An undisclosed Australian pension is financing a toll road expansion in Texas using a first-of-its kind issuance of non-investment grade Build America Bonds, setting the stage for what could become a new way of getting pension investors involved in investing in US infrastructure.
Texas' 183A: expanding
The authority will use the proceeds, approximately $98 million of tax-exempt senior bonds and $45 million of taxable Build America Bonds, to add another 5.1 miles to its 183A toll road in Austin, Texas, according to a bond offering document.
By virtue of being taxable, BABs have given tax-exempt investors like pension funds a reason to invest in US municipal debt. Traditionally, municipal securities offer investors have offered lower yields than taxable debt due to their tax-exempt status. So a pension plan that isn’t required to pay taxes to begin with would have little reason to buy them.
This is a formula that can be replicated all over the country
The Central Texas Regional Mobility Authority’s BAB issuance shows that this may be beginning to change. The buyer, an Australian pension represented by alternative asset manager AE Capital Advisors and CityView of San Antonio, Texas, bought two tranches of the subordinated BAB offering: a $35 million tranche that pays a fixed interest rate of 11.625 percent, and a $10 million variable tranche that pays 8 percent plus the rate of the consumer price index (CPI), a measure of inflation. The $10 million tranche also marks the first issuance of CPI-linked BABs since the bonds were enacted into law by the US’ stimulus bill in February 2009.
But because the US government reimburses issuers for 35 percent of their interest cost for BABs, the authority’s actual borrowing cost for both tranches could be around 7.4 percent. That’s about the same as the senior bonds, which were rated BBB- by ratings agency Standard & Poor’s and pay an interest rate of about 7.06 percent.
Like a concession
For buyers, though, the difference between BABs and traditional municipal debt can be substantial. “The subordinated bonds that support these senior bonds represent a move towards the equity segment of the overall capital structure, but with important covenant protections,” Ryan said, citing their higher rate of return and position in the “cashflow waterfall” – the flow of cash across the various levels of a capital structure.
He compares this to a concession-type of financing, where a municipality may lease a toll road in exchange for an upfront payment that gives the investor access to a steady stream of payments over several decades.
The comparisons to a concession are no accident
“The comparisons to concession financing are no accident,” Ryan said, “as we see a macro theme of capital structure optimization in the public finance markets coincident with the emergence of BABs and formal allocations by pension systems to inflation-linked and infrastructure asset classes”.
The $204.9 billion California Public Employees Retirement System, for instance, created an inflation-linked asset class in its portfolio in December 2007. It has yet to allocate the portfolio to any BAB offering. But it may do so, a spokesperson said in an email, “if the structure and return meet our criteria”.
Need for different solution
Concession-type financings remain popular in the toll road sector. Several such deals are in the works across Texas, including the $2 billion North Tarrant Express project and the $2.7 billion LBJ toll road project, both in the Dallas-Fort Worth Texas. In each case, private investors get equity in an existing section of road and commit to expanding the road under a public-private partnership (PPP) arrangement with the state’s Department of Transportation.
But last year, the Texas legislature declined to extend the department’s authority to pursue PPPs, leaving future projects in limbo. And smaller transportation providers like the Central Texas Mobility Authority never had the option to begin with.
We didn't have the authority to do concessions
“We didn’t have the authority to do concessions,” said Bill Chapman chief executive officer of the authority. Nor could the authority count on financing the 183A expansion from the US government’s infrastructure lending programme known as TIFIA, or the Transportation Infrastructure Finance and Innovation Act. “TIFIA didn’t have any funding,” Chapman said.
So there was a clear gap in available financing, Chapman said, and “we were looking for ways to fill that gap and we were looking for innovative ways to do that”.
The mixed BAB and municipal debt offering fit the bill. “It was very well received in the market and it helped us get this project moving,” Chapman said, adding that construction will begin in a matter of days.
The authority will also capture significant cost savings as a result of getting the financing in place to start construction now. Two years ago, when the project was initially priced by engineers, the estimate was between $118 and $120 million, Chapman said. Late last year, the actual bid came in at $75.8 million – a savings of about 37 percent.
“I think a year from now we wouldn’t have a competitive price,” Chapman said.
The North Texas Tollway Authority, another public toll road operator and developer in Texas, may follow Chapman’s lead. It recently authorised the use of up to $400 million of subordinated bonds for the financing of the State Highway 161 project in the northern suburbs of Dallas.
The bond offering will also be underwritten by JPMorgan.