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U.S.'s infrastructure future

by contributor Bill Sprague, Gruppo Levey | Published February 13, 2012 at 1:23 PM

Remember the federal stimulus program of 2009 that funneled billions of dollars to "shovel-ready" projects to help upgrade this country's crumbling infrastructure? How much of those funds were actually spent and whether that money was spent wisely is for others to decide, but there is still much more to be done. According to a recent study by the Urban Land Institute, in the next several years the United States needs to spend more than $2 trillion to rebuild infrastructure, including bridges, roads, water lines, dams, schools and sewage treatment plants. And even that total ignores the funds needed for new construction.

With the federal government in the middle of a budget crisis and state governments clearly without the resources to write the checks to pay for the necessary repairs, let alone prepare for the future, just what does the future hold? New York Gov. Andrew Cuomo in an op-ed piece distributed to newspapers around the state in December hinted at a viable solution when he called for creation of the New York Works Initiative. A proposed investment partnership, in part capitalized by funds from the state pension funds, would "promote innovative public-private partnerships with business and labor" to finance repair and development of the state's ailing infrastructure.

Increasingly, it appears that such public-private partnerships will become a popular alternative to typical municipal bond underwriting. Such an approach makes sense when considering how cash-strapped state, county and local governments are. With both employment and consumer spending down, income and sales tax revenues are at all-time lows, and no one truly believes that they will increase in the near future. There also is reluctance among governments -- and taxpayers -- to increase municipal debt. Issuing municipal bonds is undesirable right now because of the requisite public hearings and the fear of harming credit ratings.

Today, when going to voters for authority to issue bonds, the answer is often no. Last summer, Nassau County, N.Y., voters rejected the bond approach to finance construction of a new sports arena, even though the outcome of such a vote may be the loss of the local hockey team, the New York Islanders. Even sports teams are not immune to these trends. In addition, states' initiatives to hold the line on tax increases, such as New York's legislatively imposed 2% limit on property tax increases, serve as a disincentive to using general credit.

The private sector is in a bind as well. Utilities companies, for example, must upgrade electric grids, yet they too are hesitant to tap their debt capacity because of the potential impact on their credit ratings. Raising equity capital at depressed levels is also unappetizing. Creating liquidity by tapping into the value of their physical assets is one alternative that is being explored by an increasing number of companies.

Among the main providers of capital, the investment mindset has changed significantly in the aftermath of the financial industry's collapse. As recently as 2005-2006, double-digit returns were the expected norm, and selling deals for short-term results trumped long-term risk assessment.

Today the pendulum has swung back, and investors are closely scrutinizing the risk-reward characteristics of every investment opportunity. While investors still want high returns, today they are much more likely to trade higher returns for investments in more stable long-life assets, where they do not have to worry about taking reinvestment risks every two years.

A solution here is to use pension assets to build, invest in or acquire infrastructure assets. The investment characteristics of many infrastructure projects -- long life, low risk -- are appealing, especially to those investors who have comparable long-life liabilities that they need to match. Infrastructure investment can be beneficial to more than just pension fund managers. Consider insurance companies, colleges, universities and wealthy individuals seeking low-risk assets with returns for the next 20 years. The key is matching investment opportunities with the right private capital sources.

California Public Employees' Retirement System, which has $225 billion in assets, for instance, recently committed to invest up to $800 million into the state's energy-related infrastructure over the next three years. In Canada, the Caisse de dépôt et placement du Québec, a large fund manager of mainly Quebec public and private pension and insurance funds, recently bought a 17% stake ($850 million) in the United States' largest refined petroleum products pipeline, Colonial Pipeline Co. In England, Britain's Chancellor of the Exchequer George Osborne is asking pension funds to contribute £20 billion ($32 billion) or more to U.K. infrastructure projects over the next 10 years.

The pressure to find alternative financing for companies, states, counties and cities is only increasing. In Harrisburg, Pa., the city may be forced to sell its parking lots. In Illinois, the state privatized toll-road collections. Each corporation or government entity must approach its unique needs in its own best way, but it's clear that the future infrastructure requirements of this country will be met with the burgeoning of a strong system of public-private partnerships that matches the right capital to specific projects.

Bill Sprague is managing director at Gruppo, Levey & Co. responsible for capital formation, both private capital markets and structured finance.

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