The US EPA’s WIFIA water infrastructure loan program has in fact established itself as an institutional lender to the US state & local public sector.

That’s not as easy as it sounds. Most state & local infrastructure agencies are highly rated and can issue tax-exempt bonds. In effect, state & local borrowers already have a long-established source of cost-effective, federally subsidized debt. How did a relatively new federal loan program make any headway against this alternative?

It’s not the interest rate on a WIFIA loan — the US Treasury rate WIFIA offers isn’t that different than the overall yield on a highly rated muni bond series for a highly rated issuer. But although WIFIA loans are similar to muni bonds, federal loans can include special features that make them especially attractive to public-sector infrastructure agencies. Currently, WIFIA’s primary loan product is a costless interest rate lock, which highly rated borrowers can use as an interest rate call option on long-term financing.

The free interest rate call option feature transformed WIFIA from what is was likely intended to be, an infrequently used project finance lender, to effectively a participant in the mainstream US state & local public-sector market.

Offering a free call option on long-duration debt is a great way to build a loan portfolio. But is that the point of a federal infrastructure loan program? Not exactly — the loans should have a real-world outcome that wouldn’t have happened otherwise. Free call options, though of course very welcome to borrowers, don’t really accomplish that.

But new WIFIA loan features — focused on current federal policy objectives like climate adaptation, water affordability & equity and SRF leverage — could. This potential to make a large-scale impact in US water infrastructure is the real significance of the WIFIA Bank. The federal government has built an efficient institutional lender to the US state & local public sector, an unusual achievement. Now what are policymakers going to do with it?

As noted at the end of a prior post on innovative infrastructure-related innovation, a straightforward way to inspire more innovation in the uses of WIFIA loan benefits is simply to combine data sets.

The key elements are data about current and selected WIFIA projects (plenty of that online from EPA and local water systems), data that might be relevant to the affected communities (ranging from economic statistics to climate exposure – also widely available) and estimates of the financial value of WIFIA loan benefits connected to the project’s financing.

This last data set defines the funding that might be available for innovative initiatives, so it’s obviously the core element of inspiration for any realistic plan.  But estimates for the actual value of WIFIA loan benefits are not directly available.  Press releases for WIFIA financings often include simple totals of interest rate savings, but this is not the same as the type of value required to establish additional funding capacity, which is the real point.  In any case, press releases are (understandably) not going to follow a rigorous or consistent methodology in the numbers they report.

Fortunately, however, since the relevant WIFIA borrowers are all highly rated public water systems, there’s plenty of raw material from publicly available financial information to model WIFIA loan value estimates accurately, if not precisely.  A standardized model, with specific project and borrower data input for the variables, will provide a uniform and consistent approach.  It’s also a practical and efficient way to generate value numbers for the dozens of individual projects involved.  This part of the exercise, though it involves an extra step, is pretty straightforward too.

Piles of statistics and financial numbers are…well, not exactly the best material to spark fires of innovation, however important they might be for actual implementation and consensus-building.  But since a WIFIA financing is ultimately grounded in a physical project, with a specific real-world location and a clearly defined zone of impact, the piles of data can be anchored around a physical place.  The obvious way to start with data visualization in this case (the kind of presentation that does spark innovation) is a map overlay.  The graphic at the top of this post shows what some elements might look like – the base layer is the WIFIA project itself and the top layer is the WIFIA loan benefit value.  The layers in between are where the inspiration and innovation happen.

As noted in a prior post, a private-sector lender would be willing to offer a climate contingent loan for adaptation infrastructure investment if there was a way to hedge the risk that it won’t be fully repaid if extreme conditions don’t develop.  The fundamental nature of the hedge would be a parallel investment that paid more if extreme conditions don’t develop.

It’s not exactly hard to imagine entities with economic exposure to extreme climate change that would very much want some insurance for the all the costs they’ll incur in those possibly disastrous conditions.  They’d be willing to pay premiums for an insurance contract that didn’t pay anything if extreme climate conditions don’t develop – in which case the premiums are all gain for the writer of this contract.

So, a portfolio of climate insurance contracts (which will have gains if extreme conditions don’t develop) would hedge a portfolio of climate contingent loans (which will have losses in those conditions).  And vice-versa if extreme conditions do develop.

Fostering innovation in the US water sector is a core WIFIA Loan Program policy objective.  It’s right there in the name.  The Program has had a great start on the infrastructure finance part.  But a clear story about enabling innovation has yet to emerge.  It’s a tough objective.

WIFIA faces intrinsic challenges in this part of its mission.  Most importantly, ‘innovation’ and ‘investment-grade credit rating’ aren’t exactly a natural match.  Innovation almost always entails risk, and financing it involves a different kind of capital than the investment-grade loans that WIFIA offers.

Certainly, a WIFIA loan to a highly rated public water system can finance an innovative infrastructure project or even an experimental technology – if the system takes all the risk and puts its solid creditworthiness behind the loan.  No problem.  But can the Program then honestly claim to have enabled the innovation?  It’s conceivable that the low cost and other features of a WIFIA loan might have made a slight but essential difference in the project’s overall numbers, just enough to get it over the edge of infeasibility and into greenlight land.  That’d be a solid win, right?

Tax-exempt muni bond yields are hitting historic lows relative to US Treasuries. In the short term, this reflects supply and demand dynamics that may reverse once state & local governments start issuing more debt. But there are longer term factors – the prospect of higher tax rates and the ‘put’ precedent set by the Fed’s MLF last year – that may cause sub-Treasury rates to be persistent.