Evolving Debt Finance Practices for Surface Transportation (2017)

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5 chapter one IntroductIon Background Transportation spending represents 8% of total expenditures by states. In 2015, transportation invest- ment by states grew 4%. The driving factor behind this growth was a 9% increase in state funds, which counteracted a 2% decline in federal funding. The Fixing America’s Surface Transportation (FAST) Act, enacted on December 4, 2015, provides modest growth in federal funds in the near term, but state funds will continue to be the primary source of funds for state transportation investment. State funds, including general funds and revenues dedicated to transportation (excluding bond pro- ceeds), accounted for 60% of total transportation spending in 2014; federal funds, 31%; and bond proceeds, 9% (National Association of State Budget Officers 2016). Although states’ share of the cost of transportation investment is growing, the total level of invest- ment is not sufficient to maintain the system in good condition or accommodate new capacity for growth. States meet transportation investment needs with a combination of federal funds, state taxes and fees, and general revenues. However, the primary sources of transportation revenue are federal and state motor fuel taxes. The federal tax is a per-gallon tax, and because of inflation and improved fuel efficiency standards, it is generating declining revenues with decreasing purchasing power. ASCE’s 2013 Report Card for America’s Infrastructure gives the nation’s roadways and transit a grade of D and bridges a grade of C+. Forty-two percent of America’s major urban highways are congested, costing the economy an estimated $101 billion annually in wasted time and fuel. In addition, one in nine of the nation’s bridges is structurally deficient, and the average bridge is 42 years old. Current investment is projected to result in a decline in conditions and performance. To improve conditions and performance of just the Interstates and National Highway System, FHWA estimates that a $170 billion annual capital investment is needed ($79 billion more than the current $91 billion spending level). In addition, deficient and deteriorating transit systems cost the U.S. economy $90 billion in 2010 because many transit agencies are struggling to maintain aging and obsolete fleets and facilities amid an economic downturn that reduced funding, forcing service cuts and fare increases. FTA estimates a maintenance backlog of nearly $78 billion to bring all transit systems to a state of good repair. FTA also estimates a $25 billion per year funding gap exists and is expected to grow. States are struggling to meet investment needs and face a new regulatory environment for debt management. The Dodd–Frank Wall Street Reform and Consumer Protection Act, passed in response to the financial crisis that began in 2007 and the Great Recession that followed, resulted in signifi- cant changes to the regulatory environment in which the municipal securities market operates. To implement the Act, the Municipal Securities Rulemaking Board (MSRB) and the Financial Industry Regulatory Authority (FINRA) established new rules to improve the fairness and transparency of the municipal securities market and protect state and local government issuers and investors. For example, the Dodd–Frank rules clarify the fiduciary duties of municipal advisors, require disclosure of reference price information for same-day principal trades, impose a best execution requirement for trades involving retail investors, and revise continuing disclosure requirements for issuers. These changes have placed added pressures on issuers of state transportation debt and require additional focus on debt management and compliance.

6 deBt Issuance for surface transportatIon Most states have a long history of issuing debt to bridge funding gaps and accelerate transportation infrastructure improvements. Eighty-six percent of states (36 of 42 survey respondents answering this question) report having outstanding debt obligations for transportation purposes, and 95% of states report the authority to issue debt for such purposes. However, among those states, the amounts and types of debt issued vary. Figure 6 shows the percentage of resources used for debt service as reported to FHWA, showing a 10-year trend across all states. The portion of available resources used for debt service remained relatively stable between 2005 and 2009 but has gradually increased in the second half of the decade, growing from 8% in 2005 to 12% by 2014. Chapter two of this report provides additional data on debt service across states. State debt issuance takes many forms, such as general obligation bonds, revenue bonds, project finance such as toll revenue bonds, and a variety of other federal and state debt mechanisms. Each form of debt has a different credit profile and thus a potentially different debt management approach. For example, project finance debt such as toll revenue bonds can be nonrecourse or limited recourse to other resources of the issuing entity. In such financings, the debt is repaid from the cash flow gen- erated by the project. With general obligation or tax-backed bonds, the success of the project may not be tied to the ability to repay the debt. In addition to conventional debt issuance (e.g., general obligation and revenue bonds) and project finance, a variety of other federal and state program debt mechanisms are used by states. These include: • Grant anticipation borrowing—The ability to securitize anticipated federal or state grant pro- ceeds to generate funds for capital outlays. These debt obligations are commonly referred to as Grant Anticipation Revenue Vehicle (GARVEE) bonds for highways and grant anticipation notes (GANs) for transit. • State infrastructure banks (SIBs) and other revolving loan funds (RLFs)—SIBs are lending organizations initially funded with a combination of federal and state funds. Loans from these capitalization funds are made to projects at low interest rates and flexible terms, with repay- ments recycled into subsequent rounds of loans. RLFs are similar to SIBs and exist in state gov- ernment to support state and local infrastructure investment. Initially, the term SIB referred to loan funds with some level of federal capitalization, but today the term is used more generically. • Federal credit assistance—Federal credit, provided through the Transportation Infrastructure Financing and Innovation Act (TIFIA) program and the Railroad Rehabilitation Infrastructure Financing (RRIF) program, provides direct loans (often on a subordinate basis with flexible repayment terms) and other credit assistance for large transportation projects with identified revenue streams. • Private activity bonds (PABs)—PABs allow private parties to issue tax-exempt debt based on the public purpose of the bond proceeds, subject to statutory limitations and eligibility provisions. • State and local finance mechanisms—State and local governments have developed a variety of finance programs to facilitate capital investment. Examples include long-term asset lease arrangements, loan guarantees, and availability payments (i.e., guaranteed or leaselike pay- FIGURE 6 Debt service as a percentage of total disbursements. Source: FHWA Highway Statistics Series Table F-2. Note: Debt service includes interest and bond retirement categories.

7 ments to private concessionaires or operators, sometimes supported by but not directly depen- dent on toll or other user fee revenues). These federal, state, and local financing programs have facilitated debt issuance and expanded the range of financing options available for certain transportation infrastructure investments. Such tools are companions to project delivery tools and trends, including but not limited to increased use of user fee-backed and project financing approaches, new institutions such as enterprises or regional transportation authorities, and the expanded but still relatively niche role of public–private partner- ships (P3s) and concession agreements to provide transportation infrastructure. The previously pub- lished report—NCHRP Synthesis 395: Debt Finance Practices for Surface Transportation (Henkin 2009)—introduced these topics, and the current synthesis expands the discussion. study purpose and oBjectIves This synthesis study updates and extends the 2009 NCHRP Synthesis 395: Debt Finance Practices for Surface Transportation. The current synthesis provides information on basic principles of debt issu- ance for surface transportation projects based on survey responses provided by state DOT officials. The expertise from the state DOT officials with greater debt issuance experience is summarized in a manner designed to be useful to administrators and elected officials in states and local governments who are less familiar with the nuances of debt-financing decisions. The goal of this report is to docu- ment practices and identify principles used by financial managers and debt-issuing authorities for when and how to use debt-financing techniques to fund investments in transportation infrastructure, including bonds, notes, loans, and other debt instruments from the capital markets, private banks, governmental entities, or any other source. The primary focus of the report is on the practices of state agencies with responsibility for sur- face transportation investment. Within that broad category, the report focuses on state DOTs that are responsible for highway and other modal infrastructure. Except as specified, the report does not include information on local debt issuance and includes only limited information on the debt issuance and practices of other state transportation agencies, except as reported by the state DOT representa- tives. Anticipated audiences for this report include state transportation agencies and public authori- ties, legislative oversight committees, relevant commissions, and other interested stakeholders, with a focus on senior state DOT managers who have financial oversight responsibility. study approach The underlying review for this synthesis was composed of the following activities: • Review of relevant literature, including the FHWA Highway Statistics Series. • A comprehensive survey of state DOTs (with the assistance of the AASHTO Subcommittee for Transportation Finance Policy) regarding debt issuance and management practices. Appendix A reproduces the survey questionnaire, and Appendix B lists the respondents. • Interviews with selected state DOT officials. • Review of selected states’ policies, guidelines, and documentation. The survey resulted in responses from 44 states. Although 44 states provided responses to some ele- ments of the survey, fewer states answered some questions. Throughout the report, the number of respondents for each question is provided. synthesIs report organIzatIon Following this introductory chapter, the report is organized as follows: • Chapter two: Use of Debt Finance for Surface Transportation—Provides summary information on the issuance of debt for surface transportation purposes, including who has the authority to issue transportation-related debt and where that authority is derived, whether from a statute,

8 state constitution, or other source. Purposes of debt issuance, types of debt and debt structures authorized, and formal and informal policies for issuing debt also are examined. • Chapter three: Special Debt Issuance and Management Topics—Reviews findings relating to the policies, principles, and guidelines currently followed by state transportation agencies (or other state entities with primary responsibility for issuing transportation-related debt) regard- ing emerging debt practices, such as contractor financing arrangements and P3s. This chapter combines information collected through the literature review and gathered through the survey of state DOTs. • Chapter four: Highlighted State Debt Practices and Policies—Incorporates findings from the literature review and survey relating to state practices and policies for decision making about debt issuance and debt management. The chapter focuses on practices specifically applied to surface transportation purposes and addresses general guidelines and principles applied by state government agencies to manage debt for a variety of public purposes. • Chapter five: Identified Research Needs—Highlights areas identified as potentially benefiting from additional research. The primary source of information for these findings is survey respon- dents, supported by the literature review. • Chapter six: Conclusions—Summarizes key findings, including the state of current practices and information on the state of research and opportunities for additional research. • Glossary of Key Terms—Provides a list of key terms used in debt-financing discussions both within the report and more broadly. • Additional Resources, References, and Links for State Debt Management Policies—Provides a list of various resources related to transportation debt financing, including websites and a list of website links to state debt management policies provided by survey respondents. • Appendices—The following appendices support the body of the report: – Appendix A: Survey Questionnaire; – Appendix B: List of Survey Respondents by State; – Appendix C: Detailed State Responses to Qualitative Survey Questions; and – Appendix D: Proposed Research Needs Statement.