GPM First
Chapter 33 of The Principles of Project Finance (978-1-4094-3982-0) by Rod Morison

Fixing US Infrastructure


John Sellers, a Principal

Yavapai Regional Capital Inc

Over the very same 30 years in which the US economy slid into a level of debt to GDP approaching ratings downgrade potential, US infrastructure quality has deteriorated commensurately. Ironically, it was here in the US that the seeds of global privatization were sown in the power industry in the early 1980s following the passage of PURPA. This promoted private sector competition which sponsored a global revolution in electrical generating infrastructure. Different observers have different definitions of infrastructure, but as considered here, we’ve excluded the power sector because of its relative efficiency but included transportation systems (highways, roads, air, water, and rail), water utilities, and some other kinds of public facilities (schools, postal facilities, and prisons). In the US Mountain West where we operate, there are also some infrastructure components that are somewhat special, such as flood control and dams, which have also been largely neglected.

The Seeds of the Problem

Unfortunately, with over 30,000 municipal issuers, the efficiencies generated in the utility sector never materialized in the highly fragmented public sector. The US dollar, as reserve currency, promoted complacency. House prices would rise forever, impact fees would never disappear, people would continue to move westwards and pay ever-increasing house prices that filled state and local coffers. The US political system simply would not tolerate change because the very same public employees who benefited also had sway via their unions over politicians and hence significant control over negotiating their own pensions. The myth was perpetrated that tax-exempt debt always produced cheaper financing. The background to all this was that generally apathetic US voters was far too busy buying electronics and boats to notice the managerial and financial decay of local government, and certainly not astute enough to notice the build-up of the now ticking time bomb: Public pensions. The result was highly inefficient government combined with an infrastructure financing system that never could keep up with what was needed to compete globally and in many cases, couldn’t even provide necessary maintenance.

We now recognize that the needs are enormous. The Society of Civil Engineers quotes a US$1.6tr need over the next five years merely to bring US infrastructure up to standard. We think the number is greater than that because unless you’ve witnessed it with your own eyes, the real needs are hard to comprehend. For instance, there are 14,000 water companies in the US – double the number of banks. Many regulate themselves and some represent real healthcare challenges and water utility black holes with understated renewal costs.

The 2008 Financial Crisis

As a result of the financial crisis, much has changed, although the dawning of the real problem has been death by a thousand cuts in the public sector. Early on, we wrote of the possibilities for rebuilding both the US economy and US Mountain States infrastructure using private capital. This was only weeks after the 2008 fiscal crisis, a ‘financial Pearl Harbour.’ Unfortunately, the denial at the time, much of which still remains in certain quarters, did not serve to douse the flames on the burning battleships or motivate the troops to load up with ammo and mobilize to fight the good fight. Instead, a lukewarm stimulus soup was spread unevenly over the embers, with little lasting effect other than more national debt and a lot of lethargy. This slow death is now creeping closer and can be felt by all.

Anyone familiar with international crises could see the pattern unfolding – and it did. Creditors are not stupid. After 30 years of filling the porous cheese of the American economy with every imaginable type of debt from overseas, the excess was sucked out with a whoosh overnight. It was replaced by the sound of the constant drip of the Fed pumping money into the economy – QE1 and QE2. Two years ago, expressing concern about the US credit rating was almost treason; today it’s conventional wisdom. To quote John Boehner: ‘The country’s broke.’

As expected, cities and states were to a greater or lesser degree ring-fenced by the credit markets, especially as the Greece-like, hidden off balance-sheet debt related to public sector pensions began to make news. Some still believe that things will be fine in the muni market; default rates are still low, so what’s the big deal? This is reminiscent of Walt Wriston’s famous adage in the ’70s that ‘countries don’t go bankrupt.’ He later modified that to add – they just don’t pay you back!

As bankers, we were taught to observe how countries fight wars to see how they deal with financial crises. For a nation like the US, used to relying on technology and overwhelming force, the analogy I like is the Battle of the Bulge. The air cover (Washington) has disappeared. It’s now hand-to-hand in foxholes. It’s inspiring to watch some public officials as they battle on without support from Federal or even State capitals, casting off shackles and taking initiative.

Unfortunately, in the intervening two years, not much has happened from a public private partnership (PPP) deal standpoint except the bankruptcy in San Diego of a private toll road. In hindsight, this was not a case of lessons to be learned but, instead, what were all the lessons and basic principles readily available at the time that were overlooked in the eagerness to do a deal?

This is not over and the doomsday machine is ticking in Washington.

Why the US is Lagging

The US is the obvious final market for private capital to make its mark in infrastructure, representing the last and biggest bastion to embrace public-private-partnerships. Why is the market not taking off? First of all, we believe it is although it is only apparent in small pockets of activity, some of the factors at work are:

Lack of Risk Takers

The shock of the financial crisis and the slow dawning realization that the stimulus did little is having a debilitating effect at all levels, individual, personal, business, and political, of course. Traditional American risk-taking and optimism has almost, but not quite, disappeared. This is most apparent in the financial sector. Seasoned bankers like us are astonished by the disappearance of the US banking industry as a credible, risk-taking system of intermediation between investors and borrowers. The culture of professional banking has been lost; a new generation of bankers will be needed to fix that, – the kind that don’t want to sit in front of a computer screen all day.

Public Finance vs Project Finance

Anyone familiar with the evolution of Export Finance into Project Finance in international markets will recognize the parallels between Public Finance and PPPs in the US.

Project Financing is the long-term financing of a project based upon the projected cash flows of the project rather than the balance sheets of the project sponsors or taxation revenues pledged by a government entity. Most commonly known as non-recourse loans, these are secured by project assets including the revenue-producing contracts, and paid entirely from project cash flow supported by financial modelling. Project lenders are given a lien on all of these assets, and are able to assume control of a project if the project company does not comply with loan terms. Usually, refinancing occurs post completion, which means that project finance is essentially a highly structured form of construction lending. Risk identification and allocation are key components. This business is much more about risk management than relationships.

Public Finance, on the other hand, essentially revolves around bonding on a long-term basis of various types of taxation revenues that a government pledges to lenders. The essential difference between project finance and public finance is the risk profile. With a few exceptions the bondholders of tax-exempt debt are insulated from the risks of project construction and completion. Public debt financing in the US is much more of a relationship business and depends on the ability of politicians to squeeze taxation revenues from their voter base which can then be securitized.

Although tax-exempt bonds produce nominally low rates because of tax benefits, it’s a little analogous to a private business being restricted to factoring its receivables. If you are a business or a city trying to beat the average growth expectations, you are denied financing markets such as equity and debt which want to pick winners. Would Google exist if it had relied on factoring its receivables?

The nirvana, of course, is to use private capital to finance and bring greater discipline to the construction cycle, then use nominal tax savings from tax-exempt debt as a takeout. This is achievable but requires some adjustment amongst financial players as discussed below. This also requires us to remember the lessons of the international arena. Traditional public finance and new PPP/project finance sources must collaborate – not compete.

The essential difference, difficult to explain to public officials, is the impact of behavioural change triggered by a new private, and very different, financing process. The risk profile with a project financed transaction is such that the finance is not simply a source of money but a whole new process of ensuring that construction is on time and budget. It’s an iterative process, with lots of balls in the air at once rather than slow linear steps, a process perceived as highly risky for public officials because it means taking decisions that are conditional–the ‘conditional waltz’ as we call it.

In the power industry, the effect that this construction financing discipline had on overall construction costs led to 40% savings. The effect will be repeated for PPPs, especially when private sector creativity can bring more efficient technology to solutions, dramatically reducing costs through innovation.

Lack of Project Finance Capability in US Banks

US banks led the charge into project finance lending in the 1970s. Any other country that has had an infrastructure boom has seen its banking industry first participate and then change and adapt, faced with what are usually large capital needs. This occurred first with UK banks with North Sea Oil in the 70s. The Australian banks followed in the 80s, as well as the Japanese, because of their mutual energy import/export situations. The same eventually happened with the European banks in the 90s to the point where those banks now dominate the lending market.

As a well-researched recent Standard & Poor’s study points out, US banks did the reverse. They engaged in a disastrous march out of this business in the 80s, abandoning a US$1.9tr asset class that project finance professionals knew deserved investment grade ratings. Project finance loans were much less risky because of the fundamentals of the due diligence involved. Over the intervening 20 years, this would have been a highly attractive business for US banks on a risk-adjusted basis. They preferred securitizing sub-prime mortgages instead.

The question now arises as to how to get US banks to re-enter the market, without offering subsidies, grants, or other incentives such as the relaxed capital or lending requirements that caused Fannie and Freddie to collapse. Put another way, how to avoid creating an ‘Infrannie’, either due to insufficient capital or moral hazard risk?

We have suggested to Washington that the results of this S&P study be pointed out more forcibly to US banks’ senior management and to regulators, so far without success. The emerging National Infrastructure Bank, now the proposed American Infrastructure Finance Authority (AIFA) can play a significant jawboning role here, well beyond its likely US$10bn of initial capital. In the meantime, we continue to plug away at the local level with regional banks, using projects as examples of good lending opportunities. With relatively lower capital requirements relative to large banks in the future, they are the natural motors of project lending.

Failure of the Existing Financial Institutions to Adapt

One of the best arguments for a National Infrastructure Bank is that there is no one existing institution that has the ingredients for success in the US infrastructure space. Even if we had such an institution, we believe it would have to be geographically organized along the lines of the Federal Reserve Board, with strong regional groupings connecting states with common needs into manageable blocks. We bill ourselves as a ‘regional infrastructure merchant bank’ for that very reason – tying in the common needs of the Mountain States.

This is best exemplified by the current financial actors with some, but not all, having the needed skill sets:

  1. Money centre banks – They have no real regional presence, retired from project lending years ago, lost their lending culture, and are only interested in securities intermediation. They are likely to be hampered by higher capital needs as they are deemed ‘systemic’ because their balance sheets exceed US$50bn.

  2. Regional commercial banks – They have great relationships, but are still stuck on how to build loan volume in their traditional markets of real estate, credit card, and retail lending. They are not ready for project finance yet and are more likely to expand their loan books by cannibalistic acquisitions.

  3. Public finance firms – They have even better regional relationships, especially for the regional firms because they have an immense client network of public officials. But in general, they are terrified of PPPs because, not only do they lack the transactional skill sets, but these very transactions require grappling with issues in potentially confrontational, complex negotiating settings. Being completely relationship-driven, they are fearful of the loss of bread and butter business this could bring.

  4. Foreign banks – These dominate the project lending business globally and in the US, but they have little or no regional presence. My own experience based in a Europe Head Office tells me their senior managements are also very fearful as to what happens to your risk profile when you step into a world they perceive as very dangerous – US state and local government.


We see serious consolidation opportunities here for public finance, project finance and regional commercial banks with balance sheets to come together. Otherwise, where is the loan growth?

Inapplicability of the Overseas Model

The US is different from the rest of the world, especially with its decentralized political and independent political system. It is shocking how few people understand state and local governments’ workings. With trust being in short supply across the board, there is a need for new models of mixed ownership for infrastructure assets and decision making, independent of politics, tailored to the unique features of the US market. At its core, this includes the special needs of transparency and ‘buy-in’ at the grass-roots level. Otherwise, deals will never close. What this means for seasoned international PPP practitioners is:

  1. Do not expect to win mandates in this business the old-fashioned way – in the local Ritz Carlton. It’s not going to happen. Be visible throughout the community. Some of the most creative work we do is with local officials in small offices designing some unique structures.

  2. Do not attend any east coast investment conferences where people lament the lack of deal flow – if you do, you are part of the problem.

  3. Get to really understand transparency and ensure via broad-based public outreach that project-affected officials and communities see you practicing it. An American who doesn’t know or trust what his government ‘is up to’ is an army of one who can kill local buy-in on anything.


The typical PPP model, where a government hires an adviser, runs a beauty competition, and then picks a winner with their financial model wrapped up in a bundled black box, is unnatural in American local politics. It’s like an arranged marriage. Take a lesson from the energy industry: think joint ventures.

Assume every government official is risk-averse. Give cover to those braver ones by presenting the compelling project benefits that their constituents will enjoy. You just have to spot and support the more entrepreneurial players.

Impact Fees

One of the most inefficient means of financing infrastructure in the US is impact fees. Essentially, private developers hand over money for government to build or improve infrastructure as a condition of private development approval. This has a couple of disadvantages in that costs are being loaded into house prices, which is fine if house prices and starts are growing. But it feeds public coffers with a revenue source that is ephemeral as it’s based on housing starts. Which banker would lend over 30 years based effectively upon a stream of real estate commissions? This is also not good for regional cooperation because the competition for those impact fees kills genuine regional cooperation for projects needing regional breadth. Governments may say that they play the cooperation game but privately, the knives are out competing with their neighbours for the impact fees associated with development.

A better system is for regional improvement districts or joint powers authorities that levy reasonable long-term user charges that then provide the long-term revenue base for longer-term financing. Arizona’s recent passage of HB2003 is a good example of this, proving that public officials are starting to understand this concept.

Sector Approaches

One cannot ignore sectorial differences in figuring out issues retarding project development. And there is no more contentious issue than the first of these in the dry Mountain State’s region in which we operate.

(i) Water

Putting aside the gorilla in the room, i.e., the severe underpricing of water because of lack of market pricing, the biggest impediment we have seen is the use of the word privatization. What has not been fully appreciated is the need for a true partnership in water – not an outright sale to the private sector. The model we like is to retain the public agency as the interface with the retail water users with the long-term infrastructure contract between the relevant City or Municipality Enterprise Fund and the PPP project entity. To keep the public counterparty creditworthy, of course, the long-term tariff structure to the retail users’ needs explaining. The good news here for retail users is that they have price certainty over say 30 years for their water. The bad news is that there is a need for price escalation, albeit not full CPI and certainly lower than some recent predatory increases from unscrupulous providers. This is analogous to persuading airlines to hedge fuel cost in the 80s. They would love to do it, but not be the first and certainly not the last, for fear of being a long-term more expensive place to live if somewhere else does not raise rates. On the other hand, try explaining that to the retail water users in Anthem, Arizona, who have been hit by violent water price increases that could repeat next year and the year after that, etc.

(ii) Transport

Transport is the big dollar driver of infrastructure and the sector most capable of creating jobs. In most states, it also is an often neglected means of achieving regional cooperation. Public officials will enter the room in a water context with daggers drawn. In a regional transport context, those same officials can be seen chatting over cocktails. Therefore, getting a really successful transport project off the ground in most states would be a huge impetus.

The issue we see here is not just the voter’s disposition against tolls. Most public officials secretly understand people can be persuaded to pay them if value for money is apparent. The issue is how to create this. The model we favour is not to import the traditional black box model where a beauty competition awards the winner the concession. We saw the perverse effects of that internationally when the World Bank relaxed its procurement competition rules for bundled PPP consortia concession bids. We prefer an open book, completely transparent model where each cost component is built up separately to generate the user charges. Then, even an unsolicited proposal might produce an offer that could not be matched. We are presently in the throes of testing this model with a Financial Model that was immediately made a public record – before award. So far it’s working. A couple of prerequisites are to make sure every potential player understands there are no cozy deals, and a first-rate detailed financial model that tells you instantly the effect on financeability of on-going contract award and pricing decisions.

There is No Seed Capital

The challenge, of course, is how to build the tsunami of projects to create jobs and remedy widespread infrastructure weakness. You need an earthquake to start a tsunami, but when government has no money, who will kick-start initiative and seed the initial investment? Without that, the result is a blocked pipeline that cries out to be unblocked. The textbook tells you that government backed by political will needs to seed the early stages of a project. The problem is this seed capital is simply not available and is unlikely to return any time soon, if at all. There is a gap in the market need to finance the revolution that is coming. To finance this, we at Yavapai Regional Capital decided we must help create a new investment asset class, effectively infrastructure venture capital. A relatively few dollars can kick-start projects where return-hungry, conflict-free investors co-invest alongside local investors and governments ready to contribute their own value-added time. In the latter case, if you’re looking for political will, we believe this government sweat equity meets the political will test and frankly it’s all that’s on the table.

This is not a financing structure for the faint-hearted, but investors bemoaning inadequate returns should delight in it. Why would you expect superior returns financing the sale of an existing infrastructure asset, where by definition the goal—to maximize the sales price – works against your return? Early-stage development equity can control new builds with new cost paradigms and efficiencies. This can generate competitive user charges that consumers might find impossible to refuse. If users actually want the product, investors should think of these as attractive assets from a risk standpoint.

The major risk to private development equity will be local political risk. But internationally, we found ways to split commercial/political risk and insure the latter. If we can do that in the US, by getting governments to self-insure the political risk, i.e., insure themselves, who would not invest, if the economics look sound?

In short, these modest investments in new projects, where the cost savings achieved from the start assure users of competitive charges, can bring venture capital returns over the same short two-year time horizon, and in the process, unblock the pipeline.

A National Infrastructure Bank

With the re-emergence of the National Infrastructure Bank as AIFA, Washington appears decided for once to concentrate on something that the market can’t easily supply: project finance debt, commercial bank style. In so doing, it will push private project development to the forefront. Project professionals know projects carry on the way they start. Getting transparent, hungry, private development equity involved early offers the prospect of an early-stage, transparent, pork-free, consultant- and endless-studies-free (almost) environment. Bringing this no-nonsense project discipline will be revolutionary and the revolution is already here in the small pockets that always germinate them.

A Leadership Vacuum

First, there is absolutely no shortage of good projects – people are surfacing them. Some, having been on the drawing boards with insufficient money for years, represent basic needs, and therefore extraordinary opportunities. But the commodity in short supply is leadership. Where are those few Marines prepared to ride into the valley of death? The key is to find the winners. In the Mountain States, these are often the smaller municipal kids on the block, who are used to being the low guy on the regional totem pole. Elsewhere, be prepared for resistance from Dinosaurus Governicus, accustomed to regional dominance and ready funding. Some of these might never ‘get it,’ so it’s a case of picking the champions.

Regionality is also becoming more critical. When money was unlimited, everyone could have their own project and go it alone. Now, regional joint ventures are starting to take hold, because there is no alternative. These present a perfect opportunity to create the integrated, multi-community outreach programmes needed for up-front buy-in.

Despite the above, Arizona, Colorado, Nevada, New Mexico, and Utah, a ‘Mountain Mega’ as defined by Brookings and ASU, are experiencing some of the fastest growth anywhere in the US. They have a vision, and these states could associate with huge regional investment ramifications.


Two entrepreneurial politicians were seen recently separately ‘riding into the valley of death’ in the press on the same day championing farsighted infrastructure developments. Winston Churchill said, ‘The US eventually gets it right.’ We’re amongst those who still believe that. The US is eventually going to realise that with 14m unemployed, US$14tr of government debt and US$2tr of corporate cash on the sidelines, private capital is going to be used to fix jobs and infrastructure without adding to the deficit. Betting against the revolutionaries we see moving projects forwards in a new way is effectively betting against the American psyche. Who’d take that bet?

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