Build America Bonds

A seminal toll road financing in Texas shows that Build America Bonds could help governments bridge their capital needs for infrastructure while giving institutional investors another means of exposure to the asset class

looking for ways
to fill the gap

For governments hoping to deliver big public works projects, let’s just say it’s a time for problem-solving. Projects have piled up, financing has dried up and, as if to rub it all in, construction costs have come off their highs of two years ago.

For market observers, a three-letter solution comes to mind: PPP, or public-private partnerships, to infuse private capital into projects and get them moving off the books. But as a recent toll road financing demonstrates, investors and bankers are finding ways beyond PPPs to think outside the box – and for the US, that could set the stage for a new way of getting pension investors involved in US infrastructure.

In March, an undisclosed Australian pension helped finance a toll road expansion in Texas by purchasing $45 million of a first-of-its-kind issuance of non-investment grade Build America Bonds (BABs). The issuer, the Central Texas Regional Mobility Authority, will use the proceeds, along with approximately $98 million of traditional tax-exempt senior bonds, to get moving on a 5.1 mile extension to its 183A toll road in Austin.

“This is a formula that can be replicated all over the country,” says Paul Ryan, head of North American infrastructure investment banking advisory at JPMorgan, which underwrote the senior bond offering and placed the subordinated BABs.

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 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.

The Central Texas Regional Mobility Authority’s BAB issuance shows that this may be changing. The Australian pension bought two tranches of the subordinated BAB offering: a $35 million tranche paying a fixed interest rate of 11.625 percent, and a $10 million variable tranche paying 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, the difference can be substantial. By providing investors with a higher return commensurate with their lower position in the capital structure as well as a CPI-linked return, the structure is not unlike a concession. Under a concession, 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 resulting equity-like return is not unlike the BAB offering, save for the political risk that can sometimes accompany a PPP and the greater ease of investing through the bond market as opposed to a bidding consortium in a project (still a fairly rare opportunity in the US).

The offering didn’t just solve a problem of access for investors. It also helped the Central Texas Regional Mobility Authority get access to capital at a time when most other sources weren’t available. It did not have the legal authority to do a concession, according to chief executive Bill Chapman, and the federal government’s infrastructure credit programme, known as TIFIA, didn’t have any money available to lend. So there was a clear financing gap, Chapman says, 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.”

An added perk: they got the better of those pesky construction costs. By getting the financing in place now, they can take advantage of a $75.8 million bid for the project – much less than the original estimate of nearly $120 million. “I think a year from now we wouldn’t have a competitive price,” Chapman said.