Imagine an infrastructure project for large-scale water management, like flood control or dam rehabilitation. The optimal scale of the project for both national and regional benefit is about $1 billion. For various reasons, a Federal Agency will be involved in overall project construction and management. But the Agency can only allocate $600 million to the specific project.
A Regional Water Authority recognizes the importance of the project for the communities within their jurisdiction. The Authority agrees to provide the $400 million balance so the project can be completed at the optimal scale, which is especially important for regional benefits.
The Authority can’t write a lump-sum check for the $400 million, and in any case, they want a long-term contractual agreement with the project that specifies all their rights and obligations in detail. They will make periodic payments under this contract to cover their share of O&M and (most importantly here) provide cash flow for servicing $400 million of long-term debt to fund the construction cost balance. All these arrangements are of course Project Finance 101.
The Authority will fund the contractual payments by a combination of general and special taxes, water rates, and other revenues from the regional communities that will benefit from the project. This source of funding has a high level of creditworthiness, which gives the Authority several financing options.
First, they consider issuing tax-exempt bonds. Bond credit rating will be based primarily on the Authority’s ability to make contractual payments from regional taxes. An investment-grade rating is confidently expected. However, bond tax counsel points out that due to the Federal Agency’s involvement in the project, they’ll need to confirm that the federal government is not providing a direct or indirect guarantee of bond debt service, per IRC Section 149 (b). After an analysis of the economic substance of the transaction, especially with respect to the regionally based source of repayment, tax counsel signs off on an unqualified opinion that tax-exempt status is justified.
Next, the Authority looks at the WIFIA loan program. The project is clearly statutorily eligible, and although the Treasury-based interest rate is not too different than tax-exempt bond yields, WIFIA loans offer various interest rate management and term features that are especially useful for large-scale, long-lived projects. A WIFIA loan is, however, limited to 49% of “project” cost, which in this case means 49% of $400 million, or $196 million, since that represents the Authority share of the full project. Fortunately, tax-exempt bonds and WIFIA loans are easy to combine and effectively complementary, so the Authority settles on a two-tranche financing plan for their share, $204 million of bonds and a $196 million WIFIA loan.
All good? Not quite – the Authority’s application to the WIFIA program checks all the boxes with respect statutory eligibility, creditworthiness and other risk factors, public benefit and policy importance, and environmental reviews. But there’s a problem – just as federal involvement in the project raised questions for the tax-exempt bonds, it requires special consideration for WIFIA’s FCRA budgeting of the loan. Without FCRA treatment, the loan would absorb far too much of the program’s budget and can’t proceed.
FCRA treatment is only available for a federal loan to a ‘non-federal borrower’. In one sense, the overall project is the ‘borrower’ because that’s where money will be spent, which prompts another question — is the overall project is federal or non-federal? But in another sense, the non-federal Authority is the ‘borrower’ because it is substantially obligated to repay the loan through contractual payments, which are ultimately sourced from non-federal communities. Which characterization of ‘borrower’ should prevail?
OMB’s Current Criteria
OMB’s 2020 FCRA criteria for federally involved projects appear to be directed towards the first characterization. The criteria, which are in fact a series of questions, apparently seek to determine if the overall project is a ‘federal project’, though the principles behind the determination are undisclosed. The only principle stated explicitly is that if there’s any ambiguity, the project is presumed to be federal. Well, isn’t that convenient?
In effect, OMB’s current criteria appear to be trying to determine whether the overall project is a ‘federal project’. But even with a clearer statement of principles, not only is that approach inherently ambiguous, FCRA law and its underlying principles are narrowly focused only on specific substantive borrowers and the source of repayment. I don’t see any basis for an overall characterization of some activity as ‘federal’ to disqualify every part of it for FCRA treatment, which is what OMB seemed to be aiming at. I get the prudential caution, but their approach doesn’t seem consistent with either current FCRA law or the 1967 Budget Report.
A Better Approach
There’s no question that FCRA criteria are required for a federal program loan to a project with federal involvement, just as tax counsel must carefully consider the tax-exemption of bonds issued by such a project.
But I think a sounder & more efficient approach would narrowly focus the criteria on a ‘non-federal interest’ in a project that has significant federal involvement. As the above illustration suggests, a WIFIA loan to a non-federal interest in the project might qualify for FCRA if the obligation and source of repayment were demonstrably non-federal, and the proceeds of the loan were roughly in line with the benefits the non-federal borrower expected to receive. That narrower approach is more consistent with FCRA’s sole threshold qualification of a “non-federal borrower under a contract that requires the repayment of such funds” and reflects the 1967 Report’s ‘market discipline’ requirement, too.
Maybe the issue just needs better, generally agreed definitions? I think simply defining ‘non-federal interest’ vs. ‘federal interest’ for federally involved projects in the context of FCRA law would result in more constructive discussions & efficient solutions for all the stakeholders.