VIEWPOINTS
Debt Debate: Bailing Out the 73 Toll Road
The board of the Transportation Corridor Agencies is expected to decide Thursday whether to proceed with a controversial, staff-recommended, $3.9 billion bailout of the financially struggling San Joaquin Hills (73) Toll Road. Last week a board committee rejected an alternative plan offered by County Treasurer-Tax Collector John Moorlach that would give the Foothill/Eastern (241, 261 and 133) Toll Roads an option to acquire the 73 and avoid new financing. The board kept alive a similar alternative plan by Supervisor Bill Campbell, calling for Foothill/Eastern to make a loan to the 73. Walter D. Kreutzen, TCA’s chief executive, makes the case for the $3.9 billion refinancing.
Stop the Gravy Train
By John Moorlach
So they plan a toll road and sell tax-
exempt bonds to build it. The projected toll revenues will be used for administration and debt payments. But actual revenues don’t meet the projected revenues. Fortunately you can issue bonds again to pay off (defease) the first borrowing and stretch out the new payments in accordance with updated revenue forecasts. But you can only do this once with tax-exempt bonds.
Now you find that the second set of projections also were overly optimistic. So what do you do? Form a buyer of the toll road and issue new debt. And, if the third projected revenue forecast is too high, then you can borrow one more time. If that doesn’t work, we have a recipe,find someone else to merge with and repeat. At this rate, you’ll never pay off the construction debt.
Whatever happened to measure twice, cut once? This is a toll payer’s nightmare, but a bond underwriter’s dream come true. I get the sense they’re probably thinking, “The boilerplate is in place, let’s make easy money.” This time the proposed TCA merger and $4.1 billion refinancing will generate some $50 million in fees.
It’s time to stop this compulsive behavior and deal with our toll road issues head-on (pun intended).
Let’s assume that the Foothill-Eastern Toll Road board chooses to cooperate with the San Joaquin Hills Toll Road board.
San Joaquin projects net revenues between July 1, 2003 and June 30, 2036 of $3.6 billion. It has debt service commitments for the same period of $4.7 billion. With the availability of debt service reserve funds of $0.2 billion, it needs $0.9 billion to pay off its bondholders in a timely fashion.
Foothill-Eastern, on the other hand, projects net revenues for nearly the same period, ending June 30, 2040, of $8.2 billion. Its debt service commitment is $5.9 billion. That leaves $2.3 billion of available cash, so a transfer of $0.9 billion is manageable.
You can now see why I have provided a bona fide proposal to shift the $0.9 billion from one toll road to the other. Supervisors Campbell and Norby have submitted similar proposals.
What response do we get? “We trust our consultants!” Reminds me of what former Supervisor Riley said about his then-Treasurer Citron, “I don’t know how in the hell he does it, but he makes us all look good.” At his final board meeting, Riley would quote Governor Reagan, who appointed him, with the sage advice of “trust, but verify.”
Although we have to maintain good working relationships with bond underwriters, perhaps this gravy train needs a serious dose of verification.
So what are the presumed flaws in the alternative proposals raised by the critics?
The first is the concern about financing the Foothill-South extension. Please, if current bondholders are being paid, then I believe new financing is a slam-dunk. And it would probably have higher credit ratings, thanks to a positive track record before issuance.
The second is a potential Internal Revenue Code Section 1001 positive-arbitrage cost of $30 million. Please, its application is doubtful. But its implementation is less costly than the projected $50 million in underwriting and related fees to do the refinancing.
The third concern is that legislation may be required to consummate the alternative proposals. There are legislators hostile to more roads on remaining open spaces that want to prevent the Foothill-South extension from being built. Please, a refinancing will prevent this? No. Legislation of this nature will happen regardless.
The fourth concern is a covenant in the original indentures that requires a coverage ratio of 130%. (Toll revenues should be 30% greater than the amount of the annual debt service.) My proposal will not meet this requirement for the proposed Foothill-South for 17 of 32 years from 2008 to 2040. However, for eight of those years, the coverage is 120% or more. Please, this can be mitigated.
What happens to the other 30% of toll revenues? It goes in the bank and accumulates every year. Why not use this growing balance to meet the coverage ratio test? Because some bright Wall Street lawyer drafted the bond indentures to exclude this significant pot of money! Stupid. And also can be mitigated.
Which brings us to the last concern on the difficulty of amending the bond indentures. Please, if we show the bondholders that we have satisfactory funds to pay their bonds in a timely manner, won’t they consent to the amendment? Sure they would. Will the bond insurer? Maybe not, it would prefer another $110 million premium, even though the three alternative proposals show them not losing a dime on their original insurance coverage. So why give them free money?
Now we’re up to $160 million in new fees. And the county and cities are looking at potential layoffs? It gets worse.
The additional years of debt payments result in another $2.8 billion in tolls to be paid. We’re paying $3 billion for the underwriters’ proposal! The TCA can solve its current cash flow concerns without having to take on more debt to get out of debt. And we can wake up from a bad dream.
The Best Solution
By Walter D. Kreutzen
Orange
County’s toll road agencies are at a crossroads that undoubtedly will influence the future of transportation financing. The issue isn’t whether consolidating Orange County’s two toll road agencies makes sense. Most people see the logic of having one agency, not two, operate the toll road system. The issue has been figuring out the best way to do it.
In 2002, after attempts to increase toll revenue and refinance the debt, the San Joaquin Hills Agency, which operates the 73 Toll Road, began a comprehensive analysis to find all possible ways to establish long-term financial stability. The looming reality was clear,find a long-term solution, or face the second largest municipal bond default in history.
Consolidation with its sister Foothill/Eastern Agency was determined to be the most viable alternative, and both agencies studied the concept further.
After two years of analysis, toll agency staff, legal and financial consultants and two independent financial advisory firms hired by the boards recommended a financial plan that calls for a third entity, the Transportation Corridor System, to issue approximately $3.9 billion in new bonds to acquire the two agencies, then use the money to effectively pay off the agencies’ existing $3.9 billion in debt.
The plan makes sense on a number of levels. Historically low interest rates will cut long-term debt costs to the tune of $600 million for both agencies and by an estimated $100 million for the Foothill/Eastern Agency alone. Tolls will not increase more than already planned, and in fact, toll rates at some locations on the 241 will be lower than originally scheduled. The plan also creates healthy reserves and protects against future revenue declines by assuming a much more conservative growth rate than previous forecasts.
Critics of the recommended acquisition plan say it’s too expensive. But when you look at the actual costs, nearly 70%, or about $140 million, is strictly for bond insurance,a cost that is offset by an estimated $330 million in savings. The second largest cost, to compensate those who sell the bonds and develop the finance plan, has been closely scrutinized. In fact, these fees are 40% lower on a per-bond basis over past toll road financings and make up less than 1% of the total transaction.
As any homeowner knows, the question to ask is: Are the costs reasonable? If you lower your monthly mortgage payment or pay off the debt sooner, then the benefits outweigh the costs. The $162 million in “fees” needed to close the acquisition plan is well worth the ability to save commuters an estimated $2.7 billion in additional tolls and $600 million in long-term debt costs for both agencies.
While the agencies’ directors are considering alternative plans that attempt to avoid such fees, the most recent analysis shows that, even assuming a number of legal and tax hurdles could be overcome, the end results are higher debt service costs, billions in additional tolls and the delayed construction of millions of dollars of transportation projects that improve regional mobility.
The recommended plan to consolidate the agencies wipes the slate clean and solves a structural debt problem that burdens the 73 Toll Road. It puts both agencies on more solid financial footing to complete the 241 Toll Road and to build much needed future interchanges to accommodate Orange County’s changing landscape.
The plan isn’t perfect, and there are many challenges that must still be overcome. But it is the least expensive solution available now to avoid the inevitable default of a local public agency in Orange County.
Without this innovative financing model, the 51-mile toll road system that takes 280,000 cars per day off our freeways and city streets simply wouldn’t exist. Let’s not wait and see how a default will hurt Orange County. Let’s act on a solution that allows us to pay off our debts and complete the toll road system without burdening drivers with decades of unnecessary debt and tolls.
