Informed but opinionated commentary and analysis on urban transportation topics from the Secret Worldwide Transit Cabal. Names have been omitted to protect the guilty.

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PRIVATE-SECTOR FINANCING? (Japan Monorail 22)

"It is the unfortunate destiny of the ridiculous to be subject to ridicule."
James Howard Kunstler

From the Cabalmaster:

(Sorry for the long hiatus--the Seattle Monorail fiasco took up much of our time in the last few weeks).

PRIVATE-SECTOR FINANCING?

The following elaboration of the alleged "private-sector" financing of Japanese monorails makes very interesting reading. As one source tells us, "Much of what seems 'inscrutable' about Japan actually makes perfect sense -- if you can discern the underlying logic."

In Japan, ruled by avowed conservatives for most of the post-WWII era, "the system" discourages "subsidies" but accepts debt. The Japanese financial system is very reluctant to acknowledge "bad" (unrecoverable) debt and to write it off. Banks keep much bad debt "on the books," under the polite fiction that someday, it will be paid off. The public sector also does this, because writing off the debt issued to build something is the same as paying for it out of tax revenues -- in other words, a subsidy.

Contrary to what many outsiders believe, most of the "private investment" in monorails, gadgets and rail projects is not "risk capital" at all. It is secured borrowing from the private sector.

"Infrastructure" is paid for by government "grants." A considerable chunk of this money is raised by government debt issues.

Rolling stock and other facilities are financed by something resembling an "equipment trust" arrangement by the municipal agency. But, instead of "equipment trust certificates," the agency issues shares of stock.

[This sounds strange if not bizarre at first, but the following example helps clarify things.]

Suppose the City of Los Angeles wanted to use a Japanese-style joint venture bewteen private and public sectors to finance a westward extension of the Red Line subway.

It would organize the "Wilshire Boulevard Rapid Transit Company, Ltd" as a for-profit corporation, identical in organization to the private-sector model. There would, however, be a twist: all shares would, at first, be held by government agencies: L.A. City, L.A. County, Beverly Hills and Santa Monica.

The company would finance construction of the tunnel, from Western to the ocean. They would raise the money from state and federal grants, and from "local" funds. But the local share would actually be borrowed from the private sector.

In financial terms, this would work as follows: The stock represents the capitalized value of the company, which is set at the minimum level required for the intended amount of borrowing.

[We assume that this "initial capitalization" is backed, at least nominally, by public assets or tax revenues.]

Each government entity holds a percentage of the stock. Under an arrangement that uses this equity as collateral, with a lot of "leveraging," the three cities and the county borrow money from the private sector. Private lenders get municipal and county debt (bonds), but not stock.

"Infrastructure" represents a "sunk" cost, unrecoverable in case of liquidation. That is, if the facility were to be abandoned, very little of the amount invested in infrastructure could be recovered for other uses. "Risk" capital is seldom available for large-scale (equity) investments of this type, so the majority of the project cost must be financed with debt. Taxpayers pay to service this debt, at least at first.

In contrast to "infrastructure," track, power facilities, station equipment and rolling stock do have "residual" value that could be recovered (at least in theory) upon liquidation. And so, L.A. city sells stock to banks and other private investors, and uses the money to pay for trains and other "equipment."

This money does not represent "venture" or "risk" capital, for reasons that will elude those who cling to rigid definitions of categories such as "stock" and "bonds." In brief, the instruments in question are called "stock," and legally are stock, but do not behave like stock." Capital appreciation" (i.e. stock price goes up) is possible in theory but is usually a polite fiction. Return on investment is paid as "dividends" rather than "interest." Dividends are nice but payment is not "required; " that is, non-payment of dividends does not lead to "default." The promised dividend payments are set to provide a rate of return acceptable to the lender.

[Since we know that banks buy and sell debt, we shouldn't be surprised that banks (and other "institutional" investors such as insurance companies) also buy and sell this type of "stock." It also helps to know that Japan currently has very low interest rates, owing to its long recession, so these "dividends" can be nominal.]

In some cases, local enterprises that benefit (or can be persuaded that they will benefit) from the project will purchase stock. However, this usually doesn't happen with new urban transit projects. The financing arrangement provides a convenient channel for "supplier financing," which does happen with monorails and other gadgets.

Things really get interesting from opening day. The Japanese-style "Wilshire Boulevard Rapid Transit Co" would have its own rolling stock and staff -- and its own ("stage," or distance-based!) fare structure. Trains would operate through between Union Station and Santa Monica, but passengers would have to pay a "double" fare for travel to and from points west of the LACMTA interchange, Wilshire/Western.

Do those Wilshire fares seem kinda high? Well, yes, they were explicitly set that way in order to recover some of the construction cost.

What goes on in the accounting office is REALLY interesting. In brief, a portion of operating revenues is paid as "dividends" to the private lenders who hold part of the company's stock. Another share of revenues may be allocated as "dividends" payable to the cities. The remainder pays all, or some, of the operating cost.

"Dividends" paid to cities may be used to service some of the municipal debt issued to build the "infrastructure." With creative accounting, they could also be used to cover operating deficits (which would require that the line earn enough revenue to cover all operating costs AND the share of "dividends" paid to private lenders.

Operating deficits may also be covered by debt issues, with interest charged against the next year's operating budget. This creates a mountain of debt in a hurry. As an alternative, operating deficits may be paid from other funds, with each year's deficit charged to an account called "cumulative loss." This represents money that will eventually be paid back as traffic grows.

Hence the typical projection along these lines: "the facility will become profitable after 10 years of operation, and all accumulated losses will be paid back after 20 years."

But this doesn't matter to private lenders as much as the implicit "guarantee" by the municipality that the promised payments will be made.

Of course, if the projections don't pass muster with the central government, the required "infrastructure" grants will not be provided.

THIS is "private-sector" financing??? We don't think so -- but you know we're opinionated!




posted by The Cabalmaster, Master of All Transit-dom 10/31/2002 02:23:00 PM