DAM-SAFETY-PROJECTS-WITH-A-USEFUL-LIFE-OF-MORE-THAN-35-YEARS

As outlined in a previous post, a 55-year post-completion loan term might be an especially useful feature for CWIFP’s initial implementation. This post expands on the idea that limiting the scope of an amendment to extend WIFIA’s maximum may be critical to its chances.

Competing for High Quality Applications

The primary reason that the WIFIA program was surprisingly successful out of the gate was that very creditworthy entities submitted high-quality applications for low-risk projects. Applications like that get through the federal transaction processes and oversight bureaucracy with relative efficiency, quickly establishing an experience base of what works and a track record of reliably successful transaction completion. That kind of successful launch is self-reinforcing, internally by continually improving processing efficiency and externally by attracting further high-quality applications.

Contrast WIFIA’s story to that of TIFIA, a program that started with applications from complex and risky project financings. Those kinds of deals are hard enough for the private sector, but rough material indeed to feed into easily jammed federal machinery. And it showed in the program’s results and reputation.

However, there is one problem with high-quality applicants: they have very cost-effective financing alternatives in the tax-exempt bond market. Back in 2017, when WIFIA was starting up, a WIFIA loan with a 35-year post-completion term was competitive with 30-year muni high-grade water revenue muni bonds, primarily because the loan’s rate lock avoided negative arbitrage costs. That’s not the case in current market conditions, as outlined in the prior post.

A Quiet Veto

A 55-year loan term would dramatically improve the numbers and be a game changer for WIFIA and CWIFP loans. Unfortunately, the municipal bond industry knows that, too. Their lobby will have a quiet word with the Decision Makers Who Matter, and the 55-year term will be quietly dropped, as it has been when proposed over the past several years.

Wait…a federally subsidized debt market that has an effective monopoly on US public infrastructure finance due to that subsidy is acting behind-the-scenes to protect said monopoly by curtailing the capability of another federally subsidized source of infrastructure finance, one that incidentally utilizes genuine federal comparative advantages in lending and costs the taxpayers less? Isn’t that…rent-seeking? Yes, I’m afraid it is. And?

A Limited — and Realistic — Approach

Back in the real world, a 55-year term that can apply to all qualifying WIFIA projects (as HR 5664 and past amendments have proposed) will likely be a non-starter because the scope will include many municipal water projects that would otherwise be financed with bonds. But if the scope was limited to specific asset classes that aren’t part of the muni market’s bread-and-butter, then relative indifference, if not leniency, might be shown. The chances of that are improved if it can be shown that WIFIA loans to the asset class are likely to enable projects that wouldn’t have happened otherwise, providing the bond market (or at least its PAB segment) a new possible opportunity to get some of the non-WIFIA 51% share of project capitalization. I’d guess that similar arguments were critical in getting a 75-year term for TIFIA’s P3s and other tough transportation project financings.

It seems to me that dam safety projects are that kind of asset class, at least in terms of relative infrequency and unimportance to the muni market. And that’s the class CWIFP must start with in any case, not just because of the specific funding the program has received for dam safety projects, but due to the draconian strictures of the current FCRA Criteria, which block pretty much everything else that Congress intended CWIFP to do.

A successful start is important for any enterprise, but especially for a government lending program. A lot of long-term aspirations can be built on near-term results. So, with the real-world binding constraints and short-term goals in mind, I think there’s a compelling case to limit the current 55-year term amendment to dam safety projects for which CWIFP has funding. The operative language might look something like the draft at the top of this post.

At the end of a prior post, I noted that the authors of the current Criteria ought to explain why the ‘or assets’ was omitted from the conclusion of the Background section. Or, more exactly in the context of an apparently smoking gun, to provide an alternative explanation to the obvious one, which is that the omission arbitrarily makes otherwise eligible non-federal cost shares in federally involved projects ineligible for WIFIA financing, and that’s the result they wanted.

Well, it’s only fair that the authors be given a chance to explain their side. Below is an email sent yesterday to the OMB contact noted in the Criteria’s Federal Register publication, cc’d to relevant published contacts at GAO and CBO. Naturally, I’m not expecting any reply, but if there is one, I’ll post that too.

Email-to-OMB-re-omission-092223-InRecap

Yesterday, HR 8127 was essentially reintroduced in this Congress as HR 5664. There are a few minor changes, but the Section 7 FCRA amendment language remains the same. As discussed in previous posts, I have some reservations about this approach, not the least of which is that CBO will presumably apply the same scoring to the same language that they saw before. But obviously I don’t know all the political dynamics here and they, not technical FCRA matters, that will determine the outcome. So, the original approach remains effectively Plan A.

If it doesn’t work, perhaps the New Approach outlined recently can serve as Plan B.

But what if no FCRA amendment in any form is included in legislation that’s likely to be enacted this year? Again, I’m in no position to predict the odds of this political outcome, but I’d guess it’s far from negligible. Game over for another year?

Perhaps not necessarily. If things look like they’re going south for Plan A and B amendments, here’s a Plan C that doesn’t even require an amendment, just another Congressional directive. The core of the FCRA non-federal issue is not FCRA or WIFIA law, but the way the current Criteria require it to be interpreted. Yes, the right statutory amendment would settle the issue for good, but in the meantime it’s important to note that the current Criteria aren’t themselves statutory (as much as they have pretenses to be — looking at you, footnote 4) and what one Congressional Directive can create, another presumably can modify.

There’s nothing wrong with FCRA criteria per se, even if they don’t appear to be necessary in a world of honest and intelligent loan applicants. It’s just that the current Criteria are an unholy mess. With suitable revisions, even while leaving in place a lot of the blather about ‘federal projects’ for appearances’ sake, FCRA Criteria v2.0 could include a clear path to WIFIA eligibility for non-federal cost share assets in a federally involved project. The substantive criteria could be essentially the same as proposed in Plan A or B amendments, perhaps artfully camouflaged if necessary.

The new directive is required to re-open the ring for the correct parties — this time, CWIFP as well as OMB and WIFIA — and to precisely clarify the objective for the updates. Otherwise, it can look a lot like the original Directive. Perhaps something like this, changes in bold:

Provided further, That the Administrator, together with the Secretary of the Army and the Director of the Office of Management and Budget,, shall jointly develop updated criteria for Section 3908 (b)(8) eligibility for direct loans and loan guarantees authorized by the Water Infrastructure Finance and Innovation Act of 2014 that limit Federal credit participation in financing a non-Federal cost share in a project that has federal involvement consistent with the requirements for the budgetary treatment provided for in section 504 of the Federal Credit Reform Act of 1990 and based on all relevant recommendations contained in the 1967 Report of the President’s Commission on Budget Concepts; and the Administrator, the Director, and the Secretary, shall, not later than [90] days after the date of enactment of this Act, publish such criteria in the Federal Register.

As with the original Directive, presumably a new directive can be added into the WIFIA “Program Account” section of FY2024’s omnibus spending bill right up to the last minute, right?

Of course, even if the ring is re-opened with the right parties and clear rules, there’ll still be fight. But I’m pretty confident of a positive outcome in that forum. The Pro-Eligibility side will be prepared this time with clear and correct FCRA law and principles, while the Pro-Criteria side will be defending a baseless and embarrassing mess. And if there’s no agreement after 90 days, well, then it’s back to the amendment plan. As described at the end of the New Approach post, the Pro-Criteria side can do it the easy way or the hard way, but they’re bound to lose in the end.

The Corps’ section of the WIFIA loan program, CWIFP, has just published its first Notice of Funding Availability. It’s always great to see progress at federal infrastructure loan programs, for this one in particular.

As discussed in a prior post about CWIFP’s potential borrowers, large non-federal dams will likely be the majority of initial applicants, which is a good way to start things off because successful WIFIA precedents will smooth the way:

Direct loans to large dam projects should obviously be an important part of CWIFP’s development and policy outcomes, especially in the Program’s early phases. A lot of WIFIA experience will neatly translate to large dam loan origination and execution at CWIFP, jump-starting operations and the first closings.

But if you’re benefitting from WIFIA precedents, you’ll also get WIFIA’s challenges, including competition. Like large water agency projects, large non-federal dam projects are likely to be undertaken by substantial and highly creditworthy public-sector utilities that have plenty of cost-effective financing alternatives, especially in the tax-exempt bond market. Rates there are currently significantly below the UST curve that CWIFP lends at. Worse, the UST curve stubbornly remains very inverted, which means the usual primary benefit of a WIFIA-type loan, the avoidance of negative arbitrage during the construction phase, is pretty much negligible [1].

These conditions are reflected in the NPV of the difference between a CWIFP loan with a 35-year post-completion tenor relative to a 30-year high-grade muni bond. I’d estimate about a 1% benefit. That’s not as bad as a negative result, but you have to deduct the extra transaction costs and federal crosscutters, plus the possible execution friction with any new program, as compared to just doing another off-the-shelf muni issue with your friendly local bond underwriter.

Back in 2017, when WIFIA was getting started, things were very different, with a loan NPV benefit under the same methodology of about 9%, which is the level it more-or-less remained at until recently. Timing is everything, eh?

Things change, of course. The inverted UST yield curve should (must?) go back to normal sometime relatively soon, which will reestablish the negative arbitrage benefit. High long-term rates are likely to persist for a while, and they do improve the benefit of tax-exemption relative to low rates [2], which leads to sub-UST yields, other things being equal. But in this economic and geopolitical environment, who knows? Uncertainty is more likely to increase than not, and that increases the value of unique non-rate CWIFP loan features like flexibility and optionality. Most of all, the need for US essential infrastructure renewal and financing for it will certainly go only in one direction — up.

Even if CWIFP might have a harder row to hoe at the start than WIFIA did, the program’s longer-term prospects are of course good. Still, a successful launch is important. Given the likelihood of an initial large-dam project applicant base with serious market competition for the same deals, it makes sense to consider how CWIFP’s competitive position might be improved in the near-term.

Where that involves amending the statutes that CWIFP shares with WIFIA, I’d suggest prioritizing two that might have a chance to be included in this fall’s legislation. Both have been frequently discussed on this site:

A 55-year term — As you can see from the first column in the above chart, the NPV benefit of an extended loan term is around 6% even in the current adverse rate environment. That’s getting closer to levels that prevailed during WIFIA’s successful start. There’s no rational reason that legislators should object to something they gave to the TIFIA program in 2021, or for CBO to punitively score the change. OMB objects behind the scenes? Who knows, but maybe they can be kept busy enough with their FCRA issue.

But there’s still the competition, aka the tax-exempt bond lobby. It never surfaces publicly, but I cannot believe that they would be indifferent to the change if it applied to all WIFIA deals. Perhaps many municipal water projects have a useful life within 30 years, but not all of them. And for those projects with a long useful life, a 55-year post-completion term is a slam dunk relative to a 30-year maximum term bond. You think they’ll just watch as a 49% slice is taken away from a big part of their pie? I don’t think so — their response will be a very quiet but very firm veto expressed to the decision makers that matter most.

However, it is just possible that the lobby will be calmer about dam projects than they are about a mainstay source of water revenue bonds. Maybe they’ll listen long enough to see that a 55-year CWIFP loan in some cases will be the enabling component of a dam project’s capitalization, and they’ll get a shot at a 51% slice that wouldn’t have been there otherwise. So perhaps the near-term objective of an extended term amendment should be limited. Maybe propose that the amendment apply only those dam safety projects for which credit subsidy funding is already in place from the IIJA and last year’s appropriation bill? That’s limited enough, in size and time, but could serve the primary purpose of jumpstarting CWIFP’s applications.

Something like this, which slightly modifies amendment language that’s already been proposed:

‘‘(B) DAM SAFETY PROJECTS WITH A USEFUL LIFE OF MORE THAN 35 YEARS.
“Notwithstanding subparagraph (A), for a dam safety project with a useful life of more than 35 years (as determined by the Secretary or the Administrator, as applicable), and which is eligible for the financial assistance provided by the Consolidated Appropriations Act of 2021 and the Consolidated Appropriations Act of 2022, the final maturity date of a secured loan under this section shall be not later than the earlier of….”

The Limited Buydown — Despite its sure-fire appeal to applicants in these uncertain times and being an established precedent in other infrastructure loan programs, this one is a long shot as it hasn’t yet been included in any WIFIA amendment bill I’m aware of. But it’s worth a try, perhaps with the same limited scope described above for the 55-year amendment. Cost is a potential issue for this loan feature but actualizing it in a loan execution rate is always completely subject to program’s discretion (i.e., only if the money is available at the time). And cost doesn’t arise or is even measurable until loan executions start to happen, which is likely a year or so away in any case. The important point is that it shouldn’t cost anything in this Congress. In the meantime, applicants will see that locking in a contingent interest-rate benefit of this kind is better than not having it all, which may help build traffic.

Two potential amendments I haven’t mentioned here — a fix for the FCRA Criteria issue and a clarification and expansion of the rules for bundled projects — are of course also important for CWIFP, arguably even more than the other two for long-term growth prospects. Work on these will continue, but the priority should be on CWIFP’s near-term potential applicants. A successful launch will immensely improve the prospects for everything else.

_____________________________________________________________________________________________

Notes

[1] I’m not familiar enough with tax arbitrage rules to be certain that the negative arbitrage cost actually amounts to zero, despite the numbers based on current rates. There are tricky things about the limit like ‘lower of YTM and yield-to-first-call’. But I’m pretty sure it’s negligible, given how high UST rates within five years are.

[2] As noted in a recent post, higher absolute levels of interest rates also erode a WIFIA loan’s value relative to a tax-exempt bond with a comparable term because the tax exemption is applied to a larger amount of income. An older post describes the numbers: Subsidized Debt and Term, Interest Rates. Beyond the 30-year term in the muni market, however, uncertainty about the tax code and income will likely outweigh this advantage — hence another reason for a 55-year WIFIA term.

In my line-by-line review of the current Criteria’s Background section, I noticed a small detail that seems significant as to precisely where the Criteria go off the rails. That detail is covered in the review, but I thought it worth surfacing in further depth.

First, read the following sentence as the primary premise for a series of questions about WIFIA loan eligibility for a Section 3908(b)(8) non-federal cost share:

To limit Federal credit participation in a federally involved project consistent with FCRA law and 1967 Budget Report principles, only non-Federal projects or assets are eligible for WIFIA loans and loan guarantees.

That seems OK, right? It is saying that a non-federal cost share in a federally involved project has to be an authentic non-federal asset for a WIFIA loan, which is obviously true and not just because of FCRA treatment. As for the non-federal project part, that’s true as well, but not relevant because the WIFIA loan is specifically for the cost share asset, not the overall project. With this premise, answers to any eligibility questions can focus on the non-federal cost share asset, where things should be pretty straightforward — a non-federal borrower, non-federal repayment and no funny business with the federal participant.

A Barely Noticeable Deletion

Now read this one:

To limit Federal credit participation in a federally involved project consistent with FCRA law and 1967 Budget Report principles, only non-Federal projects are eligible for WIFIA loans and loan guarantees.

Almost the same words — except the ‘or assets‘ part is missing. That barely noticeable deletion entirely changes the premise. Now the focus is solely on (and implicitly limited to) the overall project — is it federal or not? Yes or no? And if the federally involved project is found to be a ‘federal project’ (it will), then ineligibility is established right there — and the facts about the non-federal cost share don’t matter.

Of course, the Criteria essentially use the latter language as the conclusion of the Background section and the premise of the questions. Of course, because it leads directly to the rabbit hole of vague consolidation concepts that can turn any federally involved project into a ‘federal project’. We knew that, but the story is in fact worse.

Everywhere in the Background section, the phrase ‘projects or assets‘ is used, as in the first example sentence above. This persuades the reader to think that when the various aspects of the FCRA problem are considered with respect to a specific non-federal cost share, eligibility as a non-federal asset won’t be difficult to establish. Then, on the very last line, the rules of the game are subtly changed to make that effectively impossible, as only non-federal projects can be eligible. On its jargon-filled surface, the Background section might look like an honest analysis, judiciously seeking the correct application of FCRA principles to specific loans for specific assets. But in the conclusive step, its authors essentially pull a classic three-card monte move, apparently in the expectation that the mark — uh, applicant — will be too confused and intimidated to question the con.

J’accuse…

Was this intentional? As a well-thought-out strategic plan, probably not. But on another level, it’s easy to imagine that there was a near-final draft of the Background section that had ‘projects or assets‘ throughout. Someone then suddenly realized that the ‘or assets‘ words in the final line would not necessarily lead to the desired outcome, so the words were simply deleted, regardless of the rest of the text.

Perhaps that’s not deception per se. But it seems to me that the deletion is specific evidence that the Criteria are and always were intended to reach a certain conclusion about eligibility. With that objective, FCRA law and the principles in the 1967 Report don’t need to be really understood or even read, and they obviously weren’t. Instead, all that arcane technical stuff is simply useful camouflage to confuse others. Just toss a jargon-filled word salad, ask a bunch of leading questions to go through the motions, and make the pre-ordained and unappealable judgement of ineligibility. Convicta et combusta.

J’accuse…the current Criteria aren’t just wrong. They were developed in bad faith from the start. If not, what else could be the purpose of deleting the words ‘or assets‘ in the most consequential sentence of the Criteria? Can the authors of the Criteria explain that?