P3 – The Partnership That Joins Public and Private Sectors
P3s or PPPs: What Are They?
Public-Private Partnerships, also known as PPPs or P3s, are joint ventures between the public and private sectors wherein governments leverage the financing capacity and expertise of the private sector to accomplish a public purpose.
A P3 such as the recent 99-year city of Chicago parking garage and toll road concession deals center on the acquisition of revenue-producing public infrastructure by the private sector. However, P3’s also have been utilized in diverse applications such as health care (the Global Alliance for Vaccines and Immunization combats infectious disease) and education (the National Maritime College of Ireland).
The private sector’s interest in P3 infrastructure deals has been influenced by the weakness of the so-called “dot com” and real estate investment sectors and by the ongoing worldwide terrorism threat. Infrastructure is widely viewed as a relatively safe and stable environment with investment-return opportunities that exceed yields realized in other low-risk financial instruments such as government bonds.
The public sector is motivated by the desire to free up its financial resources and administrative expertise for those government services considered to be its “core competency” or those it feels simply should not be privatized. Funds from the sale or lease of public assets can also jump-start capital campaigns for public interests such as parks, libraries and schools.
While the majority of P3’s have been successful (such as the Chicago Skyway), some have been outright failures (such as Australia’s Airport Link). The concept of transferring the responsibility, authority and revenue rights to public assets remains, therefore, controversial.
Alternatives to Asset Divestiture & P3’s:
Increment Bonding, Enterprise Funds & 6320 Corporations
Some critics of the recent trend toward public asset divestitures warn that the cold, hard cash offered by PPP’s is fool’s gold. As quoted by Joseph A. Giannone in a Dec. 7, 2006, Reuters article, privatization expert John Foote, a senior fellow at Harvard University, stated: “The public sector should not be seduced by the dollars without first examining all the issues. These deals aren’t always in the public’s best interests.”
Several alternatives put forth by critics may be options for some governmental entities considering PPP’s for the sale or lease of revenue-producing infrastructure.
If the objective is to reap a lump sum of cash now to deal with current needs, governments can take advantage of the well-established and stable bond market, critics point out. They say governments should emulate PPP’s by “monetizing” a primary source of these gargantuan upfront payments: future rate increases.
Dennis J. Enright, a principal and founder of NW Financial Group and a critic of Chicago’s privatization deals, says the question is: “Should the public sector capture the excess revenues generated for public transportation purposes or should they allow the private sector to capture these revenues?”
Capturing these excess revenues could be done in at least two novel ways, Enright says, utilizing relatively cheap municipal bond financing. First, if allowed by bond protocols, future rate increases in excess of bonding coverage requirements could be separately pledged to support a revenue bond. This would be similar in effect to a homeowner taking out a second mortgage due to increases in local home prices that elevate the value of the home.
There are ways to get around bonding limitations on pledging future rate increases, Enright suggests in his May 1, 2006, analysis critiquing the sale of Chicago’s Skyway toll road. “Another alternative financing structure would be a toll surcharge that could be securitized on its own without direct debt on toll road operations.”
Proponents of PPP’s argue that bonding entities are not going to look kindly on these sorts of “second” tier pledges and will tighten bond requirements accordingly. Or, if they allow them, borrowers may pay higher initial rates as a result. Further, PPP champions say, critics put too much emphasis on rate increases, rather than on the “value engineering” that a PPP will deploy in support of its acquisition.
They say that improving the quality and efficiency of the asset, such as improving audit procedures, painting, cleaning and installing new revenue controls in an acquired parking garage, will yield as much or more revenue in the long run than rate increases.
Indeed, industry sources close to the new Chicago parking PPP who wish to remain anonymous say that the new operation has yielded a significant and unexpected increase in revenues from unearthing and resolving management and accounting issues from the previously city-owned operation. Governments, these sources say from industry experience, simply cannot match the private sector’s performance, innovation and incentive to succeed.
Parking Enterprise Funds
Some municipalities and universities are attempting to harness the power of private sector entrepreneurship by creating an in-house Parking Enterprise Fund (PEF). The PEF is run as a “wholly-owned subsidiary” of the creating entity, much as the NBC television network and parking operator Interpark are subsidiaries of General Electric.
Revenues collected by the PEF are utilized to pay all expenses. Profits from the PEF are used to bankroll and/or leverage capital projects such as parking garage construction.
The creation of a PEF often creates an initial budget “hole” for the creating entity. Thus, in some cases, the PEF offsets the loss of revenues to the general fund by making a “rent” payment back to the creating entity.
In the PEF model, parking functions are still under the auspices of the entity, as though it were still a department or division of the entity. Authority and decision-making still flow from within the political system that created it; no separate board of governance is required, as is typical with parking authorities. Examples ofgovernments with PEF’s include Norfolk, VA, and Wilmington, NC.
A “6320 Corporation” is a creature of an administrative ruling made by the Internal Revenue Service (# 20 of the year it was made, 1963, hence the “63” and “20” in “6320”). It is a captive financial entity that is allowed to issue bonds and enter into agreements with its creating government to purchase, own and lease assets. The corporation must serve a nonprofit governmental or “public” purpose, and is not supposed to benefit a specific private interest, although some do indirectly.
Such corporations are normally exempt from state Taxpayer Bill of Rights (TABOR) requirements since taxpayers are not responsible for any debt the corporation incurs. In many states with TABOR requirements, governments are limited not by what they can spend or bond, but by what they can collect in taxes or related fees. A 6320 Corporation may allow governments to bypass public approvals of bonds that the entity might issue or the payments or fees it might collect.
In a typical arrangement, a separate board of directors governs a 6320 Corporation; it cannot be controlled in any way by the creating entity, although in practice the board members are often political appointees. The 6320 Corporation issues bonds to build new facilities; these facilities are then leased back to the creating entity. Either the owner (the 6320) but more typically the lessee (the creating entity) operates the facilities.
A major distinction between a 6320 Corporation and a parking authority or utility is that once the bonds are paid off, the 6320 typically goes out of business and asset ownership reverts to the creating entity.
Ratings agencies have expressed some concerns over the use of this provision by municipalities as a way to expand their bonding capacity and now include a calculation of such revenues and expenses in their bonding capacity calculation. Some municipalities have escaped this limitation by converting the lease agreement from a guarantee to an annual appropriation, despite the increase this might have on the interest rate the 6320 pays to its bondholders.
Although 6320 Corporations have been used in a number of venues, such as courthouse construction in Kentucky and toll roads in Virginia, municipalities are only beginning to consider their use in a parking context.
See the full text of the Reuters article by Joseph A. Giannone at: http://www.reuters.com/article/reutersEdge/idUSN0744524720061207?sp=true
For Dennis J. Enright’s analysis, see:
Charles R. “Charlie” Munn III, CAPP, CPFM, is a parking research principal for Scotchtown Associates, a human resources and customer service consulting firm. Contact him at: firstname.lastname@example.org.
Pros & Cons of P3’s
• Upfront cash payments can exceed revenues generated over time by the asset; windfalls can be directed to other long-term needs.
• Where divestitures “defease” (pay off) existing general obligation bonds, bonding capacity may be redirected to other projects.
• New owner/lessee assumes financial and legal risks for the asset; agreement can include specific operating, renovation or investment requirements.
• Extricates government from a business that is typically not its core competency; allows government to refocus on what it does best.
• Asset stays put and remains a viable part of the community; even in a “sale,” the new owners/lessees are not removing the asset as a public utility.
• Can improve quality of operations; operating standards can be written into sale/lease documents.
• Successful track record of results in Europe, Asia and North America.
• Governmental entity can reclaim asset if new owner/lessee fails to meet operating standards set by agreement or encounters financial difficulty.
• In a lease scenario, government can reclaim asset at the end of the lease term when it may be more valuable.
• Sometimes difficult to achieve political consensus on the concept of selling a public asset for private profit.
• Only measure of control over operational quality is what is written into agreement; if it’s not in the agreement, new owner/lessee is not required to do it.
• New owner/lessee can raise rates as it sees fit, unless limited by agreement (however placing limits on rates will reduce amount of upfront payments).
• Government loses benefit of the “upside” of the asset, such as future rate increases, new development/demand, etc.
• New operator/owner could default or fail financially, or find the asset was in poor shape or misrepresented requiring Government to step back in as operator.
• Asset’s responsiveness to the community’s needs is no longer subject to the political environment but up to the “goodwill” of the new owner/lessee.
• Loss of good-paying government jobs with benefits; private sector will pay less and have few or no benefits for workers.
• PPP’s are a slippery slope: where does it stop?
A Brief History of P3’s
• 1930s – European governments utilize state-owned companies to build and operate toll roads.
• 1940s – European governments take on private partners to expand and rebuild infrastructure damaged by war.
• 1950s thru 1980s – Partnerships expand to include ports and airports, such as London’s Heathrow. Today, 55 airports in Europe are rivately owned or operated.
• State-controlled enterprises gradually morph into private companies as expanding capital needs outpace the ability of governments to meet them. For example, Autostrade SpA, a company founded by the state in the 1930s, became wholly private in 1999 and now operates more than 2,000 toll roads in Italy.
• 1990s – PPP’s expand into Asia and Australia, where they catch on quickly. There are half a dozen toll roads in and around Sydney alone. Some, such as Sydney’s Airport Link fail, leading to the realization of the limits of such deals.
• 1999 – First PPP in North America, with the privatization of Toronto’s 407 ETR Toll Road.
• 2000-2001 – “Dot com” crash and 9/11 catastrophe have Wall Street investors looking for safe investments; money begins pouring into infrastructure funds.
• 2004 – Chicago’s Skyway toll road becomes America’s first infrastructure PPP, yielding $1.8 billion for a 99-year lease.
• 2006 – A 75-year lease of the 157-mile Indiana Toll Road nets the state a record $3.8 billion.
• 2006 – Chicago awards a 99-year lease for its parking garages, generating $563 million.
• 2006 – Acquisition of six U.S. ports by a company with
ownership in the United Arab Emirates becomes political football over concerns the PPP will provide cover for terrorist activities.
• 2007 – Chicago prepares RFP to privatize Midway Airport and mulls the possibility of offering its parking meter operations for PPP.