WIFIA loans to refinance existing debt would do a lot of good.
Can a WIFIA loan be used to refinance existing debt as part of a new financing for major capital expenditure on a water system?
It’s easy to see why that would make sense for borrowers, even highly rated public water agencies. Major capital expenditure on a failing or obsolete part of an integrated system will presumably extend the system’s overall useful life. A big capex project provides the basis – and, more pointedly, the need – to stretch out the maturity schedule and lower debt service payments not only on the new capex financing but existing system debt as well. The long tenor features of a WIFIA loan would be especially useful for this purpose in the context of a broader recapitalization .
WIFIA loans may also lower the overall cost of capital in a broader recap. As frequently pointed out in this blog, WIFIA’s Treasuries-flat interest rate in itself isn’t very compelling for highly rated public water agencies who normally can issue tax-exempt revenue bonds at about the same rate or less all along the 30-year Treasury yield curve. This looks like it’ll continue to be true in the post-Covid crisis market – highly rated water issues specifically are at the forefront of a return to normal conditions. But for maturities longer than 30 years, WIFIA’s Treasuries flat-forward rate is distinctly attractive, and possibly more so now. A larger system recapitalization will obviously utilize more of this benefit in absolute terms than a smaller capex financing.
More importantly, a system recapitalization incorporating a WIFIA loan may result in a per-dollar improvement in cost as well. For example, a new pumping facility might have a useful life of 30 years. A WIFIA loan for a discrete financing of the capex within that time frame would be of limited value. But the new facility plus its pipes and other distribution system assets will be much longer-lived, on average. In an optimal system recapitalization including maturities of up to (say) 40 years, a WIFIA loan can be structured to provide all the maturities beyond 30 years, allowing revenue bonds to offer their most cost-effective rates by remaining in their natural 30-year market. This is Finance 101 — a larger single deal including multiple types of assets permits a more efficient utilization of two complementary debt sources than would a smaller deal or two separate ones.
WIFIA’s interest rate management features can add another, somewhat technical, benefit. A WIFIA loan rate is set at the time of loan commitment. The drawdown schedule is flexible and not specifically tied to construction payments. It is possible (and frequently done by WIFIA borrowers) to make a single draw of the full commitment up to 12 months after construction completion and use cheaper shorter-term financing for the actual payments. In effect, WIFIA offers a locked rate on the term financing with optional construction draws at the same rate.
If a WIFIA loan drawdown for refinancing existing debt was basically treated like a construction draw, a par call date anytime between WIFIA loan commitment and one year after the completion of the work could be accommodated. Since major water capex usually take a few years at least, and you get another year after that, this feature would provide a significant time window for coordinating repayment of existing debt (that can’t yet be called) with new investment (that ought to be done as soon as possible).
The value of WIFIA’s rate-lock here would be two-fold. First, construction and refinancing account escrows aren’t necessary for the WIFIA loan part of the recapitalization, which avoids negative arbitrage that can be significant in a long construction phase. Second, and more subtly, if the existing debt was a candidate for a taxable advance refunding, WIFIA’s Treasuries-flat interest rate will look relatively more attractive, even within the 30-year taxable market but also with respect to credit spreads thereafter.
All good for water sector borrowers. And not dangerous or expensive for federal taxpayers either, since highly rated public water agencies are likely the main entities that will find these specific features useful. The vast majority of WIFIA’s current pending and closed loans are to such creditworthy agencies anyway. Refinancing would be another useful tool to provide to an important and very creditworthy public-sector customer base.
The Answer is “No-ish”
Returning to our original question, unfortunately the answer is “no”. But it doesn’t seem to be “no way ever”.
There isn’t an explicit prohibition on refinancing existing debt in the WIFIA statute. As noted above, the Program is already operating in scale on the basis that refinancing all types of construction debt is acceptable. As a practical matter this likely involves borrowers accumulating and rolling over draws under their short-term facilities as construction payments are made, so WIFIA is refinancing specifically short-term debt. But in theory a term bond that came due one year after construction completion would also be acceptable, as long as the original proceeds were traced to eligible capex. One WIFIA borrower is financing a a major renewal program with a nine-year construction phase – they presumably could have issued a ten-year bond to be repaid from the WIFIA loan, if for some reason that had made sense. Or even a 30-year bond with a ten-year par call?
The problem is not that the Program is comprehensively designed by statute or operated in practice to prohibit a WIFIA loan being used to refinance existing debt. Rather, it appears to be simply a matter of omission in the list of eligible uses for a WIFIA loan, which focus on tangible capex and closely related intangible costs (e.g. development planning, capitalized interest). Still, an omission is not to be taken lightly in a government program. I think a statutory fix will needed for WIFIA to start actually offering the kind of recapitalization features described above.
Mechanics
How hard would that be to do? At this time, in this Congress? Or even in a calmer 2021? Nothing involving legislation looks easy these days, but maybe it’s not impossible in this case, especially if a minimalist approach is taken. Adding something to WIFIA’s Eligible Activities list can (I think) be characterized as a technical amendment, at least in form. The specific language and other mechanics of that may be straightforward and appear to be thoroughly non-controversial, so an attempt is not unrealistic. The following is my best guess as to what this might look like.
As it happens, there’s already a bill making its way through Congress which includes a proposed water reclamation infrastructure loan program that’s closely modeled on WIFIA, right down to the acronym, ‘RIFIA’. And RIFIA includes a provision for refinancing. Karma, no?
The bill is HR 2473, the SAVE Water Resources Act. There’s a lot else besides RIFIA going on in this bill, some of which appears to be generating a distinct lack of bipartisan harmony. The bill did get reported out of the Committee on Natural Resources in March of this year, but only on a 19 to 12 vote. However, from what I can tell (based on such reporting and archived hearings as I could find), the various disagreements don’t seem to involve the RIFIA part or the refinancing language.
The proposed RIFIA statutory language in the bill is pretty much a carbon copy of the WIFIA statute, as modified for reclamation projects in the Western states. RIFIA’s Eligible Activities list includes this:
(F) refinancing long-term project obligations or Federal credit instruments, if that refinancing provides additional funding capacity for the completion, enhancement, or expansion of any project selected for assistance under this Act
I don’t know the backstory about why this refinancing provision was added to the WIFIA template, and it may be worth investigating. I’m guessing it’s related to something about giant existing projects with debt that’s so old and infrequently managed that refinancing it is a critical source of funding for new investment. The motivation for highly rated water agencies to fine-tune their system’s continuously managed and refunded debt capitalization with a WIFIA loan is quite different. But the principle – the potential to save the public’s money — is exactly the same. This fortuitous language also has had the benefit of at least some review in the Congressional process, so I think it is a good place to start for a proposed technical amendment.
Another minor (and very technical) amendment may be required, primarily for clarification. To work as intended, the refinancing language requires that the term ‘project’ include both the new capex and the related existing assets in the system. That’s actually a natural perspective in real world terms – the point of upgrading one part of the system is to improve the performance of the whole system, and that is the basis on which the new capex is planned and evaluated by water agencies. Presumably a “project” is also “selected for assistance” by WIFIA because it is beneficial to the system’s end-users and the environment, not because the proposed capex will improve the engineering specs of a specific part.
In WIFIA’s list of Eligible Projects, however, the language most relevant to water system refinancing uses the term “facility” as the focal point of the project:
(5) A project for repair, rehabilitation, or replacement of a treatment works, community water system, or aging water distribution or waste collection facility
If strictly interpreted, this might mean that an Eligible Project is limited to discrete facilities or similar functional components within a system. In practice, I don’t think that was the intent or how the Program is actually operating with respect to eligibility and evaluation. Since the current Eligible Activities list effectively limits WIFIA financing to new construction anyway, it’s likely the question hasn’t arisen. But it might, both when the refinancing amendment is being considered and (possibly worse) after it is enacted. To be on the safe side, the proposed amendments package should include adding “or system” after “facility” to the relevant sentence.
With the addition of the RIFIA language to the Eligible Activities list, and the clarifying addition to the Eligible Projects list, I think the full scope of WIFIA features described above will become available to borrowers who are proposing a combination of new capex and refinancing existing debt. In theory, a proposal could include an extreme imbalance of the two – say $5 million of capex with a $495 million refinancing – that actually results in a lot of savings for water ratepayers. In practice, the optics of using WIFIA purely for a large refinancing transaction is obviously a bridge too far at this point, regardless of potential benefits. WIFIA has a competitive selection process and its capacity is oversubscribed. The Program is also very sensibly managed within its federal context. Sophisticated public water agencies, the group most likely to benefit from refinancing, know all this and much else besides about managing optics. They’re unlikely to propose anything extreme out of the gate.
Still, to forestall extreme hypotheticals from becoming a distracting talking point and generally keep things calm, it might make sense to improve refinancing optics by modifying the RIFIA language. There’s some precedent for this in WIFIA itself. Debt service on a WIFIA loan can be deferred for up to five years after construction completion, a useful feature inherited from TIFIA for revenue-risk project financings (e.g. toll roads) in an operational start-up phase. Given WIFIA’s rigorous credit analysis, investment-grade rating requirements and (most importantly) the fact that the vast majority of WIFIA applicants are actually public water systems with little revenue risk, a few years of deferral is hardly imprudent. But it can look bad on the surface – “giving a break to deadbeats who can’t pay their bills” and all that – so the deferral section includes language that enables the Program to impose additional credit criteria. It turns out that the feature has been sought by WIFIA’s most highly rated applicants in order to extend the rate-lock on accrued interest during deferral (talk about fine-tuning!) and duly approved by the Administrator without apparent fuss. The language still serves an optical purpose, and in the same spirit (and expectation of smooth approval), it can be simply added to the RIFIA template.
Here’s the final product, to be inserted at the end of WIFIA’s list of Eligible Activities in Section 3906:
(5) Contingent on the project meeting such criteria as the Administrator may establish, refinancing long-term project obligations or Federal credit instruments, if that refinancing provides additional funding capacity for the completion, enhancement, or expansion of any project selected for assistance under this Act
Even a technical amendment needs a pitchbook. On one level, this is straightforward because refinancing can be characterized (accurately, more or less) as a tool intended for public water agencies to reduce their cost of capital and lengthen debt maturities, both of which should ultimately reduce water rates or improve service. Variations on this theme that incorporate other stakeholders are also soundbite-ready:
- “The ability to access refinancing savings with a WIFIA loan will enable and encourage more construction – and good jobs – in the US water sector”
WIFIA requires compliance with the Davis Bacon act, in effect a union-scale wage rate. Presumably operations labor on existing assets is already unionized at highly rated public water agencies. Davis Bacon apparently hasn’t been a constraint for prior WIFIA applications involving capex labor.
- “WIFIA refinancing will incentivize a holistic, system-wide perspective and longer-term planning horizons while increasing funding for improved sustainability and resiliency investment”
WIFIA will require an environmental review of the entire project, not just the new capex. This shouldn’t be a problem for existing assets in full compliance anyway, which presumably will get a Categorical Exclusion from NEPA review. But it does encourage an integrated, system-wide perspective in the course of financing specific new capex.
- “Including refinancing loans in WIFIA will reduce average construction and credit risk – the Program will be able to achieve its goals without be forced to select marginal projects”
Fiscal hawks and small-government proponents aren’t generally fans of federal loan programs, but refinancing loans for highly rated water agencies are relatively benign from a federal taxpayer perspective. Another Solyndra is very unlikely, to say the least.
All of these positive points, and perhaps many more like them, are intensified by the need for federal policy to assist local public-sector agencies with post-Covid economic recovery. This is a valid reason in itself for considering the expansion, and it should be highlighted or even lead the proposal.
Mission
The mechanics might be the easy part. A serious effort to allow existing debt refinancing at WIFIA should be prepared for a heavier part of the lift. The current omission in the Eligible Activities list is not an oversight. Rather, it reflects an original and still-widespread understanding that WIFIA’s fundamental mission is to improve US water infrastructure by directly enabling increased investment in physical infrastructure that wouldn’t have otherwise happened. Classic images of this outcome usually involve a ribbon-cutting event at a new facility (ideally incorporating an innovative technology like desalination, but an upgraded treatment plant will do) that arguably was only made possible or at least accelerated by a WIFIA loan. Does a purely intangible activity like refinancing existing debt incurred for completed assets fit into this picture?
It doesn’t. WIFIA is going to need a bigger perceived mission to offer refinancing loans on a significant scale. A number of good arguments can be advanced for expanding the mission to include intangible outcomes from US water sector refinancings, especially in the context of post-Covid recovery. These are implicitly reflected in the pitch points outlined in the prior section, which in themselves are intentionally focused on positive outcomes, not rationale. That may be all that’s needed to secure an adequate consensus about mission change for a low-key proposal, perhaps based mainly on tacit agreement or plain indifference to such apparent nuances. After all, including refinancings won’t require new funding, doesn’t look dangerous and will make public water agencies (and their ratepaying voters) happy. It’s possible that simply passing a technical amendment will in itself effectively expand the Program’s mission without any explicit discussion.
But if WIFIA’s mission does become a question and a more substantial case needs to be made, and because that case might be useful for future initiatives in connection with federal infrastructure loan programs, I think it’s worth beginning to develop a more fundamental argument about why WIFIA’s mission should be re-examined. This is a big topic that has implications beyond refinancing, including guidance for other basic terms of the Program, its overall capacity and its relationship with other debt market, especially muni bonds. I’ve already sketched out parts of it within this blog and elsewhere, and I expect it’ll be a primary focus of InRecap for a while, especially in the context of post-Covid economic recovery. For the specific purpose of expanding WIFIA for refinancing loans, it’s enough at this point to briefly summarize the basic argument.
That argument starts with the factual observation that WIFIA is already primarily providing intangible financial (not physical) outcomes for the US water sector. Then it posits that this is the largely the reason for WIFIA’s success, and that these intangible outcomes are in fact effective at improving US water infrastructure, albeit in a different way than originally planned. In effect, this argument makes the case that WIFIA’s mission has in fact already expanded to include purely financial outcomes and it’s working well. So why not continue the positive trend and include refinancings? It’s a good start.