Mainstreaming Innovative Finance: A Capital Markets Perspective
Jeffrey Carey, Managing Director
Municipal Markets, Merrill Lynch & Co.
Senate Committee on Environment & Public Works
Chairmen, Ranking Members, members of the Committees, ladies and gentlemen, I am Jeff Carey, a Managing Director in Municipal Markets at Merrill Lynch. As a 24-year veteran in public, transportation, and infrastructure finance, I have had the privilege to work with U.S. Department of Transportation and Federal Highway Administration officials, as well as our clients, state transportation officials and other project sponsors, during the last decade on the development and implementation of “Innovative Finance” mechanisms for Federal-aid transportation programs. Thank you for inviting me to provide a wrap-up commentary from a Capital Markets perspective at today’s Joint Hearing.
You have heard testimony this morning from two very experienced panels of U.S. DOT and state transportation officials, a city councilwoman, the GAO, and Professor Seltzer on the very significant accomplishments of the DOT Innovative Finance Initiatives. Public finance industry professionals are pleased to have played a role in creating the strong market reception for the new transportation funding tools and expanded flexibility for public/private partnerships. We commend these panel participants, and the leadership from DOT and FHwA, other state transportation officials, and private sponsors for the dramatic evolution from the Eisenhower-era, Federal-aid funding to the wide array of financing instruments and programs introduced and utilized over the last eight years.
To briefly reflect on the prior testimony involving program and project finance and case studies, ISTEA, post-ISTEA initiatives and TEA-21 implementation have produced the following market-related accomplishments: 1) dramatically increasing bondholder investment in transportation projects and state programs; 2) new and/or specially dedicated revenue streams, particularly for the purpose of retiring debt obligations; 3) broad market acceptance of the use of Federal-aid funding for debt instrument financing; 4) more coordination with other funding partners beyond states, and; 5) lower financing costs and increased project feasibility through Federal credit enhancement.
1. Addressing characteristics sought by the Capital Markets and private sector project sponsors provides efficient market access and innovative transportation finance opportunities. What do market intermediaries – underwriters, rating agencies, bond issuers, project sponsors and institutional and individual investors want?
Sound, understandable credits
Evidence of government support
Strong debt service payment coverage
Predictability and Federal program consistency with evolution of new instruments
Market rate investment returns for bonds, development costs, and equity
Reasonable and reliable timing of issuer’s revenue/grant receipts
Acronyms that capture the Federal programs’ spirit and promote investor familiarity
Diversified range of investment opportunities
Volume, market profile, and liquidity
For example, the track record and predictability of the Federal-aid highway program since the Eisenhower-era has enabled Grant Anticipation Revenue Vehicles (GARVEE) bonds to be structured without the double-barrel credit of other state credit backstops, as first used in New Mexico.
It was the strong issuance history of municipal bond banks in states such as Vermont, as well as the successful use of state wastewater and clean water revolving funds, that served as the model for the development of State Infrastructure Banks (SIBs) in the mid-1990’s.
And it was the broad market acceptance of municipal bond insurance and bank letters of credit that provided a model for the development of TIFIA credit assistance and pre-TIFIA successes such as the Alameda Corridor multi-modal project.
As David Seltzer commented in the first panel, are the Federal policy incentives in Innovative Finance initiatives suitable to attract and expand capital markets investment? And are the programmatic tools and requirements balanced to provide the characteristics sought by debt investors and private sponsors, as well as public entities?
2. How various Innovative Financing components have been used by public agencies and, in some cases, private sponsors, and received by the markets provides a roadmap for surface transportation reauthorization.
When State Infrastructure Banks (SIBs) were created as part of the NHS Act in 1995, the pilot program for 10 state transportation revolving funds became very popular in 1996, in part, because of supplemental Federal funding for “seed” capitalization matched with non-Federal funds. As highlighted in FHwA’s State Infrastructure Bank Review from earlier this year, 32 states have active SIBs and have made different levels of highway and transit project assistance primarily through loans, despite widespread under-capitalization and the curtailment of the program in TEA-21. Limited capitalization has resulted from the inability to use Federal-aid funds, outside of four states, and the application of Federal requirements to all moneys deposited in the SIB, regardless of whether the source was state or private contributions, or repaid loans. In addition, only two states have leveraged their SIB programs through the issuance of bonds.
As a flexible, state-directed tool, SIBs have greater potential to provide loans and credit enhancement that can be realized through further modification as part of Reauthorization:
· Extend the program to included all states;
· Expand capitalization to meet demands with supplemental Federal appropriations and by permitting the use of future Federal-aid funds to capitalize SIBs;
· Rollback the imposition of Federal requirements on SIB-funded projects, or, at least, exempt “recycled” loan repayments and state contributions, as permitted under the 1995 NHS Act Pilot Program;
· Encourage states to expand capitalization by leveraging their SIB program through the issuance of bonds; and
· Remove “pilot” moniker from the SIB Pilot Program to send strong signal of on-going Federal support.
Reauthorization should provide incentives for public/private, market-based partnerships that finance, develop, operate, and maintain highways, mass transit facilities, high-speed rail and freight rail, and inter-modal facilities. This could be accomplished by permitting the targeted use of $15-20 billion of a new class of private activity bonds, and/or by modifying certain restrictions in the Internal Revenue Code on tax-exempt bond financing of transportation modes. We commend the members of the Senate and the Finance Committee for your prior consideration of the Highway Innovation and Cost Savings Act (HICSA, 1999), the Highway Infrastructure Privatization Act (HIPA, 1997), and, most recently, the Multi-Modal Transportation Financing Act (Multitrans).
My office is across West Street from the World Trade Center site. As workers in downtown Manhattan, we greatly appreciated your passage of Federal legislation creating a “Liberty Zone” for the redevelopment of lower Manhattan and for the creation of a new type of tax-exempt private activity bonds, Liberty Bonds, for the rebuilding and economic revitalization of New York City.
Existing tax law discourages private investment in transportation projects, prohibiting lower cost tax-exempt financing for projects involving private equity investment and incentive-based, private sector operating contracts. Transportation infrastructure financing deserves a bond mechanism similar to Liberty Bonds under Reauthorization to attract more private investment, as well as increase the use of new construction techniques, cost controls, performance guarantees and technologies. A new class of private activity bonds for qualified highway infrastructure, mass commuting vehicles, and other transportation projects would expand the application of the tax-exempt financing and lower the cost of capital, making public-private partnerships more attractive to public sector sponsors than conventional approaches.
3. Past “Innovative Finance” should become mainstream transportation finance under TEA-21 reauthorization and the Federal government should provide new financing tools and initiatives, at least on a pilot basis. From a financial markets perspective, Congress should use this opportunity to make refinements to more clearly articulate transportation financial assistance goals and send a consistent message as to how the Federal government is going to act toward investors, project sponsors and all program participants.
· TEA-21’s funding guarantees and firewalls—that permit the flexible use of GARVEE Bonds beyond multiple reauthorization periods—should be maintained, and radical swings in budgetary funding from RABA (Revenue Aligned Budgetary Authority) should be avoided. Similarly, transit funding guarantees should also be preserved.
· Examine the creation of a government corporation, perhaps in a form discussed by AASHTO, to provide a focus on transportation infrastructure finance, possibly administer a portion of DOT’s financing programs, and provide a basis for new financing tools, such as tax credit bonds. Federal government corporations have helped the capital markets create strong and liquid markets to fulfill other policy and programmatic objectives.
The creation and implementation of U.S. DOT Innovative Financing Initiatives over the last eight years has prompted an even more vigorous debate about transportation financing issues, challenges, and future innovation with the coming year’s surface transportation reauthorization. This ongoing debate, coupled with past and current Program successes, will encourage a further willingness to look beyond Federal-aid grant reimbursement, introduce additional players in transportation finance and enlarge the spectrum of instruments and programs to attract additional private and capital markets investment. The success of Innovative Finance places a higher level of responsibility on the Federal reauthorization process to maintain the characteristics attracting strong capital markets participation. Municipal Markets participants will continue to work with Congress, DOT, states, local governments, and private sector sponsors to maximize leverage and investment levels in transportation infrastructure over the coming authorization period and beyond.
I am pleased to have the opportunity to participate in today’s Joint Hearing with such knowledgeable witnesses. Thank you, again, for the opportunity to testify. I look forward to responding to any questions you may have.