"Non-Traditional Approaches for Solving Budgetary Pressure"

1. National Association of State Auditors, Comptrollers and Treasurers (NASACT)Burlington, VermontAugust 16, 2011 "Non-Traditional Approaches for Solving Budgetary Pressure" Kevin J. McHugh Managing Director Navigant Consulting

2. What is a Public/Private Partnership (P-3?) • A collaboration between the public and private sectors that would optimize an activity that could be considered as either a public venture or private venture. • Typically, in a Government setting, a private entity (corporation) would assume the operational, financial and technical risks of the Government who currently provides the service. • Basically, a public/private partnership is a collaborative decision as to a distinction between public and private sectors

3. What are the Pro’s and Con’s of Privatization? Pro’s • Can be an effective way to fund critical infrastructure needs • Can be a source of immediate revenue for stressed budgets • Can be attractive to investors, thus infrastructure privatization might be appealing to potential bidders, due to private infrastructure funding • Can enable private firms to invest in highly leveraged infrastructure investments, due to low interest rates • Can be a politically expedient solution to public issues • Can often deliver greater efficiencies in some instances than Government and may result in better service at a lower cost

4. What are the Pro’s and Con’s of Privatization? (cont’d) Con’s • Privatization might pose constraints to future operations • Privatization might have some social consequences • Privatization might be viewed as stealing from the future, rather then investing in the future • Privatization may result in an undervalued deal • Privatization via private entities may result in failure • Privatization in some instances may raise concern due to lack of public input

5. The Fact: States and Municipalities are in Financial Distress • Financial distress has increased interest in finding new sources of revenue, cutting expenses and consideration of private funding and expertise • Revenue shortages continue • Underfunded infrastructure is well known and documented and approaching $3-4 trillion to move capital improvement needs • Cost of services is increasing • Underfunded/unfunded pensions

6. If considering a P-3 – What should your goal be? • Look at your asset base: land, infrastructure, land improvements, buildings/building services, intangible/intellectual property, pension plan investments, and the like. • Are any of these assets unused or underutilized? • Are any of these assets associated with non-Governmental core or baselines services? • Are any of these assets considered to be “high risk” or “under performing”?

7. Policies and Procedures Do you have a policy statement to evaluate a P-3 on a “case-by-case” basis? At a minimum, you should consider: • Is the project desirable and what are the economic and fiscal impacts? • Does it contribute to the Government’s goals and strategies? • Does it consider jobs that will increase per capita income, or target a sector important to the Government’s growth? • Do you have synergies that would attract other and future P-3 initiatives? • Does the transaction result in improved fiscal, economic, and/or social benefits greater than those without a P-3? • Does the transaction provide a fair and reasonable return to the Government commensurate with the associated risk?

8. What other considerations are there other than P-3? There are two other Considerations: • Sale/Leaseback of State Facilities and • Enhanced–Use Leasing Program

9. An overview of a Government Sale/Leaseback (GSL) Program Background: A Government Sale/Leaseback program is a programthat would provide a State, County or City Government an opportunity to obtain funds from Government owned buildings that are typically 20 years and older, and usually with minimum associated debt. Usually, the initial financing associated with these older properties has been significantly paid off/down. The lender/investor would provide the Government with “cash” typically based upon the Fair Market Value of the property.

10. An overview of a Government Sale/Leaseback (GSL) Program (cont’d) The typical structure of the program would be: • The Government sells the Government owned buildings to the investor for its Fair Market Value. Part two of this transaction is that the Government enters into a lease agreement with the investor. The lease can have fixed, or flat, rental payments for the term, or in some situations, the rent can be “lower” in the initial years, with escalation of the rent in the later years. • Investor guarantees the donation of the property back to the Government by the end of the lease. Investor has the option to donate earlier and typically targets the end of the 10th year as the time to donate (due to tax issues) for a $10 million purchase and at the end of the 12th year for a $100 million purchase. This targeted date may change if tax laws change or interest rates rise by approximately 250-300 basis points by the end of the 10th or 12th year. If the property is donated before the expiration of the lease, the Government shall assume the investor financing, which is fully amortized over the term of the lease with a fixed rate. The loan payments are slightly less than the rent payments. • At any time during the lease, the Government can accelerate the above donation.

11. An overview of a Government Sale/Leaseback (GSL) Program (cont’d) The common advantages to the Government would be: • Government receives cash from the built up equity of Government-owned property. • Government is guaranteed to receive the property back in the form of a donation from investor at the end of the lease. • Government is likely to receive the property back earlier than the end of the lease due to investor tax issues, if tax laws do not change or if interest rates do not increase by approximately 250-300 basis points by the end of the 10th or 12th year of the lease. • Typically, for a GSL structure, the Government is not required to obtain voter approval through a referendum. • The proposed GSL structure is a Capital Lease and is considered debt on the Government’s Balance Sheet. However, the GSL structure may be viewed more positively by analysts than a general obligation bond due to the residual value (through the Donation) being treated as an additional Government asset.

12. An overview of an Enhanced-Use Lease (EUL) Program Background:Under this program, the Government would establish policies for their Enhanced–Use Lease Program. Typically, the Government would lease real property (could be land and buildings or excess land at existing facilities), currently under their control, or jurisdiction, to public or private entities on a long term basis (typically 20 to 75 years) in return for cash and/or “in-kind” consideration (the provision of goods, facilities, construction services, or other activities that result in a demonstrable improvement of services to its citizens) as all, or part of, the consideration for the lease.

13. An overview of an Enhanced-Use Lease (EUL) Program (cont’d) The typical structure of an EUL Program would be: • Lease terms are typically in the 20 to 75 year range. • The “Consideration” for the lease is cash in an amount equal to the Fair Market Value of the property. • Typically, the funds generated from an EUL are deposited into a Capital Asset Account. • The lessee is usually required to pay for all costs associated with the lease, including: • The project construction and activities to be carried out by the lessee • The direct costs to the Government for administration of the lease • Utilities • Any other costs associated with the operation of a leased facility • All construction, or operating costs associated with the EUL are borne by the lessee.

14. An overview of an Enhanced-Use Lease (EUL) Program (cont’d) The common advantages to the Government would be: • The EUL provides the developer (lessee) with the long-term property interest necessary to secure financing through capital markets, and allows the developer to amortize any capital improvements made to the property, or facility. Although the underlying land is Government property, the facility would be subject to state and local taxes, resulting in an increased tax base for the local community. • Cost savings to the Government, in return for the lease, the Government must obtain fair consideration (monetary and/or in-kind) in various forms including, but not limited to revenue, facilities, space, or services. • Projects include buildings, parking facilities, senior/long term care facilities, prisons, co-generation/energy facilities, water/waste water facilities, toll roads and the like. • Other projects typically follow, which allows the Government to go back to its basic core services.

15. Whether P-3, Sale/Leaseback or EUL, you need to consider the following as your key objectives: Realistic agreements must be employed to ensure that financial expectations and overall expectations are “real” and well thought-out! Understand the budgeting for these transactions as not to shift fiscal responsibilities back to the Government, or to the taxpayers. Involve appropriate Legal Counsel experienced in these types of transactions. Valuation of the Government owned assets is critical. Do not transact at book value! The cost approach to valuation of Government owned designed buildings is one value, Fair Market Value for typical office buildings is another value, and cost of replacement value for unique or monumental buildings are key valuation factors. Additionally, the Fair Market Value of the underlying, or excess land is of paramount importance.

16. Questions?

17. Kevin J. McHugh Managing Director Navigant Capital Advisors Kevin.mchugh@ncacf.com (646) 227-4701