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Skeptical Chicago Eyes P3s

CHICAGO — With public ire over the former mayor’s flawed $1.15 billion lease of Chicago’s parking meter system still clouding the local political landscape for public private partnerships, the city is turning to a next-generation model as it eyes private dollars to fund infrastructure and lower the cost of some city services.

Skepticism runs deep in the veins of Chicagoans when discussing the P3 model most familiar to a local crowd — leasing an existing revenue-generating asset to private investors and operators who capture future asset revenues in exchange for a hefty upfront cash payment.

Under former Mayor Richard Daley, Chicago pioneered the path to asset privatization with the 99-year lease of the Chicago Skyway toll bridge in 2005 for $1.8 billion. Daley went on to strike a lease involving downtown city and park district parking garages. Chicago established its first formal reserve with $500 million with proceeds from the Skyway lease and won a round of rating upgrades as a result.

But the parking meter privatization in late 2008 turned the public against such deals. The private operators were unprepared initially to manage the system, adding to the public’s anger over skyrocketing rates.

The City Council came under fire for rubber-stamping the deal and Daley used most of the proceeds to cover budget deficits over the next three years, raising questions about what the city has to show for the 75-year “partnership.”

The sore spot was underscored in the title of the conference, “Beyond Parking Meters: The Future of Public-Private Partnerships in Illinois” hosted here last week by the Chicago Federal Reserve Bank and the Chicago Civic Federation, an organization that tracks local and state government spending.

With state and federal funding lagging and international investment interest in P3s rising, Mayor Rahm Emanuel and the city’s sister agencies are looking to tap private dollars and panelists at the conference outlined some of the opportunities.

Conference panelist John Schmidt, a partner at Mayer Brown LLP in Chicago, whose practice in recent years has focused on large-scale infrastructure financing nationally, pointed to the authority established by the Commonwealth of Puerto Rico to oversee P3 deals as a model for successful implementation.

It’s similar to models adopted by Canada and the private sector. Such an authority combines technical and intellectual capacity and a depth of political support, Schmidt said. “If you can combine those … then you can really make something happen,” he said

One lease deal that stalled, but Schmidt said could now be resurrected, is the city’s proposed $2.5 billion lease of Midway Airport. Struck in 2008, it fell apart in 2009 when the private consortium couldn’t raise financing due to the international credit crunch. The city had banked on the Midway deal to help shore up its pension funding and to fund infrastructure, because of restrictions imposed in state legislation.

The Daley administration continued to obtain extensions to keep Midway’s slot in the federal pilot program that allows for the private operation of a handful of airports, and Emanuel has done the same since taking office last May.

Emanuel has treaded cautiously on the subject of a Midway lease, pledging any asset deal and the use of proceeds would face stricter scrutiny and restrictions. The city is expected tell the Federal Aviation Administration whether it will relinquish the spot by the end of the month.

With investment interest building internationally, Schmidt said Chicago could pull off a successful Midway privatization, although the question remains “whether the city wants to do it.” Schmidt, a legal adviser on the Midway deal, cited strong investor interest in the proposed privatization of Luis Muñoz Marin International Airport in San Juan, Puerto Rico.

Two fronts where Chicago is advancing efforts to tap private sector help are a new infrastructure bank trust and a competitive service delivery program in which city employees and private companies vie for the right to deliver a city service with the aim of reducing costs.

The city implemented such a competition for recycling collection over the summer in an attempt to generate savings, allowing officials to expand recycling services to additional neighborhoods.

The city is exploring other areas ripe for such competition, including curb work, tree trimming and towing, city budget director Alexandra Holt said during a presentation. The city has studied similar programs implemented by Charlotte, Phoenix and Indianapolis.

Emanuel introduced the Chicago Infrastructure Trust ordinance last week. The city identified $200 million worth of energy-efficiency projects at city facilities and schools to be funded through the trust, with anticipated savings of $20 million in the city’s annual $170 million bill for energy consumption.

Officials have plans to eventually tap the trust on a broader scale for projects tied to transportation, education and utility assets owned by the city and its sister entities, such as the Chicago Transit Authority and the Chicago Board of Education.

The city has agreements with a handful of private investment and financing firms to consider financing more $1 billion of projects. Emanuel and Chicago chief financial officer Lois Scott have attempted to highlight the program’s differences from an outright asset sale, and have pledged that the deals will face City Council and public scrutiny.

Officials said the trust would serve as a financing method for projects with defined revenue streams, such as energy savings or through the imposition of special fees or surcharges. A revenue stream is needed to both repay investors and offer some return.

Chicago has nonbinding agreements from Citibank NA, Citi Infrastructure Investors, Macquarie Infrastructure and Real Assets Inc., JPMorgan Asset Management Infrastructure Group and Ullico to consider investing in projects.

Structuring options include the use of private equity from the firms, vendor financing, and traditional tax-exempt and taxable borrowing, along with other methods that leverage specific revenue streams or a pool of revenue sources.

The trust would set up as a nonprofit that would use the city as a conduit to access the bond market when needed. “The trust gives us an additional financing tool,” Scott said in an interview last week. She said the trust’s nonprofit status will also make projects eligible for potential investment from private foundations and public pension funds.

Many market participants at the conference described the details released about the trust so far as vague and said the ordinance did little to shed light on how it would work. The trust would also have credit support and grant-making capabilities for select projects. It could not put the city’s full-faith-and-credit pledge behind a project financing.

Five unpaid members appointed by Emanuel with council approval would govern the trust. The trust faces investor disclosure rules similar to the city’s and will be required to submit annual reports for public and council review.

“The proof will be when it gets going,” Schmidt said.

The CTA — whose leaders are appointed by Emanuel — is exploring a P3 to help finance the $5 billion reconstruction and expansion of its Red Line rail transit line. It would somewhat follow a model used by the Denver Regional Transportation District by relying on a range of financing methods.

The Denver agency’s $6.7 billion FasTracks program includes commuter rail, light rail, bus and other improvements. The program is tapping P3 investment, federal grants, bonds, sales taxes, and tax-increment financing, said panelist Phillip Washington, the district’s general manager.

The CTA last month hired Goldman, Sachs & Co., Loop Capital Markets LLC and Estrada Hinojosa & Co. to analyze the use of P3s and other alternative financing methods. The CTA envisions the use of P3s to leverage new non-farebox revenue sources and capture real-estate value created by the Red Line.

While the U.S. lags far behind Canada and Europe in embracing the use of P3s to build courthouses, schools and libraries that fall into the category of “social infrastructure,” more governments are eying such investment following the 2010 deal to build the new Long Beach, Calif., courthouse, panelists said.

A private consortium is financing, designing, building, operating and maintaining the courthouse in return for availability payments for 35 years.

While traditional tax-exempt financing may appear the most affordable means to finance social infrastructure projects, market participants pointed to a myriad of factors to consider in determining the value of using a P3.

They include the benefits of risk transfer, budget certainty, the potential for quicker construction, and limited balance sheet impact, according to Ted Hamer, a director in KPMG LLP’s global infrastructure advisory practice.

Interest in the U.S. has lagged due to a fragmented market here compared to a country like the United Kingdom with a centralized system of financing projects like schools, Hamer said.

The use of an availability payment structure — instead of one in which an income stream like tolls is directly handed over to private investors — could grow as governments look to maintain control of revenue streams, said Nathan Flynn, a director in infrastructure banking at William Blair & Co.

One concern for investors over the availability-payment structure is annual appropriation risk because some governments cannot adopt an ongoing appropriation.

“Appropriation risk is real,” Hamer said, with investors paying close attention to a government’s financial position and political landscape.

Though the conference mostly steered clear of discussing the parking meter deal, Flynn reminded participants that Chicago’s motive for privatizing such a non-core asset was not budget relief.

“The city was not in dire financial shape” when it began looking at the transaction, he said. His firm served as the city’s advisor on the deal.

A “defensible” case could be made for tapping the parking-meter lease proceeds in 2009 as a dive in revenues caught city officials off guard after the 2008 financial collapse, according to Schmidt.

The ongoing use of proceeds to help balance the 2010 and 2011 budgets becomes more difficult to justify, said Schmidt, who was among the key early advisers to Daley’s administration on the Skyway lease but did not work on the meter transaction. Chicago’s meter deal — with few restrictions on the use of proceeds — has served as a lesson few want to repeat nationally.

“Sometimes a bad example can be helpful,” Schmidt said.

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