WHAT TOLLS? GOV CORZINE, ASSET MONETIZATION & SECURITIZATION

For whatever reason Governor Corzine and the loyal opposition are not talking about “Asset Monetization” and “Securitization”. Yet there must be some basic rules that form the foundation for any and every such program. Accordingly, the purpose of the following is to begin thinking about that discussion.

At first glance the structure would appear to be a broad balance sheet reorganization that structurally matches disparate groups of capital assets with dissimilar groups of capital liabilities.

DEFINITIONS:

ASSET MONITIZATION: Future cash receipts generated over a set time period in the future are traded for cash today, i.e. Turnpike or Parkway tolls from 01/01/08 through 01/01/18 may be sold to investors. The sale price is today’s value of that cash flow where each future flow is discounted to give the investor a current market rate of return on the investment.

Issuing debt as a means of receiving cash today with the promise to repay with toll revenues tomorrow is called SECURITIZATION. Using a bond to borrow against future toll revenues securitizes the future toll revenues.

AN IMAGINARY ILLUSTRATION TO UNDERSTAND THE COST.

The following projections are totally made up and for demonstration purposes only. And, keep in mind that the issuance of debt can take many different forms. For instance, New Jersey could sell one fixed maturity bond backed by 10 years of toll revenues and repay the total debt in year 10. Or, costs might be lowered by treating each year’s receipts as a separate bond that will be repaid when that year’s tolls are received. The theory is the shorter the time to maturity, i.e. the time until the loan is due to be paid, the lower the interest rate that will be paid. In effect the shorter pay date lessens the lenders time exposure to deterioration in the borrower’s ability to pay or that interest rates will move higher. In reality there are many more possible debt structures. All have unique costs as well as unique benefits.

If we unrealistically assume the current years revenues are $1,000,000 and those revenues grow at 2% per year, the annual income stream from tolls over the next 10 years is as follows:

TOLL REVENUE PER YEAR

2008-2009 1,020,000
2009-2010 1,040,400
2010-2011 1,061,208
2011-2012 1,082,432
2012-2013 1,104,081
2013-2014 1,126,162
2014-2015 1,148,686
2015-2016 1,171,659
2016-2017 1,195,092
2017-2018 1,218,994

TOTAL 11,168,714

If investors demand a 6% taxable return on their investment, the amount the State can borrow in 2008 is $6, 236,251. At the 6% rate $6,236,251 grows to $11,168,714 in 2018 and that total is thus the sum paid to investors as a lump sum in 2018.

This means the borrowed funds received must reduce expenses whose annual cost is greater than 6%. If used to reduce expenses or fund a project where the the cost is less than 6% the State loses money. If used to reduce expenses or fund a project that costs more than 6% the State saves money.

State, county and local government bonds are generally exempt from federal, and in certain instances State, income taxes. Because they are exempt the interest rate paid on “municipal bonds” is determined in part by an investor keeping more tax free interest than would be kept after paying taxes on a taxable bond. Ask yourself, all things being equal, would you buy a 6% bond that is taxed or a 6% bond that is tax-exempt. Logic dictates you will buy the tax exempt bond until the tax exempt interest rate is equal to the after tax interest rate you receive on taxable bonds.

The tax-free rate equivalent to 6% taxable is 4.62% for someone in the 30% tax bracket. Given a premium to induce such an investor to buy the new security the price might be 4.75% or higher. At 5.00% tax free, the present value of $11,168,714 – the amount the State of New Jersey borrow in 2008 – is $6,856,623.

SOME INITIAL THOUGHTS ABOUT ASSET – LIABILITY MATCHING

(1) The trick appears to be in the issuance of lower cost tax exempt bonds (in effect a federal subsidy) to reduce higher cost expenses or to fund higher cost projects.

Historically, this was done through what is called a pre-refunding. The borrowed funds were used to retire outstanding higher cost debt. In effect the proceeds from the sale of future toll revenues as tax exempt bonds would be reinvested in taxable bonds. As the taxable bonds pay off the proceeds are used to pay off the old debt. The higher interest earned by the State on the taxable bonds lessens the total amount which must be borrowed to retire the older, higher cost debt. The issuer saves by paying a lower interest rate on the new, substitute debt.

The problem with this structure and its distance cousins is whether the IRS allows the tax exemption to be used in this manner. Don’t count on it.

(2) Or, the proceeds from tax exempt toll revenue bonds could be used to make capital improvements, i.e. a turnpike extension. In this instance the issuance of toll revenue bonds is nothing new. A Turnpike or Parkway bond paid for by toll revenue is a typical financing. Assuming the money can be used to build new schools, however, toll revenues are a (partial?) substitute for the property tax as a new source of construction funds. In effect toll revenues are a selective, steadily increasing tax (based on the cost of living?) whose proceeds are used as an alternative to the more general property tax. In this instance the school is an asset matched with a self-liquidating liability.

Here too, one must ask if the use of toll revenues to fund non-road related capital improvements is the cheapest way to fund such projects as opposed to merely reallocating the cost via a hidden tax. Increasing the debt load of the toll roads by a substantial sale of its toll income, regardless of whether it is through a public benefit corporation or not, weakens the credit rating and increases borrowing costs while limiting future borrowing capacity. And, how does one make any reasonable estimates about spending needs without a school funding formula.

Furthermore, one has to wonder if this form of financing fatally conflicts with the Governor Corzine’s commitment to reduce greenhouse gases. On the one hand he needs to raise tolls in a manner that at least does not reduce traffic, i.e. congestion pricing in fact. On the other hand, Governor Corzine needs to reduce emissions and may therefore need to reduce auto and truck traffic. If it costs more to use the toll roads and it costs more to reduce emissions on those roads (less traffic, higher costs, or both), the diseconomies could have a rippling negative effect as the costs are passed on in the form of higher prices and / or insufficient revenues to repay the bond (more people and freight take the bus and train).

Finally, the most important question, however, is how does such a financing scheme encourage thoughtful spending rather than merely expand it. What are its political and economic boundaries and limitations and how strong are those breaks? Without such circuit breakers this form of financing is open to debilitating abuse.

(3) If the money can be used to fund earlier pension liabilities, i.e. cover the payments that were never made, the use is essentially borrowing to play the stock market. New Jersey’s been there, done that. Hopefully, never again. The more prudent alternative, if possible, might be to directly pay any increase in toll revenues directly into the pension fund.