New article in Water Finance & Management. Very timely in light of a broader theme — the need to get creative about the interaction between the municipal bond market and federal credit programs. It shouldn’t ever have to be a zero-sum game — but especially not now, when state & local governments and infrastructure agencies need the best financing resources they can get.

Note: Additional 3-Year scenarios here.

There’s a federal budget methodology for estimating the cost of amending the MLF. And one for not doing so. These numbers should be included in the debate.

Now that the Fed’s $500 billion Municipal Liquidity Facility (MLF) appears to have accomplished its lender-of-last-resort mission for the muni market without actually having to lend much money, there’s an intense debate about what (if anything) to do with all the dry powder that’s left.

The debate so far involves important and difficult issues that would be more relevant if the MLF was just another federal loan program or central bank operation.  But it’s not – by definition, federally subsidized MLF loans would be an alternative to federally subsidized tax-exempt bonds. Since there’s no difference in principle, the actual issue would seem to be a choice between two ways to deliver $500 billion of federally subsidized debt to state & local governments: either (1) amend the MLF to be a lender-of-actual-loans, or (2) let the $500 billion be placed in the now-functioning muni market.  Either way federal taxpayers will pay the freight. So their cost should be a big factor in the choice.

Now that some in Congress have shown that they take technical budget accounting matters at WIFIA extremely seriously, these diligent lawmakers should be very interested in directing the CBO to take a look at what appears to be a glaring error in Program scoring.

The Joint Committee on Taxation makes a major assumption about the projected impact of the WIFIA Program on federal revenues, which in turn makes a significant difference in CBO Cost Estimates.  Here’s the relevant language from CBO’s June 28, 2018 scoring for S.2800:

JCT is assuming classic loan program ‘strict additionality’ here.  Their expectation is that an infrastructure project that otherwise would not proceed will be able to do so only with a WIFIA loan.  And since most water infrastructure is built by public-sector agencies and financed with tax-exempt debt, tax-exempt bonds are expected to be issued for the 51% of project capital cost that’s not covered by the WIFIA loan.  Hence, a $49 million WIFIA loan will cause the additional issuance of $51 million of long-term tax-exempt bonds.  Since in the absence of WIFIA, the project wouldn’t have proceeded and the bonds would not have been issued, the bonds’ tax revenue impact must be included in Program budget scoring.

JCT’s logic is completely correct.  And at the Program’s outset, it was also completely reasonable for them to assume that the Program would develop along these lines, based on the general applicability of additionality objectives behind loan program policy and specifically on actual outcomes at TIFIA, the transportation loan program on which WIFIA was very closely modelled. 

This is a case where “if some is good, more is better” might actually be true.

As frequently noted here, very long-term loans are a federal strength. Very long-lived infrastructure assets are often best financed with debt of a similar term, especially when cash flow for debt service is relatively certain (e.g. water rates, taxes) but not particularly abundant due to slow demographic and economic growth. Or say, when long-lasting effects of a major pandemic-related shutdown are expected. Like now.

But it’s never a good idea make the repayment of a financing too back-ended or exclude the discipline of the private-sector markets. A roughly 50/50 mix of shorter-term, faster amortizing market-sourced debt and a long-term federal loan with slower payoff combines a lot of positive elements in an optimal (or at least improved) financing of a long-lived asset.

And of course that’s how a 51%/49% muni bond/WIFIA loan combination works. Right now, an optimized muni/WIFIA financing for a highly rated public water agency could save almost 10% present value on debt service compared to bonds alone. Great — but that’s effectively limited by WIFIA’s current 35-year maximum post-construction term. For the right assets and credit quality, a federal loan could extend much longer with little increase in risk or FCRA cost. And the muni bond component could be pushed within its now-recovered market too. Extend the max WIFIA term to 55 years, and the PV benefit is almost 18%. It’s not for every asset, credit or fiscal condition, but since both lenders working together are fundamentally capable of providing this kind of financing, why not amend WIFIA’s max term and offer it?

Below is a summary of the numbers comparing the current 35-year max term with an equivalent 55-year extended case. Click on the picture to expand. For an even deeper look, the macro-less Excel models are here: 35-year and 55-year cases. A related analysis from late last year has some additional context: WIFIA Extended Term BCA.

Not surprisingly, since the extension makes intuitive sense, the idea is surfacing in the real-world, which is what prompted this post. The WIFIA Improvement Act (H.R.8217) was introduced a few days ago. The first part of this short bill proposes an extension of max term to 55 years for projects with a useful life at least that long — “as determined by the Secretary or the Administrator, as applicable”. And the usual rigorous credit review still applies. So no games. The project has to be the real deal life-wise and the borrower has to show they’re absolutely good for repaying 55-year post-construction money. As noted, it’s not for everybody. But since a lot of basic water infrastructure is extremely long-lived (that’s what needs replacing), and a lot of public water agencies are highly rated (AA- median per Fitch), there’s likely to be quite a large qualifying pool of potential borrowers. All of whom are certainly thinking about the challenges of a post-Covid-19 future. Like everyone else in the state & local public sector.

The second part of HR 8217 is a proposed modification of the FCRA treatment (or lack thereof) for projects that are nominally federally owned but otherwise demonstrably not federal in the things that really matter in FCRA — who borrows the cash and where the repayment comes from. Unlike the 55-year term part of the bill, this proposal applies to only a very small subset of water projects, mostly related to Bureau of Reclamation legacy assets.

Sounds uber-technical and uncontroversial, no? Unfortunately the modification is related to the recent unpleasantness about federal ownership criteria that got WIFIA punished in House Appropriations with a (hopefully soon-to-be-reconsidered) defunding. That’ll keep things interesting, but when the smoke clears at least there’ll be additional clarity on this issue. So notwithstanding the limited applicability to a few water projects, this proposed modification might surface some important things about WIFIA’s future direction — definitely a topic for another post or two.

Here’s the first, where we discuss WIFIA’s surprising success:

A follow-on conversation, focused on WIFIA’s potential Covid-19 responses: