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.