A prior post described an analysis of the estimated economic cost of WIFIA’s $16 billion portfolio of loans and loan commitments at federal FYE 2022. For various reasons outlined there, a simple estimate of the cash cost of funding the portfolio is probably a more pragmatic approach. This post starts to sketch that out.

WIFIA has built its $16 billion portfolio with 92 loans over the last five fiscal years. I assume that the average WIFIA loan has a weighted-average life (WAL) of about 20 years and therefore is executed or re-executed with an interest rate corresponding to then-current 20Y UST yield. My portfolio model starts with the reported loan amounts and execution dates. The model assigns each loan an interest rate equal to the 20Y UST on its execution date.

My portfolio model shows a simple average interest rate of 1.96% for the 92 loans. WIFIA’s website reports a 2.00% average, which I assume is also simple, given its purpose.  This seems to confirm my estimates of the portfolio’s basic characteristics.

The weighted-average interest rate (WAIR) is a more useful metric for estimating future portfolio interest revenue because it weights individual loan amounts. I estimate the WAIR at FYE 2022 to be 1.86%, a little lower than the simple average due to loan volume in the second half of 2021.

The chart below summarizes the data I’m using on a monthly basis FY 2018-2022.

The portfolio model at FYE 2022 is the basis for projecting future loan interest revenues and Treasury funding cost. Assumptions for three additional primary factors are necessary, (1) schedule of drawdown of remaining loan commitments and overall loan portfolio principal amortization, (2) the WAIR each year, and (3) Treasury’s average interest cost to fund the outstanding loan balance each year.

Simplified Primary Assumptions

In a detailed model, each loan’s drawdown, amortization schedule and interest rate would be considered, and projections would be based on the aggregate. The WIFIA program certainly has that data, and even from publicly available information (e.g., press releases about a project progress, borrower financial reports, etc.) a lot could be estimated. For this exercise, however, I’m going to make some highly simplified assumptions about the portfolio’s characteristics as a whole. This will of course limit the precision of the results, but I think they’ll still be accurate enough for the purposes discussed in more detail below.

For drawdown and amortization, I start with the assumption that the portfolio is 75% undrawn at FYE 2022. This appears to be consistent with EPA’s estimated numbers in the 2023 White House budget. The portfolio is assumed to be fully drawn in 2028, with 35-year straight-line principal amortization starting in 2029. The portfolio is fully amortized in 2064.

I assume that the portfolio’s WAIR in any year will remain at 1.86%. This certainly won’t be the case in reality, as various loans amortize in different ways, and the annual WAIR will fluctuate. But I think on average over the portfolio’s full term, it should be accurate enough.

Assumptions about Treasury’s interest cost to fund the portfolio are the main difference between economic and cash projections. Obviously, Treasury does not actually match fund its ‘investments’ in the WIFIA portfolio by issuing zero-coupon bonds, the methodology used in FCRA economic evaluations. Instead, portfolio funding is sourced from overall debt issuance, and will be reflected in an amount of additional federal debt equal to the portfolio’s outstanding at any point. Needless to say, the size of WIFIA’s portfolio is completely immaterial to the overall level of federal borrowing, so it won’t impact anything at Treasury. In that context, the cash interest cost of funding the portfolio each year will simply be a very tiny slice of the average overall cost of federal borrowing.

The average interest rate on federal debt depends on a huge number of factors and projecting it for the next forty years is a difficult mission, to say the least. Fortunately, CBO provides exactly this projection in its Long-Term Budget Outlook, at least for years to 2052. In their 2022 Extended Baseline Projection, they assume as a primary economic variable that average nominal rates on federal debt outstanding will be 2.5% for 2022-2032, 3.4% for 2033-2042 and 4.0% for 2043-2052. I use these points to create a simple linear pattern that peaks at 4.0% and declines back to 2.5% by 2064.

CBO itself makes clear that such long-term projections are in effect speculative. But as discussed further below, that doesn’t matter for the primary purpose of this exercise, which is to present WIFIA’s cost in terms of federal cash budgeting concepts. In fact, using CBO’s own numbers (whatever they are) is central to establishing a plausible case that WIFIA’s cash numbers aren’t so bad.

The chart below summarizes the simplified assumptions for our projections.

Reduced Tax Expenditures?

There is one other factor to add to the mix, especially with respect to the purpose of this exercise. If WIFIA loans create future incremental federal revenues, could those be included to offset a part of WIFIA’s interest cost?

It appears that such a ‘dynamic analysis’ is often performed by CBO but “not generally reflected in CBO’s cost estimates”. That’s probably just as well in this case because it might raise some uncomfortable questions. But I think there is one type of dynamic analysis that CBO has included in budget scoring for WIFIA legislation — the impact of WIFIA loans on the issuance of tax-exempt debt.

I’ve written about this several times over the last few years. The most succinct summary is a one-pager in the form of a letter to the Joint Committee on Taxation in 2021. For more background, here’s a long post on the topic and a detailed analysis. One thing to note is that JCT admits that its methodology is somewhat speculative. Like the CBO’s similar admission about its projections, that doesn’t really matter for our purposes — if they’re willing to use it for scoring, we’ll work with it, too. Note also that I’m using JCT’s methodology, not their assumptions, which appear to be incorrect with respect to WIFIA’s actual outcomes.

The basic idea is simply that WIFIA loans to highly rated public-sector agencies displace tax-exempt bonds that would have otherwise been issued, thereby reducing future tax expenditures. It’s a cash concept, so estimates can be included in this cash analysis. For the current case, I make some conservative assumptions: (1) 75% of outstanding WIFIA loans displace tax-exempt bonds, with the balance having no effect, (2) a federal tax rate of 25%, and (3) taxable substitute bonds yield an average of 2.75%. The annual reduction in tax expenditures (in effect, an increase in federal tax revenues) is equal to the annual tax paid on the substitute taxable portfolio’s income.

Annual WIFIA Revenue, Treasury Interest Cost

Putting all those factors together, it’s straightforward to project WIFIA revenue (without and with the tax effect) and Treasury’s cost. The chart below summarizes the results annually. As expected, Treasury’s cost is always higher than WIFIA’s revenues — even on a cash basis.

It’s also straightforward to net the revenues and costs, as shown in the next chart below. WIFIA cash losses are at their worst when the portfolio is fully drawn and CBO projects that average federal interest rates are high. They tail off as the portfolio is amortized and rates stabilize. For the next few years, the picture isn’t so bad either — that’s what we want to work with here.

The final chart summarizes the dollar amounts and percentages of the $16 billion portfolio as of FYE 2022. The undiscounted sums, and even the discounted numbers, don’t look great. I had hoped that a cash analysis, which uses medium-term federal interest costs, might be significantly better than the economic results, which reflect the full Treasury yield curve. CBO’s relatively high baseline projections of federal interest cost derailed that simple story. But there are other ways to look at things.

Estimating the economic cost of something requires that you look at the full extent of its impact, no matter how far in the future, and estimate its present value by appropriate discounting. That’s not necessarily true for cash cost projections, which can be easily sliced & diced to determine whether inflows match outflows for periods of particular interest.

CBO establishes one such a period of interest — the 10-year budget scoring protocol for new legislation, something familiar to all policy (and political) stakeholders in WIFIA’s future, or intended lack thereof. In contrast to the full cash results, the next ten years of WIFIA’s FYE 2022 portfolio don’t look so bad, especially if the correct tax effect is included. These can be further packaged on an annual basis. For example, “The portfolio net funding cost is unfortunate, but it’s only about $70 million a year or half of one percent of the portfolio. That’s not much of a problem for a popular program, is it?”

That’s where this cash analysis is going. The goal is not truth, but narrative. The simplified and preliminary analysis in this post needs a lot of refinement. But it shows promise for its fundamental purpose.

The lights are on.  The band plays.  Applications are submitted, loans are efficiently closed, and glowing press releases are issued.  The high credit quality of the portfolio continues.  Everything looks great above the discretionary appropriations waterline. 

But below that waterline, where the technical machinery of FCRA interest rate re-estimates operates, I think the picture is very different.  Red ink is flooding in.  WIFIA loan commitments bear interest rates that reflect Treasury’s full economic cost of funding them on the day of execution.  But actual funding will occur years later.  When rates rise, so too does the cost of funding the commitments, in a scale that dwarfs the program’s discretionary appropriations.  If rates fall?  The loan commitments are cancelled or reset lower and drawn are loans refinanced.  As currently operated, WIFIA will never have anywhere near sufficient funding gains to offset massive, ever-accumulating losses.  It is true, per the letter of the law, that such re-estimate losses are off budget, but taxpayers will bear them just the same.  Did Congress intend or even contemplate this outcome?  Is this consistent with the spirit of the Anti-deficiency Act?  Does WIFIA have only political friends and no competitors with political clout?  Government loan programs are said to be unsinkable, but they can run into trouble, as the DOE LPO’s Solyndra loan demonstrated.  And WIFIA itself was nearly defunded in 2020 over a budget issue far less substantive than this.

This post brings an analysis of the economic cost of WIFIA up to federal FYE of September 30, 2022.  Prior posts covered FYE 21 and some interim periods.  All the analyses are based on publicly available information.   The methodology is outlined in the first analysis and remains basically unchanged except for a few minor refinements.

Which Reality?   It Depends

One thing is important to note.  This post, as were prior ones on the topic, will be focused on the economic funding cost of WIFIA’s portfolio, which I think is accurately reflected by FCRA’s budgeting methodology.  The economic cost of anything is a somewhat theoretical concept.  In this case, it means an estimate of the resources that the federal government must allocate to fund WIFIA loan commitments for their full 35-year term.  The best real-world data to make that estimate at a particular point comes from the current Treasury rate curve, which can be used to price a series of zero-coupon bonds that exactly match the loan’s debt service schedule.  If the loan’s expected debt service payments cover these virtual zeroes when due, as was apparently contemplated in the Program’s legislation, then no further resources are necessary for its funding.  But if they don’t – the issue here – then the shortfall must be made up from other resources, which ultimately means taxes.  Discounting that stream of expected future taxes at Treasury’s own risk-free rates (only one thing is more certain than taxes, after all) results in a fair estimate of the present value of the nation’s resources that’ll need to be allocated to fund the WIFIA loan.  Think about it as an amount of value that will be taken out of the economy, set aside for the loan, and precluded from other uses.  Things could change, of course, for better or worse, but I think the estimate is the best snapshot of the loan’s real-world cost that you’ll get at any point.

WIFIA’s economic cost could perhaps be justified if the economic benefits of the loans equaled or exceeded it.  But I’m not sure that WIFIA loans have very much impact on water infrastructure itself since most (possibly all) of the financed projects would have gone ahead anyway.  Instead, the loans appear to have primarily facilitated indirect transfer payments in the form of slightly lower water rates for the lucky communities that got them.  It might be hard to make a serious case that WIFIA’s net economic benefits cover even the Program’s small discretionary appropriations.  But one thing is unquestionably true:  $16 billion of highly rated, bond-like WIFIA loans did not miraculously unleash billions of dollars in additional economic value for the US water infrastructure sector that was somehow overlooked by long-established local utilities, most with excellent access to infrastructure financing alternatives.  The most likely economic outcome is a deadweight loss, or close to it.

Estimates of economic reality are not the only way to look at the cost of WIFIA loans, however.  In fact, they may be the least relevant for practical purposes.  That’s demonstrated by WIFIA itself.  The Program blithely offers ‘free’ interest rate options because loan cost re-estimates, per FCRA, are completely off-budget and buried in obscure footnotes.  There’s a certain irony here – FCRA methodology does a good job of precisely estimating the economic cost of loan re-estimates, but FCRA law requires that those estimates are effectively hidden.  And the result is completely predictable: A $16 billion portfolio of high-quality loans and loan commitments was created with only about $200 million of on-budget (discretionary) appropriations by offering an unbeatable interest rate feature, the actual cost of which is likely to be about $2 billion in off-budget (mandatory) appropriations.  The Program looks fabulously successful, and in one sense I suppose it is, in terms of how bureaucratic Washington sees these things.  I doubt it was an intentional plan, however.  Most likely the Program just kept going with a loan feature that seemed to attract high-quality applicants and didn’t require any additional on-budget resources.  Further thought about it was unnecessary. 

Still, even if basically hidden, the scale of the economic cost of the WIFIA Program could be an issue in a political context.  If someone wanted to dig out the numbers, there’s plenty of soundbite material in a cost factor that’s likely to be ten times higher than the budgeted appropriations.  Add in language from interpretations of the Anti-Deficiency Act’s intent (a topic for future posts) and it would not be difficult to paint a very ugly picture.

WIFIA enjoys broad support, but it is not immune from opposition.  There’ll always be the possibility of ideological or partisan attack, which is what fueled the Solyndra uproar.  More alarmingly, the Program competes directly with the tax-exempt municipal bond market, whose lunch is eaten every time a WIFIA loan with a free interest rate option displaces an otherwise similar water revenue bond.  Their lobby can’t really make an overt attack on a program that provides state and local governments with another avenue to federally subsidized infrastructure financing.  That’s a bit too close to home.  But quietly raising a scary-sounding FCRA budgeting issue to a few key players is a perfect way to damage the competition while appearing to take a disinterested, public-spirited position.  I think such a tactic might have been behind the disproportionate reaction to WIFIA’s minor issue with loans to federally involved projects.  The Program was nearly defunded in 2020 due to a delay in publishing some technical criteria related to the tiny handful of applications from projects with federal involvement.  A bureaucratic delay?  In the middle of a pandemic?  On an issue that literally has zero economic impact?  Really?  Yes, really.  And it almost worked.  

In contrast to the sideshow of federally involved projects, the Program’s economic cost of interest rate re-estimates is both central to its current operations and huge, relative to what Congress expected the cost to be.  The numbers require some analysis, but a bond portfolio analyst wouldn’t find any difficulties in making a case if told where to look and what conclusions to draw.  In some ways, I’m surprised an attack hasn’t already occurred. 

A Packaging Alternative

Between WIFIA simply ignoring the Program’s economic cost and someone gleefully using its full impact for an agenda-driven purpose, there may be another approach that can re-package the cost issue in a softer, yet somewhat valid, way.  FCRA’s reality-based methodology is unique in federal cost budgeting, which largely utilizes cash accounting concepts.  Inserting a FCRA result into an artificial, cash budget world is arguably a category mistake given the actual degree of reality federal institutions operate in, akin to telling an undiplomatic truth at a garden party.  Instead, why not follow proper etiquette and estimate the projected cash cost of WIFIA’s portfolio?  That’ll look a bit better.  More importantly, a cash approach can be sliced and diced in ways that FCRA’s lump-sum of hard economic truth cannot.  What is truth anyway?

The next posts on this topic will start to pivot to a cash approach to WIFIA’s cost.  I have two goals in mind there.  The first is to raise some (but not complete) awareness of WIFIA’s funding cost to encourage product development at the Program.  Handing out free interest rate options is obviously an easy, fun, and effective way to create loan volume, but beyond that bureaucratic metric, it doesn’t accomplish much in the real world of US infrastructure.  WIFIA could do much more, and if it’s gently made clear to the Program and its stakeholders that the interest rate product is not in fact costless, they might try harder to find better ways to spend the same amount of money.

The second goal is to preempt, or at least to prepare a defense against, a political attack on WIFIA’s cost by having numbers out there that support a different narrative.  The cash approach is the lingua franca of federal budget policymakers and far easier to understand than FCRA, making it the right material for this purpose.

For the rest of this post, however, we’ll stay in the world of cold, hard reality.  Whatever edifices of spin need to be built for the greater good of more and better infrastructure loan programs, that reality remains the foundation.

Estimated WIFIA Portfolio at FYE 2022

Estimating the basic characteristics of WIFIA’s portfolio at FYE 2022 is straightforward.  The EPA website provides a list of closed deals, including amount and execution date.  There’s also plenty of public data about daily Treasury rates.  I’m assuming that WIFIA loans on average have a 20-year weighted average life (WAL), based on the typical amortization patterns for a 35-year project finance loan.  Per WIFIA law, a loan commitment gets an interest rate that basically corresponds to the UST rate for the loan’s WAL on the execution (or re-execution) date, hence I assume it’s the 20Y UST off Treasury’s SLG list or daily curve (they’re usually about the same).

Based on loan amounts and corresponding estimated interest rates, the weighted average interest rate (WAIR) of the portfolio at FYE 2022 appears to be 1.86%.  WIFIA’s website reports a portfolio average interest rate of 2.00%, but I believe this is a simple average, which would be closer their purpose of informing borrowers.  When I run a simple average on my numbers, I get 1.96%, which is very close.  That would seem to confirm my basic assumptions. 

The first chart breaks down loan commitments closed each month for the period in which WIFIA has been operating, the last five fiscal years 2018-2022.  Monthly averages of 20Y UST and 1YUST are also included to provide a sense, respectively, of (1) execution rates, and (2) the likelihood of the borrower using the WIFIA loan versus short-term financing for construction draws.  The lower short-term rates are, the more likely that the borrower will not draw the loan and use the rate lock as an interest rate option until construction completion.

The chart reflects WIFIA’s rapid startup in a period of huge movements in interest rates.  The last five years were certainly an interesting time to be creating a $16 billion portfolio of long-term, fixed-rate commitments, no?

It’s not surprising that there was a flurry of loans closed in the fall and early winter of 2020 when rates were hitting historic lows.  I’m sure the borrowers kept plenty of pressure on for executions and re-executions.  Volume has remained somewhat steady since, despite sharply rising 20Y rates.  Of course, planned projects will need financing on their own schedules and municipal bond yields will have risen as well.  But one factor, especially for loans closed over the last six months, might be the expectation that if rates fall over the next few years, the loan can be re-executed at a lower rate.  So why wait?  Once the loan is executed, the downside of even higher rates is capped while the upside of lower rates is still available.  I’d guess that nine of the latest loans, totaling about $2.2 billion, are likely candidates for re-execution if the 20Y UST gets back down to 2.50%.  Loan re-executions aren’t a statutory feature, but if future re-execution was a conscious expectation among these borrowers, WIFIA will have a hard time backtracking from precedents established in 2018-2021.  Most likely, the Program will continue resetting loan rates because there’s apparently no budgetary reason not to, and without that shield of fiscal prudence, it’s hard to counter unpleasant reactions from the Program’s eminently qualified beneficiaries.  How can a federal program stop giving out something that appears to cost the taxpayers nothing?  Yet in fact re-executions will lower the portfolio’s WAIR, turning the ‘FCRA re-estimate loss ratchet’ a few clicks further.

How much of the $16 billion of loan commitments have been drawn and are now funded loans?  WIFIA doesn’t directly provide any data on this, and there isn’t much information from other publicly available sources.  I don’t think this is the result of confidentiality or non-disclosure requirements, but simply the fact that loan drawdowns aren’t exactly great press release material.  In effect, no one cares.  But it is an important metric for estimating the economic cost of WIFIA’s FYE 2022 portfolio going forward.  Loans that have been 90% funded are not subject to further FCRA re-estimates, which means they’re not exposed to changing rates.  In a sense, potential gains or losses are realized when the loan is funded (in effect, a transfer to Treasury) and recorded in an off-budget account, something that should show up somewhere in WIFIA’s books.

Perhaps there’s more public disclosure of WIFIA’s accounts than I’ve been able to find, but for obvious reasons (primarily widespread indifference) locating this kind of thing is not easy.  There is one hint about WIFIA’s drawn loans in the White House 2023 budget published in the spring 2022.  In the EPA technical appendix, there’s a section for the WIFIA Program in which some numbers are presented in the federal budgeting format, a complex accounting language of its own.  From what I can understand, EPA estimates that the Program will have drawn loans of $3.8 billion and re-estimate losses of $140 million at FYE 2022.

The $3.8 billion, or 25% of the portfolio, seems plausible.  The amount would include earlier loans to smaller projects that are at or near completion, and whose smaller borrowers have fewer short-term financing alternatives.  Big projects with big borrowers, as well as recent loans, would make up the other 75%.  Or at least that was a plausible picture when the estimates were put together, perhaps early in 2022.  With the historically sharp rise in short-term rates this year, much may have changed, as drawing on WIFIA loans previously being kept as an option suddenly looks like the cheapest source of financing for construction draws.  It’s possible or even likely that the portfolio’s drawdown percentage was in fact much higher on September 30^th, but for now I’ll work with the 25%.

The $140 million of re-estimate losses (presumably solely from rising interest rates) looks lower than I would have expected.  However, as noted above, funded loans are likely to be with smaller, earlier borrowers who were drawing for construction costs before 20Y UST rates nosedived.  It’s also an EPA estimate which may have changed in the last six months, and there are likely other unfathomable factors at work, too.  Like the drawdown percentage, I’ll work with the number for now.  It’s worth noting that this loss is still about 4% of the funded loans, or over four times WIFIA’s typical credit subsidy of less than one percent.  Not huge in dollar terms, but definitely headed in the wrong direction.

Those assumptions leave 75% of the portfolio, or about $12 billion, exposed to changing rates.  For simplicity, I’ll assume that these loan commitments have the same WAIR, 1.86%, as the overall portfolio, though it’s probably lower.  The economic cost of funding these loans is the center of the analysis.

Before getting into the FCRA results, it’s worth doing a quick reality check.  Imagine you’re a bond portfolio manager doing a ‘mark-to-market’ (i.e., calculation of unrealized gains or losses) estimate for FYE value-at-risk reporting.  You’ve got a $12 billion portfolio of very high-quality, fixed-rate 35-year bonds with a weighted-average yield of 1.9% and a WAL of 20 years.  The 20Y UST at your FYE is 3.95%.  What’s the very best price you could expect, however theoretical, if you sold the entire portfolio that day?

The answer, which you can calculate with a two-line spreadsheet, is about $9 billion, for a $3 billion loss. The result could change in future of course – rates could fall, and your loss would be reduced.  They could keep rising, too, however, and it’ll get worse.  The $3 billion loss estimate is simply an estimate of risk at one point.  Still, you should expect losses, potentially big ones, if you’re committed to sell the portfolio over the next few years. Senior management will not be pleased.

Potential FCRA Re-Estimate Losses

FCRA methodology essentially does the same thing as pricing a bond, by discounting future payments to a present value.  Its process can be more precise because the appropriate discount rate need only to be derived from the US Treasury curve, as the federal government is the sole financing source (and hence ‘buyer’) of WIFIA loans.  The ‘purchase’ occurs when the loan commitment is funded, creating a federal investment that is amortized with loan revenues – or mandatory appropriation for taxes, if projected revenues are insufficient.  The exact loss to be covered by taxpayers is realized and recorded when the loan is funded.  As noted above, about $140 million of such losses have already been realized in funding $3.8 billion of loans.

For the remaining $12 billion of loan commitments, we can perform a FYE mark-to-market exercise very similar to the bond portfolio manager’s doleful task described above.  The portfolio characteristics are basically the same, in terms of amount, WAIR and WAL.  The 20Y UST was 3.95% on September 30, 2022, the federal FYE.  A few things are different.  FCRA methodology refines the discount rate using a zero-coupon curve derived from the overall UST curve for that day, called the ‘single effective rate’ or SER.  My estimate of the FYE SER was 3.78%, which was used for the analysis.

Just like the portfolio manager considering a hypothetical sale of the entire portfolio on the FYE date, we can ‘mark-to-market’ what the re-estimate losses would be in the hypothetical case that all $12 billion of the remaining loan commitments were drawn at FYE.  That unrealized loss is about $3 billion, or almost 20% of WIFIA’s portfolio.

Twenty percent?  For a portfolio that Congress apparently thought would cost taxpayers less than one percent?  Of course, these are unrealized losses, and as such just an indicator of the risk of potential losses, not the final damage.  Interest rates are high right now primarily because the Fed is attempting to control inflation, but that won’t last forever.  And the total portfolio of WIFIA loan commitments literally cannot be drawn now or even soon because draws must track construction progress, which will take place over at least five or six years.  If interest rates fall during that period, realized losses won’t be so bad.

It’s not difficult to model a range of outcomes depending on rates. The chart below shows potential realized re-estimate losses on the FYE 2022 portfolio at various 20Y UST rates (as converted into SERs in the model).

The simplest way to look at the results is as the potential losses that’ll be realized at the average 20Y UST rate during the multi-year period of portfolio funding.  That average probably won’t be close to today’s 4% level, nor will it end up in 2% territory.  Maybe somewhere around 3%?  This average rate results in about $2 billion of re-estimates losses, or about 13% of the portfolio.  That’s better than 20%, but still has plenty of sticker shock in it.  Depending on your natural optimism or lack thereof, maybe it’s 2.5% (a loss of about $900 million, or 5%) or 3.5% (a loss of about $2.5 billion, or 16%).

Who knows what Treasury rates will do over the next half-decade? But no matter how you look at the portfolio’s cost, the fundamental point is always the same – for any realistic projection of the rates at which WIFIA loan commitments will be funded, there will be re-estimate losses far in excess of WIFIA’s discretionary appropriations.  WIFIA’s FYE 2022 portfolio is irreparably holed beneath the economic cost waterline. The only question is whether the volume of red ink will sink the ship.

A recent bill proposes an extension of WIFIA’s maximum loan term to 55 years.  That could be a useful change for many stormwater systems planning long-lived projects.

Ideally, the financing term of an infrastructure project should match the project’s useful life.  That way, annual debt service is minimized, and the project’s capital cost is appropriately spread over time and generations.

This is especially true when the source of the financing is a state or federal infrastructure loan program that offers subsidized interest rates.  The maximum possible term will result in the highest present value of savings compared to market alternatives.  No mystery there.

The US EPA’s Water Infrastructure Finance and Innovation Act (WIFIA) loan program offers an interest rate based on the US Treasury yield curve when the loan is executed.  In effect, it’s the federal government’s cost of borrowing to fund the loan, without any mark-up.  For private-sector borrowers, that’s always a great deal.  For public-sector borrowers, especially highly rated ones, the situation is more complicated.   They can access another, federally subsidized alternative, the tax-exempt municipal bond market.  Rates in that market are often at —or even below—US Treasuries.

But for long-lived water infrastructure assets, WIFIA currently offers an additional advantage – a 35-year post-construction loan term.  Since infrastructure construction periods are usually in the range of five-to-ten years, a WIFIA loan can have a total term of 40-45 years, significantly better than the 30-year municipal bond market.  A WIFIA loan is limited to 49% of project cost, but it can be very flexibly combined with shorter term tax-exempt or other subsidized financing, optimizing the overall cost.

For water infrastructure projects with a large proportion of mechanical equipment (e.g., water treatment plants), WIFIA’s current maximum loan term is completely adequate to match the project’s overall useful life.  That’s not necessarily the case for projects with a high proportion of non-mechanical assets like concrete structures and site modification.  These projects often have an overall useful life well beyond 45 years.  Obvious examples include large-scale water management systems involving dams and canals, which are very long-lived.  But it’s also applicable to many local stormwater projects where the primary assets, conveyance systems, have useful lives of 50-100 years, according to ASCE.  Shouldn’t the financing needs of these types of projects be on WIFIA’s radar screen?

Extending WIFIA’s Maximum Loan Term

Successful federal programs aren’t cast in stone at inception.  They evolve over time, expanding and modifying their capabilities to reflect experience and needs.  Currently, WIFIA loans to stormwater projects total about $700 million, only 4.5% of the program’s $15.4 portfolio, by far its smallest percentage.  From a US water infrastructure policy perspective, WIFIA should seek a more balanced mix.  Extending WIFIA’s maximum loan term for very long-lived infrastructure projects will make the program more useful to the stormwater sector, increasing application and loan volume.

A statutory amendment will be required.  But it’s not difficult to make the case for implementing this change.  Long-term lending is a federal strength, relative to the private debt markets.  Extending WIFIA’s loan term is a simple amendment.  There’s a direct recent precedent in the 2021 Infrastructure Investment and Jobs Act.  In that law, the US DOT’s TIFIA loan program, WIFIA’s predecessor in the transportation sector, amended its maximum loan term to 75 years.

Unsurprisingly, proponents of another water infrastructure sector have come to the same conclusion.  The ‘‘Water Infrastructure Finance and Innovation Act Amendments of 2022’’ (H.R. 8127) was introduced in Congress in June 2022.  Most of the amendments are intended for large-scale Western water management projects, especially those where the Army Corps of Engineers is involved (the Corps recently began the process of utilizing its own allocation of WIFIA funding).  However, the loan term extension to 55 years included in the bill will apply to all WIFIA projects with a useful life at least that long.  Obviously, that’s relevant for Western dams and canals – but it will apply to many local stormwater projects, too.

What would a 55-year WIFIA loan term look like for long-lived project?  The chart below shows one important aspect, annual debt service after construction completion.  Its underlying model is highly simplified.  Assumptions include a $100 million project financed with a 51%/49% combination of tax-exempt bonds and a WIFIA loan, both with a Treasury-like 3.0% interest rate and a level-payment debt service payment schedule over the post-construction term.  For clarity, some other WIFIA features are excluded.  But even with these simplifications, the chart accurately reflects the significant magnitude of lowered payments.  Apart from annual debt service, the discounted present value of additional savings for a 55-year WIFIA term are about 5% of project cost.  That’s on top of the other benefits of a WIFIA loan compared to market alternatives.

The Bigger Picture

The simple change of extending WIFIA’s maximum loan term should also be considered in the context of the program’s bigger picture, especially for the stormwater sector.  WIFIA has been remarkably, albeit somewhat narrowly, successful in the past few years, becoming an important resource for relatively large and highly rated drinking water and wastewater utilities.  That success is an excellent foundation for future growth.  WIFIA growth is usually understood in terms of more funding for greater loan volume, but it’s equally important for its loan capabilities, which can be refined to meet the specific needs of many areas of water infrastructure financing.  Extending WIFIA’s loan term, either by the current bill or through other legislative paths, is a way to begin this process, which still has a long way to go.  The stormwater infrastructure sector, with its specific funding challenges and asset types, can be engaged from the start by supporting an extension of WIFIA’s maximum loan term.

The last two posts here were about CIFIA’s pre-execution rate collar, or limited buydown.  The posts considered several things:

• Limited buydowns are potentially important to carbon pipeline developers during the process of negotiating and finalizing rights-of-way and other contracts.  A rate collar will help stabilize the project’s financing economics at a time when many difficult time/money decisions are being made, well before construction starts.  To the extent that also helps accelerate pipeline development, it’s presumably at the core of CIFIA’s policy mission.

• If rates rise after a CIFIA application is accepted, the limited buydown feature will prove its value.  But in this situation, CIFIA may find it difficult to manage the impact of a large volume of limited buydowns on the program’s available discretionary appropriations.  Unlike post-execution rate locks, which automatically receive permanent indefinite budget authority, an in-the-money pre-execution rate collar will likely require an apportionment of CIFIA’s Congressional funding when the loan is executed.

• If rates fall, I think CIFIA can (and should) reset developers’ original applications to reflect the lower rates.  This is based on precedents from the WIFIA loan program, which has reset many post-execution rate locks.  The analogy is not exact for limited buydowns, but substantively very close.  The lower reset rates, however, will be prone to the budget issue noted above.

One general conclusion arises from all this:  If I’m correct that limited buydowns will be important both to pipeline developers (for project economics) and CIFIA (for fundamental policy outcomes), the program’s budget authority will be the limiting factor on offering this feature, unless rates become relatively stable, something that’s not likely to happen over the next few years.

An Arbitrary Limit

That kind of limiting factor on a useful interest rate management policy tool seems arbitrary.   Its origin is solely in FCRA’s distinction between what gets permanent indefinite authority (interest rate re-estimates on executed loans) and what does not (anything pre-execution).  That’s not based on any real-world factors in infrastructure investment.  WIFIA’s highly rated public water agencies certainly appreciate the post-execution rate lock because it avoids negative arbitrage cost if they’d had to escrow a muni bond issue instead.  But did they really need it?  Did it make any difference to their projects’ designs or timelines?  Yet WIFIA’s success was built on the ability to offer and then to enhance (by resets and expanding project definition to include long-term construction programs) free post-execution rate locks without worrying in the slightest about a discretionary budget impact.

In complete contrast, even if CIFIA pre-execution rate collars are critical to carbon pipeline development the program will likely need to worry about their discretionary budget impact, possibly to the point of rationing the feature under some circumstances.  This is true despite the lack of any substantive difference between a five-year post-execution rate lock and a three-year pre-execution collar followed by a two-year post-execution rate lock in terms of taxpayer cost.   As noted in a prior post, both simply amount to the federal government locking in an interest rate five years before the loans are funded.

Mitigating the Limiting Factor

FCRA law isn’t going to change anytime soon.  Still, there might be some scope to improve the budgetary treatment of those interest rate management tools that are useful to CIFIA and to future federal programs that might find themselves in the same situation.  The rest of this post outlines one approach that might be workable.

The key concept is what constitutes ‘execution’ in FCRA.  It’s apparently based on incurring an obligation, which makes sense in the context of a major theme in federal budgeting, anti-deficiency.  Here’s the language from Section 502 (2) of the FCRA statute:

The authority to incur new direct loan obligations…shall constitute new budget authority in an amount equal to the cost of the direct loan…

I think that’s black-and-white, both in language and in principle.  If a government agency incurs an obligation by executing a loan agreement, it’ll need authorized appropriations to cover the estimated cost at that point.  Cost here means the discounted present value of expected loan losses due to default but also Treasury’s economic funding loss if the loan’s interest rate is less than the relevant Treasury yield that day.  WIFIA’s loans are executed and re-executed with a current Treasury rate, so there’s no funding loss and no need for appropriations beyond the PV of expected defaults.  However, an in-the-money limited buydown will, by definition, result in an executed loan with a sub-Treasury rate and a funding loss.  Hence the problem.  I don’t think there’s any way around this part of the equation.

There’s more latitude in the definition of a ‘direct loan obligation’ in Section 504 (d)(1) of FCRA.  The definition needs to reflect an intrinsic reality of credit agreements, that there are always conditions the borrower must fulfill before the lender is obligated to write a check: 

The term “direct loan obligation” means a binding agreement by a Federal agency to make a direct loan when specified conditions are fulfilled by the borrower.

In a multi-billion-dollar project financing loan agreement, ‘specified conditions’ will naturally be a long list, especially if it includes the usual array of federal policy compliance items.  Absent other considerations, the developer will want to make sure that the list can be checked-off expeditiously and the lender undisputedly obliged to deliver the money.  In practice, this means executing the loan agreement only when project variables are settled down and construction draws are soon to be necessary.

In theory, however, a loan agreement could be executed well before any construction drawdowns were required.  The list of specified conditions might be longer and less precise, and project variables not quite so settled.  But the lender is still in effect making a ‘binding agreement’ of some sort.  A private-sector lender might use the additional conditionality to wiggle out of funding the loan, though a public-sector lending program will almost certainly be more forgiving.  Most importantly for this discussion, however, I think any kind of ‘binding agreement’ will be sufficient to trigger a loan execution for FCRA purposes – and put any further interest rate re-estimates into permanent indefinite budget authority territory.

Loan Execution-Lite

We can call this approach ‘Loan Execution-Lite’ – a loan agreement that isn’t meant to be funded in the near-future but binds the federal lender in a way that’s sufficient to trigger FCRA permanent indefinite budget authority.  For CIFIA in a rising rate environment, the point is to ‘convert’ budget-absorbing limited buydowns into worry-free executed loans.  During falling rates, CIFIA should be able to offer WIFIA-type resets and interest-rate management enhancements with confidence.

For developers, the value of execution-lite loans is added certainty with respect to interest rates, rising or falling, compared to limited buydowns.  That’s its primary purpose.  Of course, an execution-lite loan is less certain about everything else due to its expanded conditionality.  But this conditionality would need to have been worked through anyway for a typical, close-to-drawdown loan execution.  Term-sheet negotiations will continue as before, except that in legal form they’ll be about amendments to an existing agreement, not a new loan.  Nothing needs to change in the developer’s real-world actions.

A loan execution-lite agreement can be seen as a formalizing a step between loan application (with its limited buydown) and full, near-drawable loan execution (with its permanent indefinite budget authority).  In some ways, that’s more consistent with project real-world development, which is an incremental, not binary, process.

The diagram below illustrates the three-phase concept with a timeline.  The loan process will still start with an application and limited buydown, and that’s all it should be during the initial stages of development.  But once project development is sufficiently advanced for contract negotiations and finalizations to begin, an executed-lite loan agreement will be increasingly possible.  Interest rate certainty is important to the developer in this phase, and the program should want the budget treatment to support it.  The executed-lite loan agreement then gets amended to the extent necessary to be a drawable commitment shortly before construction begins.

How realistic is this execution-lite approach?  I can visualize the legal forms and I believe they’re basically consistent with the relevant FCRA statutes and published budget methodologies.  But it’s certainly new ground and, as such, prone to all sorts of negative bureaucratic interpretations, especially since the point of the exercise is to expand budget authority in a way that wasn’t explicitly described in FCRA law.  Still, WIFIA’s resets and other rate-lock enhancements relied on similar expansive interpretations, and they got through.

Naturally, CIFIA motivation is necessary, something that could surface quickly if a budget shortfall appears possible.  Otherwise, demand from borrowers for execution-lite loans will be the needed impetus.  During a period of rising rates, that’ll require a somewhat theoretical mindset from the developers, since the limited buydowns will appear to be working and the program’s budget is not their direct problem.  But if a raft of applications is made during a time of peaking rates that then consistently decline (a very possible scenario in 2022-2024), the demand for limited buydown resets could be more visceral, given the numbers involved.  WIFIA’s resets were driven by similar dynamics.  Since application resets at CIFIA will in any case require approvals and new processes, that might be the time for the program and its stakeholders to consider pushing the budget envelope a little further with an innovative approach. Sooner, of course, would be better.