Sunday, September 12th, 2010

Indianapolis Parking Meters – The City’s Response

I hope my readers will indulge my writings on this issue, which might be irrelevant to those of you who aren’t in Indy. But this matter is of critical importance. Hopefully at least the principles of deal analysis are useful.

The city has issued a response to my parking meter post . By Deputy Mayor Michael Huber, it is titled “Parking Meter Modernization Will Improve Infrastructure and Spur Economic Activity” and that link will take you to the entire text. I hold Michael Huber and his capabilities in high regard, but I must disagree with him in this instance.

The first part of the response deals with the modernization plan. Let me be clear: I fully support modernizing meters, bringing parking rates in line with the market, and investing in infrastructure. That plan is a good one and Mayor Ballard should be applauded for addressing an area that has been ignored for too long. I believe this enjoys wide support in the community. My issue is with the privatization agreement that is proposed to implement the plan. The report also mentions the water transaction, which I’ll again note that I thought was a good one, even though there were many critics.

I should also acknowledge that the city did learn some important lessons from the Chicago fiasco. This is not a lump sum deal. Money is going to infrastructure, not papering over deficits. Rates won’t go up until the meters are upgraded. There was a limited exemption from bagging fees for a small number of mega-events like the Super Bowl. And they even made sure the receipts would work with motorcycles.

Unfortunately, the deal still contains fatal flaws that would make it a big mistake to implement.

The city’s response more or less acknowledges most of the points I made – the contract cannot be terminated for convenience, the contract is similar to Chicago’s, permit parking is required in Broad Ripple, bagging fees are $15, the placard program is being revoked, etc. They merely disagree on some of the specifics around them and the importance of them.

This is very positive since now the debate can be on those issues, which are the real critical parts of this deal. It has become clear that the majority of people had no idea about these items. The bulk of the discussion has been around the modernization aspects that are fairly uncontroversial. I will address some of the points the city makes. As always, I encourage everyone to investigate for themselves and draw their own conclusions.

Use of the Chicago Template

The financial structure of the Indianapolis deal is very different Chicago’s. But the contract is very similar. The city says, “Indianapolis and Chicago may be similar in certain provisions of the contract, but that is where the similarity ends.” I believe this understates the degree of similarity between the two contracts, of which large portions – I estimate a majority – are word for word identical.

There is no reason not to use tried and true templates. But the city should not have used the Chicago contract as a model. The Chicago contract is known to be bad for the public.

The city also says that other concession agreements such as the Indiana Toll Road are also similar. I have not reviewed that agreement, so it is certainly possible. However, the Toll Road, Chicago Skyway, and Chicago parking meter transactions all involved large, one-time lump sum payments in excess of one billion dollars. The Indianapolis agreement is not a lump sum deal, and so the use of a contract template built for lump sum deals is not appropriate.

The Indianapolis contract should have been structured as a partnership or joint venture, without the onerous and one-sided provisions of the Chicago contract. The majority of the defects in the transaction stem from the use of this template.

Termination for Convenience – The Most Critical Issue

The city notes that the contract does provide for termination by the city in select cases. As I myself noted, “The city can only terminate the deal if the vendor defaults, which is virtually impossible.” The conditions under which the city can terminate include things like the vendor filing bankruptcy. These are extremely unlikely to happen.

The city acknowledges that the contract cannot be terminated for convenience. This is what would give the city the right to cancel the deal if it decides that it is no longer in the public interest. The city says, “if the City could simply walk away at any point in the contract, there would no practical reason for ACS or any third party to make an up-front investment without substantial penalties to the City for termination.”

Obviously if a vendor gives you $35 million in cash, it would be unfair for to terminate it without penalty. But in this case, the city cannot terminate the agreement even if it gives the money back. This might not matter in the case of the Toll Road, since refunding $3.9 billion is not realistic for the state. But in this case it is very realistic.

Typical outsourcing contracts would provide for a termination for convenience with a pre-negotiated penalty that declines over time, decreasing to zero at a reasonable point (e.g., seven years). This figure should be set high enough to compensate the vendor for their investment and discourage gratuitous cancellation, but not so high as to be a de facto lock in.

Unlike with a Toll Road that is only about moving cars, the role of parking is not principally financial or even about transportation. Rather, it is about optimizing the use of a precious public resource. Rates should be set high enough so that there are spots available if someone wants to patronize a local business, but not so high that it keeps people away. Because neighborhoods change over time, and business conditions are dynamic, this isn’t a process that can be done all at once for 50 years. What if business on Mass Ave starts to suffer? What if Broad Ripple hits a rough patch? This might seem unlikely, but who could have predicted 50 years ago in 1960 what would happen to the city’s various neighborhoods? By the way, can anyone even remember who was mayor in 1960?

I’m a white kid who used to live in a trailer on a gravel road in Southern Indiana. That’s about as far removed from the urban African American experience as you can get. So it didn’t occur to me until after Amos Brown’s show was over that in 1960 Indianapolis was a segregated city. The Civil Rights Act wasn’t passed until 1964. Today we have a black President of the United States. That’s change. And the world is changing even faster by the minute. There is simply no way to predict what will happen even 10 years out. Setting parking rates far into the future, with significant penalties for reductions, unduly ties the city’s hands.

The city simply should not commit itself to a long term deal of this nature. There is nothing more important in this matter than obtaining a reasonable termination for convenience that the city could realistically exercise if conditions change. This is even more important than getting more money. Because if the current deal is executed, it will be game over for 50 years.

The Deal Financials

The city takes a different financial view of the deal that me, but I will demonstrate that even with the city’s numbers the deal still looks very profitable to the vendor, that costs should actually go down, not up, and that this transaction is really a form of high interest borrowing a la payday loans.

This Is a Very Profitable Deal
I tend to avoid marketing materials and look directly at raw financial statements. The parking meter financial statements are in Schedule 9 of the contract on page 151 of the PDF. It reports revenues of $3.7380M, expenses (personal services, contractual services, and “internal charges”) of $844.1K for a EBITDA (profits) of $2.8867M, or a profit margin of 77%.

The city’s response says that this does not include enforcement, indicating that actual expenses are $3.1M and only $750K in funds available “for infrastructure improvements or parking meter upgrades.” It is not clear to me if that is intended to indicate the total system profits, but let’s assume that it does. Even $750K a year is $750K more than the Toll Road made in 50 years, so this is a profitable asset.

I would be interested in seeing a detailed schedule of the other $2.26M expenses. Even at a fully loaded cost $100,000 per year, this is 22 FTE’s. That’s a lot of people to write parking tickets for meters.

I had previously used a $7M estimate for meter upgrades based on an August city presentation. The city’s response indicates that their current estimate is $10M. The city and I agree that potentially 3-4 technology refreshes would be required. The Indy Star reported this morning that the city has 3,669 metered spots. The contract requires the city to add 130 new meters for a total of 3,799. This equates to $2632 per spot for upgrades. Chicago has about 36,000 meters and a spokesman for the concessionaire says that they invested $40 million This equates to only ~$1100 per spot for upgrades. And this is based on actual investments already made.

However, using the city’s numbers, and factoring in inflation, I would estimate the vendor would incur approximately $300M in operating costs and $85M in capital costs. Based on the IBJ’s estimate of $724M-$1.2B in revenues for the vendor, this would mean total profits of $339M to $815M, or a potential profit margin of 68%. Obviously the total profits would have to be discounted to the present value, but so would any future city revenues.

Costs Should Go Down, Not Up
I assumed costs would remain constant on a real basis and increase only with inflation. The city says this does “not include millions of dollars in new expenses that would be incurred by the vendor, including the operation and maintenance of high-end technology systems (including new hardware and software), the additional personnel required to operate a stand-alone business, or the proposed extended hours of the parking system.”

I find it difficult to accept that putting in modern technology will actually raise costs by millions of dollars. People implement modern technology to reduce costs. That’s what modernization is all about. For example, each pay and display meter will serve up to 20 spaces. Even at lower densities, that is far few meters to empty, maintain, etc. With credit card payments, there will be less change to collect, etc.

Pay and display systems are basically special purpose computers like ATMs. We all know the cost of computer technology is plunging, so future purchases may be far less expensive. And each generation of technology gets better and cheaper. For example, we used to have to get paper tickets for airlines. Now we get e-tickets. You still had to stand in line to get a boarding pass, so the next generation replaced expensive agents with self-serve kiosks. Now the kiosks are likely to be eliminated as well since you can have your boarding pass texted to your cell phone – how much does that cost? This all happened within a decade or so. This has been repeated across almost every industry.

In the future, you might not even need machines. Maybe you’ll just text your license plate number to the system, and it will register your presence in the spot. Then an enforcement officer driving down the street could simply scan license plates electronically. Or even maybe future chips in cars will be picked up by a wireless network and they’ll text you a ticket, or let you refill the meter by text. This is all very realistic technology. Remember, we already have full body “x-ray vision” scanners at airports.

When I was managing technology systems, we were expected to reduce costs by at least 5-10% per year no questions asked, no excuses, even when we already benchmarked as best in class on costs. I expect that a well-run company like ACS/Xerox has similar expectations for its managers. While some debate this, I believe strong cost control is one reason the private sector really can do things more cheaply than government. That’s why I don’t object to hiring ACS to run the meters on some type of an annual contract. Though given that Denison parking already operates the system and will continue doing so, it’s not clear to me exactly what ACS will be doing other than being the city’s banker.

This Transaction Is Really a High Interest Loan
Speaking of which, unlike the Toll Road lease which should be thought of as a sale, the best way to look at this transaction is as a loan. The city is in effect borrowing $45 million from Xerox, and that company’s profits on the transaction represent the interest. So it is critical to understand how much profit they plan to make to understand if this is a good deal or not.

Is it better to borrow money from Xerox or some other way such as issuing bonds? There are several reasons to believe, even beyond analyzing the deal financials, that Xerox is more expensive.

1. Credit Ratings. Depending on the source, the city has a credit rating of AAA/AA+, the best there is. As of February this year, Xerox had a credit rating of BBB-, the lowest investment grade rating. Xerox can’t get money for free. It has to come from somewhere. It costs them more to get it than it would Indy directly, so that will be passed through, with margin, to the city. Indianapolis can issue debt directly at rock bottom rates.

2. Taxes. Municipal bonds issued by the city are tax exempt. Xerox is not. The US corporate income tax rate is 35%. This means a good chunk of that company’s share of the profits is likely to get sent to Washington. So they need to earn more profits to cover that.

3. Cost of Capital. Businesses can be funded with either debt or equity. Debt like bank loans or bonds are safer than equity. They get guaranteed interest and have first priority to be repaid. For equity like stocks, there’s no guaranteed return, the price might go down, and if the company goes bankrupt, you lose everything. So equity holders demand the prospect of higher returns for that risk. If the city issued debt, it would be a very safe investment, so it has a low risk premium. But Xerox is a publicly traded company. Beyond the debt it issued at BBB-, its stockholders have equity, and demand higher returns than what they can get on municipal bonds. If the stockholders wanted muni-bond rates, that’s what they would have bought, not stock. So Xerox’s CFO makes sure that whenever they take on a deal, it earns a high enough return to please stockholders, not just bond holders. This makes rates even higher.

Add it all up and Xerox is not a particularly good place to borrow money. They aren’t a bank. That’s not their business. They are a technology company – and a very good one. Incidentally, the concession holder on the Chicago agreement, Morgan Stanley, is literally a bank.

I again draw an analogy to a person who can’t get a regular bank to loan them money, and so has to go the check cashing store to get a payday loan. But the city is hardly a deadbeat and can get money even cheaper than Xerox can.

They city says it would probably have to use “the moral obligation of the City to sell bonds given the lack of detailed historical financial information regarding parking revenues.” This sounds to me like they mean they couldn’t issue revenue bonds, but would instead have to issue general obligation debt. The city previously said in the IBJ it would be able to issue about $20 million in revenue bonds. That leaves a $25 million gap to get the same upfront cash and pay for modernization.

Even general obligation debt would be cheaper than this transaction. Also, there may be other creative ways to access funds. Perhaps Citizens Energy could take this over too. They are a locally controlled non-profit that is a quality operation with a long track record of managing field service operations. And one that would probably do a true partnership model without all these fees.

Whatever the case, I believe there are better financial options for the city than privatization. While there would be more revenue risk to the city, given the 45-80% of the revenues being given away, it would take quite a collapse indeed for the city to be any worse off by owning the meters itself. And no doubt ACS/Xerox factored all the risk into their price up front, so the city is already paying for it.

Even Abdul Hakim-Shabazz wrote, “I think revenue bonds tied to the parking meter revenue will be a better way to go. You modernize the meter system, retain ownership, and still get your infrastructure fixed.”

Penalties, Etc.

The most important thing to understand is that the risk of having to pay penalties to the vendor is very real. This is not a theoretical or academic exercise. CBS-2 Chicago, in a story entitled, “Parking meter firm gets paid even when streets are closed,” revealed:

It’s the gift that just keeps giving, to the private company the city hired to operate city parking meters….Here’s the reason: There are street repairs, art fairs and block parties –- all events that prevent you from parking in normally legal spots. When those spots have parking meters along them, Chicago Parking Meter LLC, the company that got the billion-dollar deal with the city, can’t make money, right? Actually, it’s a great deal for the parking meter company. They usually make money because you have to plug the meter to park legally. When you can’t park at a metered spot because of street construction or other projects, they still get paid.

Records obtained by CBS 2 for the first quarter of 2009 of the contract lists street by street the lost income for February March and April of 2009 totaling more than $106,000. That amount will surely go up for the spring and summer — the seasons for street closings. “The city will be paying perhaps as much as $500,000 a year to protect the revenue stream for those guys,” Krislov said.

The question is how much the city might have to pay. The city says that the closure allowances need to be viewed in light of the larger hours Chicago’s meters are enforced, and “the recommended temporary closure threshold is about the same for both Indianapolis and Chicago.” This is a fair point. However, Chicago got a bad deal. Indianapolis could do better. Remember, Chicago is exceeding their allowances.

The city notes that events will not necessarily be charged a closure fee, saying “If the City deems that a specific event or organization will not be required to pay to temporary close meters, the City has the flexibility to close meters beyond its 6 percent allowance, and the vendor will withhold a proportionate amount of revenue share for that right.” Withholding revenue in this case means paying the vendor. It is true that the city could cover this fee itself. But it is not required to, and if it won’t, then the event will have to pay. The city says, “each program or request will be assessed on its merits (a continuation of the current policy).”

I think I may have been unclear in my original post on permanent removal fees. I only intended to say that the bagging fees assume more or less 100% occupancy, not the permanent removal fees. The city is correct that after year one, this is based on actual revenue reductions based on the formulas on pages 132 and 133 of the contract. I should note, however, that these formulas do not account for any corresponding reduction in cost from having fewer metered spots to manage. These fees will be significant in any case.

As with Chicago, it is actually better for the vendor if meters are shut down, such as during a long construction project. They get paid as if the meters were operational, but don’t have to do anything. To consider an extreme case, if the city decided to make parking free and remove all meters, the vendor could simply cease all operations except cashing the city’s checks and still make as much revenue as ever without any corresponding costs. This is very unlikely to happen, but it demonstrates the principle at work.

The city notes that even if the privatization transactions was not done, the city would still lose money if it removed meters permanently. That is correct. But it would only lose its own money. It would not be required to guarantee profits for a private company on that spot.

Permit Parking

The city says, “A residential parking permit in Broad Ripple and a parking garage have been considered a high priority long before this parking modernization effort began.” That’s true. And I have no issue with implementing a residential permit parking scheme. However, it is important to remember that the contract requires the city to have such a plan if it builds a parking garage in Broad Ripple: “In the event the City builds a public parking garage in Zone 4 during the Term, the City will agree to institute a Residential Permit program for non-metered parking spaces in and around Zone 4 to be administered by the Concessionaire on terms mutually agreeable to the Parties” (page 47). Establishing permit parking should not be done in a vendor contract, but through the normal public process. And it should remain free to be changed if conditions changed.

The city disagrees with me that it has limited its right to establish other zones. I will simply reprint the relevant passage from the contract: “The City reserves the right to designate certain on-street parking that are not Metered Parking Spaces as residential parking requiring a Residential Permit, provided that such designation does not materially effect the Metered Parking System in the surrounding area.” (page 38, emphasis added).

The city notes that the Concessionaire can only charge a nominal management fee for running these. That is true. But remember, the vendor will get the rights to the parking ticket revenue from enforcement, less the revenue share: “All fees collected for the issuance of Residential Permits shall be retained by the Concessionaire and all Parking Violations Revenue shall be retained by Concessionaire.” (page 38) That’s where the money is.

Miscellaneous

Reserved Meters: The city notes that the vendor is only entitled to a 25% share of these meters, not a full revenue share. They are right and that was my mistake. I will correct the original post.

Revenue Share: Several times the city points out that any funds that go to the concessionaire must be split with the city, so they do not all go to the vendor. That’s true, but it is still 45-80% of the money. It is not clear why the vendor should be entitled to anything from tickets written by IMPD, advertising, etc. Or why the vendor should receive this compensation when the city uses the spots for itself on official business.

Indemnification: If this is not a risk, then the vendor should have no objection to removing the clause. I found this particularly interesting because it was a clear change to what was otherwise the same text as Chicago, and one that served to create an even more iron-clad contract for the vendor. The success of the IVI-IPO lawsuit or similar suit might be the only way for Chicago to extract itself from that disaster. If the vendor considers it a risk, the city should consider it a risk.

Offsetting Adds and Removes: One thing I did not see the city address was the lack of any provision for offsetting adds and removes. I could not find that in the contract, but admittedly, it is long and complex. If the city adds 10 meters and removes 5, that should be treated as a net add of 5, not 10 adds + penalties for five removals.

Morgan Stanley and Timing

The city says that different Morgan Stanley groups worked on Indy and Chicago. I never said the exact same divisions worked on it. Morgan Stanley, like most large corporations, is a many-tentacled beast. But whether it is the left hand or the right hand, it is all a family, dedicated to making money across all of its groups.

Consensus is Morgan Stanley made a huge profit on Chicago’s deal. But that came at a cost. Privatizing parking meters got a well-deserved black eye, so they can’t repeat that coup. That market died. So now Morgan Stanley has an incentive to want to restart the market for privatizing parking. If Indianapolis leases its meters, other cities might start taking a serious look at meter privatization, then the other arms of Morgan Stanley can swoop in for another payday. As Am Law Daily noted of Pittsburgh consideration of leasing meters, this puts parking meters transactions “back in play.” Morgan Stanley has every incentive to want to restart that market.

Admittedly, so do all over investment banks. If there’s one thing we learned in the financial crisis, it’s that Wall Street is populated with sharks. And if you’re swimming with sharks, you need good protection – like setting another shark to watch. That’s why I recommended an independent analysis. That’s exactly what Pittsburgh has done. Their city council voted to do have someone else check Morgan Stanley’s math:

Ms. Hairston’s advice for council to take an active role came a day after the body’s preliminary vote for an outside valuation of parking authority assets.

Representatives of Morgan Stanley, Mr. Ravenstahl’s financial advisers, had discouraged the outside review, saying it could scare away investors. Morgan Stanley’s infrastructure investment group also is the leading investor in Chicago Parking Meters LLC, the consortium that received Chicago’s on-street parking lease.

On Thursday, with council members still fuming about the financiers’ efforts to shut down their inquiry, Ms. Hairston told them they had every right to demand a third-party study.

Despite Morgan Stanley’s warnings, bidders showed up in droves to Pittsburgh.

Interestingly, even Pittsburgh’s mayor doesn’t want to lease the meters:

Ravenstahl has said privatization is necessary to bolster Pittsburgh’s underfunded pension system. “Let’s be clear: The mayor doesn’t want to do this,” said mayoral spokeswoman Joanna Doven.

Pittsburgh’s pension fund is in awful shape. As the Pittsburgh City Paper reports: “That fund is in sad shape: It has only 30 cents of every dollar it will need to pay the pensions promised to city workers upon retirement. What’s more, the state legislature has given Pittsburgh until New Year’s Eve to raise the total to 50 cents. If the city fails, the state will take the pension over — and demand an extra $30 million from the city each year. That, warned Ravenstahl, translates into a 24 percent property-tax hike. Or a 44 percent hike in wage tax. Or laying off 400 cops.” That’s called being between a rock and a hard place.

There are also indications that the market for public assets may not be as robust as the city thinks. At the same time the Chicago leased its parking meters, it attempted to privatize Midway airport. That transaction failed because the winner bidder was unable to secure financing. Perhaps there is still money to invest, but only on particularly lucrative deals.

Conclusion

Again, I am very supportive of the modernization aspects of the mayor’s plan. But the privatization transaction should not be undertaken. There has to be a better way to make it happen. I believe the Council and the public are now aware of the material issues, and the right debates are going to happen, hopefully with the right outcome. I again applaud the mayor for seeking creative solutions to addressing long deferred problems, but this deal is not the right answer for the city.

Further reading:

Parking Meters and the Perils of Privatization
Indy’s “Son of Chicago” Parking Meter Lease to Be a Disaster for City

5 Comments
Topics: Economic Development, Public Policy, Technology, Transportation
Cities: Indianapolis

5 Responses to “Indianapolis Parking Meters – The City’s Response”

  1. My simple question is this:

    Why can’t parking meters have embedded, internet-capable cameras that take pictures of license plates? It seems that this is the easiest solution: park for too long, get a ticket in the mail. No meter-monitoring required.

    That would significantly cut expenses. It would also allow for us to make parking revenue entirely based on fines, which is an attractive option. It gets rid of the hassle of having change for a parking meter, yet ensures that people won’t be tempted to hog the public resource.

  2. Goof says:

    Simple answer.

    Oops that camera just was too dirty to take pictures for billing my parking….. or maybe it was the duck tape.

  3. DC Hoosier says:

    Robby…

    DC (who’s parking run by ACS) has taken your idea a bit further. They have cars that drive around and take digital photos of all parked car license plates. The photos are time stamped and recorded. This car is driving around during all parking enforcement hours. If they drive around again and the camera sees that you’ve overstayed your limit… a ticket is printed and mailed to the registered address of that license plate. No more paying meter maids to walk, pause, ticket and repeat. Just one car and no stoping… very efficient.

  4. Unigov says:

    I would like to point out that the Toll Road deal was a sham transaction; that is, one entered into solely for the purpose of tax benefits. By leasing the Toll Road, the lessees can depreciate it, whereas the state of Indiana cannot. This depreciation in effect flows thru to the lessee investors and enables tax writeoffs or offsets that otherwise would not exist.

    In other words, the Toll Road lease shifted taxes away from the lessee.

  5. Good examples of potential technology solutions. Thanks for the comments.

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