Here’s a new article in Water Finance & Management:
Additional Context
This post adds some context to the article, specifically with respect to federal fiscal constraints.
I’ve discussed SRF leverage in several prior posts. In this one, The Limited Buydown and SRFs, I suggest that a WIFIA limited buydown might help smaller SRFs take the first step towards portfolio leverage. It’s worth noting that a limited buydown (which TIFIA and CIFIA already have) would in effect allow the Program to offer sub-UST rates in certain circumstances. More scope to utilize sub-UST rates for specific goals is therefore a matter of degree, not a violation of a founding principle, among federal infrastructure loan programs.
In another post, In Retrospect, An Ironic Criticism of the SRF-WIN Act, I point out that if WIFIA’s interest rate re-estimates were included in the budget numbers, the cost of sub-UST rates wouldn’t look that bad. This is an example of what I’m saying in the WFM article about the need for specific evaluation context for Program tools and their intended purposes. And that evaluation needs to go beyond surface appearances.
Both of those posts dealt with somewhat technical aspects of WIFIA’s capabilities in SRF leverage. Now I think a more fundamental question is emerging: In the face of federal fiscal constraints, to what extent can WIFIA leverage replace direct grants?
The question arises generally because the US economic and fiscal outlook is, well, not looking so good. Specifically, it relates to two recent developments that may effectively constrain the generous funding provided to SRFs by the IIJA in 2021. The first is the earmarking of a significant amount of annual funding in 2022. Earmarking is not an overall reduction, but it is a constraint. The second, from a couple of weeks ago, is more ominous — NACWA warns against proposed ‘radical spending cuts’ to SRFs in FY24. The 2024 budget negotiations have a long way to go, so I don’t know how real this is. But even if the proposed cuts are primarily a political bargaining chip, it shows that annual SRF funding shouldn’t be seen as a politically untouchable entitlement. In hard times, it’ll be subject to the same constraints faced by other discretionary expenditures.
The policy objective of federal funding for SRFs is to increase their loan-making capacity. That can be achieved simply & directly with annual grants. But it can also be achieved, albeit less simply & directly, with federal leverage. The existence of SWIFIA effectively recognizes that federal leverage to increase SRF loan-making capacity might require special features in WIFIA loans like the limited buydown or sub-UST rates. When federal fiscal constraints are a priority, the cost of the features can be compared to the cost of direct grant funding to achieve a given amount of loan-making capacity. The features need to actually produce the same result but also cost federal taxpayers less. If the cost is the more or even the same, what’s the point?
How Might the Numbers Look?
The chart below shows a quick illustration of how I think WIFIA leverage could balance cuts in federal grant funding for SRFs. This is a bit speculative at this point — no doubt there’s a lot of devils in the details and maybe in the main assumptions as well. But the efficiency of leverage for financial portfolios is well-established, so I’m confident that the basic ideas are valid.
The chart looks at four scenarios:
Pre-Cut Funding for Unleveraged SRFs: Let’s say a group of unleveraged SRFs expected to receive $200 million from federal grants. The marginal effect of this (ignoring details like state contribution etc. for simplicity) should be to increase loan-making capacity by $200 million. That’s the policy objective and, among SRF stakeholders, the political expectation.
Post-Cut Funding for Unleveraged SRFs: But now assume that federal funding is proposed to be cut by 50% to $100 million. The effect will be a marginal decrease in loan-making capacity compared to the pre-cut scenario of $100 million. The policy objective won’t be achieved but more importantly, there’ll be serious political pushback.
Post-Cut with WIFIA UST Leverage: With $100 million of grant funding, the SRFs could (with a lot of simplification here) borrow $96 million from SWIFIA for a total of $196 million of new loan-making capacity, a very conservative 2:1 leverage ratio. Under current WIFIA, the credit subsidy cost of the loan with a UST rate would be about $1 million. For a total federal outlay of $101 million, the cut could be basically balanced by leverage and policy objectives maintained. SRF stakeholders of course would prefer grants, but as a Plan B, it might be acceptable.
However, the problem is that in general WIFIA loans with UST rates don’t seem to encourage SRF leverage. Would that change if the cuts became real? I don’t know — perhaps in some cases. But I am sure that since WIFIA UST loans are currently available, simply pointing that out to angry SRF stakeholders probably won’t help. If some sort of political compromise or at least amelioration is being sought, SWIFIA features will need to be improved before suggesting them as an alternative.
Post-Cut with WIFIA Sub-UST Leverage: Assume that improvement takes the form of SWIFIA being able to offer loans at 80% of the UST rate to SRFs that will especially be affected by the cuts, are currently unleveraged, are of smaller size, etc. Would that feature result in SRF leverage and the targeted increase in loan-making capacity? Again, I don’t know but I’d guess that there’s a fair chance it would be effective. For one thing, as pointed out in the WFM article, a sub-UST rate goes to the central issue of portfolio leverage, matching SRF debt service inflows and outflows. A sub-UST rate would substantially improve those numbers. For another, 80% UST loans for select SRFs were specifically sought by SRF-WIN proponents in 2018. They might have had some different objectives back then, but the expectation that this sub-UST rate would effectively increase leverage was presumably grounded in their own, well-informed expectations. And presumably, offering the same rate SRF-WIN proponents wanted but failed to get in 2018 would garner some positive political traction.
In terms of federal outlays, 80% UST loans require about 10% in credit subsidy cost. Total outlay would therefore be about $110 million on the federal side — still a big net cut from $200 million. But the substantive compromise of offering sub-UST rates to SRFs surely has a much lower cost in terms of political capital and a far better chance of maintaining policy targets.
The ‘win-win’ approach described here should be seen primarily as an alternative to attritional, zero-sum politics — there’ll be plenty more of that soon in any case. Expanding WIFIA’s capabilities is one way water sector stakeholders can avoid some of the worst effects of the coming storm.