This is the fourth post in the FCRA Non-Federal Series

In July 2022, the GAO published a report on the FCRA non-federal issue, Transparency Needed for Evaluation of Potential Federal Involvement in Projects Seeking Loans.  Unlike the two prior reports discussed in this series, the GAO Report does not analyze budget principles but primarily describes the results of an investigation.  It was requested by the House’s Budget Committee in 2020 and the investigation was conducted from June 2021 to July 2022. 

The core of the GAO Report is a description of OMB’s concepts underlying the FCRA non-federal criteria for WIFIA published in 2020, per the Congressional directive.  Interestingly, Treasury involvement is not mentioned, even though in the directive it was named along with EPA and OMB as one of primary parties responsible for criteria development.  That doesn’t mean Treasury wasn’t involved in some way, though the relative lack of focus and precision about debt mechanics in the published criteria does suggest their input was limited.

The Report also briefly describes GAO investigation into how the FCRA non-federal issue is considered at five other federal infrastructure loan programs, though outside of WIFIA, it’s apparently non-existent or very infrequent.  That scope, however, is the context for GAO’s single recommendation, that criteria for the FCRA non-federal issue be developed and applied uniformly to all federal loan programs.  Since the GAO Report does not question or evaluate OMB’s thought processes or the resultant WIFIA criteria, the implication is that WIFIA’s currently published criteria should be the model for a universal application.

Factors Considered by OMB in the Development of the Criteria

There are five important paragraphs in the GAO Report on OMB’s description of its thinking in developing the FCRA non-federal criteria. I’ll quote them and make some general observations about each in sequence.

According to OMB staff, their classification of a borrower as federal or non-federal depends on whether a loan is sought for a federal or non-federal activity, rather than solely on whether the direct recipient of the loan is a federal or non-federal entity.  In other words, the fact that a loan applicant is not a federal entity does not automatically mean that the proposed project will be considered non-federal for the purposes of FCRA.

• 1967 Report makes it clear that the distinguishing characteristic of a federal program loan is the obligation to repay, not what it is ‘sought for’.  Repayment is the ‘activity’ that matters here.  I think it can be assumed (though it should also be confirmed) that if substantial non-federal entities are willing to commit to repay a large amount of money over decades, they are doing it out of non-federal self-interest – the project, or part thereof, that they’re paying for is (perhaps sadly) not a patriotic gift to the nation.  Their presumably rational decision to allocate their own non-federal resources for loan repayment is the external, non-federal discipline that the 1967 Report is looking for with respect to separate budget treatment.

• FCRA does not classify ‘projects’ – only federal program loans.  With that more precise language replacement, the sentence can be flipped around with equal truth: “In other words, the fact that a loan applicant is a federal entity (e.g., for CBO scoring purposes) does not automatically mean that the proposed program loan will be considered federal for the purposes of FCRA.” Again, it all depends on who’s repaying the loan.

Structure of the Project.  OMB staff stated that if the federal government is the primary recipient of a completed project or if it receives the majority of a benefit from a project completed by a non-federal borrower, OMB may determine the loan would not qualify for FCRA’s special budgetary treatment.

• On surface this makes complete sense – if the project’s primary beneficiary is federal, then it’s a federal project.  This echoes the CBO Report’s criteria and its examples describing facilities dedicated for use by federal agencies.

• But there’s a missing piece that ought to be made explicit.  If the project’s primary beneficiary is federal, then what is the ultimate source of the proposed program loan’s repayment?  Presumably, it will also be a federal entity, directly or (more likely) indirectly through contractual or lease payments, as in CBO’s examples.  If that’s the case, then a proposed program loan will fail the external discipline test and should not receive FCRA treatment.  But much more fundamentally, infrastructure loan programs are intended to support financing for large-scale public projects that benefit specific local or regional communities.  It’s hard to imagine that a large-scale infrastructure project that primarily benefitted only a federal agency would even meet threshold eligibility at an infrastructure loan program – much less that local or regional communities would pay for it.

• Still, the ‘Structure of the Project’ is important, though the key point about this is not mentioned.  In the real world, a large-scale project with federal participation but with substantial non-federal participants, owners, and stakeholders, and financed at least in part by non-recourse debt, will have a complex structure that can’t be easily classified as wholly one thing or another [1].  It depends on what ‘activity’ you’re concerned about.  Regarding FCRA treatment, that activity is specifically the repayment of a program loan and whether it is subject to external, non-federal discipline.  For the FCRA non-federal issue, consideration of the project’s structure needs to be focused on answering this precise question.

Financing of the Project.  OMB also assesses the resources available to a borrower for repayment and how dependent a project may be on federal support.  OMB staff stated that as part of credit program implementation, agencies are asked why a given objective cannot be achieved without federal support, what existing private sources of credit are available to support the project’s objective, and what other federal credit or noncredit programs exist to support the objective.

• The first sentence starts in a promising way with a mention of loan repayment (finally!) but then slides into an apparent implication that the overall degree of federal support for a project will determine the ‘resources available’ for that repayment.  In fact, they aren’t necessarily related.  In a real-world infrastructure project financing, the ‘borrower’ is likely to be a special purpose company e.g., ProjectCo LLC.  But the substantive source of repayment for the program loan and other non-recourse debt will be the non-federal resources of the beneficiaries of the project (or relevant parts thereof), likely local or regional communities.  The federal participant will most likely be involved at or below the ProjectCo development, management, and ownership level.  The relationship between the repaying beneficiaries and the federal participant needs to be examined, but assuming they’re honest and rational actors, it’s unlikely that the resources for loan repayment will be considered federal.  The degree of overall federal support for the project, outside repayment resources, might be a policy matter for the loan program to consider, but it isn’t a FCRA issue.

• The questions about loan program objectives are explicitly asked in OMB Circular A-129 and are applicable to all federal credit programs and loans.  But what they address is whether federal credit is necessary, not ‘federal support’ as a whole.  Certainly, the questions have nothing to do with FCRA.  If a loan program is making loans to highly rated, indisputably non-federal public agencies with excellent access to the tax-exempt bond market for financing essential infrastructure projects that they’ll do anyway, the loans will certainly receive FCRA treatment, but one might wonder how they’re consistent with Circular A-129 [2].  On the other hand, a program loan to a one-off, very large-scale, and barely investment-grade infrastructure project financing being developed by a consortium of regional authorities and including a federal participant will have great answers to the Circular’s questions but encounter the FCRA non-federal issue.  What is OMB’s point here?

• Perhaps OMB is thinking that the FCRA non-federal issue might be correlated to a project receiving a lot of federal support, in effect ‘reminding’ the loan program that there might be a Circular A-129 issue (e.g., the loan is not necessary) with that, even though the two are separate.  While that reminder might not be a bad idea in terms of overall policy objectives, I’m not sure it belongs in the specific FCRA criteria that Congress asked for or how it would work with other loan program eligibility or selection criteria.  For example, WIFIA explicitly references federal support in its selection criteria: §3907 (b)(2)(K) The extent to which assistance under this chapter reduces the contribution of Federal assistance to the project.  A federally involved project that would otherwise need to rely completely on federal resources but has decided to raise non-recourse debt, including a program loan, to be repaid from non-federal sources is clearly reducing ‘Federal assistance’ to the project.  In this case, the project’s FCRA non-federal issue is indicating an opportunity to reduce federal support, a statutory program objective.

Project Liabilities.  OMB staff stated that, in some cases, former or current federal involvement in projects may confer a significant level of control and future responsibility, or liability, to the federal government.  OMB staff stated that in these cases, future activity completed by a non-federal borrower on an asset would still be considered a federal project.

• OMB appears to be referring to the project’s non-debt liabilities – that is, recourse performance obligations of the project’s owners, developers, and the federal participant.  These can be substantial in a classic project financing, though they are usually off-set by contractual arrangements with other creditworthy parties – construction bonding, insurance, third-party O&M management, etc.  It’s possible (maybe likely in some cases) that the federal participant can uniquely absorb some project risks that the private-sector or sub-national governments can’t.  But presumably this is part of the federal participant’s policy implementation towards objectives that can be achieved by the project, especially if the project won’t happen otherwise.  If there is a cost, it will need to be authorized in the usual way and, if paid, show up in the participant’s part of the federal budget.  Certainly, this role will enhance or may even enable the project with respect to the benefits that non-federal entities are willing to pay for.  But isn’t that the point of federal involvement in the first place?

• More specifically, for the FCRA non-federal issue, the federal participant’s “level of control and future responsibility, or liability” needs to be put in the context of the project’s non-recourse debt and program loan repayment.  Any project finance lender would want to see that a project’s developers, managers, and owners are willing to commit to exercise control and assume the responsibilities and liabilities that are needed to make the project successful, even though the loan is not recourse to any of them.  Maybe the federal participant can and will take an out-sized role relative to the others – but that’s a difference in degree, not principle.  Regardless of how excellent and beneficial the project is due to the federal participant’s capabilities and efforts, an independent decision must be made by the project’s non-federal beneficiaries to commit their non-federal resources to make long-term payments to the project.  Their decision, not those of the federal participant, is the basis of the project’s non-recourse debt repayment and therefore the source of external, non-federal discipline for the program loan’s FCRA treatment.  

• The ’former’ involvement of the federal government in aspects of the project (primarily land or existing large-scale federal infrastructure, I think) should be seen in the same context with respect to the specific FCRA non-federal issue.  Such historical facts may increase the federal participant’s role or responsibilities in a new project.  But no matter how large, these are in a sense ‘sunk costs’ – the marginal improvement attainable by the new project construction is what the project’s non-federal beneficiaries are willing to pay for, and thus the non-lender recourse debt’s source of repayment.  A concessionaire’s gift shop in a federal park is a tiny fraction of the park’s total operations, but that doesn’t make the shop’s loan from a local bank a ‘federal loan’.  The federal government is de facto committed to certain kinds of disaster relief that make it possible to obtain mortgages on structures built in flood plains where flood insurance is unavailable – are those mortgages ‘federal debt’? 

OMB staff reported that they developed these criteria based on the principles outlined in the 1967 Report of the President’s Commission on Budget Concepts.  OMB staff stated that OMB applies concepts from the report to determine if an activity is federal in nature, and thereby ineligible for special budgetary treatment under FCRA.  If an activity is determined to be federal in nature, then an agency must seek appropriations to pay for the full value of the activity and record its full liability for the activity consistent with the recording statute.

• This paragraph simply states what is already known, that OMB used the 1967 Report as a primary source, per the Congressional directive, and that FCRA treatment is not intended for federal borrowers.  But it’s quoted here in full because of the specific use of the word ‘activity’.  If the relevant activity is precisely defined as a ‘program loan that finances infrastructure construction for beneficiaries who will use their own resources for loan repayment’, then the FCRA non-federal issue is somewhat straightforward:  FCRA treatment is justified when the beneficiaries and their resources are demonstrably non-federal (thereby imposing external discipline to loan repayment), otherwise not. With that definition of ‘activity’, the paragraph makes sense with an additional clarification that the ‘agency’ is in fact the loan program itself.

• However, if the activity is defined as a ‘program loan to a project that might be considered ‘federal’ due to federal participation, in which case the loan is also necessarily ‘federal’, then I think the FCRA non-federal issue ‘could easily carry on into quite esoteric matters’, as the 1967 Report put it.  And those matters would seem to go well beyond program loans and FCRA.  If a complex, multi-party project financing with a federal participant, but without a program loan, is considered ‘federal’ per the OMB’s criteria, then should all the project’s non-recourse debt be considered ‘federal’, regardless of purpose or repayment source?  In this case, FCRA is not relevant because there’s no program loan, but shouldn’t the federal participant (as the ‘agency’ referred to in the paragraph) be recording the ‘full liability’ of the project anyway?  If not, why?  What if the non-recourse debt includes tax-exempt bonds — are these ‘federal’ tax-exempt bonds? And does scale matter?  What about a bank loan to a privately owned gift shop on the project’s grounds?  And so on.  Unfortunately, it seems that OMB was loosely using the latter definition of activity, or some variation thereof.   As a result, I think their criteria inevitably slid into a rabbit hole. The lack of a precise definition of ‘activity’ is a fundamental — but easily fixable — problem with the current criteria. More on this in future posts.

Other Items in the GAO Report

• GAO notes that OMB publishes government-wide criteria for various aspects of federal loan program implementation and budgeting (e.g., Circulars A-11 and A-129), but not yet for the specific FCRA non-federal issue.  This is apparently due to the infrequency of the issue arising, even at WIFIA.  But that may change now that the Corps’ part of WIFIA authorization, CWIFP, is being implemented.  Was the urgency of the Congressional directive related to the expectation of Corps’ projects applying for CWIFP loans?

• WIFIA managers noted that the Fargo-Moorhead program loan would not have passed the current criteria, but details weren’t provided.  The disqualification of this transaction under current criteria will be an important data and illustration point for future post in this series.

• GAO lists the five other infrastructure loan programs they investigated with respect to the FCRA non-federal issue – TIFIA, RRIF, and three USDA programs for water, energy, and telecommunications, respectively.  None except RRIF encountered the issue.  The way RRIF described its analysis of the FCRA issue for a loan to Amtrak, arguably a ‘federal’ operation per OMB’s criteria [3], appears to be simpler and more consistent with the 1967 Report’s external discipline principle, and notes same the policy objective of reducing federal cost as in WIFIA’s selection criteria (emphasis added):

Another way that case study programs screen for federal participation in projects applying for loans is by evaluating the overall sources of financing for a project.  Ensuring a borrower can finance a project with some non-federal sources helps reduce the amount of fiscal risk to the federal government.  For example, DOT officials told us that as part of their loan evaluation, they ensured the 2016 Railroad Rehabilitation and Improvement Financing loan provided to Amtrak was fully repayable by Northeast Corridor revenues.  DOT officials assessed Amtrak’s available revenues and did not consider any federal assistance as a repayment source for the loan.

• GAO’s recommendation that OMB should publish government-wide criteria (again, implicitly based on those published for WIFIA) is succinct and unqualified. It should be recalled that the Congressional directive explicitly excluded a public comment period for the development of WIFIA criteria. Would that also be the case for government-wide FCRA criteria?

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Notes

[1] The second part of the prior post in this series sketches out a classic project financing.

[2] This in fact describes the vast majority of WIFIA loans. The need for loan assistance to highly rated public water agencies financing basic, essential water infrastructure projects is not clear, nor is the additionality. I don’t think OMB has ever questioned the program’s compliance with their A-129 criteria in their course of annual reviews.

[3] Amtrak is apparently considered a federal ‘independent agency’. If it were evaluated by WIFIA’s current criteria for the FCRA non-federal issue as a ‘project’, it likely would be considered a federal project due aspects of federal exercise of sovereign power, ownership, control and liability. Presumably, if OMB’s current WIFIA criteria were in place government wide when RRIF was considering the Amtrak loan in 2016, the program would have had to reject it, despite the persuasiveness of their alternative analysis based on a non-federal source of repayment.

In 2018, three water advocacy organizations opposed the SRF-WIN Act. The underlying dynamics were probably more complex, but they stated their nominal objections in a letter to the Senate committee holding hearings on the Act and other water legislation being considered at the time. One of the letter’s points is that loans with the sub-Treasury rates proposed for smaller SRFs in SRF-WIN would have very much lower credit subsidy leverage ratios (loan amount/cost) than the current WIFIA program — about 3.7 and 8.5 times for the Act’s 50% and 80% Treasury rates, respectively. This was contrasted (with the usual rhetoric) to WIFIA’s 100:1 ratio for its highly rated loans executed at rates reflecting full Treasury cost. (Well, executed at full hypothetical cost on the day but not actually funded until years later — you know where this is going, right?)

How’s that looking now? On the surface, WIFIA’s $16 billion portfolio at FYE 2022 did indeed only cost about $160 million of discretionary credit subsidy appropriations. And, if calculated at current rates, those SRF-WIN sub-Treasury would result in leverage ratios about what the statement predicted — 3.8x and 8.7x, respectively, assuming that the SRF loans were as highly rated as those of WIFIA, almost certainly the case.

But what’s missing is the elephant — the cost of WIFIA’s mandatory appropriations to cover Treasury’s funding losses due to interest rate re-estimates. The average interest rate of WIFIA’s undrawn loan commitments at FYE 2022 was about 2%. If those loans were drawn on 9/30/22, when the 20Y UST was about 4%, the cost would have been $3.3 billion. As the loans are actually drawn, the cost might be lower — or it might be higher. But it will certainly be far more than the discretionary appropriations allocated to the portfolio.

The chart above shows the economic cost and leverage ratio of WIFIA’s portfolio at FYE 2022 compared to those of the SRF-WIN alternatives on the same day. WIFIA’s mandatory appropriations are now included. It can be assumed that the SRF-WIN alternatives would have used only discretionary appropriations because the SRF loans would have been drawn shortly after execution, whether Treasury rates had risen or fallen. Far from being 100:1, WIFIA’s actual leverage ratio is about 4.8x — a little better than the Act’s 50% Treasury option but much worse than the 80% option, which was more likely to be utilized.

Ah, the elephant. It was perhaps predictable in 2018. But now it’s obvious in the actual results of WIFIA’s current $16 billion portfolio of sub-Treasury loan commitments. Once pointed out, it’s hard not to see it as a major policy error. Hard, but not impossible — just don’t talk about it, okay?

Here’s some slightly modified, cut-and-paste language from CIFIA law that would add the interest rate limited buydown feature to WIFIA’s statute. I think this would work as-is for CWIFP, maybe a further modified version would be needed for SWIFIA.

LB-amendment-draft-11152022-InRecap

This is the third post in the FCRA Non-Federal Series

The Congressional directive does not mention the 2017 Report, How CBO Determines Whether to Classify an Activity as Governmental When Estimating Its Budgetary Effects, but according to the GAO Report (the subject of the next post in this series), OMB considered their FCRA loan criteria to be consistent with its views.  The CBO Report also appears to be one of two primary sources OMB used, the other being the Budget Commission’s 1967 Report.

The CBO Report is much shorter than the 1967 Report and has a specific focus on the practical issues that CBO encounters when scoring legislation that involves non-federal entities.  It describes how CBO decides whether to include ‘activities’ of non-federal entities in the budget score.  Federal program loans are not considered per se, but arguably they’re covered by CBO’s inclusion of the “cash flows related to those activities”.

Introductory Section

The introductory section of the report reiterates the ‘when in doubt, include it’ principle from the 1967 Report:

To make such determinations, CBO follows guidelines from the 1967 Report of the President’s Commission on Budget Concepts, which includes the following recommendation: “The federal budget should, as a general rule, be comprehensive of the full range of federal activities. Borderline entities and transactions should be included in the budget unless there are exceptionally persuasive reasons for exclusion.”

The report echoes another principle that the Budget Commission established as a primary reason for the separate treatment of federal credit within the budget, correctly measuring economic impact:

Although the federal budget is primarily a tool for tracking the government’s cash flows, it also serves as a measure of the scope of federal activities and their effects on the economy.  Treating the activities of some nonfederal entities as part of the federal budget, even if those transactions would not flow through the Treasury, helps to accomplish that objective.

Interestingly, CBO notes that its scoring and OMB budgetary treatment may differ, something also described in one of the report’s examples:

The Office of Management and Budget in the executive branch is responsible for recording cash flows related to enacted legislation in the federal budget.  Its budgetary treatment of activities may differ from the treatment CBO uses in its cost estimates.

General Observations About the Introductory Section:

• As discussed in the prior post in this series, ‘borderline’ ambiguity does not arise with federal program loans — they are indisputably included in the federal budget. The specific FCRA budget question is whether a program loan to a federally involved project should be given FCRA treatment or included in the general cash-based budget. For CBO scoring, it is easy to see that federal involvement in an infrastructure project can raise a different question – whether, regardless of the nominal form of ownership and the involvement of non-federal participants, cash flows related to the project’s activities beyond those pertaining directly to the federal participant should be considered federal.  The two questions both require an examination of the federal participant’s role in the project and its financing, but they are not necessarily related beyond that.

• To better reflect the economic impact of a federal action, CBO says its scoring will sometimes add the cash flows of non-federal entities.  But in some situations, perhaps subtraction of cash flows in and out of the Treasury will provide better information?  In fact, such subtraction is precisely what the federal budget’s separate FCRA section for federal credit programs was expected by the 1967 Budget Commission to do.  Since a program loan comes with a non-federal obligation to repay, including the large initial funding outflow and extended repayment inflows in a cash-based budget will distort the true picture of the loan’s economic impact.  FCRA basically nets the reversing cash flows on a present value basis and records the much smaller residual amount as the loan’s effective federal outflow or subsidy payment.  Both CBO scoring and FCRA budgeting are aiming to provide better information about federal actions, but it should be kept in mind that they work in an almost opposite way.  In effect, CBO scoring asks, ‘what non-federal cash flows should be included?’ while FCRA budgeting asks, ‘what federal outflows and non-federal inflows should be excluded?’.

• It’s not surprising that CBO scoring and OMB budgeting might differ in some situations.  In private-sector GAAP accounting, a company’s balance sheet will consolidate the non-recourse debt of a majority-owned project.  That arguably gives a truer picture of the scale of the company’s operations, but the company’s recourse liabilities (as disclosed in the financial notes) will be a much more important factor for credit rating agencies’ models.  I think CBO and OMB differences might be analogous – CBO is looking at a bigger picture and tends to consolidate activities, while OMB is focused on the budgetary cost of specific actions in a less consolidated context.

CBO’s Criteria for Identifying Governmental Activities

After the introductory section, the CBO Report states two fundamental criteria for consolidating the activities and related cash flows of a non-federal entity into a score:

1) The activity would require the exercise of the sovereign power of the federal government by or on behalf of a nonfederal entity; or

2) The activity would serve a specific governmental purpose; the entity would be directed, controlled, or owned by the government; or both of those conditions would be met.

The next two sub-sections briefly describe more about these criteria.  The first, the exercise of sovereign power, seems to be summed up here (emphasis added):

If legislation would authorize a non-federal entity to use the sovereign powers of the federal government, CBO considers the cash flows of activities related to that exercise to be federal.

The next, governmental purpose and control, is apparently applicable to a very broad scope of economic activity (emphasis added):

If a nonfederal entity would serve a [federal] governmental purpose or act on behalf of the government to satisfy a federal policy objective or achieve a regulatory outcome, CBO might consider the costs of those activities to be federal costs.

The balance of the report is taken up with descriptions of scoring examples and case studies in the context of these criteria.  None specifically involve major public infrastructure projects with federal participation, though one about power transmission systems and two about federal facilities are potentially indirectly relevant.

General Observations About CBO’s Criteria

• The two criteria seem to be very consistent with the 1967 Report’s fundamental external discipline principle, the foundation of both general federal budget inclusion and FCRA’s exception for a program loan’s reversing cash flows.   If the federal government is the primary cause or controller of an activity at a non-federal entity, then the cash flows related to that activity are not effectively subject to non-federal external discipline and should be included in federal budget metrics like CBO’s scoring.  This would also be the case when the activity in question a federal program loan – if the federal government is the primary source of the loan’s repayment or is compelling non-federal entities to repay it, then external discipline is lacking, FCRA budgetary treatment will not apply, and all the loan’s cash flows should be reflected in the federal budget.  In terms of principle applied to a hypothetical clear-cut case, CBO scoring and FCRA budgetary treatment would come to the same conclusion.

• But the scope of the descriptive language for the criteria is very broad.  A literal interpretation would produce some odd results.  Regarding federal sovereign power, CWSRFs and DWSRFs are obviously non-federal, state entities.  But they owe their existence to federal CWA legislation and their continued capitalization to legislated federal funding that comes with any number of strings attached.  Are the cash flows of SRF loans therefore ‘related to the exercise’ of federal power?  When an SRF issues a tax-exempt municipal bond to leverage its loan portfolio, should those bonds be considered federal debt [1]?  When SRF leverage comes from the SWIFIA program, should the program’s loan be ineligible for FCRA budgetary treatment [2]?

• A literal interpretation of the government purpose and control criteria has the same problem.  If a local water authority is constructing a CSO system in compliance with a federal consent decree, does that make it a ‘federal’ project?  If the authority issues municipal bonds to finance the project, are the bonds ‘federal’ because the authority was arguably ‘compelled’ to raise local taxes to repay them [3]?  If WIFIA makes a loan to the authority for the CSO project in the same circumstances, should the loan receive FCRA treatment [4]?

• To be fair, the CBO Report’s scoring examples (the bulk of the document) make it clear that CBO applies their two criteria in limited and realistic ways.  They don’t make odd decisions in reality. CBO’s pragmatic approach is the correct context in which to consider how the report’s criteria should be applied to the FCRA non-federal issue. The 1967 Report’s budget principles and specific criteria like those in the CBO Report need to be anchored in the real-world to be useful and efficient for policy implementation.

CBO’s Criteria in the Context of a Public Infrastructure Project Financing

The best way, I think, to provide a realistic anchor for the FCRA non-federal issue is to describe the basic elements of major public infrastructure project financings that are likely both (1) to apply to a federal loan program and (2) to have a federal participant, and then to see where and how CBO’s criteria might be applied.

The main distinguishing characteristic of a classic project financing is that the primary source of repayment for the project’s debt is not the project owners, but other creditworthy entities that purchase the project’s output under long-term contracts or (more typically for public infrastructure) the communities that benefit from the project’s existence and operations.  The latter agree to pay taxes or user fees that will cover the project’s operational costs and amortize the financing of the project’s construction costs.  Since the project’s debt is not fundamentally recourse to the project’s owners (who are also often its developers and managers), it’s usually called ‘non-recourse debt’ — but in fact the debt has a lot of recourse to project’s contractual counterparties, cash flows, and other security.

The relationship between the project’s beneficiaries and the non-recourse lenders, though usually mediated by the project’s owners or managers, is critical to the project’s success.  There are any numbers of factors related to the type of power and control that the CBO criteria describe.  The non-recourse lenders will require that the beneficiaries execute lengthy, long-term contractual obligations to pay for the project.  In addition to debt service, payments must cover detailed specifications for project maintenance and operations.  In turn, the beneficiaries require that the lenders provide cost-effective financing on acceptable terms that are consistent with their ability and willingness to pay for the project.  Most importantly, it is a very long-term relationship – each side will rely on the other to perform for decades.

The role of the project’s owners and manager is of course also critical to its success.  But this is most intense during the initial planning, development, and construction phases of the project’s life.  For large-scale public infrastructure like roads and waterways, most of the value is realized by successful construction completion and subsequent O&M activities are relatively routine.

In this kind of classic project financing for major public infrastructure projects, the beneficiaries are local or regional communities that agree to pay taxes or user fees for the value they expect to receive.  Federal involvement is primarily at the initial development stages, with a possible continuing role in project ownership and management.  Non-recourse lenders can include federal infrastructure loan programs if the project meets threshold and transaction quality eligibility requirements [5].  The nature and interaction of these three parties will determine whether a program loan will be subject to external discipline for OMB’s FCRA budgetary treatment and consistent with CBO’s scoring criteria for non-federal activities.

• The most important point here for both FCRA classification and CBO scoring is that there are two distinct types of project cash flows related to different activities – those related to project development, construction, and management of the project, and those related to (and often legally segregated for) non-recourse debt repayment.  This distinction means that CBO scoring criteria should not be applied in an undivided way, as if all the project’s cash flows were necessarily related.  Rather, the scoring decision should be more nuanced (as it appears to be in the CBO Report’s real-world examples) and include or exclude non-federal project cash flows towards the aim of providing the most accurate picture of federal involvement.  Non-recourse debt service will usually be an infrastructure project’s largest post-completion cash flow — incorrectly including these amounts (which should not be distinguished between those for private-sector debt and for a program loan, if there is one) would be misleading with respect to the scale of federal involvement in the project.

• With this distinction in mind, CBO scoring criteria can first be applied at the project’s partnership or JV entity level, where the federal participant and non-federal participants will interact directly.  At this level, there will be many factors related to the project’s planning, design, development, authorizations, and construction in which the federal participant has a dominant or even exclusive role [6].  That may be the basis for including non-federal cash flows related to those activities in the CBO score.  But note that even if all the cash flows at this level are included, that does not necessarily mean that the cash flows related to the repayment of non-recourse debt should also be included.

• To determine whether non-recourse repayment cash flows should be included in CBO scoring, the relationship between their source, the project’s beneficiaries, and the federal participant should be separately considered.  This is also the most important focal point for OMB’s FCRA treatment classification.  Are the primary beneficiaries of the project non-federal entities? It’s a bit hard to imagine that they would be otherwise for a large-scale public infrastructure project — perhaps if the project exclusively serves a major military facility?  Most usually, the beneficiaries will be communities represented by a sub-national state, local or regional authority.

• After it is established that the source of repayment is non-federal, more nuanced questions can be asked.  Most importantly, is the federal participant compelling the beneficiaries in some way, unrelated to the enforcement of widely applicable federal laws, to repay project debt?   This may be indirect — if the federal participant requires some aspect of project design, scope, siting, construction, etc. that is not consistent with standard public infrastructure benefit-cost principles and makes rejection of the project by the ‘beneficiaries’ practically impossible, that might be a form of compulsion.  This too is hard enough to imagine on the project’s physical level, much less with respect to the federal participant’s policy objectives and the beneficiaries’ legal rights.  But the question, and others like it pertaining to any power and control dynamics that might exist between the federal participant and the project debt’s source of repayment, can be asked in the context of the CBO criteria.

• OMB should be asking similar questions about the federal participant’s relationship with the project’s source of repayment for FCRA loan budgeting, if the project has applied for a federal infrastructure loan. Of course, these appear to be included in some form in OMB’s current FCRA criteria for WIFIA. But I think a more explicit and precise approach is necessary to avoid over-inclusion and ambiguity. Looking at the CBO Report gives a sense of the pitfalls to be avoided — if CBO’s brief description of their criteria is too literally interpreted, the results are odd and misleading, but their more expansive examples show limited and realistic applications of the criteria. This kind of realism needs to be surfaced for the FCRA non-federal issue, whether for improved criteria or a statutory fix. Much more on this topic in future posts in this series.

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Notes

[1] JCT, the CBO’s tax section, estimates the tax revenue impact from legislation that might change the amount of the tax-exempt bonds issued in future. This includes estimates for WIFIA’s (supposed) effect of increasing bond issuance. The broader point is that including the bonds’ repayment cash flows in scoring isn’t being considered, even though JCT is presumably modelling them for the tax impact.

[2] Like WIFIA, the tax revenue impact of SRF leverage with tax-exempt bonds is explicitly included in CBO scoring. Again, plenty of focus on these cash flows.

[3] In theory, this is not just a CBO scoring issue — if the creditworthiness of tax-exempt debt is ‘substantively’ supported by the federal government, the tax-exempt status may be questionable. Forcing local taxpayers to repay a bond would have this effect. There will be more on this in a future post in this series.

[4] This is a real case: Decatur Priority Areas Sewer Assessment and Rehabilitation Program Consent Decree Packages. There is no publicly available information indicating that OMB ever questioned the FCRA treatment of the DeKalb CSO loan.

[5] In the four programs that generally limit loan size to 49% of project cost (TIFIA, WIFIA, SWIFIA and CWIFP), a program loan is not likely to be the sole source of non-recourse debt for a large infrastructure project. If CBO scoring includes the program loan to a federally involved project, presumably the private-sector debt will also be included.

[6] If the federal participant is the source of specific legislative authority to enable the project, that’s a major factor to consider with respect to initial project cash flows — equity investments by non-federal participants, for example. But once in place, that doesn’t mean that all of the project’s cash flows were enabled by the specific project legislation in any meaningful way. For the repayment of project’s non-recourse debt, the agreement by the non-federal beneficiaries to pay taxes, and by the non-recourse lenders to provide financing, are much more important with respect to non-federal external discipline and FCRA classification.

Yes, WIFIA’s FCRA budgeting issue with federally involved projects is important. Everyone recognizes that. Now, what about this one?

Here is more information. But don’t talk about it, okay?

• FCRA Re-Estimates and the Anti-Deficiency Act

• The Cost of WIFIA’s FYE 2022 Portfolio (TL/DR Version)

• Estimating the Cash Cost of WIFIA’s FYE 2022 Portfolio

• The Economic Cost of WIFIA’s Portfolio at FYE 2022