Private capital’s forceful friend

There’s a broad consensus among policymakers in the US that private sector capital for infrastructure renewal and development will be a necessary part of the solution to the infrastructure deficit. But specific proposals often hit walls of fierce local resistance.

A common theme is an appeal to a simplistic principle: private sector financial investors are predatory outsiders who can’t be trusted. And so these walls become apparently immovable objects, impervious to logic or persuasion.

Yet in many of the same places, something like an unstoppable force is developing in the form of unfunded public pension plan liabilities. The size of these funding gaps is mind-boggling, and the potential impact is severe, near-term – and almost completely localised.

Here’s a thought: could the force of the funding gap issue, if channeled into infrastructure-based financing transactions, also help break down resistance to non-traditional forms of infrastructure financing?

A recent Infrastructure Investor article, ‘When Antonyms Collide’ (July 4, 2013), shows a path. Industry Funds Management successfully characterised its acquisition of Australian port infrastructure as ‘social privatisation’, where the investment returns benefitted Australian retirees, not ‘faceless, greedy fat-cats’.

In this context, the sale of local infrastructure assets to local public pension funds in exchange for cancellation of some local public sector liability seems less far-fetched. Yes, there will be new or higher user fees on that infrastructure – but the payers will know that the transaction reduced their own public sector liability, that their public services will be preserved, and that the user fees are ultimately going to themselves or their neighbours.

Social leveraging

Is full privatisation necessary to channel the force? Perhaps not. The primary purpose of a funding gap deal is not to improve infrastructure management or operations through privatisation, but only to defease a defined long-term liability. Leveraging an asset with long-term debt is sufficient for this narrow purpose, and additional complexity probably should be avoided in a situation already filled with contention.

A ‘social leveraging’ transaction would still include a sale of a piece of local infrastructure – but to a publicly owned trust. The trust would raise long-term debt from the public pension plan, and the proceeds of the sale would be recycled to the pension plan to reduce the funding gap. Incremental user fees or charges would be clearly traceable through debt service to retiree benefits.

Of course, similar transactions are routinely done by US local governments, except that the long-term debt is raised externally, most often in the tax-exempt bond market. In cases where credit-rating levels and infrastructure asset types permit, this will still be the most cost-effective route.

But in the more extreme scenarios contemplated here, a significant amount of risk transfer to the long-term lender will be required. The local government may need to limit its fixed obligations under a lease or concession in order to avoid a ratings downgrade, and the available infrastructure assets may have uncertain revenues.

In these cases, a direct bilateral agreement between the public sector and the local public pension plan might offer the best (or only) deal. There are silver linings. Although bilateral private debt is expensive, the higher yield goes to local retirees, not ‘fat cats’, and transaction costs are low. If the project runs into trouble in future, the chance of successful work-out with a local relationship lender (as opposed to ‘faceless’ bondholders) is far higher. Customised optimisations, such as longer tenor, flexible amortisation and inflation-indexed pricing, can be negotiated.

But the most important potential aspect of a successful social leveraging deal would be cultural, not transactional. New or increased user fees for infrastructure will never be welcome – yet if clearly understood, they can be accepted. A transparent transaction with local parties that addresses a very bad local issue in the least painful way might establish another principle: institutional investors are part of the solution, not the problem.

John Ryan
Managing director
Greengate LLC
jryan@greengatellc.com