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38 Creative financing is essential to spreading the risks; expanding the base of knowledge and experience; and tapping into the fiscal advantages of certain partners, such as local governmentsâ superior bond ratings and guarantees, to make projects âpencil outâ (Cervero et al., 2004). Transit agencies and local governments traditionally pay for large transit projects in three ways (see also Table 11): â¢ Grants provided by local, regional, state, and federal sources; â¢ Pay-as-you-go funds, corresponding to the cash-flow needs of the project, especially if the project can be built in segments; and â¢ Financing, primarily through tax-exempt or municipal bonds, secured by sales taxes, gas taxes, and sometimes fare revenues. In some instances, such as with grant anticipation notes, financing can be secured by grants, such as from the FTA. However, as discussed in the following, it is rare that financing is secured solely by value capture revenues. It is typical for a major transit project to include all three funding sources. 6.1 Funding For many transit agencies, the major funding sources for capital projects are: â¢ Sales taxes at the local level; â¢ Federal grants from the FTA, the FRA, or the FHWA; and â¢ State grants, often funded with state-level gas tax monies. Few, if any, transit agencies earn an operating surplus that could be used for funding capital. However, some transit agencies have issued bonds secured by fare-box revenues (with operating costs covered by other sources) or used innovative direct revenues like naming rights to fund certain assets. Transit agencies and local governments can also contribute to project funding through land contributions, air rights leasing, and, in some instances, by expediting the entitlement approval process (Bernick and Freilich, 1998). 6.2 Tax-Exempt Financing Typically, transit agencies and local governments are allowed to issue municipal bonds that are exempt from federal taxes and many state and local taxes, depending on the laws of each state. They also may borrow from banks and private placement providers. In order to borrow from these markets or institutions, the credit of the transit agency or local government or the C h a p t e r 6 Creditworthiness, Finance, and Funding
Creditworthiness, Finance, and Funding 39 project in question must usually be âinvestment grade,â a term that refers to the credit rating of the entity or the project. An investment-grade rating is one in which the rating is above the level of âBBBâ for Standard & Poorâs (S&P)/Fitch Ratings or âBaaâ for Moodyâs, the three major credit rating agencies (Standard & Poorâs, 2016; Moodyâs Investor Service, 2016; Fitch Ratings, 2016a). Such a rating or higher (e.g., âBBB,â âA,â âAAâ or âAAAâ on the S&P ratings scale) assumes a relatively low to moderate credit risk (Fitch Ratings, 2016a). Many retail bond funds primarily purchase bonds that are rated investment grade or higher. Since these bond funds dominate the tax-exempt market, a bond without an investment rating will be purchased by fewer investors, if any. Therefore, most transit agencies and local govern- ments strive to issue investment-grade bonds. Most bonds for transit issuers and projects tend to be rated âA.â These bonds or debt instruments are often secured by sales taxes, as were the Denver Union Station Project Authority senior lien notes, which were rated âAâ based on a combination of several grants and tax sources (Fitch Ratings, 2015a). While banks and private placement providers such as insurance companies are usually not required to follow this investment-grade/nonâinvestment-grade framework, they often view investments in a similar way. These providers are somewhat more willing to consider nonâ investment-grade credits in return for higher yields. When transit agencies or local governments issue bonds or obtain loans for projects depen- dent on real estate revenues, these instruments are often backed by another creditworthy source, such as sales taxes or the credit of the local government, known as a âdouble-barrelâ or âback- stop.â For example, in the Denver Union Station case, the Transportation Infrastructure Finance and Innovation Act (TIFIA) loan was secured by the RTDâs sales tax pledge. The subordinate RRIF loan was secured by TIF and special assessment district revenues and the appropriation guarantee of up to $8 million from the City and County of Denver to cover a portion of the $12 million annual RRIF debt service (Denver Union Station Project Authority, 2011). Funding Sources Financing Mechanisms Direct System Revenues Other Funding Sources Traditional Fare box Nonâfare box â Traditional advertising â Parking Local â Sales taxes â Other local taxes (gas, lodging, rental car) â State and federal grants Tax-exempt and taxable bonds Bank debt Innovative Station related â Concessions â Parking innovations â Innovative advertising Right-of-way sharing Value capture related â Joint development â Special assessment district â Tax increment finance â Impact fees/negotiated exactions â Parking fees â Naming rights Tolls from partner agencies Innovative finance â TIFIA â RRIF â State infra. bank â Tax credit loans Via a P3 delivery mechanism â Private activity bonds â Availability payments â Private equity Note: TIFIA = Transportation Infrastructure Finance and Innovation Act. Table 11. Transit funding sources and financing mechanisms.
40 Guide to Value Capture Financing for public transportation projects Because real estate markets are highly cyclical and the marketsâ absorption of new real estate projects can be fickleâespecially when the developments are somewhat innovative or are higher priced than comparable real estateâcredit rating agencies have traditionally been cautious about assigning an investment-grade rating to infrastructure projects dependent on new real estateârelated revenues such as TIF bonds. The business cycle poses a key risk consideration for developers and, in some instances, transit agencies and local governments. Credit rating agen- cies feel more comfortable assigning investment-grade ratings to projects that are supported by existing revenue, such as the financing associated with the Dulles Metrorail special assessment district in the Washington, D.C., area (see Appendix G). For example, the City of New York helped to finance the 7th Avenue Rail Extension project using a structure based on the tax increment revenues from the Hudson Yards development project. The City of New York pledged to cover the interest costs for the life of the bonds if rev- enues proved to be insufficient and with its obligation being absolute and unconditional, subject to appropriation. Moodyâs assigned an âA2â credit rating, which was three notches lower than the cityâs general obligation rating of âAa2,â reflecting the need for annual appropriation of the cityâs interest subsidy, the nature of the project being financed, and volatility in New York Cityâs real estate markets that could delay development in the Hudson Yards area (Moodyâs Investor Service, 2011). Knowledge of the criteria applied to the rating of debt issued by or on behalf of U.S. state and local governments is useful for understanding how ratings agencies view state and local debt. Fitch Ratings outlines five key drivers of its state and local ratings (Fitch Ratings, 2016c): 1. Overall sector risk: The starting point for analysis of U.S. state and local issuers is the recog- nition that all operations are within the United States. 2. Foundational economic analysis: Issuer-specific analysis begins with consideration of the performance, trends, and prospects for the economic base, which could apply to states, local governments, transit agencies, and so forth. 3. Four key factors: Fitch Ratings identified four key ratings factors that play a significant role in driving the rating outcome for a given issuer in the context of its economic baseârevenue framework, expenditure framework, long-term liability burden, and operating performance. 4. Performance through economic cycles: Fitch Ratings creates scenarios that take into consid- eration how a governmentâs revenues may be affected in a cyclical downturn and the options available to address the resulting budget gap. 5. Strength of the pledge: The ultimate bond rating reflects the strength of the pledge. Ratings are assigned to specific securities based on their legal provisions and relationships to/separation from the general credit quality of the related government. This is expressed through an issuer default rating. 6.3 Innovative Finance Some federal and state programs can be advantageous for value capture financing, including: â¢ The TIFIA loan program administered by the U.S. DOTâs Build America Bureau; â¢ The RRIF program, administered by the U.S. DOTâs Build America Bureau; and â¢ State infrastructure banks, which are managed by many state governments. While each program has its own lending criteria, common to TIFIA and RRIF are their attractive terms, including: â¢ Below-market interest rates, usually reflecting the cost of borrowing to the federal govern- ment or the state; and
Creditworthiness, Finance, and Funding 41 â¢ Below-market repayment terms allowing for longer periods of interest capitalization, more flexibility and greater back loading of repayments, and longer duration. As shown in Figure 15, the TIFIA principal is paid back after senior debt service and corresponds to the shape of the net cash-flow line. For some projects where the early year ramp-up or real estate absorption is uncertain, these instruments can provide cash-flow relief. The TIFIA program requires that if a borrower is financing a project with the same revenue pledged to secure both senior debt2 (such as a tax-exempt bond) and a subordinate TIFIA loan, then the senior debt must be investment grade. Due to TIFIAâs âspringing lienâ structure, which forces TIFIA to âspringâ to the senior position following two bankruptcy-related events, credit rating agencies rate both senior and TIFIA debt at the same priority position, and therefore both debt instruments must be investment grade. While value capture financing can take advantage of features within TIFIA to accommodate uncertain cash flow resulting from the vagaries of real estate markets, its utility is limited by requirements that such cash flows be highly reliable or subject to a backstop. Where financing is dependent on TIF, joint development, or impact fee revenues related to new development, a backstop or other mitigation of real estate market risk may be required. As discussed previously, sales taxes provided such a backstop for Denver Union Stationâs senior debt, and the City and County of Denver helped support the subordinate debt to realize the transaction. More information about how this mechanism worked, and the stacking of TIFIA and RRIF, can be found in the Denver Union Station case study in Appendix C. Special assessments imposed against real estate assets with a track record of producing similar assessment revenues may not require an additional backstop. As more TOD projects are developed and credit markets become more comfortable with them, lenders may accept more real estateâ based risk. Impact fees and negotiated exactions have been financed with private placements or nonrated bonds, sometimes using the land as collateral (primarily for large master-planned residential projects). For instance, in 2015 the developer of a Dallas-area real estate development closed a $16.8 million nonrated bond to fund road and other improvements secured by property and funded by assessments (City of Celina, 2015). Note: DS = debt service. 0 50 100 150 200 250 300 2013 2018 2023 2028 2033 2038 2043 $ M ill io ns TIFIA Principal TIFIA Interest Payable Senior DS Net Cash Flow Available for DS Figure 15. Illustration of typical TIFIA loan cash-flow features.
42 Guide to Value Capture Financing for public transportation projects 6.4 FAST Act TOD Provisions for TIFIA, RRIF, and FTA TOD Pilot Planning Grant Program The 2015 FAST Act included substantive and procedural changes to the TIFIA and RRIF pro- grams. The U.S. DOTâs Build America Bureau is responsible for streamlining credit opportuni- ties and grants for transportation infrastructure development projects in the United States. As such, the bureau serves as a single point of contact for all programs and tools, including TIFIA, RRIF, and private activity bonds.3 Additionally, the FAST Act expands TIFIAâs and RRIFâs ability to support TOD projects, potentially enhancing value capture projects. It also extends the TOD Pilot Planning Grant pro- gram. The FAST Act expands TIFIA eligibility to include TOD-specific and local infrastructure projects. Subject projects can include parking garages, property acquisition, and bike/pedestrian infrastructure. In addition, the FAST Act lowers the TIFIA project cost requirement for TOD and local infrastructure from $50 million to $10 millionâmaking smaller projects eligible. This is particularly useful for smaller cities, which typically have smaller-scale, lower-cost projects. The FAST Act also reduces application costs for low-cost, low-risk projects, including $2 million in annual grants to help defray these costs for smaller projects (Smart Growth America, 2015). The FAST Act extends the range of RRIF-eligible infrastructure as follows: (Sec 11604) (E) finance economic development, including commercial and residential development, and related infrastructure and activities, thatâ (i) incorporates private investment; (ii) is physically or functionally related to a passenger rail station or multimodal station that includes rail service; (iii) has a high probability of the applicant commencing the contracting process for construction not later than 90 days after the date on which the direct loan or loan guarantee is obligated for the proj- ect under this title; and (iv) has a high probability of reducing the need for financial assistance under any other Federal program for the relevant passenger rail station or service by increasing ridership, tenant lease payments, or oth- er activities that generate revenue exceeding costs (United States Government Printing office, 2015). The FAST Act also extends the TOD Pilot Planning Grant program, which supports planning around new transit investments and includes efforts to create or preserve affordable housing. As of 2016, the pilot program has funded $19.5 million in TOD project plans, ranging from streetcar projects to station-area TOD plans to bus rapid transit station planning (FTA, 2015). Creation or preservation of affordable housing near TOD, as the FAST Actâs TOD Pilot Planning Grant program supports, is a public policy objective that can be hindered through the value created by public transit or helped if value capture is applied to address affordable housing needs. The very value creation that can be induced through infrastructure investment can exacerbate already sub- stantial economic challenges related to affordable housing. The fundamental problem of workforce and affordable housing is that the cost and market value of high-quality housing in appropriate locations exceed the ability of tenant/owners/occupants of that housing to pay for it without an undue and inappropriately high (rent) burden. The value capture opportunities addressed in this guide exist because investment in transportation infrastructure can induce value creation in the marketplace. The nature of such value creation elevates market values and raises housing costs. As such, communities that desire to preserve or create affordable housing opportunities near transit need to make use of public policy tools such as inclusionary zoning, tax credits, streamlined reviews or permitting, and federal tools such as the FTAâs TOD Pilot Planning Grant program. Some value capture mechanisms have been used to directly address affordable housing. For example, the Transbay Redevelopment Plan associated with the San Francisco Transbay Terminal project specifically outlines creation of affordable housing as part of its objectives. The Transbay
Creditworthiness, Finance, and Funding 43 project is partially funded through a tax increment. A portion of the tax increment is allocated to pay capital costs for the Transbay Terminal, while the rest is used to address other needs, includ- ing affordable housing. Specifically, $126 million of the total tax increment will fund afford- able housing activities within the Transbay Redevelopment Project Area (San Francisco Office of Community Investment and Infrastructure, 2016).4 6.5 PublicâPrivate Partnership Financing Developers can directly finance a transit project through a P3 project delivery structure. In a P3 delivery structure, private developers enter into a long-term concession agreement that allows them to design, build, finance, operate, and maintain the facility. In return for receiving payments from the public project sponsor or revenues associated with the project, developers finance some or all of the capital investment using a combination of debt, including senior private activity bonds (a form of tax-exempt financing authorized by the U.S. DOT and TIFIA loans) and equity. The P3 approach has been used for several transit projects, including the Denver Eagle P3, a commuter rail facility connecting Denver Union Station with Denver International Airport. Within transit projects, the P3 developer typically receives availability payments as its revenue source. Availability payments are payments made to a P3 developer by a public project sponsor (e.g., a state DOT or transit agency) based on project milestones or facility performance stan- dards in exchange for particular services. Availability paymentâbased P3 structures are typically used for transit projects due to the fact that typical revenue streams associated with transit proj- ects, such as fare-box, advertising, and station concessions, are not attractive enough to offset the high capital costs associated with designing, building, financing, operating, and maintaining transit facilities.5 Formal P3 structures have not typically been employed for the real estate development por- tion of value capture projects. In the case of Denver Union Station, a developer served as the master developer but was not the entity responsible for station and infrastructure construction loans. Rather, the developer was focused on the development of adjacent residential and com- mercial property. One exception is All Aboard Florida, the developer of MiamiCentral, the Miami terminus of a private intercity rail line between Miami and Orlando. All Aboard Florida will develop both the stations and the real estate along the line. An important fact is that All Aboard Florida is a subsidiary of Florida East Coast Industries, which has been the owner of most of the rail lines and adjacent property for over a century, using it primarily in the last decades for rail freight (All Aboard Florida, 2016). A developer could conceivably enter into a P3 with a transit agency or local government to finance a transit project that would be supported by value capture revenues, providing equity or corporate credit to serve as the financing backstop. The Bechtel Corporation was engaged in a version of that arrangement when it built the extension of the Portland streetcar to Portland International Airport in exchange for nearby airport land that could be developed for commer- cial purposes as partial compensation (TriMet, 2016).