Recent Experiences with Asset Privatization in State and Local Government
By now, there is no need to recount how badly the Great Recession battered public finances, other than to reiterate that governments’ fiscal challenges remain unprecedented - especially at the state and local level. The economy’s steep, prolonged downturn and slow recovery have hit tax revenues hard and put historic pressure on safety net programs.
As noted in CSG's new fiscal and economic policy brief, challenges will likely persist through 2012, as Recovery Act funds dry up, healthcare costs grow, and other structural factors weigh on state and local budgets. For policy makers weary of cutting spending or raising taxes to close budget gaps, asset privatization – the long-term sale or transfer of public assets to private parties – offers an attractive alternative. Here is a run-down on some recent experiences with this practice at the state and local level.
But first, a little background.
What is Asset Privatization?
Privatization often comes up in debates over who should provide public services, such as municipal refuse collection, social welfare services, and the like.
In addition to services, governments may also privatize assets, espcially those capable of generating recurring revenue (e.g. parking meters). Private investors pay cash to access to this revenue; they might also manage the asset, though control over rates, usage, and other decisions varies from agreement to agreement.
According to the Government Finance Officers Association (GFOA), agreements come in three forms:
1. Outright sales. Outright sales agreements permanently relinquish control of an asset to private parties; they sometimes include reversionary provisions that re-establish public control in the event of performance failure.
2. Management contracts. Management contracts transfer day-to-day operations to private parties, but the government generally retains title to the asset and enforces performance and quality standards.
3. Leases. Leases temporarily transfer assets to private parties. Rights and responsibilities to the asset usually revert to the government at the end of the lease term.
Recent Experiences with Privatization at the State and Local Level
Recent privatization experiences at the state and local level include several high-profile deals. Here’s a look at some of them, starting in 2005.
2005: Leasing the Chicago Skyway
City officials leased the Chicago Skyway, a 7.8 mile toll facility linking the Dan Ryan Expressway and Indiana Toll Road, to Spanish and Australian investors in 2005. The investment consortium, Skyway Concession Company, LLC, paid Chicago $1.83 billion for a 99-year operating lease. The lease entitles Skyway to all toll revenues. Skyway is also responsible for maintenance and upkeep.
In 2009, Bloomberg reported that the Australian company underlying Skyway, Macquarie Infrastructure Group, was considering selling its stake in the road. The firm’s revenue projections had not held true, since drivers cut back on their travel due to the recession. The Skyway remains in Macquarie's infrastructure portfolio.
2006: Toll Road Leasing in Indiana
Macquarie’s portfolio also includes the Indiana Toll Road, which the state leased for $3.85 billion in 2006. Macquarie joined Spanish firm Cintra, with whom it collaborated on Skyway, to land the Indiana deal. Together, they formed the Indiana Toll Road Concession Company, which now oversees the road’s operations.
In June, 2011, Bloomberg Businessweek reported that the Indiana venture was experiencing financial trouble of its own. Traffic volume depressed by the recession drove revenues below forecast, making it difficult for the consortium to cover its operating costs and debt service. For now, an emergency reserve fund has helped to bridge the gap between toll revenues and expenditures.
For its part, the state has made off well, according to Governor Mitch Daniels. Proceeds from the toll road lease have been used to fund infrastructure improvements, most recently a lane expansion project that the Northwest Indiana Times reported complete in December, 2011. On a visit to the completed project, Daniels praised the toll road deal, and said he was still getting questions from other states interested in leasing (more on this below).
2008: Chicago Privatizes Parking Meters, Pennsylvania takes a Pass on Turnpike Lease
Chicago officials crafted additional leases following the Skyway transaction, including a 2008 deal to transfer 36,000 parking meters to investors led by Morgan Stanley. As reported in Reuters, the investors paid $1.16 billion for a 75-year lease on the meters.
In Pennsylvania, investors withdrew a $12.8 billion offer after lawmakers did not vote on a measure to lease the state’s turnpike. Previously, the state had selected a bid from Pennsylvania Transportation Partners (PTP), an investment consortium led by Citigroup and Spanish firm Abertis Infraestructuras SA. According to Toll Road News, Governor Ed Rendell supported a 75-year lease with PTP as a means of raising cash for the state’s transportation financing needs, a policy similar to that pursued in Indiana.
2009: Arizona Proposes to Sell State Buildings, Lease Them Back
Arizona garnered national attention for a 2009 proposal to sell and then lease back some of its buildings. According to the Arizona Republic, the state executed two such transactions in 2010 – one for $735 million in January and another for $300 million in June – to shore up its budget.
A document from the Arizona Department of Administration describes how the deals worked. In brief, the state sold the buildings to a bank trustee, who purchased them by issuing certificates of participation to private investors. In buying these certificates, the investors purchased a share of future lease revenues, which the state will pay them over time per the terms of a lease purchase agreement.
Because of its mechanics, this type of transaction is commonly referred to as a “sale leaseback.” The asset owner (in this case, the state of Arizona) first sells its assets to a third party (in this case, the bank trustee). The third party buys the assets by issuing certificates of participation to private investors. The original asset owner then leases the buildings back per the terms of a lease agreement, and makes lease payments to investors in possession of the certificates.
In her most recent state of the state address (reproduced in this piece from the Tucson Sentinel), Brewer called for buying back some of the leased buildings. She told the legislature to send a bill by Statehood Day that would allow the state to buy back its capitol building.
2010: Privatization across the U.S.
The Wall Street Journal reported that many privatization deals were taking hold in state and local government in 2010. In an August, 2010 piece, WSJ noted that U.S. and foreign investors were vetting 35 different transactions, “with hundreds more in the works.” Assets underlying the 35 deals totaled $45 billion in value. They included public parking infrastructure in San Francisco, Las Vegas, Pittsburgh, and Dallas, water supplies in Milwaukee, and airports in Louisiana, Georgia, and Puerto Rico.
2011: State Officials Commission KMPG to Study Options for Ohio Turnpike
In November, 2011, the Columbus Dispatch reported that state officials had commissioned financial services firm KPMG to study options to enhance the Ohio turnpike’s revenue potential. Taking a cue from Pennsylvania and Indiana, Governor John Kasich expressed interest in leasing the road. However, as reported in an August, 2011 Bloomberg piece, Daniels and Rendell were cool on the prospects of a lease deal in Ohio. Daniels did not think Ohio could net the same amount of cash Indiana received in 2006, when credit conditions were better and funding sources more prevalent.
Still, Kasich expressed optimism about getting a good offer. In the Dispatch, Ohio DOT director Jerry Wray called the turnpike “a hugely valuable untapped asset,” and suggested enhancing its revenue – via a lease or some other action – could go a long way toward funding critical transportation investments.
2012: UK Considers Privatizing Dormitories
Education Realty Trusts could assume control of the University of Kentucky’s dormitories, though an agreement has not been finalized. According to the Wall Street Journal, UK may transfer over 6,000 housing units to Education Realty, in exchange for ground lease payments and up to $500 million dollars in renovations over the next five to seven years. The university would like to maintain control over residence life programs, and has also expressed interest in having the real estate company retain its housing staff. It is not clear yet which party will set rental rates.
Education Realty is devising plans to modernize the university’s existing units, and is also planning to add 2,500 new units. University officials hope revamped housing will prove attractive to potential students, whom WSJ claims are putting an increasingly high premium on modern accommodations.
Privatization: Weighing the Pros and Cons
As with any policy, asset privatization has its proponents – and its critics.
Critics cite potential for price increases and reduced service quality in objection to privatization. Proponents counter that privatization encourages operational efficiency, which can translate into lower costs for end users.
GFOA recommends finance officials play a central role in crafting any privatization deal, so as to ensure that governments fully understand the risks and long-run implications.
For more on privatization and related issues, see the following:
- States mull privatizing business recruitment, job creation efforts, Stateline Midwest Vol. 20, No. 3: March, 2011.
- Public-Private Partnerships and Infrastructure, E-newsletter Issue #69 | May 12, 2011.
- Public-Private Partnerships in Transportation: A Few Updates, CSG Knowledge Center, June 10, 2011.
- Public-Private Partnerships to Ensure Global Competitiveness, E-newsletter Issue #78 | September 16, 2011.
- States Look to Private Sector on Infrastructure, E-newsletter Issue #79 | September 29, 2011.
- Transportation Policy Academy Pt. 9: National Council for Public-Private Partnerships’ Richard Norment (Summary of Mr. Norment’s remarks), CSG Knowledge Center, November 4, 2011.
- The Role of the Finance Officer in Privatization, Government Finance Officers Association BEST PRATICE Series, 2009.
- Using Public-Private Partnerships to Carry Out Highway Projects, Congressional Budget Office, January 2012 (see especially chapters two and three).