Kathleen Brown at ULI: Public-Private Partnerships Work; Still Have Political Challenges

Rapoport: Since I spend most of my week in Washington I wanted to just spend a minute with you talking about what Washington's view, or ignorance, of public-private partnerships (P3) is, and why it may be important in stimulating deal-flow in the United States...

...What is the Obama Administration saying about P3s? Very briefly, Ray LaHood, the Secretary of the Department of Transportation, started to mouth the words "public-private partnership." Why wouldn't he? That is less money that Washington has to give the governors and mayors if our private equity clients are willing to finance these deals.

Developers here might want to take a look at what may be a model of future stimulus funds called the $1.5 billion Discretionary Fund that Ray LaHood has. In short, all of the stimulus money, except for this pot, was given to the governors and mayors. This $1.5 billion is available for transportation and unique related projects where the local city or governor can raise most of the funds. A developer could put in for $30 million or $40 million out of this pot of money, as long as the city has a P3 mentality that allows the developer to bring his own private equity. This could be the model of future stimulus funds.

As we talk to governors and mayors around the country who don't have a P3 law, like California, we warn them that it might mean they are going to be left out if the next wave of stimulus money in 2010 has provisions on it that you must put skin in the game. The only way to do that is to have fully embraced public-private partnership. My thesis is that the urgency of this market is such that the more political will that we see from Obama and from Congress to send the right signals to the mayors and governors to do more deals, the better off that will be. How could they send that signal? In the reauthorization of the transportation bill-up Sept. 30-they could increase the TIFIA funding, which is a subordinated debt-product that could be used to structure a P3 deal, to have this layering of bank debt that is subordinate. If they increased that, it would be a good signal. If they lifted the limits on private activity bonds, that would also be a good signal.

The handwriting will be on the wall. Watch and see whether Obama starts sending more signals that P3 is a really good thing. A good way to do that would be to set up a Best Practices Center in Washington. Every other country, you heard, has a partnership-Partnerships UK, Partnerships British Columbia. It's no secret that Governor Schwarzenegger, when he got interested in P3 four or five years ago, had to leave the country to find anybody who knew anything about it. He went up to Canada to meet with Larry Blaine at Partnerships British Columbia. Why don't we have that type of center in Washington, never to dictate policy or tell a mayor what to privatize or not, but to simply show him, or her, the standardized deal documents, the best practices, and provide expertise?

Kathleen Brown: ...Let me take just a moment, with some illustrations, to talk about what public-private partnerships are not. Number one, they are not new. Number two, they are not one-size-fits-all solutions. Number three, they are not easy. Number four, they are certainly not a silver bullet.

They are not new: In point of fact, our country, our cities, our state, our towns, and our villages were all built around public-private partnerships in the earliest part of the 18th century....

...It is not a new concept and it is also not a concept with only one model. There are various spectrums of public-private partnerships. Even without a public-private partnership law in California, the government didn't build the roads. They hired contractors through a procurement process...We are dealing with an area where public-private partnerships are getting wrapped up as something totally new. They are not new and they come in this variety of spectrums. They also, as you have heard, can be different kinds of projects-greenfield, brownfield. We aren't going to see a lot of brownfields in California unless they really can't solve the budget problems in Sacramento. Greenfield is the area we are going to focus on as there is greater public acceptance. That is what the California law provides, and that is going to be the case throughout the western United States, where we don't have quite as many of the brownfield assets, meaning existing assets.

The assets that I consider the sweet spot are what I call a hybrid, or dark-greenfield, asset. It's where there is a need. It's new. It doesn't exist, and there is a lot of pressure, public acclaim, and need. Like managed lanes, for example, you feel a crisis politically and you can bring the stakeholders together to say, "This is a project we need. How can we get it?" Public-private partnerships might be a vehicle to look at.

There are also numerous kinds of financing structures. I won't predict that we are going to see the Chicago Skyway, or Indiana Toll Way, or even the Chicago parking structures, multiplied 35 or 40 times. Those days are behind us because of the financial realities we are dealing with. As you look at a public-private partnership it is really critical to manage expectations because you create a successful project if you set your expectations properly at the outset. I remember in Sacramento, when we were talking with the administration and others about the lottery. We had very conservative numbers on what we thought the state could get for a concession on the lottery and another firm came in and doubled the number we were talking about. It got people's attention, but we thought it was going to be extremely important to deliver on which, again, can create a negative impression on public-private partnerships.

They can also come in the form of up-front proceeds, all at once. You can also take proceeds over time. The Chicago Skyway and Indiana Toll Way were up-front proceeds. The Florida I-95 was the closed availability payment model in the United States. That is a different kind of model as well. In that model the bidder will put the lowest possible bid, as opposed to the skyway, which used the highest bid as the winner-as would L.A. parking. But the public sector will pay availability payments when that project is made available to the public. It's like a lease payment and the goal is to compete in the private marketplace to get the lowest possible cost of designing, building, operating, and maintaining that asset.

Another modern example of public-private partnership is the Port of Oakland, right here in California. The port put out an RFP for a private operator to come in and operate several of its berths and terminals. Ports of America won that bid-a $649 million net present value transaction with $60 million in up-front proceeds. The concessionaire was going to pay an initial $19.5 million in the first year, and it was for 35 years. The Port of Oakland has a new variation on financing structures for public-private partnership, and given the decline of port traffic in the west, the Port of Oakland was exceedingly happy with that transaction.

So, it's not new, it's not one-size-fits-all, and it's not easy. From my perspective it is a financial transaction, which, even in the face of the financial markets we are seeing today, is a lot easier to manage than the political transaction, which is inherent and embedded in each one of these projects. Given the amount of work that Goldman Sachs has done in the public-private partnership realm, we went out and did a lot of polling data. As a "recovering elected official" I am here to tell you that if public-private partnership was a candidate, it would lose very, very badly. Anyone going into this-a developer, an issuer, or an investor-please understand that it's a losing campaign but you're on the right side of goodness, truth, and nobility because of the needs. Get out there and fight-but fight smartly. You've heard it before. You need a champion, whether it was Ed Rendell who really carried it around on the Pennsylvania Turnpike, though ultimately not successful due, in a large part, to the financial markets. Had the markets been better and he reached the goal, the politics could have fallen into place. Mayor Daley has been enormously successful. Mitch Daniels was successful. Everybody predicted that he would lose because of the Indiana Tollway. He did not lose and the representatives who supported it and lived in the district where the toll way went through also did not lose. The House did change from Republican to Democratic control, but the key there was that it was not a political death knell for Mitch Daniels.

One other message that I would share from a political perspective is that words kill. You need a brand manager for public-private partnership communication. If you say "privatization": Dead on arrival! It does not play in the public sector. It is a partnership. It is a monetization of assets. It's a solution, but it is not privatization. It is not because the public still generally owns these assets even though there could be a long-term lease.

You need to have experienced advisors. And you need to pick the best teams in your concession when you're doing your Requests for Qualifications. Another key political point-you need to have a goal. If you just want to do a public-private partnership because you think you need a project, forget it. It is a campaign. You need to have a reason. People have to want the end result. They may not like the public-private partnership but they want the road; they want the water facility. They want the project.

The financial landscape: the markets are open. Good projects will find capital. The I-95 managed lanes and reconstruction of roads in the Miami County area, which I mentioned earlier, required $1.6 billion to design, build, operate, maintain, and finance over 35 years-not the Chicago 99-year variety. The bidders bid to a MAP-maximum availability payment. Availability payments have another great advantage because not only do you go for the lowest bid-the lowest cost to the public sector to get the project-but they are subject to performance and compliance requirements on a monthly basis. That is built into the contract. Critically, in this market, $800 million in debt financing was raised. It's not the big numbers of $1.83 billion from the Skyway project or what the Pennsylvania Turnpike was looking for-$12 or $14 billion-but $800 million was raised from a consortium of smaller project finance banks in Spain.

I mentioned the successful Port of Oakland, which has a 50-year concession. The Midway Airport is one that is perhaps not successful and yet the city of Chicago did walk away with a check for $125 million. They've announced that they are going out to find another bidder. You have to look at the case specifics to see why a deal was successful or not. In this case it was very much about a bid that everyone else in the marketplace felt was overly aggressive. You combine that with when they tried to raise the debt funding, and they couldn't do that combined with the finance partners' own financial difficulties...

...The Build America Bond is the most powerful financial stimulus that we have seen in the public sector market, certainly in my lifetime. The government will pay 35 percent direct subsidy to government issuers for the construction of capital projects. It is good for two years, meaning you can issue bonds for a two-year period. The subsidy lasts the lifetime of those bonds. It has lowered the cost of borrowing for public sector issuers.

The state of California did $6.855 billion last month. The interest, the DIP, on the 30-year bond was 4.83 percent versus what a similar, non-callable tax exempt bond would have been on the same day, which is estimated to be over 5.5 percent. We saved over half a billion dollars for the state of California. It introduces the public sector to a whole range of new issues because these are taxable bonds. It is a market that is twice the size of the private sector market and, because so many Build America Bonds have been issued, we have sucked out supply, where there has been too much supply and not enough demand in the tax exempt market and fundamentally altered that supply/demand imbalance. The taxable market had just the opposite problem. They had more demand and not enough supply because their primary issue was with financial institutions have been out of the traditional investment-grade market.