In a recent EPA webinar on funding availability at the WIFIA Program, several questions came up about combining SRF and WIFIA loans for specific projects.  This is of course allowed and frequently done.  The WIFIA team noted several differences between a Program loan and what might typically be offered by SRFs.  SRF loans vary by state, but in general they’re shorter in term – about 20 years maximum, versus WIFIA’s 35-year post-completion term.  Within that term, WIFIA can be very flexible about amortization schedules that effectively accommodate the SRF loan’s shorter and usually more strict schedules – a point that the team especially emphasized.

WIFIA’s five-year debt service deferral option after project completion was also highlighted as an example of the Program’s unique flexibility in loan structuring.

Other differences were discussed — loan forgiveness is sometimes offered by SRFs but not by WIFIA, SRF pricing varies a lot compared to WIFIA’s US Treasury flat rate, etc.  But WIFIA’s longer term and the deferral option appear to be primary synergistic benefits of SRF/WIFIA loan combinations at the project level.

I’ve written about the benefits of large-scale WIFIA loans to the SRFs themselves in prior posts and articles.  Fund capitalization from a ‘wholesale’ lender (WIFIA) to ‘retail’ lenders (SRFs) will play to their respective strengths, maximizing overall economic benefits and efficiency.  In theory, WIFIA should specialize in the wholesale role exclusively.  But reality is never quite so simple, and if an SRF/WIFIA combination works at the project level – and gets stuff built – that’s also a good outcome.  As such, it’s worth a quick look at some hypothetical numbers showing why the combination works.

Assume a $100 million project in a large community that can qualify for both a WIFIA and a local SRF loan.  The interest rate on both is 3.0%, (about the current 30-year US Treasury yield), significantly less than the borrower’s market alternatives.  The project is very long-lived, but the SRF loan’s maximum term is 20 years with required level-payment amortization.  The loans are compared below at the time of project completion.

The borrower’s first option is to simply to borrow $100 million from the local SRF, which has available capacity.  The blue bars are the SRF loan balance – the red line is the annual post-completion debt service:

The SRF-only loan will work, but the borrower would prefer to minimize debt service in the early years of the project. A longer term WIFIA loan for the full $100 million is not possible of course — for a large community, the statutory maximum amount is 49% of project cost. But the two loans can be combined, with the SRF loan providing the 51% balance. The yellow bars show the WIFIA loan balance, and the blue line is the annual debt service of the combined loans (the red line from the prior chart is included for comparison):

This combination gets closer to the borrower’s preferences — debt service is essentially halved for the first five years with the WIFIA deferral option. For years 6 through 20, the WIFIA loan is in interest-only mode, reducing debt service by about 25%. Starting in year 21, level payment amortization of the WIFIA loan continues for the next 15 years at about the same level.

If the borrower was looking for even lower debt service in the very long term, a combination with a 55-year WIFIA loan would be even better, were that available — as it might (and should) be in the future. The green line shows debt service for this case:

The above charts provide a quick visual demonstration of the fundamental benefit of the combination — lower debt service in the early years. But a real comparison should reflect how much the borrower values the near-term cash savings versus paying debt service for a longer period. In specific situations, there are usually plenty of real-world reasons that such a comparison doesn’t need much (if any) quantification beyond the dollars saved, a five-year planning horizon, for example. However, to do it correctly — if only in order to defend the decision — a classic Value for Money (VfM) analysis is required. This essentially involves a present value (PV) comparison of the cases over their full terms, using a discount rate that ideally reflects all the preferential and goal-oriented aspects of the situation.

That’s often difficult in the real-world, but it’s easy enough in this simplified, hypothetical analysis. The valuation baseline is the SRF-only case. The chart below shows the cost of financing of the two combination cases (WIFIA 35-year and 55-year loans, respectively) compared to that baseline using different discount rates:

Note that if the borrower’s discount rate was 3.0% (the interest rate on both loans) the net benefit would be zero — the cost of financing is exactly the same for all cases, regardless of WIFIA’s term and deferral options. But that’s certainly not realistic — the reason the borrower was considering SRF and WIFIA loans in the first place was because their rates are subsidized in comparison to market alternatives. Let’s say those market alternatives average about 4% at a minimum — already the borrower can save about $4 million PV with the WIFIA 35-year combination case (and even more in the 55-year case). As the borrower includes risk factors (a local recession, for example) in the discount rate, the benefit of a longer term rises further. I’d guess that the typical discount rate for tax or rate-funded public infrastructure projects for long-term cash flow is at least 200 bps. higher than the risk-free, US Treasury rate — so about 5% here, for an $8 million saving (8% of project cost) in the 35-year WIFIA loan combination. In a word – plenty.

Interestingly, one ‘risk’ that usually needs to be considered in a VfM analysis is that interest rates might fall dramatically in the future but a make-whole pre-payment penalty effectively prevents project debt refinancing. It’s possible that SRF loans sometime require such penalties, but WIFIA certainly does not — prepayment is fully optional and penalty-less — and in a long-term timeframe that matters much more.

This is a quick update of the analysis of WIFIA’s FYE 2021 loan portfolio with respect to interest rate re-estimate exposure. At FYE 2021, the portfolio included 59 loans and loan commitments totaling about $11.5 billion. Since then, the program has added 29 loans totaling $3.8 billion, but these are not included in this update, nor are any further commitment drawdowns. They will be included in a FYE 2022 update later this year. For various reasons, it’s not likely that the additional loans or drawdowns will materially change the scale of the FYE 2021 portfolio’s interest rate exposure.

The biggest update of course is the rise in interest rates since autumn last year. The most relevant rate, 20YR UST, averaged 3.48% for June 2022, up 1.49% from the September 2021 average. This rise was much, much faster than the CBO’s projections:

If all of the FYE 2021 loan commitments were drawn on June 30, 2022, realized funding losses would be about $2.4 billion, or about 20% of the portfolio:

That translates into future mandatory appropriations that dwarf the program’s discretionary appropriations:

Of course, these funding losses are unrealized, and WIFIA is not a private-sector bank with a limited capital base. A lot could change:

• Interest rates could fall back to low levels before the loan commitments are drawn. This might happen in a deflationary recession.

• A stagflationary recession or even prolonged high inflation will probably mean higher rates, but in that case the real value of future mandatory appropriations will be reduced.

• Disruptions in private debt markets might result in later loan commitments being drawn and amortized at relatively high rates, resulting in funding gains that offset the FYE 2021 portfolio’s losses. This would require WIFIA to suspend its reset policy, but that’s presumably possible, as it’s not legislatively required.

No doubt there are other possible outcomes — we live in uncertain times. Still, the scale of potential funding losses relative to what Congress thought were the necessary discretionary appropriations for the program is a red flag. As described in the FYE 2021 analysis, these giant off-budget losses point to a FCRA budgeting loophole that should be recognized and addressed.

To be clear, there’s nothing wrong with federal infrastructure loan programs offering interest rate management products — they’re likely to be more valuable than ever. And Treasury certainly has the capability and economies of scale to provide them at the lowest possible cost to the US taxpayer. But to make such products sustainable, their cost has to be correctly assessed and put on the discretionary budget. Otherwise, unpleasant surprises are virtually certain.

It’s a simple change. WIFIA’s current maximum loan term is 35 years post-construction. That should be extended to at least 55 years for long-lived water infrastructure projects.

The topic has been covered in previous posts: WIFIA 55-Year Loan Term (September 2020) and Extended Term for WIFIA Loans (February 2021).

Same Story

The basic story hasn’t changed. Although interest rates are significantly higher than before, the benefit of a 55-year term WIFIA loan relative to a 35-year term one is about 6% lower PV of debt service, or about $6 million for a $100 million project. The other numbers (minor FCRA cost increases, lower tax-expenditure) are also about the same:

The primary driver of the increased benefit – a longer term’s relatively greater utilization of US Treasury flat-forward pricing – also remains the same:

There’s even a bill in Congress, the Water Infrastructure Finance and Innovation Act Amendments of 2022, that has precisely the same language for a 55-year term as the WIFIA Improvement Act of 2020 did. (There are other things in the 2022 bill, too, but that’s a topic for another post.)

Different World

What’s changed – a lot – is the outlook for the economic, political and social context in which US water infrastructure renewal will develop in the coming years. Federal infrastructure loan programs are likely to be an increasingly important federal policy tool in more challenging conditions. Here’s a recent post: Hard Times Ahead.

In the relative optimism of recent years, extending the maximum term of certain loans in a small sectoral program for large water utilities might have seemed…well, not exactly a compelling priority, regardless of logic or potential benefits. I think it was seen as a minor change for some Western water management projects that had other issues with the WIFIA program (federal budgeting) and useful only to a regional constituency. The WIFIA Improvement Act of 2020 went nowhere.

A pessimistic outlook will – or at least, should – change that perception. Yes, it’s still a minor change and only applicable to long-lived water projects. But more relevant in a tough environment:

• Local funding will be even scarcer, especially for types of infrastructure where it’s easier to kick the can and defer renewal – like stormwater systems. These projects tend to be mainly composed of long-lived, structural assets which could support and benefit from a 55-year loan term. As more water agencies look for WIFIA loans to mitigate the effects of higher interest rates and inflation, they’ll be plenty with long-lived assets. And they’ll be looking for every penny of benefit they can get. That constituency will be national in scale and highly motivated.

• Federal infrastructure loan programs will need to expand their capacity but also their capabilities. Not big, transformational changes (that’ll be impossible) but many small, specific modifications to loan products that have predictable benefits. Extending WIFIA’s maximum term is a perfect example of what’ll be required. As such it can serve as a demonstration that, despite overall political polarization and dysfunction, at least one area of federal policy can be successful. It shouldn’t be difficult — TIFIA just extended their maximum term (to 75 years, no less) in the 2021 IIJAA. A win for WIFIA’s maximum term will encourage more of what will work.

• More subtly, longer terms for infrastructure loans help shift the focus to the long run, where it belongs, and away from a business-as-usual mindset. That focus matters for evaluating investment in climate change, long-term environmental sustainability and quality of life for future generations. It’s no secret that the ESG agenda doesn’t seem to have the kind of consensus behind it as it did recently – a trend that is likely to get worse. An extended term for WIFIA loans is a small step in the right direction.

A lot of decisions about US public infrastructure will need to happen in the near future. That’s not a choice. For the past decade at least, there was reason for optimism that those decisions would include additional investment for sustainability, social goals and climate change adaptation.

But suddenly, that optimism doesn’t look so justified anymore, as yet more articles like this appear. Now it seems almost certain that funding for anything other than bare bones replacement will face economic, political and social headwinds.

Local infrastructure funding will have to deal with anxious tax and rate payers that are already beset with inflation and slow growth. Federal funding, so recently looking bright, could dry up in a wholesale change in the political environment and changing priorities.

Right or wrong, that’s how it is. Hard times mean a focus on short-term, just-good-enough solutions. Unfortunately, climate adaptation investment only has really obvious value in the long-term.

Is there any way to make it easier to include long-term value in today’s public infrastructure decisions, at least from a federal perspective? I think federal infrastructure financing programs could help a lot. A long-term policy perspective comes naturally to programs that offer loans with terms of 40 years (WIFIA) or even 75 in some cases (TIFIA). Apart from low interest rates, stretching out amortization schedules and other structural refinements mean that short-term funding impacts can be minimized. And future repayment comes when the value of additional investment is seen (perhaps even welcomed) in real time.

If only from a practical, realpolitik viewpoint, I also think federal infrastructure loan programs are worth extra attention right now. The programs have solid bipartisan support and usually fly way beneath our polarized political storms. They’re easy on the federal deficit and easy to expand in size and capability, given the federal government’s unique strengths as a long-term lender. Several are operating successfully already, a proven base to work with and a model for copies, like CIFIA.

Maybe there’s better news ahead. But despite my natural optimism, something tells me that the next few years are going to be challenging. We shouldn’t give up on continuing positive climate change policies, of course. But it’s time to start looking for practical solutions to keep that positive direction going in more difficult times.

New article online at Water Finance & Management with Chad Praul of Environmental Incentives.

Federal loan programs like WIFIA and impact investors share important common goals. The investors need bigger scale to connect with US essential public infrastructure. WIFIA needs innovative proposals.

Realizing better outcomes in US infrastructure renewal through innovative financing won’t be easy. But it’s a critical path in real-world decisions about funding and consensus building. A long road — WIFIA and impact investors should go together.