The WIFIA Loan Program has had a successful start. How that happened is surprising — and raises two questions
Most public infrastructure projects in the US are undertaken by state & local authorities or agencies that have investment-grade credit ratings and efficient access to the tax-exempt municipal bond market. Over the past few years, this market has been characterized by a growing supply of investor capital and historically low interest rates. For the most highly rated issuers, rates on infrastructure-related financing are typically below or near those of US Treasuries all along the 30-year curve. In particular, revenue bonds for essential ratepayer-funded water systems can be placed with a substantial investor base that forms a significant segment of this market. Recently, sudden liquidity issues resulting from the Covid-19 crisis caused muni rates to spike far above recent trends, but the market seems to be normalizing quickly, especially for highly rated issuers.
In light of the attractive features of the muni bond market for highly rated water agencies, it may have seemed safe to predict that when the US EPA’s Water Infrastructure Finance and Innovation Act (WIFIA) Loan Program became operational in 2017, these agencies would not be among the Program’s applicants. A WIFIA loan does offer a rate equal to Treasuries, but it also requires a customized investment-grade rating, compliance with Federal environmental and economic policies, and a multi-step application, approval, and execution process. For highly rated public water agencies that could do an off-the-shelf tax-exempt bond issue at pretty much the same rates with far less hassle, what would be the net benefit of a WIFIA loan? And since these agencies have plenty of access to a large, fully functioning debt capital market that is already federally subsidized by a tax-exemption, what would be the policy purpose of that anyway?
Instead, it seemed much more likely that WIFIA would follow an analogous path to its predecessor program, the US DOT’s Transportation Infrastructure Finance and Innovation Act (TIFIA) Loan Program, on which the water program was closely modeled. Since it began operations in 1999, TIFIA has primarily provided minimally investment-grade loans to greenfield project financings with some element of user-fee revenue risk. This type of loan can be expensive and difficult to place in the muni or other debt markets, so the relative benefits of a TIFIA application to the borrower are clear and significant. In addition, new greenfield projects relying on uncertain revenues are often contingent on the availability of subsidized financing. A project of this type might not proceed at all without a TIFIA loan, a plausible claim that clearly demonstrates the loan’s ‘additionality’ with respect to US infrastructure investment and substantiates the program’s policy rationale. Success can be stated in a simple, soundbite-ready story. And if TIFIA arguably increases the amount of investment in greenfield project financings in the transportation sector, its analogue WIFIA would presumably be doing the same, and in much the same way, in the water sector.
Unfortunately, a transformative policy objective that’s easy to explain is not always easy to implement. TIFIA has completed a significant number of financings, but revenue-risk project finance is a tough asset class even for the specialized departments of private-sector institutions. Complex revenue risk evaluation and transaction execution are not obvious federal government strengths, and TIFIA has experienced a number of difficulties over its history, including several large loan defaults, disappointing deal volume and frequent criticism of its laborious and unpredictable transaction processes. WIFIA would presumably face similar obstacles in executing loans for greenfield project financings in the water sector.
WIFIA’s Surprising Start
WIFIA has now completed three application rounds over the period 2017-2019, generating 90 qualified and selected applications totaling $13.6 billion of loan volume, of which nearly $5 billion has been closed. This volume in itself indicates that the Program has had a very good start. It also appears that WIFIA has avoided some of TIFIA’s process-oriented pitfalls, so far anyway. But since a selected application involves considerable input and processing from both the applicant and the Program, this list also constitutes a significant data set about Program performance and trends. What does it show?
The results are surprising. Notwithstanding very favorable conditions in the muni market during the 2017-2019 period, the vast majority of WIFIA selected applicants are in fact highly rated public water agencies. Over 85% had long-term bond credit ratings of Aa3 (Moody’s) and AA- (S&P) or better, with a significant portion having the highest ratings available, Aa1/AA+ (22%) and Aaa/AAA (6%). At this level of credit quality, tax-exempt bond rates are generally below Treasuries for maturities within 15 years and at or near Treasuries for the balance of the 30-year curve. Whatever motivated the majority of these applicants, it was clearly not the expectation of any significant interest rate savings on a 30-year financing.
Perhaps some characteristics of the water projects themselves might have made placement of their financing difficult among the water revenue bond investor base and easier at the WIFIA Program? There is no indication that this was a factor in the application decision. The list of projects is dominated by run-of-the-mill pipe replacement programs, water treatment plant upgrades, stormwater system reconstructions mandated by consent decrees, etc. – all basic water infrastructure assets, funded by ratepayers and standard fare for revenue bond buyers. Further, in almost all cases, the 51% balance of the project’s capitalization (a WIFIA loan is limited to 49% of capital cost at completion) was expected to be sourced, often wholly, from muni revenue bonds. The overall picture is that WIFIA loans are financing essential components of existing water infrastructure systems, a much-needed investment but one that is thoroughly acceptable (indeed attractive) to a large and established investor base.
The unexceptional nature of the applicants’ water infrastructure projects is naturally a positive aspect for WIFIA’s risk management . It does, however, require some examination with respect to the Program’s policy rationale. If a project is essential to keeping a water system running (e.g. pipe replacement), required for regulatory compliance (e.g. stormwater system upgrades subject to consent decrees) or effectively non-optional for some other reason, what is the ‘additionality’ to US water infrastructure investment of a WIFIA loan for highly rated public water agencies? It is clear that these agencies have both the obligation and the wherewithal to proceed with non-optional investments with or without a WIFIA loan. What proportion of selected projects might possibly be optional enough to be influenced, even if only marginally, by a WIFIA loan?
The data is intrinsically a bit more ambiguous about project optionality than applicants’ formal public bond ratings, but a preliminary assessment suggests that about 70% of selected projects are clearly non-optional, based on keywords in project descriptions (e.g. ‘consent decree’, ‘outdated’, ‘failing’ etc.). Another 18% appear to be quasi-optional based on keywords that are related to basic engineering factors (e.g. ‘improve’, ‘efficiency’ etc.) and may or may not be influenced by financing. Only 11% of selected projects look optional enough (e.g. ‘alternative’, ‘pilot’, ‘innovative’ etc.) that capitalization may be a critical factor in their proceeding.
Two Important Questions
The high credit quality and low project risk of WIFIA’s selected applications over the past three years likely goes a long way towards explaining why the Program’s transaction processes have operated smoothly from the start. By all reports, the Program is very well-managed and staffed. But more fundamentally, WIFIA simply attracted a sufficient volume of the kind of applications that fit well into institutional lending processes. For a highly rated water agency looking to finance a standard water asset, a WIFIA application is not fundamentally different than a bond prospectus in terms of detailed project description and risk disclosure. Plenty of review-ready information can be provided. Likewise, a financing that’s attractive to conservative revenue bond buyers should not raise many concerns among federal officials tasked to protect federal taxpayers. WIFIA’s bureaucratic processes are very similar to those of TIFIA, both by design and from their shared federal lending statutory context. But the review-ready, low-risk raw material WIFIA could work with from the start was far better suited to these processes than TIFIA’s idiosyncratic revenue-risk projects. With the addition of good management and staffing (and perhaps a spur of motivation from TIFIA’s travails), the WIFIA Program was in retrospect well-positioned for a smooth launch.
A smooth launch, however, does not mean that WIFIA is accomplishing its mission or explain how it might be doing so. Two questions must be addressed:
- Why is the Program attracting applications from highly rated public water agencies? These agencies are clearly making a rational assessment that the net benefits of a WIFIA loan for 49% of a planned debt financing are relatively better than their excellent alternatives in the muni bond market and elsewhere. The fact that such agencies have submitted the vast majority of WIFIA’s applications to date indicates that the assessment is widespread. But the basis of the assessment is not obvious from interest rates (about the same for 30-year financings), project characteristics (basic ratepayer-funded water assets) or transaction costs and frictions (a WIFIA loan clearly has higher upfront transactional and compliance costs than an off-the-shelf revenue bond issue). Something more subtle (but still significant) is driving this trend.
- What is the Program accomplishing in terms of US water infrastructure investment that would not have otherwise happened? As noted above, almost all of WIFIA’s selected projects to date look like they either must proceed or are optional for reasons unrelated to financing. This observation does not in itself establish that the Program is failing to impact investment in US water infrastructure. The data does suggest, however, that a WIFIA loan’s additionality, if it exists, will be found in realized or expected outcomes that aren’t defined simply in terms of whether a project proceeded or not. Those outcomes are likely to be as subtle as, and closely related to, the reasons highly rated water agencies are applying to WIFIA in the first place. Unlike a Program loan that singularly enables the ribbon-cutting on a new project, they probably will be difficult to express in a soundbite. But some measurable impact on real world investment is critical in determining whether the WIFIA Program, regardless of number of selected applications, loan volume or even absence of default, is in fact successfully completing its mission to improve US water infrastructure.