Download OMB 2025 Circular A-11 Federal Credit
I’ve written a lot about WIFIA loans’ optionality in recent posts. In this one, I’ll look at the specific connection between that optionality and what is required, per OMB’s Circular A-11, to be included in a loan’s subsidy cost estimate at commitment. I’m not a lawyer (though I’ve dealt with plenty of financial contracts), but I’ll take a legalistic approach here, as if A-11 was a ‘contractual obligation to evaluate loan cost’ and I wanted to see if the cost of WIFIA loan optionality was covered by it.
First, let’s review WIFIA loan optionality. There are two options that are statutorily permitted and undoubtedly written into the loan contract, though the word ‘option’ is probably not used:
- The option to cancel an undrawn loan commitment at any time, without penalty.
- The option to delay disbursement of the loan for any period of time after construction expenditures up to one year after project completion.
These options are probably present in some form in a lot of federal credit agreements, but they likely don’t have any predictable impact on loan subsidy cost. An individual might decide, after getting a student loan commitment, not to attend college or to defer it. Or a small agricultural project with a USDA loan commitment might be cancelled or delayed due to local funding issues. In these cases, the disbursement of the loan commitment is cancelled or delayed for highly idiosyncratic reasons that won’t be correlated to other factors included in the loan’s subsidy cost estimate. Hence, in most if not nearly all such cases, these options don’t need to be considered in the loan’s cost estimate at commitment, and the cost of final outcomes is correctly evaluated and budgeted in the standard FCRA re-estimate process.
However, things are different for WIFIA subsidy estimates, as actual operations FY18-FY25 make abundantly clear. The vast majority of WIFIA borrowers are highly rated public water systems with excellent access to the tax-exempt bond market and short-term financing. Their decisions with respect to cancellation or delay will be highly correlated with a major factor of loan cost — the level of US Treasury rates at the time of loan disbursement. Rational, sophisticated and well-resourced WIFIA borrowers can be expected to exercise their loan contract options under the following conditions:
- Cancellation of the undrawn loan commitment (if not reset) whenever UST rates have fallen below the loan commitment rate, subject to conditions in the tax-exempt bond market (typically highly correlated at about 80% of UST yields) and their perception of the value of other WIFIA loan features (likely to be relatively minor under current law).
- Disbursement will be delayed whenever the borrower’s short-term financing rates are below the WIFIA loan commitment rate. Since the UST yield curve is typically positively sloped, the delay may be lengthy, possibly right up to the maximum allowed, one year after project completion.
The exercise, or non-exercise, of these contractual options is predictable under circumstances that are not idiosyncratic but related to major observable macroeconomic metrics that the financial staff of large public water systems can be expected to use.
Importantly, the impact of option exercise on average WIFIA loan cost is also predictable:
- Exercising the cancellation option of an ‘out-of-the-money’ loan commitment will obviously have no cost impact, other than the return of previously apportioned subsidy to the Program. But the non-cancellation of an ‘in-the-money’ loan commitment and subsequent disbursement may result in material funding losses (i.e., the present value of loan debt service is lower than the funded principal amount at then-current UST discount rates). The option causes the loan to have an asymmetrical outcome with respect to funding cost. If UST rates rise after loan commitment, disbursement will incur funding losses. But if they fall, funding gains will not be realized because the commitment will be cancelled (or reset). For example, if within a certain period (say, three years), UST rises and falls are equally likely with a range (say, one standard deviation from the long-term average), it should be assumed that losses at disbursement will be incurred 50% of the time, with no commensurate gains. Even though UST interest rates are unpredictable, the asymmetrical outcomes of option exercise (or non-exercise) will have a predictable and quantifiable cost on average, similar to the way that loan credit losses can be predicted and quantified.
- The exercise of the disbursement delay option will increase the time between loan commitment and drawdown, increasing the potential difference between the UST curve at loan commitment (which sets the loan’s rate) and at disbursement (which determines the funding cost). Combined with the cancellation option, the delay option will increase the average funding cost of the loan if or when disbursed. This increased cost can also be quantified, using historical interest rate patterns (e.g., frequency and slope of yield curve) and past borrower behavior (e.g., typical disbursement delay).
Now, let’s parse through the relevant language in Circular A-11 ‘contract’ above and see if it’s applicable to the fact set outlined above:
- The ‘estimated cash flows’ used for calculating the NPV of the loan, both at loan commitment and at disbursement are obviously forward looking and include predictable contingencies. Estimates for credit losses are not based on the loan’s non-default at commitment, but on what is expected to happen on average in the future. Likewise, the fact that the loan’s interest rate at commitment will not (by definition) cause an NPV shortfall doesn’t mean that an average shortfall won’t occur or cannot be predicted at disbursement, even if interest rates themselves are unpredictable.
- The requirement that the estimates ‘include the effects’ of a list of contingencies means that anything that could affect the NPV of a loan must be considered, excepting only administrative costs. There are no other explicit qualifiers or limitations, though materiality can be assumed. I think this simply says, “if can you foresee and quantify the effect, you need to include it” in the estimate. That would be consistent with basic FCRA principles.
- One effect is specifically mentioned: “…expected actions by…the borrower within the terms of the loan contract, such as an exercise by the borrower of an option included in the loan contract.” Note that the word ‘option’ is not capitalized or defined within A-11 and is therefore applicable to the substantive optionality in a WIFIA loan contract, regardless of whether the word ‘option’ is used or not. The ‘expected actions’ by a typical highly rated WIFIA borrower would include (1) the exercise of the cancellation option on out-of-the-money commitments, but the non-cancellation of in-the-money commitments, and (2) the exercise of the delay option. Both of these actions are, on average, predictable and will have material effects on loan cost, as described above.
Bottom line? I think if A-11 was a legal contract, OMB would be obligated to estimate (or cause the Program itself to estimate) the cost of WIFIA loan optionality at loan commitment execution. With the estimate, OMB would then be obligated to apportion for the cost against Program budget authority under FCRA law and the Anti-Deficiency Act. It should be noted that there’s no evidence that OMB has ever estimated this cost in their apportionments FY18-FYTD26.
Of course, A-11 is not a legal contract with the WIFIA Program or anyone else. It’s OMB’s own guidance. Guidance for what? I assume primarily to manage all the numbers arising from FCRA law for budgeting purposes. But perhaps also to demonstrate how their processes are in compliance with the ADA? if so, there might be some legal aspects to this after all.