Transcription:
Caitlin Devitt (
Hello and welcome to The Bond Buyer Podcast. I'm Caitlin Devitt, Infrastructure Reporter at the Bond Buyer. We're here today with Roddy Devlin to talk about asset recycling, a niche market in the P3 or public private partnership world. This is where in cities and states, other government entities lease existing assets and plow the money back into infrastructure, or at least that's the definition I'm gonna go with. Roddy I think is gonna enlighten us a little bit more on that later. First, a bit about Roddy. He's a partner at Nixon Peabody. He's based in New York. He's focused on the P3 space. He works with private and public sector entities on infrastructure including P3's. He's worked on a lot of deals globally and here in the U.S., including some of the most high profile deals in the U.S. like LaGuardia, which as many of our listeners know, is a big $4 billion project that included $2.6 billion of bonds, which was the largest bond issuance to date for a U.S. P3 project. Other deals include the Phoenix Sky Harbor Airport P3 program, the Westchester Airport P3 Project in New York and the I-70 East Project in Colorado. Welcome Roddy. Thanks for being here.
Roddy Devlin (
Thank you Caitlin. Thank you very much for invitation. Looking forward to our conversation.
Caitlin Devitt (
So let's start at the beginning. Asset recycling, what's your definition?
Roddy Devlin (
That's the key question. What is asset recycling and almost as important, what is not asset recycling? The asset recycling is not a privatization. I think once the P word comes into the conversation, often the conversation gets closed down quite quickly. And a privatization in the traditional sense is the wholesale sale or transfer of a public asset to private hands. And that's certainly not how asset recycling would work and has worked in the US to date. In other countries, including UK and Australia and in Canada, there have been examples of full-scale your privatizations in the asset recycling space, but that wouldn't happen in the US. In the US we're talking about long-term leases and concessions, 35 years and above. But the key thing to note is that the public asset remains a public asset. It remains in public ownership and there's almost always your detailed KPI, key performance indicators, your performance requirements that the private sector party has to meet in order to continue to have the right to operate and collect the revenues.
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So it's not a privatization, it's not a Monetization either. That's the M word can often cause a project to be derailed as well. And monetization is just generally when a public owner takes an asset that's revenue generating and somehow leverages that flow of funds to receive an upfront payment for other other municipal purposes to pay down debts for schools, for other laudable local purposes but not necessarily for infrastructure purposes. So that's for what an asset recycling is not. What an asset recycling is in the purest sense is a government authority — you are looking at what its assets under management are, especially those which are revenue generating and identifying those which can be passed into private operation and maintenance in the long term. Whereby the private party is charged with operating, maintaining the asset, you're up to very high standards and in return can receive and benefit from the majority of the revenues generated by that asset.
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And in exchange the public owner generally receives a large upfront payment for that lease organization. And often your participants think of your revenue sharing during the life of that concession or lease as well. And then the second part of this instance, a key thing to note in asset recycling, the proceeds and income that the public party receives from that process, it's put back into infrastructure. It's either it put back into your space projects or it's put into a general infrastructure fund, which is used to use to fund your future infrastructure improvements and growth. And that's a recycling part. It's not simply taking those revenues and using them for other, your laudable public properties including paying down debt or lowering taxes, but rather taking those funds and investing them back into infrastructure. So in my mind that's what asset recycling is and how it differs from the privatizations and monetizations.
Caitlin Devitt (
Well thanks for that. That's interesting. Cause I think you're right that people often and I include myself too, sometimes interchangeably use those terms, privatization, monetization and asset recycling. And like you were kind of indicating, we do see some political pushback with some of those words like privatization, monetization and we'll get to the politics later. But first let's just talk a little bit about the market in the US. What is the market for asset recycling and how does it compare to the rest of the world?
Roddy Devlin (
Good questions both. The potential market in the US is massive, it's truly significant. I mean the figures have been, depending on who you're reading, who you believe, there's one figure that was put out there of potentially $900 billion worth of asset value, which is locked up in the public sector that could be released for investment in infrastructure. And that includes your toll roads, your airports, ports, your water wastewater plants and the like. So that's the potential market, potentially your one of the largest in the world. The market in the US to date has been, I think it's fair to say you are small. There's certainly been projects which people call asset recycling, the Chicago Skyway, the Chicago parking, Indiana toll road, Ohio State University parking, some water projects in the Northeast. Not all of those would fall within my definition of asset recycling. And that not all of those proceeds turned back into infrastructure investments. The projects that work better are the ones that have done that, How does the US compare to the rest of the world?
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The US is a unique infrastructure market in lots of ways as well. Unlike countries like Canada, the UK, Australia, with much more centralized governmental, your control over infrastructure, it makes it much harder for a unified asset recycling program to be kind of imposed from above because the Feds can't really impose anything from above when it comes to infrastructure. They can only give incentives when it comes to financing and grants and loans and the like. So certainly the US as in the P3 market has lagged behind other countries when it comes to asset recycling in the past. The infrastructure act passed last year, I hate to call it a missed opportunity because that act was truly, you know, groundshaking in many, many ways and it can't do everything. But one of the things that it didn't do was create federal incentives for asset recycling.
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What it did do is charge the sake of transportation with making a report to Congress by 2024 with regards to asset recycling and what it might do, which is not nothing. And that could start a useful conversation. But one of the things Australians did in order to incentivize asset recycling was to say to your regional governments that if they did an asset recycling program, then for every dollar, Australian dollar, that they raised from the program, the federal government put in 15 cents, essentially 15% your governmental grant on top of that. And that was something which was discussed in some quarters in the context of the infrastructure but didn't make it into the final version, which is a pity because your money talks and as I say, the Feds can't really impose anything from above, but they can give big incentives. That was, I hate to call it a missed opportunity because your things move slowly in the US but it was a shame it wasn't in the act. But we'll have to see what happens when the conversation really gets going in 2024 when that report is sent to Congress and on what asset recycling might do.
Caitlin Devitt (
Yeah, I know a lot of supporters were really pushing for more on that in the IIJA and then it kind of got watered down in the report as you said. So what do you think are some of the obstacles? I mean you just mentioned sort of federal policy and we have this kind of patchwork system here where states control, at least in the larger P3 sector, that's really kind of controlled by a lot of state laws and which states enable it and which states don't. What are some of the other obstacles to it to more to asset recycling sort of taking off a lot more in the us? I mean I think politics or maybe what people call sometimes headline risk, that seems like it would be one of them
Roddy Devlin (
For sure. I mean the US, unlike many other countries, your political risk is much more of an issue here than it is in most other countries who have embraced asset monetization. And there's a number of projects that came close to the finishing line on asset recycling the US only to fall around election cycles with one politician losing supporting the project and other not and it's for no reason other than electoral politics bluntly. So politics certainly there. There's also I think the public still hasn't fully embraced the idea of private operation and maintenance of certain public assets. And there have been some projects which have given a black eye to asset recycling, even though in my view they shouldn't. People often cite the Chicago parking project as being problematic in that regard and that your parking fees have been going up exponentially since that project was put in place much to the chagrin of Chicago residents.
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And there hasn't been a corresponding new infrastructure to point to. So it's not like the city can say, 'Well look, I know that your parking fees are going up, but look at the new roads you've got, look bypass, look at the new tunnels or bridges that you've got from this.' There's no direct link between the additional fees that you're paying and infrastructure in my view, as I say, the Chicago parking wasn't really an asset recycling for that reason, the money went elsewhere and not back into infrastructure projects. And also it does kind of flag one of the main concerns and fears around asset recycling, which is that the private sector will somehow you run amok with this asset and will just start branching up fees and sky's the limit. That's not how it works. I mean in a properly structured asset recycling your lease or concession will impose quite strict regulation on the ability of the private sector to increase fees over time and they'll closely regulated by that document.
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So government's still controlling those fees. I say controlling an inverted commerce because it's within the contract that they've entered into with the private party saying you can only increase fees by these amounts over this set time. But certainly one aspect is of the fear of profit, of excess profit healing from these assets. But that can certainly be controlled. It it's worth noting too that the US is unique with respect to its access to your tax -exempt bond financing, which is a very, your cheap source of capital for your upgrades and improvements and creation of new infrastructure in the US. PABs in particular, private activity bonds. And those have been used extensively for new build projects, so called greenfield projects, less so for so called brownfield projects and new projects. And you certainly can't use your PABs or taxes of tax-exempt bond financing to finance the upfront payment that's being used to acquire the lease or the concession.
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And that itself has I think has been a factor in the lack of uptake. And I know that you, several administrations especially especially President's Obama's administration, had pushed to introduce more tax-exempt bond options for not only for creating new infrastructure but for rehabilitating and operating existing infrastructure. So I think that the lack of access to PABs for these projects is an issue. I don't think an issue that's gonna be addressed anything soon, but it's been an issue. And one other thing too, especially here in the Northeast, but in other jurisdictions too, when you're talking about asset recycling, you're talking about an existing asset with existing operating history and existing employees and traditionally there's been union opposition to asset recycling because these public sector jobs are becoming private sector jobs and often there's opposition around that. Again, I think the projects which have done that well have been projects where the new operator has been required to interview all of the existing employees and if appropriate you offer them new jobs within the asset or if they can't be offered new jobs, then the city or the county or the state that's undertaking the asset recycling as itself taken an obligation to find them other public sector jobs.
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But I don't want to kind sugar coat the pill here. I mean part of the upside of asset recycling is kind of greater if operational efficiencies that the private sector can bring, including with new technologies. And that often you requires a reduction in manpower, a reduction in staff and employees and that is something that just has to be grasped with and you have to face that head on and make sure that those are those employees if they're not being employed with a new entity, are taken care of properly. But that's a big one that has to be faced.
Caitlin Devitt (
Interesting. The union role. Yeah, well as a Chicagoan I have to weigh in of course on the parking deal and say it is just the gift that continues to give for us. And then it seems like they actually have had more employees. They have so many people walking around giving tickets all the time. But also I assume we're at some point gonna talk a little bit more about the Indiana toll road, which you mentioned. I do take that a lot also. And they have done that. You see that it's a lot of, I mean that's part of the EZ pass trend anyway, but that they've really reduced it and there's really not, and their arms gates usually are not really working and then there's very few people working there who can help you. But interesting. So those are some of the obstacles and the IJA did double the amount of private activity bonds that it kind of, that ceiling, that volume but yeah, like you said, it can't really be used in a way for some of these deals.
Roddy Devlin (
Yeah. Is that mean the PABs are primarily focused on either your building new infrastructure or are doing extensive rehab and existing infrastructure, but your PABs in the current form certainly can't be used to you to finance the acquisition of the lease or concession by the private party. Certainly it's rare that you do an asset recycling where there's not a large capital improvement component of it. I mean even if it's an existing asset or whatever it might be, you generally the new private party is going to come in and do a extensive capital investment in that asset and that portion can be PABs financed but not the payment to the public sector.
Caitlin Devitt (
Okay. Well we're gonna take a quick break and we'll be right back after this message and we're back talking with Roddy Devlin of Nixon Peabody about asset recycling. So one sector that I've always heard is ripe for asset recycling, but we never seem, well, at least in the US it's never really seemed to take off to use upon as the US airport sector. There is enabling federal legislation. But there's only one airport that I know about that's gone that route, which is Puerto Rico's international airport. And please correct me if I'm wrong on that, but I know Chicago, St. Louis, Gary, Indiana, were all considering it but dropped it. And again, correct me if I'm wrong on that, well what's going on with the airport sector and do you think we'll ever see some, cause I always hear, when I talk to people, they say, Oh it's come, these are some big numbers, these are these fat little assets we in the private sector like some but we don't see it. So what's going on there?
Roddy Devlin (
It's a great question. There is one other airport that folk generally don't talk about because it's a bit of a wayward child. Stewart Airport in New York State was actually the first airport to go through the program, but it didn't last for long. It was a Port Authority of New York and New Jersey project and it came in and it came back out again. It wasn't a great success, but that was it, no one holds it up as a shining example. I wouldn't say in Puerto Rico is the one that people rightly hold up is the example. Again, I would just stress that it wasn't really asset recycling in that the process that Puerto Rico got from that from that asset were not plowed back into infrastructure. They're plowed back into multiple other laudable governmental needs. But there wasn't a special fund, infrastructure fund that was funded by that airport project to fund future infrastructure.
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But there's many reasons why airports have been slow to fully embrace the asset recycling model. First and foremost is you can only do it through you what used to be called the airport pilot privatization program, which was, I always hated that name pilot because it was a pilot for a decade and a half and privatization because it wasn't a privatization, it was always staying within public ownership. And as you know, that program was revamped to make it a little more user-friendly of late. But the reason why you can only do it through that program is your asset recycling you produces your revenues for the public sector. And because the Federal Aviation Authority in the US has invested funds, made grants and funded almost every commercial airport in the US, they take the view that if there's a full asset recycling of that asset, then any funds which are generated to the public owner from that asset have to be reinvested back in the airport.
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So in Puerto Rico's case, if they hadn't done it through the program, any money, including the very large upfront payment and the periodic revenue sharing thereafter, that money would have to plowed back by Puerto Rico into the airport, which makes no sense because the airport has been fully operating, maintained by the private party. So the way you get through that and during that is by going through the federal program, which requires many things, including your approval by two thirds of the passenger and cargo airlines using the airport, which often becomes a very spirited conversation, shall we say, between the airlines and the airport as the airlines recognize this as an opportunity to really ask for their pound of flesh with regards to getting what they want from the airport. And it's a long process and even in Puerto Rico, it was shall we say clunky towards the end with regards to lining up the financial close, the commercial close, and the FAA authorization.
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It was not a smooth process. On the other hand, I should say though that most of the nations looking at how the US airports would see lots of private activity there already. I mean the number of terminals which are running operated by airports or by private consortium is significant. A number of the services, baggage handling your concessions, they're all done, almost all done on the private sector side. And when you look at your projects such as the LaGuardia projects, plural or the JFK projects or New York airports as well, I'll operate you by overseen by the Port Authority of New York and New Jersey. They have managed to do quite extensive your developments outside of the program because they have been terminal specific and the port authority retains overall responsibility for the airports. So it's certainly been a lot of private, your investment and private development, private operation and maintenance of airport assets in the US but just not full airport wide asset recyclings.
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I would love to see it take off if you pardon my pun and the need is there and it would be a great way to unlock capital to invest back into airport assets or other infrastructure assets in the area. But of all the potential asset classes, I think airports are probably the one that's tied up in the most red tape and will probably be the most problematic to see done in a wide scale. I think your to roads, bridges, tunnels, water, wastewater, I think those are much easier to do in many ways. And we'll probably see more of those before we see a real slew of airport asset recycling, unfortunately.
Caitlin Devitt (
Interesting. There's a lot of nuance there. And you anticipated my next question because I was gonna ask you, what are some sectors then that you think are right for asset recycling or that we might see some more action in the next few years?
Roddy Devlin (
Well, the key thing when it comes to assets is ideally this should be revenue generating. I mean there has been some talk of potentially opening up the sector to availability payments, so-called shadow tools with the public owner making availability payments to the private party. I think that's a reach too far for the US for many years to come. And I could see a scenario under which if the revenues generated by the asset recycling work followed back into you infrastructure trust fund and that was used to make the payment, I could see a pathway there. But I think that's too avant guarde for the US for the next 10 to 15 years I would think. So you need an asset which is revenue generating towards your bridges, tunnels, airports, your water waste, water treatment facilities. You need those which are your asset generating. Ideally you need a proven track record in order to be attractive to the private sector, you need to show a good long history of revenue generation by these assets so that the private sector can adequately value what the investment should be and what the revenues might potentially be in the long term.
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And it should ideally be an asset which isn't core to the governmental purpose in my view. Your government should not necessarily be in the business of operating your toll roads, bridges, tunnels and airports. And if this is an opportunity to generate revenues to invest in other infrastructure, to kind free themselves up from the responsibility of the O and M, I think that's a good thing. And another thing that's kind of missing from this conversation too is that, and it's often not kind of tracked by the public owner either, is that these assets, they have a cost to the public sector. I mean the O and M and these things can be quite significant and hopefully it's being more than offset by the revenue generation. But you with asset recycling, you're the public owner gets to free yourself from that long term O and M obligation while being able to hold the screws to the private sector operator with regards to KPIs, key performance indicators. So we shouldn't lose sight of that.
Caitlin Devitt (
Okay, well what's a gold standard deal? Do we have one? Is it Indiana Toll Road, is it another one?
Roddy Devlin (
So it's a very interesting question. If I was giving out awards, I would give first place to Indiana toll roads and I'd give second place to Ohio State University parking. Indiana toll road is a controversial choice in some ways because the project went bankrupt. The traffic projections weren't what they were and the equity investors ending up losing their shirts in the project. But from Indiana's perspective, from a public sector perspective, they did quite well. They got that upfront payment, they were getting the revenue share, the toll road was maintained properly, operated properly, and there was no public bailout. So from that perspective, I think the public sector did quite well and it was an asset recycling in that a big chunk of the revenue generated from that project went into a trust fund for further infrastructure investment. And even the interest in those on that trust fund, quite significant and has been applied for infrastructure projects. So it ticks that second box in a way that many other assets didn't. And Ohio State University parking would get second prize because the revenues went back into the general endowment and went for many laudable purposes but weren't dedicated to the university's infrastructure whereas Indiana toll road did take that second step and managed to manage discipline itself by using that money for other infrastructure projects. I would give that the gold standard presently in the US.
Caitlin Devitt (
Yeah, I remember when Gov. Daniels did that, Mitch Daniels, and I think it was the Major Moves program was the name of it.
Roddy Devlin (
It takes discipline. If are a politician and there's a big chunk of revenue coming in, then there's a real incentive to apply that for tax cuts and for your immediate political benefit. And it takes discipline to say, 'No, I'm going gonna set this aside for the long term, for the 15-, 20-, 30-year long term because it's the right thing to do.' It takes discipline to do that recycling part.
Caitlin Devitt (
And I remember at the time or when times got hard, I can't remember if it was '08 or '09, but when Daniels was imposing cuts on all the agencies, all state agencies, you need to take 10% or whatever it was. And there was a lot of state lawmakers who were saying, let's tap that road fund. I mean it is sort of a political decision too. And then I've also heard supporters say about that bankruptcy, that it was in its own way, it was done orderly. And now since then it's been sold again so that it sort of shows that it can be done in an orderly way and that life goes on valuation.
Roddy Devlin (
Exactly, I mean it was kind of a proof of concept, I mean it was the project, the worst thing that could happen to the project from the private sector side happened. It was insolvency but the road didn't close for a single day. Everyone likes to complain about to roads, but there were no truly significant or major O and M issues on the road during the period, you continue to operate, you'll continue to use it. There was no close down. And if you were a user of the road, you probably never knew anything was happening and there was not a single governmental dollar spent. So it was a proof of concept in that it showed that from a public sector perspective, these projects can survive the critical things going wrong in the private sector side.
Caitlin Devitt (
Okay. Well let me just I'll ask you kind of a final question. We've talked about the infrastructure law, the IIJA, and the report that it's asking for, but is there anything else going on in the federal front or even among the states that we should know about that affects the sector or the market?
Roddy Devlin (
Yeah, as I mentioned, it's really difficult for the Feds to do too much beyond the carrot. And I would hope that this report, when it comes out in 2024, it will certainly look at Australia and I would imagine, and will kind of look at the fact that they manage to leverage that 15% public sector your investment into 85%, your private sector investment in the infrastructure sector, which is pretty impressive. So I'm hoping that that report when it comes out will favorably look at doing incentive grants to encourage your states, municipalities, counties, and cities to look at asset recycling. And that money will kind of bring that discipline that we talked about and give the ability not to have your head turned by tax cuts or other perfectly legitimate your pressing needs. But to have the discipline to set that money aside for future infrastructure projects.
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But the US as I mentioned before, it's a unique system and it's the counties, it's the cities. it's the authorities up and down who have ownership of these assets. And there's no one size fits all solution which is why it's been so piecemeal in the US, a project here five years later, another project you six, another project. And I think that's probably what we're going to see. Although success is success and as more countries and cities do one off projects, it's like a snowball and people will want to know you, what's happening, what's working elsewhere. And as practitioners in the space, I think it's our job to wave the flag and make sure our public sector clients know that this option is there.
Caitlin Devitt (
Interesting. Okay, well, I guess stay tuned. We'll see what's gonna happen in this very niche kind of interesting market. Roddy Devlin, thank you very much for being here with us today and for talking to us about asset recycling. Thanks to the listeners of this latest Bond Buyer podcast. Special thanks to Kevin Parise for helping out with the audio production. Don't forget to rate us, review us and subscribe at www.bondbuyer.com/subscribe For the Bond Buyer, I'm Caitlin Devitt and thanks for listening.