Law firm sees opportunity for ‘rescue investing’ in infrastructure

Allen & Overy argues in a recent report that investors are likely to have more chances to buy into concessions for distressed public assets from cash-strapped US states and localities, especially in Colorado, Rhode Island, Oregon, Ohio and Illinois.

A crushing burden of gaping budget deficits, shrinking tax revenues and skyrocketing pension liabilities is creating an opportunity for private investors to scoop-up infrastructure assets at a bargain from cash-strapped US states and localities that can no longer afford them.

That is the conclusion of a report recently published by the infrastructure practice group at law firm Allen & Overy, which ranked the 50 states according to nine indicators of probable interest in this type of so-called “rescue investing”.

Similar to distressed debt investing, where an investor might build up a substantial equity stake in a company by retiring its debt, Allen & Overy predicts rescue investing will give investors an opportunity “to redeem or defease the indebtedness of underperforming infrastructure projects . . . in exchange for long-term concessions to operate such assets”.

“It presents a ‘double-barreled’ strategy of infrastructure investing on the one hand and distressed debt investing on the other,” said David Horner, a senior counsel in the infrastructure practice group at the firm, who co-authored the report.

There are already precedents for rescue investing in publicly-financed infrastructure projects. In 2006, Australian toll road operator Transurban Group acquired a concession on the Pocahontas Parkway in Virginia, followed by Portuguese toll road operator Brisa’s purchase of a concession on the Northwest Parkway in Colorado a year later. Both transactions rescued freshly-opened toll roads from near bankruptcy by swapping revenue-backed public debt in exchange for concessions to own and operate the roads for 99 years.

Horner sees the same opportunity arising in today’s market, but on a much greater scale, as a confluence of factors is creating the worst fiscal climate for states and localities since the 1930s. The Pew Center on the States, a non-profit public policy research group, recently estimated that states are struggled to close $162 billion in budget gaps for the 2010 fiscal year. And that figure may get worse before it gets better, as a high unemployment and a sagging property market continue to eat into payroll and property taxes – two bread-butter-sources of revenue for state and local governments. The result: tax collections for the first quarter of 2009 were down a historic 11.7 percent for all states from 2008, Pew estimated.

All this comes at a time when states are also facing a $1 trillion gap between their retirement systems' assets and liabilities – a shortfall which only increases the need for new revenue sources, according to Pew.

Horner and his colleague David Slade built changes in revenue, unemployment rates, the size of budget gaps and unfunded pension liabilities, among other factors, into an index that predicts states’ likely level of interest in rescue investing. They found that Colorado, Rhode Island, Oregon, Ohio and Illinois topped the list of states where politicians may well look to creative financing solutions to pare down some of their public debt with the help of the private sector.

Horner warned that the index does not correlate perfectly with public interest in a market for infrastructure investing; Virginia, for example, which ranks 29 on their list, has established a significant track record in public-private partnerships because the state’s public policy has encouraged their use ever since the mid-90s.

Still, in Illinois, which ranked fifth on their list, a 10 March budget address by Governor Pat Quinn on proposals to close a $13 billion deficit coincided with a bill on public-private partnerships for transportation making its way through the state senate.

So even if there’s some $2.7 trillion in state and local debt outstanding in the US, the opportunity “for private capital to collaborate with the public governments to stabilize local finances” is only likely to grow, Horner said.

“We’re talking about what I would characterize as outliers,” he added. “But there are more outliers than there have been in the past that merit the attention of infrastructure investors.”