the auxiliary lanes as necessary for safety, any bad crashes on the merges will raise the charge that the state has sacrificed highway safety to bail out the 91X investors, with likely legal as well as political fallout. The fine print of the sale documents includes a WSA estimate that the freeze on the extra safety lanes involves $151m of toll revenue for 91X a political and legal time-bomb.
A NewTrac statement Nov 18 said the purchase price for the 91X franchise will be in the range $200m to $225m. It is the subject of some unrevealed formula. (Like: well split the loot but its not clear yet how much we can get away with yet.)
CPTC, the joint venture led by Kiewit spent around $130m building and developing the toll road and reported losses of $6.7m in 1996 and $12.7m in 1997. CPTC claimed to have broken even on a cash flow basis in 1998. On these numbers it put about $150m into the project, so a sale price over $200m suggests it is leaving with substantial capital gains.
Now capital gains are great if they are the result of free and open bidding, a third party professional valuation, an arms length transaction, bargaining between independent parties, and if they dont involve some politically controlled state bank intervening to endorse a certain outcome. However the skunk of an inside fix reeks throughout this NewTrac deal.
Debt Bloated Construct Shonky*
NewTrac claims that by converting to non-profit status it will lower 91Xs financing costs and pass savings on to commuters. That statement is so absurd it is an insult. NewTrac will be paying interest and doing repayments on $274m, versus CPTCs debt of around $100m, so any shading of the interest rate through state bank laundering of its debt, plus exploitation of the non-profit tax loophole, pales into insignificance beside the increase in the absolute size of the debt being held (for example: $100m x 7% vs $274m x 5.5% suggests at least doubled debt service).
Several other aspects of the financing look shonky too. Though the financing of 91X sale is in the name of a state bank, neither the bank nor the state is really standing behind it. The prospectus says that the banks obligation on the bonds is limited to net revenues received from NewTrac. Also that the bank makes no representations with respect to the accuracy, adequacy or completeness (p55) of the information and claims made in the prospectus, as if the claims were made by others.
This is a prospectus not of NewTrac but of the state bank itself! It says in effect: We at this state bank are funding the whole of the capital of this NewTrac venture but we take no responsibility for any of the information we have presented. It may all be baloney, guys. Take your chances.
At least investors in these bonds are warned!
* Shonky: this indispensible old English word is best explained: Students at Texas A&M paid a terrible price for the shonky design of their bonfire log pile.
No decent explanation has been provided for the unprecedented resort to total state bank financing of the 91X transfer to NewTrac. Usually SIBs provide 5 to 10% of the capital of a project and are able to say how their involvement is leveraging taxpayer funding.
Also, in this sale, the state bank has gone, not to an Ambac or an MBIA for bond insurance but to a small company called American Capital Access (ACA) to insure two out of four tranches of the 91X bonds. Left unstated in the prospectus is what this insurance is costing in insurance fees and extra debt to be serviced. There is also a question of what the insurance is really worth. ACA has a net worth of a mere $84m. NewTracs proposed $274m debt could take down this little bond insurer three times over.
The state bank bonds are rated Baa2 (Moody) and BBB- (S&P) and the insurance is raising the rating of the insured bonds to A (S&P) with Moody declining to rate. Moodys Chee Mee Hu said later that the rating agency was likely to withdraw its rating for 91X in the light of threats of litigation and other troubles with the sale.
NewTrac calls itself a private non-profit corporation committed to excellence in the operation, maintenance and safety of the 91 Express Lanes. NewTrac was a subterfuge and a deception from the beginning. A press release plus briefings from CPTC attempted to get this newsletter and local media in the Los Angeles area to peddle for it the lie that NewTrac was a spontaneous initiative of local Orange County leaders who had approached CPTC with the idea of a sale to a non-profit. The press release said NewTrac has approached CPTC... regarding acquiring the 91 Express Lanes. (TRnl#31 Sept 98 p1)
The state bank deserves credit for thoroughly nailing that squalid CPTC misrepresentation in its prospectus (p60) under the heading Certain Relationships: It is noted that CPTC developed the original concept of the sale of the Facility (91X) to a non-profit corporation, and participated in the formation of NewTrac and the identification of candidates to serve as board members of NewTrac. In addition, CPTC has provided funding for substantially all costs paid to date in connection with the financing, including all costs paid by NewTrac.
This makes it crystal clear the transaction is not arms length but an inside deal. And it also blows the whistle on NewTracs false filing with the IRS which claimed independence from CPTC.
Buying a Quarter-Million
A comical commentary on NewTracs liquidity is contained in item 1.1(g) of the sale documents listing Purchased Assets which NewTrac will get from CPTC as part of the sale: Cash in the sum of Two Hundred Fifty Thousand Dollars ($250,000). On or before the Closing, the parties will agree on the means by which the said cash is to be delivered to the Buyer. (pD-2)
Hundreds in plain brown wrapper to be exchanged Disneyland parking lot, Anaheim, midnight Dec 31?
NewTrac is led by Gary Hausdorfer, for 17 years mayor and councilman of the city of San Juan Capistrano and active in local transport agencies. However he objects to being called a politician, his lawyers wrote us. He is also a businessman and business consultant and has engaged in much worthy local volunteer work, they wish it to be known. Other NewTrac board members are a prominent local builder, an eminent engineer, and a super car salesman.
Newtracs board was appointed by Hausdorfer and CPTC and is answerable to no constituency or membership. It writes its own rules. This private non-profit is outside the realm of normal accountable organizations which have shareholders in the case of normal for-profit corporations, members in the case of public non-profits, or voters in the case of government-owned entities, constituencies who elect the leadership and to whom the leadership has to report and to answer.
This flawed private non-profit corporate form has been subject to a history of scandal and self-dealing as illustrated vividly in the case of William Arimony, president of the United Way of America. Arimony is completing a substantial jail term, though for year after year he got away with grand larceny because of the lack of accountability of the private non-profit form adopted by NewTrac. It emerged in trial in Virginia that he routinely subcontracted work without competitive bids to family businesses and put down as UWA expenses several mistresses apartments, vacation travel in executive jets and suchlike perks.
Arimonys outfit made no profit of course, and paid no taxes. Similarly the scandals surrounding the Olympic organizing committees have developed out of the same non-accountable private non-profit form in which a strong leader or small group appoint and control their own board. The extensive abuses of the private non-profit have been documented most thoroughly in journal articles and books by Loyola College (Baltimore MD) professor of management Thomas DiLorenzo. (TRnl#32 Oct 98 p15)
Adam Smith wrote back in 1786: I have never known much good done by those who affected to trade in the public interest. (Wealth of Nations p423) The constant CPTC-NewTrac claims of public benefit from a non-profit would have been treated with disdain by the great philosophe.
NewTrac is off to a disastrous start politically, because of the brazen self-dealing involved in the 91X sale. No competitive bids have ever been sought for the property, and there has been no independent appraisal of its value. This even though nearly two years have passed since the Kiewit principals decided they wanted out of 91X. Any management interested in getting fair market value - rather than in engineering a ripoff - would have long since gained professional appraisals of value and/or requested bids.
Orange county treasurer John Moorlach, the senior financial officer of the constituency in which 91X is located, told the ORANGE COUNTY REGISTER newspaper (12/2) the sale is not a legitimate arms-length transaction. Robert Wolf now of the State Transp Commission was also quoted as saying the 91X transaction gave an inordinate amount of profit to CPTC. That profit, others point out, is at the expense of saddling 91X with heavy new debt and putting its future in jeopardy. Moorlach (12/7) urged the state Treasurer to intercede and stop the train wreck.
The State Attorney-General Bill Lockyer, former Dem leader in the state Senate has long been a vocal critic of toll roads, but he soon jumped on the bandwagon against the NewTrac deal calling it a cozy arrangement and the state banks involvement deplorable. He said hed ask his staff to see if they could find a way of blocking it. Dep-AG Richard Finn said he was surprised at the lack of any independent appraisal of the sale price and said there was a question of whether this was an arms-length transaction.
Riverside County supervisor Bob Buster called the sale merely a contrivance to bail out CPTC and said the property should have been put out to competitive tenders to establish a fair price. Later the county board of supervisors of this county voted unanimously to urge the state to withdraw its support and ordered legal staff to see if they could move against it.
Current Caltrans officials plead no control over the deal, saying their only legal mandate under the terms of the franchise was to establish whether the new setup would keep experienced staff running the road. (Most of the CPTC people are staying on, NewTrac says under a 5-year uncompeted operations contract.)
Caltrans current stance in favor of NewTrac is completely the opposite of that taken by the department under the former Wilson Administration, where sec of transp Dean Dunphy rejected similar proposals from CPTC to trnasfer to its NewTrac contrivance.
Dunphy told us in an interview in the spring (TRnl#37 Mar 99 p1): They (CPTC) stood to make a rather startling return on capital invested, and we didnt feel the new arrangement they proposed offered the people of California a fair deal.
Another Caltrans official told us: These concessions were structured very carefully and deliberately to encourage longterm investment. They allow a high rate of return on capital precisely because we were looking for longterm investment and a longterm commitment The concession was not structured to attract a get-rich-quick kind of developer. It was designed to provide the benefit to the concessionaire over a long haul of for-profit management with a focus on the bottom line. The law under which the concessions are issued provides for the investors to be rewarded for being cost-conscious, innovative, risk-taking and customer-oriented. It was not designed for some kind of contract or cost-plus operation. Weve got plenty of that already.
Robert A. Wolf, who was an undersec of transp in the previous Wilson admin says the NewTrac purchase is probably illegal because it is not an arms length transaction: What we have here is a nonprofit organization selling bonds with the name of the state of California on them and flying under the flag of a public benefit. But they have so leveraged themselves that there is no money left for any additional road improvement. I defy anyone to say this is for the public benefit.(LA TIMES 12/4/99)
Populist Political Pitch
The official announcement of the sale claims it is good news for every commuter in the region because it will create approximately $400m to $500m in surplus which will be returned to the public in the form of improvements to roads in the area. NewTrac is abolishing the half-toll presently levied on HOV3 carpools, at a cost now of $2m to $3m annual revenues.
There are very mixed signals as to the viability of 91X, in part because of CPTCs history of trying to spin its traffic and financial record with hyperbolic gush.
The CPTC annual report for 1998 issued in May 1999 said: During our first two years of operation, we demonstrated that private capital and initiative can improve the quality of life for tens of thousands of commuters each day. In 1998 we were able to show what weve believed all along - that as an investment, the 91 Express Lanes is on solid financial footing and poised for long-term success.
The report talked only of increasing traffic and other things great and wonderful. All hype.
The prospectus issued by the state bank indicates (p40) that - contrary to this and other statements made last year by CPTC - the 91X lost a serious chunk of its traffic to the Eastern Toll Road immediately that opened Oct 98. Also contrary to claims made after that, it was not winning traffic back. Indeed traffic numbers in the prospectus indicate that as late as this fall the 91X was still losing traffic, rather than regaining it as was claimed. Toll and other revenue have not declined as seriously as traffic since the project was able to increase tolls, but revenues have been trending down a bit too.
Average daily transactions on 91X were only 17.5k/day this Sept compared to 24.6k last Sept just before the opening of the Eastern - a 29% drop. Toll revenue declined from $1.45m to $1.22m, 16%. Enrollment and minimum usage fees and other account charges and earnings grew offsetting the decline in toll revenues, so overall reported revenues were stable.
Unfortunately NewTrac seems to be continuing the CPTC habit of hype and misinformation. A History of the 91 Express Lanes distributed to the press (12/1) contained this item: December 1998: Traffic volume continues to climb.
That is a great big lie. Not only had traffic been declining before December but it continued to decline after December. Daily traffic tolled as reported in the CIEDB prospectus was 20,097 in December 1998 compared to the years high of 27,553 in July 98 (down 27%) and 21,839 in Dec 97 (down 8%). In no month reported in 1999 did traffic regain the 20k number. Traffic volume was ineluctably declining in Dec 98 and has continued to decline, the total opposite of NewTracs statement.
Less important, but also indicative of their disregard for accuracy and for facts, the NewTrac press materials repeat a CPTC claim that 91X was the first privately financed toll road in the US in more than 50 years. The investor-financed Dulles Greenway in Loudoun Co VA opened in Aug 95, 4 months before 91X, so 91X was the second. CPTC people know that perfectly well. There was major publicity at the time for both roads. (Advice: dont trust these guys to tell you how many lanes theyve got. Count em yourself.)
WSA Sees Bright Future
Wilbur Smith Assoc (WSA) has produced a traffic and revenue study (T&RS) for the CPTC sale. It examines the decline caused by the opening of the Eastern pike in some detail, and concludes that 91X traffic will recover and that its ability to gain tolls will begin growing again. Operating right alongside them, 91Xs ability to toll is almost entirely dependent on congestion levels in the free lanes. Plugging in CA-91 corridor traffic growth of 3.5%/yr 1998-2005 and 2.0% 2005-2020, and iteratively modeling the capacity of the free lanes, the WSA T&RS estimates the spillover to the toll X-lanes given various optimum toll levels. The results are summarized in the table (below) and form the financial basis for the NewTrac financing, and for the claim that the project will generate surpluses of $400m to $500m over its life.
Apparently in California a non-profit can make a profit so long as it calls it a surplus instead!
The WSA projections are, however, heavily dependent on growth of traffic relative to capacity, and consequent growth of congestion in the free lanes. Even quite small changes in capacity in the free lanes can have quite a large effect on 91X revenues. Assuming Caltrans proceeded with the auxiliary lanes for the Eastern Toll Road merge and entry ramps that the settlement with NewTrac for now precludes, there would be a 20 to 24% reduction in 91X toll revenues extending over 10 years, WSA estimates, and only a gradual reduction thereafter. This is $151.5m over 25 years (from p54 of the WSA Study dated 11/16/99.) At some point it seems likely there will be a hue and cry over Caltrans settlement. Moreover it will be argued that this extra toll revenue for 91X is at the expense of the Transp Corridors Agencies Eastern Toll Road revenues since it will be blocking Eastern traffic.
Other sensitivity tests show that assuming a lower economic growth rate for the region there is a reduction in 91X tolls of 11% by 2010 and near 15% by 2020. Recession scenarios are also modeled based on the 1991-96 end-of-cold-war recession which hit southern Calif especially hard. If there were a similar recession 2000-05, 2005 revenue for 91X would be $5.6m or 20% less.
So, if WSA has got it about right, no single one of these downside scenarios should sink NewTrac. And it also has a fallback in restoring the half-tolling HOV3s, estimated to be worth a boost ranging between 10% and 20% of revenues.
ETC not 99.375%
Another item of interest is that the sale documents revealed some problems with the 91X ETC system for the first time after nearly four years of operation during which CPTC said the system was working just fine, we and others were always told. The sale documents say: The ETC system is not meeting the contractual requirement for (a) measured or guaranteed accuracy rate of 99.375%. They dont reveal what accuracy is being achieved. The documents also say that software changes in mid-99 caused several days of very low accuracy and that the system supplier and maintainer MFS was hit for $48k for lost tolls. The documents also mention a risk of potential transponder battery failures and accelerated costs. WSA assumes a 2% toll evasion rate through the life of the project.
Why the Inside Deal?
Of course if 91X can, as the WSA analysis suggests, be profitable and viable under NewTrac while servicing $274m debt and while playing to the political gallery by abolishing half-tolls for HOVs, and promising $400m to $500m goodies to local constituencies, how much more profitable it could be as a straightforward for-profit entity with less than half that debt, while being managed by bottom-line oriented management? Which raises the question again, if CPTC were only concerned to get fair market value for its assets, why 91X was never put up for competitive bid? Why the resort to a squalid state bank deal with a contrived non-profit? CPTC have never been prepared to answer that question.
There are now a lot of people in California asking whether there were payoffs to those who approved this Caltrans/CIEDB deal. Or else, why they on earth would they go along with it. Were they just fools, or knaves?
Despite Disgraceful Behavior...
However disgraceful CPTC and its collaborators have been in this phony NewTrac sale, CPTC still deserves to be remembered for positive achievements with 91X. CPTC was the pioneer of value pricing in the US and deserves full credit for that innovation and for the hard work and excellence of customer-focussed management in implementing it. CPTC served 91X motorists well. It fulfilled its pledge to provide them free flow conditions and a safe ride by the congestion in the free lanes for a toll which is varied by hourly steps in order to reflect the changing value of the X-lanes trip, and to prevent overloading of the lanes. It built a solid clientele in a difficult new business. CPTCs pioneering demonstration of the practicality of variable pricing for express lane travel may turn out to be the most important innovation in roads since the limited access grade-separated form we call the motorway was devised.
CPTCs grubby and pathetic exit mode is a tragic distraction from a signal achievement in pioneering a new kind of highway. How brilliance can coexist with idiocy! (Contact Gary Hausdorfer NewTrac 949 727 4650, Greg Hulsizer CPTC 714 637 9191x328)