Financial, Economic Crisis Tightened Funding, Credit for Public Transit

[IMAGE]Financing.jpg[/IMAGE]Although it will take several years to adequately examine the impact the economic and financial crisis had on the public transit industry, the American Public Transportation Association (APTA) asked Jeffrey A. Parker & Associates Inc. (JPA) to conduct a study on its immediate impact.

"At the time the report was commissioned we were in the throes of the financial meltdown and AIG's demise was triggering technical default on a number of sale-leasebacks and other public-private transactions," explains Cliff Henke, member of APTA's Business Member Government Affairs Committee, who adds that Sharon Greene, both the chair and a private financial analysis expert, saw the situation as one in which the BMBG could help Congress understand the implications for transit.

Begun in the wake of the collapse of AIG and prior to the release of American Recovery and Reinvestment Act (ARRA) funds, the report, "Impacts of the Financial Crisis on the Transit Industry: Challenges and Opportunities," serves as a "snapshot in time" as of early 2009, according to Jeff Parker one of the writers of the report.

"It does give you a sense of the magnitude of the disruption that we faced about six, seven months ago," he says.

Researched credit market

To write the report, JPA researched rapidly-changing credit market conditions, identifying the concerns of private sector partners, and conducted interviews with senior management from large and small transit agencies, the Federal Transit Administration (FTA), investment banks and rating agency analysts to gather perspectives on the evolving capital market situation. The 15 public transit agencies serve more than 50 percent of all U.S. transit ridership and include San Francisco's Bay Area Rapid Transit District, the Los Angeles County Metropolitan Transportation Authority and New York's Metropolitan Transportation Authority.

Parker explains that because the market was in such a state of upheaval, it was difficult to discern trends or indicate what the future would hold. JPA had to change the results of its analysis and conclusions on an almost daily basis.

"We eventually had to freeze the report at a certain point in time and just say 'here's the way it was as of this date,'" he says.

One of the report's key observations was that the repeated financial shocks and ensuing economic recession, at that time, broadly impacted public transportation by shrinking funding sources and tightening credit, particularly in the bond market.

Because of those conditions, some public transit agencies delayed issuing significant amounts of debt or stopped engaging in complex financial transactions, thus limiting the impact of market disruption on their capital programs but constraining investment expenditures.

A number of transit agencies took advantage of the relatively cheap credit available in the pre-crisis years to create more capital investment money by applying "creative financing strategies," including complex tax-advantaged lease transactions (SILO/LILO) and/or debt products built on lower, short term interest rates and "sculpted" principal repayments that anticipated future revenue growth.

"It is virtually impossible to generalize about the public transit industry in the U.S.," says Parker. "There are enormous differences in size, complexity and in institutional arrangements. There is also tremendous variation in their sources of funding, organization and the geographical impact of the economic recession."

For those agencies that had used creative financing strategies, many were impacted by the fall of AIG, as well as other insurers, and the inability of alternative guarantors to step in to provide back-stops for LILO/SILO and variable rate transactions. Sudden gridlock in the credit markets created financial constraints that impacted agencies using these techniques, with effects that are still being unwound in some cases. Parker explains that these tools made sense at the time and were perceived as prudent risks until the "merry-go-round stopped."

Despite these events, as well as the erosion of dedicated tax revenues, transit agency credit ratings remained stable because of their use of a "gross revenue pledge," which takes the first revenue dollars off the top for debt service. This results in large debt service coverage and allowed transit agencies to maintain access to the bond market.

"The impact of downturns in revenue falls heavily on the operating budgets of agencies that have extensive amounts of debt outstanding," says Parker. "You will see some systems, such as the Massachusetts Bay Transportation Authority, that are facing some of the most serious downturns in dedicated tax revenues in recorded time and, yet, they still manage to maintain good credit ratings."

Parker adds that the impact of decreased dedicated tax revenues and gross revenue pledges impedes transit's ability to maintain services at current levels. Recession-related job losses also reduce ridership and farebox revenues, increasing subsidy requirements.

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Supplier impact

Also studied, yet more difficult to compile information on, was the serious impact of the economic and financial crisis on industry suppliers.

"Obviously from our ability to interview suppliers, you're not going to get companies that are going to come forward and tell you that they can't get their working capital lines of credit renewed and were going to have to close their doors," says Parker. "That is not a great marketing story to tell people."

Parker adds at the time the report was undertaken, well-established companies were having difficulty getting their lines of credit renewed and facing higher borrowing costs because of the financial and economic crisis. Difficulty securing working capital is especially challenging for rolling stock suppliers, who ordinarily receive payment for services on delivery or in the form of milestone payments. Having to finance their "work in progress" at higher cost and under stricter terms, made it more difficult for them to bid on new contracts.

"If their lines of credit are reduced, then suppliers have difficulty supporting the orders that they have," adds Parker.

The other major constraint on suppliers, the report found, came from a perceived rationing of capacity in the surety bond markets. The result was to make it more costly and sometimes impossible for suppliers to meet traditional bonding requirements.

"The whole assessment of risk and the amounts of surety available changed quickly," says Parker. He adds that because many of public transportation's established securement practices evolved over 100 years, it is challenging to turn them around quickly in response to the market disruption events that we have had. In cases where owners were unable to modify surety requirements, the number of bidders may have been reduced for transit procurements.

Future solutions

The impacts of the financial and economic crisis noted in JPA's report, demonstrated that "creative financing" could no longer be counted on to fill gaps in the transit industry's capital programs. The report recommends that the way to help lessen the effects of future episodes of capital market disruption is to increase cash-funded investment in public transportation at the federal level. With many states and local budgets impacted by revenue shortfalls, federal leadership becomes increasingly important.

"There is a need to define what we're trying to accomplish, in terms of system preservation and capacity expansion, and then to make sure it is adequately funded," says Parker. "We were able to hide that gap for a long time with creative financing and now those opportunities are far reduced. It is going to take real money to build transit's future."

The JPA report calls for structural reform within the industry itself to devise new service delivery strategies that reduce subsidy requirements, address pension and other legacy costs, improve self-generated revenue yields and target subsidies to those riders who are most in need. It also stresses that the economic situation creates the opportunity to discuss new models and fiscally sustainable service expansion opportunities to meet growing demand.

Further recommendations called for the federal grant-making, procurement and administrative processes to be simplified and reformed to enhance efficiency; reduction of planning cycles and project execution times to cut costs and increase service and investment; and introduction of new approaches to contracting and performance guarantees that reflect current market realities, to ensure adequate competition and reliable project delivery.

Additionally, the report makes several recommendations to assure responsibly-managed transit agencies credit access during time periods of market disruption, including:

• Expanded use of the TIFIA loan program, possibly for up to 80 percent of transportation projects costs for senior borrowing for public entities, as well as the RRIF loan program for 100 percent of eligible capital project costs;
• Over time, new federal credit mechanisms, such as an infrastructure bank or a federally-mandated municipal bond insurer, could provide similar support and stability; and
• New strategies to open municipal infrastructure to investment from pension funds and other long-term taxable fixed income investors that do not participate in tax exempt debt markets in order to broaden the pool of capital available.

Interestingly, the success of Build America Bonds, created under federal financial recovery legislation that has occurred subsequent to publishing the report, has addressed several of the needs identified in the recommendations above, according to Parker.

Finally, the report stresses that greater attention be given to downside risks and getting "back to basics" in finance policy; that financial planning models built upon expectations of increasing revenues be tempered to preserve life-line services during economic downturns; and greater visibility in transit agency debt policies for net revenue debt service coverage tests that accord higher priority to preserving everyday operations.

Continuing economic softness still affects the public transport sector, notes Parker: "Housing is down, vehicles sales are down - these critical pieces of the sales tax base remain depressed. In public transportation, ridership is heavily correlated with employment and, as long as we continue to see job losses, it's going to take its toll on fare revenues and the ability of transit systems to raise fares to keep up with growing operating expenses."

Adds Henke: "At least in the short term, more funding of operations and maintenance is necessary to get states and cities through their budget crises. If not, it primarily represents a lost opportunity for transit to help meet all the challenges we face: sustainable economic growth, energy insecurity, climate change, etc."

Despite the number of hurdles that are stacked up against public transportation, Parker feels that the industry's ability to compete with the large number of industries and programs that are also in dire need of federal dollars is very strong, because of ridership increases in recent years and transit's ability to mitigate some of the impacts of sudden spikes in energy costs, which can happen again at any time.

"In addition to that, the Obama administration really seems to have a commitment to high-speed rail and there is no sense in building a high-speed rail system in this country if we can't connect to good mass transit systems in the major urbanized areas," says Parker. "All of these positives are of a larger piece, and I am optimistic that transit will become a major growth industry in the next 10 years."