In late February, the WIFIA program closed its 100^th loan, a $74 million financing for Santa Clara Valley Water District.  This is the first part of a master agreement for future WIFIA loans totaling about $2 billion for the rehabilitation and construction of two reservoir dam projects.  Since dam finance has been a topic here recently in connection with the new CWIFP program, this loan is worth a closer look to see how three possible CWIFP enhancements – a 75-year term, a 10-year deferral and the Limited Buydown – would be useful in a real-world situation.

As usual for large water public agencies, there’s a lot of public information about the decision making process.  On December 13 last year, the SCVWD Board met to consider a final resolution to go forward with this WIFIA loan, in the course of which its potential benefits and costs were reviewed and discussed.

Here’s a link to the video of the meeting — SCVWD Board of Directors Meeting December 13, 2022.  The main WIFIA presentation starts at 0:45:10 and finishes at 0:55:03.  Discussion among the boardmembers goes to about 1:43:00 at which point the resolution to proceed is passed.  WIFIA slide deck pdf here.

Possible Enhancements Could Be Included in Future SCVWD WIFIA Loans

Although much of the WIFIA presentation was in the context of the overall $2 billion WIFIA financing plan for two dams, SCVWD’s specific resolution and subsequent loan closing was limited to a $74 million loan for planning and design costs for one dam project.  As many as nine additional WIFIA loans, closing between 2023-2032, are contemplated, but not committed, for the projects.  This time frame means that possible enhancements to WIFIA program loans may be directly relevant to SCVWD’s dam program.  Active legislative efforts, primarily connected to CWIFP implementation but specifically amending WIFIA law, are continuing.  Last year The Water Infrastructure Finance and Innovation Act Amendments of 2022 (HR 8127) was introduced in the 117^th Congress and is expected to be reintroduced soon.  This bill already includes an amendment to extend WIFIA’s maximum term to 55 years.  In addition, the Twenty-First Century Dams Act (HR 4375), also expected to be reintroduced, proposes an increase in WIFIA funding – amendments for enhancement (at least for dam projects) could be included in the same section.  Obviously, nothing is certain in this political environment, but enacting minor, technical-seeming amendments to enhance the capabilities of a popular and successful water infrastructure loan program probably has a decent chance, if anything does.  Thinking about how the enhancements might be useful to SCVWD is therefore not an academic exercise.

Apart from the financing, it’s clear from the board discussion that real-world plans for the dam projects are also far from finalized.  The dam project for which the $74 million WIFIA loan was sought, primarily a seismic retrofit of the Anderson Dam, seems to be more or less greenlighted towards construction.  But the other dam project, the Pacheco Reservoir Expansion, is still at an early (and apparently contentious) stage.  The fluidity of the situation highlights the value of a WIFIA loan’s overall flexibility, as was pointed out several times in the discussion.

There’s another aspect of this, specific to the enhancements – to the extent that possible WIFIA loan enhancements influence the final design or other real-world aspects of the infrastructure, that would demonstrate that WIFIA’s fundamental policy objective (US water infrastructure improvement, not just subsidization) is achievable.  For example, might a 75-year loan term focus attention on, and possibly enable, a plan for the Pacheco Dam that addresses very long-term sustainability, resilience and inter-generational issues?  If the enhancements are enacted while SCVWD’s situation is still fluid, their impact will be interesting to see from a policy perspective.

Debt Service Management

A primary theme in the WIFIA presentation was the loans’ usefulness in managing future debt service in the context of SCVWD’s cash flow.  In the longer term, this was about being able to customize a WIFIA loan’s amortization schedule and dovetail it with other financing by delayed principal payments.  In the front end, the full deferral of debt service (both interest and principal) allows a smoother ramp up of rate revenue.  As frequently discussed in prior posts, the ability to offer these features is a real federal government strength compared to private-sector debt markets, especially the tax-exempt public bond market.  WIFIA’s US Treasury-based pricing makes delayed amortization cost effective due to the ‘flat-forward’ Treasury curve beyond thirty years.  Interest accrued during the deferral is locked at the loan’s original rate.  And the loan or any amount of it can be prepaid without penalty.  The ‘flexibility’ of a WIFIA loan was often mentioned in the presentation and board discussion – I’d expand that description to include ‘optionality’ as well, a concept that includes potentially quantifiable value (e.g., in a refinancing situation) throughout the loan’s life.

The potential enhancements are simply that – a 75-year term, a 10-year deferral and the Limited Buydown improve the flexibility and optionality of WIFIA’s debt service management features without changing anything fundamental from the borrower’s perspective.  They will expand the program’s maximum statutory authority, but don’t prescribe what the borrower can choose, or the program is willing to approve.

Presumably SCVWD’s dam projects have useful lives when completed of at least 75 years.  As the WIFIA presenter noted, SCVWD’s credit rating for the WIFIA loan from Fitch was a near-perfect AA+.  If the enhancements were enacted, my guess is that WIFIA would approve future SCVWD loans utilizing all three to their fullest extent – risks to the federal taxpayer would remain very low and (as discussed above) program policy objectives would likely be benefitted.  Assuming that’s the case, we can consider how useful each enhancement might be in the context of SCVWD’s situation, as described in the WIFIA presentation and board discussion.

The below chart (page 9 of the pdf) summarizes the debt service requirements of about $2 billion of SCVWD’s planned WIFIA loans (blue bars) under current law. You can immediately see the back-end loading of delayed amortization. The 5-year deferral is a bit more subtle — without it, there would have been a sharper spike in debt service in 2028 than the one projected for 2033.

75-Year Term

SCVWD’s chart can be recreated to include an approximate model of the WIFIA loans using other information provided in the presentation. Assumptions can then be changed to reflect the enhancements. Here’s what a 75-year loan term would look like:

Unsurprisingly, there’s a big drop in level-payment debt service, more than $120 million annually, as the amortization period goes from 13 to 48 years. But this effect won’t start until 2055 — more than 30 years from now. Does it have practical value for SCVWD in terms of decisions that will be made in the next five years or so?

Depending on other SCVWD’s other capital plans and long-term projections, there might be a more or less direct application for the additional cash flow in the far future. But I think even outside that case, there’s always value in securing a very long-term amortization schedule for very long-lived assets like dams because it increases WIFIA loan optionality. Prepayments can always be made without penalty — SCVWD can opt to follow a 13-year amortization schedule or refinance the loans altogether if lower interest rates can be obtained. But a lot can happen in 30 years. If the need for additional financing for other projects arises, or projected revenues for some unforeseeable reason become significantly lower, $120 million of annual cash flow freed up by a 48-year amortization schedule on the WIFIA dam loans might become an important factor.

10-Year Deferral

If a 10-year deferral feature is included, WIFIA loan interest-only debt service simply starts in 2038 instead of 2033. The spike is still about the same — in fact, it’s very slightly higher due to capitalized interest. But now there’s an additional five years to ramp up rates or other revenue sources to pay it, something which may have relatively near-term value.

In any case, the same observations about increased optionality for the 75-year term apply to the 10-year deferral. Ramping up water rates is probably always a somewhat difficult and multi-factored process — having more time to accomplish it can only help. If things go better than expected, voluntary debt service payments are always an option.

Limited Buydown

When describing the loan’s projected interest rate in the WIFIA presentation, the speaker was careful to note that it was only an estimate and wouldn’t be locked until loan execution. In the current economic and financial environment, interest rate volatility is (and likely will remain) a fact of life. Rates can rise or fall quite significantly and unexpectedly in a relatively short time. In SCVWD’s multi-year planning horizon for the dam projects, big changes in this central factor are almost a certainty.

A Limited Buydown feature — currently included in the TIFIA and CIFIA loan programs but not yet in WIFIA — could help mitigate this uncertainty in SCVWD’s WIFIA financings, at least to some extent. The feature simply allows the program to execute a loan at the Treasury-based rate prevailing on the date the loan application was accepted (usually many months or even years earlier) if that rate is lower than current, with a maximum 1.50% decrease. In effect, the Limited Buydown is an interest rate cap that shields the borrower from rate increases (up to 1.50%) in the period between an accepted application and loan execution (possible draft language for the provision here).

I am fairly certain that each loan under the Master Agreement between SCVWD and WIFIA will require some form of separate execution and its interest rate will be set on the day that happens. The rate for the $74 million loan was locked in the February closing but future loans — comprising the vast majority of the $2 billion program — are presumably still exposed to interest rate volatility.

If WIFIA had a Limited Buydown provision, an interesting question arises — does the Master Agreement constitute an ‘application’ for all the individual loans contemplated to be made under its terms? A WIFIA Master Agreement might be only a conditional agreement with respect to funding loans (per CIFIA law definition anyway), but it certainly represents a high degree of ‘acceptance’ by the program of all the loans contemplated thereunder. Legal interpretations at this level of detail are way above my pay grade, but I’d guess that if the WIFIA statute had had a Limited Buydown provision when the program accepted SCVWD’s application for the financing plan under a Master Agreement, or when the Master Agreement was executed, then a Limited Buydown adjustment would be available, as of that date, for all its individual loans [1].

Let’s assume that’s the case for a simple illustration. Also assume the Limited Buydown rate is the same as estimated in the WIFIA presentation — 3.68% [2] — and that US Treasury rates for future loans under the Master Agreement rise by 1.50% to 5.18% before execution.

Without a Limited Buydown cap, forecast debt service would increase by $50 million annually, as shown in the red bars below. That’s about a 40% increase in WIFIA debt service during the interest-only period, and an 18% increase in forecast debt service overall during the same time.

With the Limited Buydown provision, debt service could remain, subject to program approval [3], as originally forecast. The assumptions for this illustration make the potential monetary value obvious, but the more general point is that the Limited Buydown reduces uncertainty of forecasting financing cost of large capital programs, at least for the WIFIA component.

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Notes

[1] Some sort of ‘reset’ or re-application of previously executed agreements might be required. Discussed here in the context of the CIFIA loan program — WIFIA Rate Lock Reset Precedents for CIFIA

[2] WIFIA rates are set by using the US Treasury yield applicable to the weighted average life (WAL) of the loan. On 12/2/22, the UST 20Y and UST 30Y yields were 3.79% and 3.56% respectively — presumably the presentation’s 3.68% rate is an interpolation corresponding to a loan life of about 25 years? That makes sense for the $74 million initial loan, but the WAL for the overall $2 billion financing is closer to 40 years, due to the deferral and long interest-only period. Still — even if the whole $2 billion were executed at 12/2/22 rates, the ‘flat forward’ convention for Treasury pricing would result in using the UST 30Y rate of 3.56%. That detail illustrates some of the value of the 75-year term — once WAL is close to 30 years (typical for long-lived infrastructure financing) there’s no extra cost in going much longer.

[3] The Limited Buydown permits, but does not require, the program to reduce the execution rate. That decision might depend on the availability of discretionary appropriation funding. Discussed here, also in the context of the CIFIA program — CIFIA’s Limited Buydown – Mind the Gap. To be really effective, WIFIA will need a much higher level of funding from Congress. Well — why not? Current funding (about $60 million per year) is almost trivial. The program has demonstrated remarkable success and is achieving its objectives — now how about some real funding?

Here’s an overview chart of various ideas discussed in recent posts for the Corps’ new loan program, CWIFP. In addition to HR 8127, which expands WIFIA’s statutory capabilities overall, I’ve included the 21st Century Dam Act as another potential avenue for enabling (and perhaps acting synergistically with) specific enhancements for dam projects. Both bills are expected to be reintroduced in the new Congress soon. Chart PDF here.

Five-CWIFP-dam-finance-enhancements-020223

In a previous post about CWIFP and dedicated funds lending to small dam projects, I suggested that a statutory path probably should begin with a directive for a in-depth study on the topic. Here’s a first cut of what the language might look like, slightly edited from yesterday:

Small-Dam-Study-Draft-Language-01312023-InRecap-Copy-2

It became clearer in the course of doing the FCRA Non-Federal Series that a lot of the apparent ambiguity of FCRA treatment for loans to federally involved projects appears to stem from imprecise language. This post will sketch out two definitions that will be useful going forward, a ‘federal project’ and a ‘non-federal interest’ in a federal project.

Federal Project

The term ‘federal project’ occurs throughout the FCRA issue. First, I think it’s important to clarify what the term does not refer to — a federal facility.

A federal facility is built to facilitate federal operations. It sometimes might look like public infrastructure, although the scale is usually smaller (e.g., office buildings, housing). But the primary end-user and direct beneficiary is federal government itself. The asset can be owned by a non-federal third party (like a real estate developer) and used by the government under some sort of contractual arrangement (like a lease). Most importantly, contractual payments will be federally sourced.

I can see that federal facilities owned by third parties would pose a problem for federal budget treatment and CBO legislative scoring. The same consolidation issue arises in private-sector FASB accounting, especially capital vs. operating lease classification. Most of the examples in the CBO Report involve lease-type contracts on federal facilities and CBO resolves their scoring treatment with what are effectively FASB 13 lease principles. If the third-party owner of a federal facility sought a federal loan to finance the asset, FCRA treatment for the loan would likely depend on the same factors.

But none of this should be relevant to FCRA treatment at federal infrastructure loan programs for the fundamental reason that federal facilities shouldn’t be eligible program borrowers in the first place. A federal facility will presumably help the government achieve beneficial public outcomes, but it’s not the end product, especially with respect to public infrastructure. Since statutory eligibility requirements at federal infrastructure loan programs focus on direct public benefit, it’s hard to imagine how a federal facility as defined above would ever comply. FCRA treatment is a moot question.

In contrast, a federal project can be defined as an infrastructure project with federal involvement but where the primary end-user and direct beneficiary is the non-federal community or region in which the infrastructure is located. Such projects will often be statutorily eligible for federal program loans — hence the importance of the FCRA non-federal issue.

But the leasing principles that apply to scoring and FCRA treatment for federal facilities do not apply for federal projects. As defined above, the primary beneficiaries of a ‘federal project’ are non-federal communities, and the relationship between the project and its non-federal beneficiaries should be the basis for FCRA classification. That requires defining another concept.

A Non-Federal Interest in a Federal Project

Imagine a federal infrastructure project that is completely built, owned, operated and paid for by a federal agency. Simple, yes? Every cash flow associated with this project will be included in the cash-based federal budget.

This project will of course benefit the local or regional community is some way. And no doubt they’re happy to see it paid for by national taxpayers. Completely rational.

But now let’s say that the federal agency won’t get enough federal funding to build the project, only a part. That agency could simply cancel the project. Or it could go the project’s beneficiaries and ask them to pony up some funding to get it done. The community could then decide, in its own self-interest and again with complete rationality, to the provide the balance. But they won’t simply write a check — they’ll want a long-term contractual agreement covering various aspects of the project to ensure they’re getting their money’s worth.

The project gets built with the community’s financial support. In one sense, it’s still a ‘federal project’, but now there’s a real and quantifiable ‘non-federal interest’ in the project. That interest may be large or small, it might involve some degree of operational control, it may or may not cover specific physical parts of the project. All those aspects will be determined (most likely in great detail) by the contract between the federal agency and the community. But one thing is certain — the project is no longer wholly federal, and federal budgeting should reflect that fact.

Let’s go further. Assume that the community can’t write a big check to pay for its share of the project’s construction cost in a lump sum upfront. But they’re willing to make payments over time under the long-term contract and their creditworthiness is good. With that contractual obligation for cash flow, the project can finance construction costs. The non-recourse lenders aren’t looking to the federal agency for repayment (there’s explicitly no recourse to the agency) or even to the collateral value of the project’s physical assets (there’s no resale market) but solely to the community’s ability, most usually through taxes or regulated user fees, to pay under the contractual obligations. What’s actually being financed here? The federal project? Not really, even though that’s where the money will be spent. Rather, it is the non-federal interest that is being financed — and the debt is non-federal.

The federal government provides various subsidies to non-federal debt for infrastructure projects that benefit the public. The biggest one by far is the tax-exemption on the debt’s interest — the basis for the tax-exempt municipal bond market, of course. Such tax-exempt debt can’t be directly or indirectly guaranteed by the federal government. If the community in our example were to seek tax-exempt financing for their non-federal interest in the federal project, they’d have to demonstrate that the source of repayment was exclusively non-federal. In most cases, that should be straightforward — the lenders will ensure that the contract is explicit about where’s the money is coming from, and the community’s taxpayers will probably have a say in approving it. Let’s assume that the non-federal interest in our example qualifies for tax-exempt financing.

There’s another way that the federal government subsidizes infrastructure with a public benefit — federal infrastructure loan programs. These programs are much smaller than the tax-exempt bond market and their interest rates aren’t generally much better. But the program loans offer various features (loan term, rate management, flexibility, etc.) that can’t be found in the bond market. The community in our example decides to seek a federal program loan in addition to their tax-exempt bonds to finance their interest in the project. The project — and therefore their interest in it — appears to be statutorily eligible for such a loan, and they make an application.

It is only at this point — not before, not with presumptions about ‘federal’ projects, not with respect to the project’s history or statutory eligibility — that FCRA treatment becomes relevant. Now FCRA criteria can be applied on the specific facts about the community’s non-federal interest. Questions and requests for additional information about that interest should be expected — just as they were for the tax-exempt qualification. And equally, the answer should be straightforward in most cases. A program loan to finance a genuinely non-federal interest in a federal project should receive FCRA treatment.

Going Forward

The more general point here is this: In the next few months. there’s likely to be a lot of discussion about the FCRA non-federal issue. Precisely defining these two concepts — a federal project and a non-federal interest in it — at the outset will make the issue and possible solutions much clearer.

In a prior post, I raised the idea that CWIFP should be allowed to lend to revolving funds that in turn lend to smaller dam rehabilitation and removal projects. This was based on an analogy to WIFIA’s explicit ability, reinforced by SWIFIA legislation, to make loans to SRFs. This post will sketch out that idea a little further.

Analogous Policy Objectives

The federal government has a lot of genuine strengths as a large-scale lender to US public infrastructure projects – cost-effective interest rate management, loan terms far longer than market, structural flexibility, etc. – that go beyond just offering cheap loans.

Large projects can utilize these features efficiently in large loans from federal programs. Smaller projects usually can’t, for any number of eligibility and transactional reasons. Yet smaller projects are the ones that would benefit most from financing alternatives.

There are two ways to address this. One is to add special provisions and policy objectives to federal infrastructure loan programs to ensure that small loans to small projects (especially in disadvantaged communities, etc.) are also being done. This approach is not ideal. Small-scale project financing is not a federal strength – arguably, it’s a weakness, or at best highly inefficient. And there is inevitably an element of federal centralization that not everyone agrees is the best way to support US local infrastructure renewal.

I think the other solution is much better, both in theory and in practice – have the federal program make large loans (with all their useful features) to local public-sector or policy-oriented lenders who in turn make loans to their local small projects. More efficient, less centralized, broader eligibility [1]. That’s the goal of SWIFIA. The DOT’s TIFIA has something similar.

Analogously with these established precedents, especially with respect to policy objectives and implementation efficiency, CWIFP should be able to make loans to local funds that will specialize in small dams.

Under Current WIFIA Statute

CWIFP doesn’t have explicit authority to do this under current WIFIA law. Even if some SRFs could make loans to small dams (e.g., as part of a larger state infrastructure bank), WIFIA loans to SRFs are limited to drinking and clean water projects specified in the CWA legislation.

But there is possible path in WIFIA’s eligible projects section, §3905.10:

A combination of projects secured by a common security pledge, each of which is eligible under paragraph (1), (2), (3), (4), (5), (6), (7), or (8), for which an eligible entity, or a combination of eligible entities, submits a single application.

Paragraphs 1 and 8 are relevant to dams and specifically noted in CWIFP’s site, as is this paragraph 10.

The interpretation of a “common security pledge” is central. A group of different projects getting together to apply for a single large WIFIA loan but with each offering separate security for the loan won’t work.

But if a separate eligible entity (the §3904 list includes various forms suitable for financial role) plans to lend individually to separate, eligible projects, then the “combination” occurs only at that entity. The security pledge that the lending entity will offer for a WIFIA loan is “common” is the sense that the one pledge covers the entity’s entire portfolio.

It needs to go further, however. If the lending entity is a thinly capitalized shell in which the only real security is in the individual loans, then the common pledge is not substantive. But that arrangement would probably fail WIFIA’s creditworthiness tests anyway. To get to an investment-grade standard on a relatively small and chunky portfolio of loans, the lending entity will need a fair amount of real capital beneath the WIFIA loan — federal or state grants, philanthropic, subordinated impact investor tranches, maybe even a slice of private-equity. A WIFIA loan is limited to 49% of the aggregate project cost — that’s probably the maximum amount of investment-grade senior debt possible in this situation, so I think it’s safe to assume that all other capital is subordinated in some way.

Now the common pledge for the senior WIFIA loan will have independent value, not just a pass-through of the individual loans. The “combination” at the lending entity is now also substantive — security in the individual projects is being combined into a single asset (the loan portfolio) and shared in various ways among the lending entity’s investors and WIFIA. It’s worth pointing out that security pledges in this kind of small loans are really about contractual cash flows (from local taxes or user fees), not the value of tangible collateral. In effect, completely fungible cash flows are being combined and shared without regard to individual loans.

I think this approach should comply with the letter and spirit of the language in §3905.10, especially since it effectively requires that the lending entity works in basically the same way as an explicitly eligible SRF. But it’s not bulletproof by any means. The language can be interpreted with a conservative slant, extrapolating “common” to mean full cross-collateralization, for example. And there’s always the basic rule of the disinclined bureaucrat – whatever is not expressly and literally permitted is prohibited.

Statutory Paths

Increasing the certainty of CWIFP’s ability to lend to small dam funds will involve a statutory change. Possible paths would range from minor word changes in §3905.10 (e.g., clarifying that “combination” and “common” requirements are satisfied by a lending portfolio) to full-blown SWIFIA-like statement with new definitions.

In the near-term, however, I think any proposed changes should be very limited until the demand for, and utility of, CWIFP loans to funds becomes clearer. It’s still early in a long-term process of program development and evolution. Perhaps the best way for now is simply some version of a study of the topic like the one proposed for collaborative delivery in Section 4 (b) of last year’s HR 8127. The study could include an assessment of the need for small dam finance, how revolving funds could address this need, various structural alternatives, and finally, required legislative changes for implementation.

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Notes

[1] This is recognized to some extent by the program itself. From page 16 of the current WIFIA handbook:

By including multiple projects in a single loan, borrowers gain:

Financing certainty for all the included projects expected to be constructed in a 5-year period. Borrowers can request disbursements for any project included in the loan immediately following closing until one year after substantial completion of the final project.

The ability to use WIFIA loans to finance smaller projects that would not individually meet the WIFIA program’s minimum project cost requirement, $5 million for small communities and $20 million all other communities.