This post is the first of three on the topic. The second is here, and the third here.

The ‘Limited Buydown’ provision in TIFIA and CIFIA loan program legislation allows a loan’s construction period interest rate lock to be set at application, not loan execution, as in the WIFIA program.  That’ll be an especially useful feature for carbon pipelines, but it might use a lot of discretionary appropriations.  This long post sets out the context and risks associated with that.

WIFIA’s Off-Budget Post-Execution Rate Lock

A WIFIA loan’s construction period interest rate lock is one of its most valuable features.  In effect, it works as an interest rate option, both on construction draws and (more importantly) on the loan’s post-construction permanent financing phase.  The option is costless to the borrower, but potentially very expensive for federal taxpayers if rates rise during the lock period.  However, under FCRA budgeting methodology, this cost is not WIFIA’s problem.  The water program’s lock begins at loan execution when the loan’s interest rate is set at then-current Treasury rates.  Hence, the required discretionary appropriation (the ‘credit subsidy’) for the loan’s cost is only about its expected credit loss, a small amount for WIFIA’s highly rated borrowers.  If Treasury rates rise between loan execution and final drawdown, the discounted present value of Treasury’s funding loss shows up as a positive adjustment to the credit subsidy amount (an ‘interest rate re-estimate’) that is automatically authorized (under FCRA’s ‘permanent indefinite authority’) and receives a mandatory appropriation covering Treasury’s loss.  The accumulated balance of these mandatory appropriations is recorded in an off-budget account, and WIFIA’s discretionary appropriations are not affected.

The theory behind this special budget treatment appears to be that post-execution interest rate changes are an exogenous and uncontrollable factor for federal loan programs and will likely balance out over time, as both positive and negative interest rate re-estimates should occur.  I think the reality is much more complicated in WIFIA’s case, but that’s another topic.

TIFIA’s and CIFIA’s (Likely) On-Budget Limited Buydown

TIFIA and CIFIA loans offer the same construction period rate lock feature with the same FCRA budget treatment after execution – with one crucial difference:  For these programs, the loan’s execution interest rate can be set at what it would have been if the loan had been executed on its application date, if that’s lower than the current Treasury rate, up to a maximum 1.50% reduction.

This pre-execution rate lock (or more precisely, ‘collar’) is called a ‘Limited Buydown’ in the legislation for both programs.  The language is not very detailed in TIFIA’s case but has apparently been interpreted to include the application date trigger.  In CIFIA’s law, the application date (or a somewhat equivalent execution of a ‘master credit agreement’) is explicitly defined as the relevant start point.

The name of the provision, introduced in the TIFIA section of the 2012 MAP-21 act, is a bit odd – the ‘limited’ part is clear enough (the 1.50% limit), but the ‘buydown’ seems to derive from a home mortgage feature whereby the borrower can lower their rate with a payment.  In the loan program’s case, the lender is doing the ‘buying’.  The provision is probably more accurately described as a ‘limited loan interest rate reduction’ or more transparently as a ‘limited sub-Treasury rate adjustment’.  Perhaps a Congressional TIFIA drafter in 2012 had worked on FHA legislation and thought that ‘buydown’ was a quick way to convey the concept, since the net effect (a lower loan rate) is the same?  Or was the name intentionally a bit obscure because the provision is in essence a kind of grant in a loan program that is otherwise generally funded at Treasury cost?  In any case, for CIFIA legislation the name was almost certainly simply inherited, even if the concept clearly got more focus.

Although the pre-execution rate collar is limited to 1.50% and has relatively more optionality than the post-execution rate lock, both have substantially the same type of benefit to the borrower and cost to the federal lender.  A WIFIA loan’s rate lock over a five-year construction period when rates are rising will cost federal taxpayers about the same as a two-year CIFIA or TIFIA rate collar followed by a post-execution rate lock on a three-year construction period.  In both cases, the federal government has committed to the interest rate on a 35-year loan five years before Treasury funds it.  If rates have risen, the borrower receives the same benefit, and the taxpayer gets stuck with the same economic cost.

But there is almost certainly a huge difference in federal budgeting between the two.  As noted above, the cost of the post-execution rate lock is covered by FCRA’s indefinite budget authority and gets buried in off-budget accounts.  The cost of the pre-execution rate collar, however, is not likely to receive that free pass.  Instead, I expect it will need to be apportioned from the program’s available discretionary appropriations when the loan is executed.  FCRA language and established methodology is straightforward about estimating and budgeting for the cost of a loan (including the cost of a sub-Treasury interest rate) when it is executed.  I can’t see any reason why the pre-execution start point of the limited buydown provision would make any difference to that.

Does this matter?  Not to WIFIA and Probably Not to TIFIA

The additional on-budget cost of the pre-execution rate collar is not necessarily important per se.  The loan is going to require some credit subsidy anyway and the cost of the rate collar just adds to that amount.  However, when the aggregate additional amount of subsidy required by the full application of the limited buydown feature is high relative to the available appropriations because rates have risen, the feature could impede loan executions at the reduced rates the borrowers expected.

Obviously, WIFIA won’t have this budgeting issue because the pre-execution rate collar is not included in the program’s statute.  But it’s interesting to consider what might have happened if it did.  The sophisticated financial staffers at WIFIA’s highly rated water agency borrowers would have immediately seen the collar’s value and timed their applications accordingly, aiming for low points in UST rates.  WIFIA hasn’t had any problem attracting applicants without the rate collar.  With this feature, the volume of applications certainly would have increased or at least been accelerated.  The program’s loan volume is very high relative to its appropriations (more than a 50:1 ratio), a sustainable path because the high quality of the program’s borrowers requires only a small amount subsidy for expected credit losses. But there’s not much headroom.   Even a slight increase in the percentage cost of the loans would impact WIFIA’s ability to execute loan volume as planned.  The cost of pre-execution rate collars during the 2020-2022 timeframe, if they had been offered, would probably have been many times WIFIA’s available appropriations.

A loan program’s likely response in this hypothetical situation would presumably be to restrict rate adjustments under the limited buydown provision to whatever budget authority was available (if any) after an adequate amount was allocated for planned loan executions at unadjusted rates.  Such rationing is possible because the buydown language in both TIFIA and CIFIA laws is explicitly permissive, not prescriptive, for program administrators.  How such subsidy rationing would be implemented practically in this situation, especially over a multi-year period, isn’t at all clear, however.  There’d certainly be disappointed borrowers.    

That still may not have mattered in WIFIA’s case.  An un-disappointed borrower is not a policy objective for federal infrastructure loan programs – a completed infrastructure project is.  The important question about possible cutbacks in limited buydowns should be simply whether the borrower’s project can go forward or not.  The vast majority (or even all) of WIFIA’s water infrastructure projects to date would have gone forward with or without a WIFIA loan in the first place (a fundamental policy topic that should get more attention).  In that low-impact outcome context, the additional benefit of a pre-execution rate collar, or the failure to deliver that expected benefit, would have made no significant difference to US water infrastructure renewal, regardless of WIFIA borrowers’ feelings.   

The same net result is the likely outcome at TIFIA, though for different reasons.  I believe TIFIA’s limited buydown provision has been utilized at least a few times.  But I doubt that it created any serious budgeting issues because TIFIA’s loan execution volume is quite slow relative to its appropriations and much of the program’s activity took place when rates were generally falling.  Even if the program’s budget headroom for limited buydowns becomes more restricted in the future, a cutback in the rate adjustments isn’t likely to stall the borrowers’ projects.  Most of the cost benefit of a TIFIA loan comes from the avoided spread between the program’s UST rate and a BBB-ish private-sector project finance loan, which will range from 0.50% to as much as 2.00%.  That’s valuable and might be an important factor enabling a transportation project, which is the right policy outcome.  A limited buydown, in contrast, is closer to a ‘nice to have’ as opposed to ‘need to have’ with respect to the viability and timing of these types of projects.  This is especially true due to the relatively small proportion of a TIFIA loan in a project’s capital stack – the statutory limit is 49% of project cost, but program policy has further limited that to about 33%.

If TIFIA’s limited buydown becomes restricted or even zeroed-out in a budget year, that might make a difference to project economics and perhaps even to some minor aspects of final project design.  But I doubt that the effect will be enough to stop the project altogether, borrower disappointment notwithstanding.  Hence, for TIFIA, the limited buydown is likely not a critical feature to the program’s policy outcomes – it may be utilized if the budget headroom is there, but probably not a showstopper if there isn’t.

It Might Matter a Lot for CIFIA

In contrast to WIFIA and TIFIA, a possible rationing of CIFIA’s limited buydown provision will probably matter, because (1) the provision is likely important for CIFIA projects, and (2) although the new program has a high level of credit subsidy appropriations, that might get used up surprisingly quickly by even a slight rise in rates.

Apparently, though not explicitly, CIFIA is really all about midwestern carbon pipelines.  There are three big ones in development that get a lot of press, with a rough total cost of about $10 billion.  The point of these pipelines is to monetize 45Q carbon tax credits, something which is now easier and much more lucrative with the passage of the Inflation Reduction Act.  I’m guessing that other pipelines are or will soon be planned.  A lot of financing for a relatively new sector will need to be found, and project sponsors will want to move quickly.

Although the basic form of CIFIA follows its similarly named predecessors, the carbon program appears to have been designed within the framework of federal credit rules to facilitate financing for exactly this pipeline development situation.  Unlike WIFIA and TIFIA, CIFIA can offer financing for 80% of project cost, regardless of size.  And, although the projects must (of course) be creditworthy, an investment grade rating is not required.  Assuming the project developer is putting in the 20% balance as straight-up equity, CIFIA is in effect a ‘one-stop, one-step’ financing program – put in a good application, check the well-established federal crosscutter boxes, and you get approval for the only loan you need.

That’s just as well, because getting the pipeline built appears to be anything but a one-stop process.  Actual construction is likely straightforward and won’t take too long once started – about two years, even for the big ones.  But securing all the easements and rights-of-way across thousands of miles of privately owned, agriculturally productive, and savvily managed property looks like a nightmare.  Moreover, it’ll be intrinsically time-consuming.  Two or three years is publicly mentioned, but I’m sure outcomes will vary widely.  Progress mainly depends on multiple price negotiations, then on bureaucratic processes for the last steps if eminent domain is required, all with a steep trade-off between time and money.  In that process, project economics could swing wildly from expectation.

It’s easy to see why a pre-execution rate collar would be critical in this phase of carbon pipeline development.  Project economics will also be highly sensitive to the interest rate on the permanent financing.  Capping that volatile factor at the start of the process of securing rights-of-way would stabilize the numbers for pipeline cost and define clearer limits for the process’ time/money trade-offs.  Waiting until loan execution to set the permanent financing rate, when all the contracts are basically done and trade-offs set in stone, could result in some nasty surprises.  It’s no surprise that when the CIFIA legislation was being drafted, someone took particular care to define the limited buydown provision in detail – it’s intended to be used.

Mind the Discretionary Appropriation Gap If Rates Rise

Since the current interest rate environment is uncertain and expected to get worse, I’d guess that the three big pipelines (which are now in the process of rights-of-way negotiations) will put in CIFIA applications as soon as the program’s doors open. There’ll likely be some other, smaller projects applying, too.  It’s therefore possible that CIFIA will have roughly $10 billion of financing subject to pre-execution rate collars by year end, from the projects currently underway.  That’s a big number on which to set rate collars for 35-year loans fixed-rate loans.  But CIFIA has $2.1 billion in appropriations over the next five years, so the FCRA impact on the program’s budget should be easily absorbed if rates rise in the next few years, right?  Right?

I’m not so sure.  Obviously, there isn’t much specific data to work with, but if a few assumptions are basically correct, avoiding subsidy rationing at CIFIA might be a near-run thing if rates rise – even a little — over the next few years.

• Let’s assume that $10 billion of applications accepted this year result in $10 billion of executed loans towards the end of 2024, when the project developers to get their rights-of-way and contract negotiations finalized.  At that point, the program should have $1.5 billion of appropriations available, the accumulated balance of scheduled authorization (the total, $2.1 billion, becomes available over a five-year schedule, accumulating until expended).  That’s the green line in the chart below.

• Also assume that the $10 billion of loans will require 8% or $800 million to cover the subsidy for projected credit losses.  This is higher than TIFIA (about 6% for minimally investment-grade loans) and much higher than WIFIA (less than 1% for that program’s average Aa3/AA- loans).  But 8% seems about right for unrated and likely sub-investment grade project finance loans to a relatively new sector, or in any case reflective of OMB’s perception of the risk thereof.  This part of the subsidy is not related to interest rates – hence ‘Non-Interest Subsidy’ in the chart.

• The final assumption is that the applications were all set with a relevant US Treasury rate (the 20Y UST, approximately reflecting weighted average loan life) of 2.75%.  I know that’s lower than the current yield, but it’s chosen to illustrate a point about change, not levels.  And because – who knows?  A few months in the current volatile economic and political environment is a long time.  It could be the actual 20Y UST rate in the near future.  Or rates might rise dramatically instead, and the 20Y UST goes from current 3.75% to 5.25%, with roughly the same effect on the illustrative model.  One thing looks for sure – CIFIA will not be setting limited buydown rates in a calm and predictable world. 

• If the 2.75% 20Y UST rate at which the applications were assumed to be set is higher two years later at loan execution, the lowered discounted present value of the loan will require additional subsidy in an equally higher amount, per FCRA methodology.  That’s the ‘Subsidy Due to Rate Change’.

The chart summarizes what happens if the 20Y UST rises between the application and execution dates.  If no change from 2.75%, then the only subsidy required is the $800 million for projected credit losses, well within CIFIA’s available appropriations.  A rise to 3%?  A little tighter, but still some headroom.  To 3.25%, an unremarkable rise of 50 bps. over two years?  Things get interesting.

If the relevant rate rises above 3.25% in this illustration case, CIFIA will probably need to start the kind of messy subsidy rationing mentioned above.  The simplest step would be to delay loan execution a few months until the FY 2025 appropriation of $300 million becomes available.  But what if rates keep rising during and after the delay?  At 3.5%, the $1.8 billion is used up, and at 3.75%, the total subsidy required exceeds the $2.1 billion initially authorized.  Note that this is all for the original 2022 applications.  Presumably, there’ll be others in the meantime, soon requiring at least the 8% subsidy at execution for the non-interest part, for which they’ll presumably have a priority claim.

In this hypothetical scenario, the limited buydown would cause CIFIA to run out of appropriations for loans to just a handful of pipelines if rates rise by about 1% over two or three years – again, well within recent experience and only two-thirds of the 1.50% limit.

The math is no mystery.  Anyone who has ever dealt with the valuation of long-term, fixed-rate bonds and loans knows that their discounted present value, or price, is very sensitive to interest rate changes.  Was the 1.50% limit in MAP-21 determined by Congressional staffers after modelling various scenarios?  Not likely. The provision’s original proponents might have known the potential benefit of a wide collar, and even suggested the number, but the Congressional staffers probably settled on 1.50% because it sounds benign – properly prudential but not overly restrictive – until you do the math.  In any case, CIFIA got the buydown provision and its limit by inheritance, and (with the inheritors properly appreciating its value for pipeline development, and making sure details were included this time) that’s now the law.

Failing in the Core Mission

If CIFIA’s available credit subsidy needs to be rationed with respect to the limited buydown, there will of course be disappointed borrowers.  As discussed above, that shouldn’t matter much in itself.  But unlike the typical projects financed by WIFIA and TIFIA, for CIFIA’s carbon pipeline projects I think the impact may go well beyond disappointment and affect the program’s policy outcomes.  Paying an unexpectedly higher interest rate on the project’s permanent financing, after all the contract negotiations have been finalized with an expectation of a lower rate, could wreak havoc on a highly leveraged project’s economics.  Whether that’s enough to stop the project altogether obviously depends on a lot of specific factors and isn’t broadly predictable.  My guess is that full showstopper situations will be rare.  Perhaps there’ll be some capital restructuring and even contract re-negotiations – painful, but not fatal.

However, if rationing ever occurs or even comes close, future CIFIA applicants may not put a lot of faith in the limited buydown provision. That may have a marginal impact on the program’s volume of applications and closed loans, the usual (and somewhat specious) soundbite measure of a loan program’s success.  But I think it will also negatively affect a much more fundamental aspect of CIFIA’s potential success – the effectiveness of the program to accelerate the volume of carbon sequestration, compared to what it would have been if CIFIA never offered limited buydowns.

As described above, a pre-execution rate collar helps pipeline developers make better – and presumably faster – decisions about the numerous time/money trade-offs that’ll be required to secure the project’s rights-of-way.  Without it, the project’s economics are less certain, and money perceived to be scarcer.  The trade-off then tilts towards extending the time involved before construction starts – lengthier, hard-ball negotiations and more chance of eminent domain proceedings.  Every delay has a quantifiable impact in terms of tons of carbon that could have been sequestered if the pipeline had been there to carry them.

The loss of 45Q revenue from those un-carried tons is the type of disappointment that goes with the territory of almost all project development when things get delayed.  But from the CIFIA program’s perspective, there is perhaps a unique policy aspect to minimizing delays.   WIFIA’s water projects and TIFIA’s transportation projects will marginally enhance a long-established stock of basic public infrastructure, the need for which is unquestionable.  A few years of delay on specific projects financed by those programs won’t make any difference to the programs’ long-term policy rationale.  In contrast, CIFIA’s infrastructure projects are all about climate change mitigation – a policy area where time is very much of the essence.

In theory, every ton of carbon not emitted into the atmosphere will mitigate climate change, and the sooner the better, starting today.  CIFIA’s policy objectives are doubtless more pragmatic, but time is still a central focus, for at least two reasons.

First, there’s the political context.  The obvious need to renew US water, transportation and other basic public infrastructure will cut through almost any level of federal political polarization or dysfunction – if anything, it might become a rare area of growing bipartisan agreement.  That’s not at all true for any federal initiatives involving climate change, to put it mildly.  I don’t think anyone can predict what future policy in this area will look like, especially for specialized climate change mitigation infrastructure, the need for which is intrinsically less visible than it is for climate resilient investment in basic infrastructure.  Stakeholders in this sector need to make hay while the sun shines, and they’ll expect CIFIA to help produce results with the level of appropriations the program currently has.  Future top-ups to CIFIA’s funding bucket are by no means assured, regardless of carbon pipeline development demand.

Second, time is really at the heart of CIFIA’s entire reason for being.  The basic economics of carbon pipelines look fundamentally creditworthy.  Carbon producers, especially ethanol plants, have an immediate and continuing need for large-scale sequestration.  The sequestration locations are many miles away, but carbon pipeline construction and operations are straightforward. Once the carbon gets there, it’s monetizable at a firm price, $85/ton, through 45Q credits.  That kind of story is eminently financeable in the private-sector debt markets, specifically with project finance bank syndicates, though the process might take some time.  Yes, a CIFIA loan will be cheaper, but the current 45Q price should make the whole operation lucrative enough – what’s the point of an additional federal program to indirectly deliver more of the same incentives?

The answer, I think, is that faster and more certain, not solely cheaper, financing is the primary purpose of CIFIA.  That’s reflected in two of the program’s notable differences to its WIFIA and TIFIA predecessors – the ability to finance 80% of project cost and the lack of an investment-grade requirement.  It’s also reflected in the evident attention that was paid to the language in the limited buydown provision.  Carbon pipeline developers will want to move fast but with as much certainty as possible.  CIFIA’s role is to deliver financing in a way that uniquely meets those two goals.  The program’s lower interest rate is simply the usual side-benefit you get with federal credit, not the main event.

I don’t know whether CIFIA was consciously designed from the start with this purpose in mind.  The program’s industry proponents probably had a clear idea about what they wanted, but began the process (again, with an eye towards speed) with pre-existing federal infrastructure loan program models and added the necessary technical-seeming modifications.  The precise federal policy rationale and objectives for CIFIA was not their problem.  I’d guess that federal policymakers didn’t put much thought into those either, and simply assumed that CIFIA would automatically incorporate the policy aspects of WIFIA and TIFIA, like a new flavor in an established consumer brand.

Regardless of CIFIA’s history or nominal policy objectives, however, the program will be evaluated by its stakeholders with respect to what it appears to be promising carbon pipeline developers in terms of faster and more certain financing.  If interest rates rise over the next few years, the limited buydown provision could be an important aspect of delivering on that promise.  In this context, any inability to execute loans at the interest rate expected by applicants due to a lack of available subsidy appropriations would be a major failure for the program.  It will be the kind of failure that has specific and quantifiable consequences for the affected projects, possibly including a delayed start to construction due to contract re-negotiation, and I’m sure that the borrowers won’t be shy about describing them.

More importantly, such a failure may impact perceptions among existing and future applicants about what overall level of certainty the program provides for the terms of an executed loan, not only with respect to the limited buydown, but other aspects of loan economics that aren’t precisely prescribed and required in the program’s legislation.  If CIFIA fails to fully deliver on the limited buydown rate, what else might the program fail to deliver?  Timely loan execution?  OMB and other approvals?  Acceptance of environmental reports?  Common-sense loan covenants and documentation?  The list goes on and on, all based on a long history of borrowers’ experience of things that go wrong at federal loan programs.

If carbon pipeline developers lose the faith that CIFIA will deliver speed and certainty, the program will have failed in its core mission.  I see the limited buydown provision as a central part of what the program is expected to do.  It’s not the only thing, but the provision is relevant to the first and perhaps most difficult part of the show, securing easements and other rights-of-way for pipeline construction.  CIFIA’s stakeholders, especially including program administrators, need to keep an eye on how rising rates might affect available discretionary appropriations.  However technical and abstract these FCRA mechanics might seem, a budgetary shortfall at CIFIA is a gap that’s well worth minding.  

This new op/ed connects two topics that I frequently comment on here:

• The first part summarizes the big picture context — why federal infrastructure loan programs should expand their loan product capabilities, not just capacity, to prepare for more difficult times ahead.

• The second part describes one very specific example of expanded loan product capability — the extension of WIFIA’s maximum post-completion loan term from 35 to 55 years.

In a recent post about AWWA’s 2022 SOTWI survey, I note that a loan with a subsidized rate should be extended by the borrower for as long as possible. That certainly makes intuitive sense — other things being equal, it obviously makes sense to receive the benefit of a subsidy for as many years as they’ll give it to you. Of course, things are never exactly equal when it comes to subsidized debt — there are always strings attached. But if you’ve already dealt with the upfront strings for your project to qualify, and ongoing compliance is not too burdensome, then the principle of ‘longer is better’ will apply, especially if prepayment at par is generally costless. Those conditions seem to characterize debt from the three sources of subsidized infrastructure financing highlighted in the AWWA survey, municipal bonds, SRFs and WIFIA.

Still, it’s worth looking at some hypothetical numbers to elucidate the nuances. That starts with assumptions about the basic subsidized rates offered by each of three, relative to a market rate. For simplicity, the market rate here is always a 0.75% spread over a long-term US Treasury rate that’s the same for loan terms from 15 to 60 years. That’s also the discount rate for the present value (PV) benefit analysis.

The project is assumed to have a five-year construction period and a very long useful life. After completion, project debt will amortize on a level-payment schedule for the balance of the total term. Loan term is the main variable in the analysis.

From there, equally simplified assumptions for the three financing sources:

• A tax rate of 22.5% for the municipal bonds, for an offered interest rate that gets the investor back to an after-tax market yield. If the market rate is 3.75%, for example, the tax-exempt bond rate will be 2.91%. Total term is limited to the market-based 30 years.

• SRFs vary widely, but for demonstration, we’ll assume here that this source will offer a rate that’s 75% of the market rate. Again, if the market rate is 3.75%, the SRF rate will be 2.81%. Total term is limited by prudential state policy to 25 years.

• WIFIA is straightforward. By statute, the loan rate is ‘not less’ than the US Treasury yield for a loan’s weighted average life. We’ll ignore the one basis point added by the program. A market rate of 3.75% with a 0.75% spread means a 3.00% US Treasury yield, and hence a 3.00% WIFIA rate. Total term is limited by statute to 35 years post-completion, for 40 years in this case. An extended WIFIA case, with 55 years post-completion, is also considered.

When debt from these three sources is discounted at the market rate, there’s always a PV benefit, and that PV benefit increases the longer the subsidized debt can be amortized after construction completion.

With full debt term from 15 to 60 years as the variable, and a long-term US Treasury rate of 3.00% applied throughout, here’s what we get:

As you could guess from their lower rates, SRF or muni bond financing has a better benefit than WIFIA in years 15 through 25 and 30, respectively, when they hit their limits. WIFIA loans are more beneficial starting from a total term of about 35 years, and materially better at the 40-year maximum. Extended WIFIA loans would deliver a much higher PV benefit, almost 14% of project cost with a 60-year term.

These results reflect the fundamental point I was making in the AWWA survey post — compared to SRFs and muni bonds, the WIFIA program can offer much longer loan terms, something that might intrigue water system CFOs for various pragmatic reasons (e.g., lower annual debt service for the first ten years), but is justified by a strict PV analysis, too.

No surprises, so far. But changing the UST interest rate in the analysis uncovers an interesting nuance. If the long-term UST is assumed to be 1.00%, for a market rate of 1.75%, we get a very different picture:

In this case, WIFIA loans are always better, and a by a lot. That’s because the market spread is a relatively large portion of the total rate when UST rates are ultra-low. Both the SRF discount and the bond tax-exemption operates on the market rate, while WIFIA cuts to the chase and eliminates the spread altogether.

But at higher UST rates, this effect completely reverses. With a long-term UST assumption of 5.00%, a WIFIA loan always delivers much less PV benefit, regardless of term, current or extended:

Again, subsidy mechanics explain the result — the SRF 25% discount and muni tax-exemption apply to the whole interest rate, while WIFIA is stuck at the UST rate, which in this case is a much bigger proportion of the market rate.

This is of course a completely abstract analysis. But I think the basic assumptions reflect (very roughly) the reality of most situations involving these sources of subsidized infrastructure financing. The broad direction of how their respective PV benefits change with longer terms and different rates is likely accurate, even if the specific numbers aren’t particularly meaningful. A few observations:

• The analysis shows what you already knew – longer terms mean more PV benefit – but it also literally illustrates something that’s important to much basic water infrastructure renewal. Look at the big empty space in the charts where the SRF and bond lines end! Not all infrastructure projects have a useful life of 60 years by any means, but surely a lot of most essential stuff gets into the 40- or 50-year time frame. Subsidized debt should encourage a long-term perspective in infrastructure renewal. I can see the prudential logic behind state SRFs’ limited terms, especially since these funds often focus on smaller, more equipment intensive projects. But why is the primary federal financial subsidy for large-scale state & local public infrastructure structured as a tax-exemption utilizable only by retail investors, a class that requires high liquidity in 30-year markets? Yes, I know — a rhetorical question. For now.

• The CBO’s latest budget and economic outlook projects 10-year Treasury rates for the period 2023-2032 that average about 3.2%. Long term Treasury rates for the period will be higher on average, but probably around 3.5%. This means that the first chart in this post, where the PV benefit from the three subsidized source differ primarily by term, is likely the most relevant one. In that context, combining the various sources will result in the maximum PV benefit available. WIFIA loans are limited to 49% of project cost in any case, but the 51% balance can be composed of faster-amortizing SRF loans and muni bonds, a structure that WIFIA explicitly permits and generally encourages. From what I’ve seen in the real world over the past few years, this is often exactly what systems are doing. More on WIFIA combinations here and here.

• Most fundamentally, I think the analysis highlights two very different policy approaches to subsidizing US infrastructure finance. Interest rate subsidies from SRF discounts and the muni bond tax-exemption are essentially transfer payments. The discounts are ultimately paid for by federal and state grants, the tax-exemption by less transparent tax expenditures. In contrast, federal loan programs in the WIFIA, TIFIA and CIFIA series offer loans to qualifying borrowers that are expected to cover their cost of Treasury funding (in theory, anyway), and require only a small appropriation for credit losses, given the borrowers’ credit quality. In these programs, taxpayers are primarily incurring the opportunity cost of not lending at market rates. I don’t see this as merely academic distinction. Transfer payments are the blunter tool — more powerful, with a greater impact, good or bad. The opportunity cost approach effectively requires loan programs to differentiate their products, not only from market debt but from other, transfer payment-based financing. That’s particularly challenging for WIFIA, as the analysis shows. But if the differentiation is based on actual federal comparative advantages (e.g., very long-term lending), positive outcomes represent a real improvement in economic efficiency. That is a sustainable approach in several ways, not just fiscally. It also requires innovation at the interface between real-world goals for physical infrastructure and the influence of finance on them. Lot of policy scope there — and ‘innovation’ is a word that’s right in all three programs’ name.

In my last update of the economic cost of WIFIA’s portfolio, The Cost of WIFIA’s FYE 21 Portfolio as of June 30, 2022, I noted that the analysis didn’t include loan commitments added since FYE 2021 or additional drawdowns. Since then, I added the 27 loans closed between FYE 2021 and 5/26/22, for a total portfolio at 6/30/22 of $15.3 billion, roughly in line with WIFIA’s website information. I also assumed that 25% of the portfolio had been drawn, versus the previous assumption of 12.5%, and that realized re-estimate losses on the drawn loans were about $100 million, versus the $25 million reported for FYE 2021.

As expected, the weighted average interest rate on the portfolio loans and loan commitments increased to about 1.8%, versus about 1.5% at FYE 2022 since rates have been rising in the interim.

Based on all that, if all WIFIA loan commitments had been drawn on 6/30/22 at the then-current 20Y UST of 3.4%, the realized funding loss would have been about $2.4 billion, the same estimate as before, as I had thought it would be. Although the portfolio’s weighted average rate is higher than at FYE 2021, portfolio volume is also greater, resulting in about the same estimated loss.

It’s not quite all bad. Note that if interest rates start to fall back to the 2.0% range, potential funding losses on the 6/30/22 portfolio will decrease more quickly than they would have with the FYE 2021 portfolio (the dotted line in the chart) since many of the recent loans will be at about that rate. A 20Y UST of 2.0%, for example would only result in a $300 million loss or 2% of the portfolio — instead of the $600 million or 5% that would have been incurred by funding the FYE 2021 portfolio. That’s much better, especially regarding the optics — but this result assumes WIFIA doesn’t reset the higher rate loan commitments downward. Given the program’s reset precedents, I’d imagine there’ll be some tough discussions if rates fall a lot, and resets will probably happen.

Of course, all of these economic cost analyses are only as good as the assumptions I’m making in the absence of direct data. The size and the closing dates of the loans are well-disclosed by WIFIA and there’s a ton of accurate UST rate data for those closing dates. I’m also pretty sure about the typical loan WAL of 20 years and FCRA methodology. But the amount of loan commitments drawn, and their realized re-estimate losses, are frankly guesstimates. Some information about the FYE 2021 portfolio did surface in White House budget appendices last year, but only indirectly and on a projected basis. Nevertheless, that data was broadly consistent with my assumptions at the time. It’ll be interesting to see what the next budget might disclose, especially regarding my assumption of $100 million of realized re-estimate losses for FY 2022. I’d predict that’s a minimum.

The American Water Works Association (AWWA) just published their annual State of the Water Industry survey for 2022. The survey covers a lot of ground, but it includes several insights into the financing of infrastructure projects which I think have implications for the WIFIA loan program, at least indirectly.

The top concern reported in the survey is infrastructure renewal. It’s not surprising that the financing for required for such large-scale renewal is also right up there at number two. Both are long-term issues – apparently, the two have been consistently ranked first and second for the last ten years.

A more subtle aspect of this concern with financing is worth elucidating. There’s a section in the survey about the potential impact of exogenous large-scale phenomena – macroeconomic, geopolitical, etc. – on the respondents’ systems. Only one, ‘Business/industrial activities’, was considered to have a slight positive impact. But the least negative score was for the ‘Bond markets’, a term which likely includes the overall state of the debt markets, given the other choices.

That result appears to reflect reality. AWWA’s members are generally highly rated, public-sector agencies that provide an essential service. If the domestic debt markets are going to be open for anyone, it’ll be issuers like these, either by investor preference or federal support (e.g., the Federal Reserve’s MLF in 2020). Relative to everything else going on at a macro level in these interesting times, it’s unsurprising that the debt markets are the least of the respondents’ worries.

The result doesn’t seem consistent with the major concern for financing reported by the same respondents. But the apparent inconsistency vanishes if you interpret the ‘concern’ more narrowly – not as a concern for the availability of financing, but for its repayment. Repayment of large-scale, long-term financing requires equally large-scale, long-term funding. That’s a thoroughly understandable major concern which is intrinsically connected to the need for infrastructure renewal – what’s built must be paid for. The challenge of borrowing is finding funding for its repayment. Where’s that going to come from?

Another section of the survey sheds some light on that question. System CFOs were asked to identify their “funding sources and/or strategies” and responses were ranked in the terms of the frequency of mention of various categories. That type of ranking requires some interpretation. It clearly doesn’t mean that current or future projects will be capitalized in a particular way. Rather, I think it reflects the CFOs’ general perception of what they’ll need to do in the coming years to cover the cash flow requirements of planned infrastructure renewal projects.

The first thing to note is that vast majority of funding is locally sourced. Only about 17% of the perceived needs will be provided exogenously, with state or federal grants. Of the 83% balance, slightly more than half will come from local action (blue shades) – raising rates, drawing on reserves, reducing O&M cost. The rest comes from financing (green shades), presumably to cover project construction cost drawdowns. The financing itself is initially exogenous, but repayment over time will be locally sourced – I’m guessing that the expectation of increased annual debt service is a primary driver of rate rises.

The CFOs’ expected sources of financing are interesting. I assume ‘Bonds’ here are primarily municipal tax-exempt revenue bonds, the standard (and frequently sole) source of financing for US state & local public infrastructure projects. It’s naturally the largest category. But I was surprised that SRF loans are a close second. WIFIA shows up as a more distant but still significant third. Both non-bond sources add up to more than half of the rankings based on mentions for financial sources.

Again, those rankings don’t mean that water infrastructure projects will on average be 55% capitalized with SRF and WIFIA loans, or even close to that percentage. Instead, I think the frequency of mentions reflects the level of CFOs’ interest in accessing SRF and WIFIA loans as an alternative to bonds. Accessing public-sector programs requires additional analysis and effort, relative to just doing another off-the-shelf bond issue, so the number of mentions might reflect what occupies the CFOs’ thinking.

What Are the CFOs Looking For?

The overall goal is surely as simple as looking for financing that requires less funding for repayment. Usually that means a lower interest rate. SRF and WIFIA loans offer subsidized, below-market rates. If the US water sector’s standard source of financing was the global debt market (which definitionally requires at-market rates), the story would be straightforward.

But the sector’s baseline source, the municipal bond market, also offers subsidized interest rates through the monetization of federal and state income tax exemptions by qualifying investors. In effect, the muni bond market is another federal & state loan program for public infrastructure, the same in principle as the SRFs and WIFIA. That requires a more nuanced comparison of the alternatives.

The terms and availability of SRF loans vary a lot among the states. I think some of them offer very discounted interest rates, even compared to the muni market. I’m sure that the CFOs’ expectations of future availability have likely increased with the 2021 IIJA and its $35 billion of SRF funding over the usual level of annual federal support. Perhaps there is also the hope that such federal largesse will also result in even lower rates or better terms? It would be interesting to see a breakdown of the SRF mentions by state of origin — I’d guess it positively correlates with those SRFs that offer the best terms relative to the muni market.

As you know, this site currently focuses on federal loan programs, not state or local ones, and SRFs per se aren’t the topic here. I’d make two general observations, though, in relation to WIFIA. First, a strong level of interest from AWWA CFOs in SRF loans probably reflects an even higher level of interest from smaller systems. WIFIA’s capabilities to leverage to SRFs ought to be expanded.

Second, the term of SRF loans usually doesn’t exceed that of the bond market (30 years) and is often shorter. That makes sense, given the SRFs’ revolving fund mechanism. Even when that mechanism is leveraged with long-term debt (about half of SRFs are), the 30-year muni market is generally the source of the leverage.

What Can WIFIA Offer?

The above interpretations of the 2022 SOTWI provides some context for expanding WIFIA’s capabilities. Increasing program loan capacity is an obvious direction, given the relative significance of the mentions and the sector’s huge needs. But what else can WIFIA do in terms of loan products, especially compared to bond and SRF loan alternatives?

Again, the CFOs’ overall goal is no doubt straightforward — the least funding required for repayment. The most direct way that a WIFIA loan would achieve that is by offering an even lower interest rate, below the current Treasury rate at the weighted-average loan life.

That kind of grant-like benefit is obviously attractive — if policymakers can offer it. I can see the logic behind those SRFs offering below UST rates on loans that were after all mostly funded from federal grants. The discounted rates are a kind of partial pass-through. But WIFIA has a very different theory.

I think a fundamental idea of the TIFIA, WIFIA and CIFIA series of federal infrastructure loan programs is that they don’t cost federal taxpayers anything in terms of funding the loans, just a small amount of credit subsidy for expected loan losses. The UST rate the borrower pays to these programs is designed to cover the federal government’s economic cost of loan funding. Taxpayers bear the opportunity cost of not lending at market rates, but that’s a sufficiently abstract concept that few notice, and anyway it doesn’t show up in FCRA budgeting, which stipulates UST-based discount rates. But under the same FCRA mechanics, any loan interest rate below UST will show up in the required credit subsidy amount. Which means more upfront discretionary appropriations — something that definitely gets noticed.

A deviation from this principle was proposed for WIFIA loans to SRFs in the 2018 WRDA. S-2800 originally included a special 50-80% discount on UST rates for qualifying SRFs, as well as other SRF provisions, most of which were enacted in SWIFIA — but not the Treasury rate discount, which apparently got pushback from a lot of areas, including the water sector itself.

Further attempts will likely fail too, especially since WIFIA now looks like a successful program that costs only pennies for the loan dollar. Hard to fix something that doesn’t look broken and is really cheap, right? Right? The reality is more complicated, but that’s another topic, and one which certainly won’t encourage discounted program rates.

Realistically, I think WIFIA is stuck with UST interest rates for the foreseeable future. But there’s more than one way to help water systems reduce required repayment funding in the timeframe that probably matters most to their infrastructure decisions — say, about the next ten years.

One way is almost as simple as a lower interest rate. A longer-term loan means the principal amortization can be spread over more years, with lower debt service in the medium term. Of course, that debt service gets paid for a longer time, which means more total interest cost. But if the first ten years is more important than the final ten for all sorts of real-world reasons, a longer term could be worth it. Even in strict theory, a loan with a subsidized rate should be extended for as long as possible.

WIFIA already has the inside track on loan term, relative to the other two financing sources. The muni bond market is essentially limited to financing terms of 30 years, due to its unique retail investor base. SRFs are generally less than that. In contrast, WIFIA, offers a 35-year term after construction completion, including an optional 5-year debt service deferral and considerable flexibility for a customized amortization schedule that accommodates other, shorter-term project debt. That’s a useful combination of features, and probably accounts for a significant part of the CFOs’ interest in the program.

As a first, practical step, why not just expand WIFIA’s capabilities in these three features? Sometimes if some is good, more actually is better. Long term lending is in fact a federal strength and it’s economically efficient to utilize that comparative advantage as much as possible. More specially:

• Extend WIFIA’s maximum loan term to 55 years (at least) for qualified projects with long-lived assets. More on that here: Update on Extended WIFIA Term — Same Story, Different World

• Extend the 5-year deferral period to 7-10 years, for qualified projects and systems. Federal comparative advantage in this feature is…well, also a little more complicated with respect to accruing interest at a previously locked rate. But the impact is minor compared to the same complication that arises with the rate lock during construction. The marginal economic cost is low — in effect, most of the horse is already out of the barn. If some systems find a longer deferral period useful, why not?

• Consider allowing an interest-only loan amortization schedule as a default option for highly rated borrowers. This can be subject to program approval of the systems’ expected prepayment plans, which will probably be bounded by their credit rating agency targets anyway. Why not give these uber-prudent borrowers additional flexibility and focus program credit analysis resources on the tougher cases?

As readers of this site know, I think there’s quite a few approaches to unlocking the program’s full potential. But the three outlined here are the simplest and probably have the broadest applicability in the context of the SOTWI survey. It would be interesting to see additional specific questions about financing sources in the 2023 SOWTI survey, the input process for which apparently starts in late 2022. Even by then, the economic and financial outlook may have changed, and likely not for the better.