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.