The American Water Works Association (AWWA) just published their annual State of the Water Industry survey for 2022. The survey covers a lot of ground, but it includes several insights into the financing of infrastructure projects which I think have implications for the WIFIA loan program, at least indirectly.

The top concern reported in the survey is infrastructure renewal. It’s not surprising that the financing for required for such large-scale renewal is also right up there at number two. Both are long-term issues – apparently, the two have been consistently ranked first and second for the last ten years.

A more subtle aspect of this concern with financing is worth elucidating. There’s a section in the survey about the potential impact of exogenous large-scale phenomena – macroeconomic, geopolitical, etc. – on the respondents’ systems. Only one, ‘Business/industrial activities’, was considered to have a slight positive impact. But the least negative score was for the ‘Bond markets’, a term which likely includes the overall state of the debt markets, given the other choices.

That result appears to reflect reality. AWWA’s members are generally highly rated, public-sector agencies that provide an essential service. If the domestic debt markets are going to be open for anyone, it’ll be issuers like these, either by investor preference or federal support (e.g., the Federal Reserve’s MLF in 2020). Relative to everything else going on at a macro level in these interesting times, it’s unsurprising that the debt markets are the least of the respondents’ worries.

The result doesn’t seem consistent with the major concern for financing reported by the same respondents. But the apparent inconsistency vanishes if you interpret the ‘concern’ more narrowly – not as a concern for the availability of financing, but for its repayment. Repayment of large-scale, long-term financing requires equally large-scale, long-term funding. That’s a thoroughly understandable major concern which is intrinsically connected to the need for infrastructure renewal – what’s built must be paid for. The challenge of borrowing is finding funding for its repayment. Where’s that going to come from?

Another section of the survey sheds some light on that question. System CFOs were asked to identify their “funding sources and/or strategies” and responses were ranked in the terms of the frequency of mention of various categories. That type of ranking requires some interpretation. It clearly doesn’t mean that current or future projects will be capitalized in a particular way. Rather, I think it reflects the CFOs’ general perception of what they’ll need to do in the coming years to cover the cash flow requirements of planned infrastructure renewal projects.

The first thing to note is that vast majority of funding is locally sourced. Only about 17% of the perceived needs will be provided exogenously, with state or federal grants. Of the 83% balance, slightly more than half will come from local action (blue shades) – raising rates, drawing on reserves, reducing O&M cost. The rest comes from financing (green shades), presumably to cover project construction cost drawdowns. The financing itself is initially exogenous, but repayment over time will be locally sourced – I’m guessing that the expectation of increased annual debt service is a primary driver of rate rises.

The CFOs’ expected sources of financing are interesting. I assume ‘Bonds’ here are primarily municipal tax-exempt revenue bonds, the standard (and frequently sole) source of financing for US state & local public infrastructure projects. It’s naturally the largest category. But I was surprised that SRF loans are a close second. WIFIA shows up as a more distant but still significant third. Both non-bond sources add up to more than half of the rankings based on mentions for financial sources.

Again, those rankings don’t mean that water infrastructure projects will on average be 55% capitalized with SRF and WIFIA loans, or even close to that percentage. Instead, I think the frequency of mentions reflects the level of CFOs’ interest in accessing SRF and WIFIA loans as an alternative to bonds. Accessing public-sector programs requires additional analysis and effort, relative to just doing another off-the-shelf bond issue, so the number of mentions might reflect what occupies the CFOs’ thinking.

What Are the CFOs Looking For?

The overall goal is surely as simple as looking for financing that requires less funding for repayment. Usually that means a lower interest rate. SRF and WIFIA loans offer subsidized, below-market rates. If the US water sector’s standard source of financing was the global debt market (which definitionally requires at-market rates), the story would be straightforward.

But the sector’s baseline source, the municipal bond market, also offers subsidized interest rates through the monetization of federal and state income tax exemptions by qualifying investors. In effect, the muni bond market is another federal & state loan program for public infrastructure, the same in principle as the SRFs and WIFIA. That requires a more nuanced comparison of the alternatives.

The terms and availability of SRF loans vary a lot among the states. I think some of them offer very discounted interest rates, even compared to the muni market. I’m sure that the CFOs’ expectations of future availability have likely increased with the 2021 IIJA and its $35 billion of SRF funding over the usual level of annual federal support. Perhaps there is also the hope that such federal largesse will also result in even lower rates or better terms? It would be interesting to see a breakdown of the SRF mentions by state of origin — I’d guess it positively correlates with those SRFs that offer the best terms relative to the muni market.

As you know, this site currently focuses on federal loan programs, not state or local ones, and SRFs per se aren’t the topic here. I’d make two general observations, though, in relation to WIFIA. First, a strong level of interest from AWWA CFOs in SRF loans probably reflects an even higher level of interest from smaller systems. WIFIA’s capabilities to leverage to SRFs ought to be expanded.

Second, the term of SRF loans usually doesn’t exceed that of the bond market (30 years) and is often shorter. That makes sense, given the SRFs’ revolving fund mechanism. Even when that mechanism is leveraged with long-term debt (about half of SRFs are), the 30-year muni market is generally the source of the leverage.

What Can WIFIA Offer?

The above interpretations of the 2022 SOTWI provides some context for expanding WIFIA’s capabilities. Increasing program loan capacity is an obvious direction, given the relative significance of the mentions and the sector’s huge needs. But what else can WIFIA do in terms of loan products, especially compared to bond and SRF loan alternatives?

Again, the CFOs’ overall goal is no doubt straightforward — the least funding required for repayment. The most direct way that a WIFIA loan would achieve that is by offering an even lower interest rate, below the current Treasury rate at the weighted-average loan life.

That kind of grant-like benefit is obviously attractive — if policymakers can offer it. I can see the logic behind those SRFs offering below UST rates on loans that were after all mostly funded from federal grants. The discounted rates are a kind of partial pass-through. But WIFIA has a very different theory.

I think a fundamental idea of the TIFIA, WIFIA and CIFIA series of federal infrastructure loan programs is that they don’t cost federal taxpayers anything in terms of funding the loans, just a small amount of credit subsidy for expected loan losses. The UST rate the borrower pays to these programs is designed to cover the federal government’s economic cost of loan funding. Taxpayers bear the opportunity cost of not lending at market rates, but that’s a sufficiently abstract concept that few notice, and anyway it doesn’t show up in FCRA budgeting, which stipulates UST-based discount rates. But under the same FCRA mechanics, any loan interest rate below UST will show up in the required credit subsidy amount. Which means more upfront discretionary appropriations — something that definitely gets noticed.

A deviation from this principle was proposed for WIFIA loans to SRFs in the 2018 WRDA. S-2800 originally included a special 50-80% discount on UST rates for qualifying SRFs, as well as other SRF provisions, most of which were enacted in SWIFIA — but not the Treasury rate discount, which apparently got pushback from a lot of areas, including the water sector itself.

Further attempts will likely fail too, especially since WIFIA now looks like a successful program that costs only pennies for the loan dollar. Hard to fix something that doesn’t look broken and is really cheap, right? Right? The reality is more complicated, but that’s another topic, and one which certainly won’t encourage discounted program rates.

Realistically, I think WIFIA is stuck with UST interest rates for the foreseeable future. But there’s more than one way to help water systems reduce required repayment funding in the timeframe that probably matters most to their infrastructure decisions — say, about the next ten years.

One way is almost as simple as a lower interest rate. A longer-term loan means the principal amortization can be spread over more years, with lower debt service in the medium term. Of course, that debt service gets paid for a longer time, which means more total interest cost. But if the first ten years is more important than the final ten for all sorts of real-world reasons, a longer term could be worth it. Even in strict theory, a loan with a subsidized rate should be extended for as long as possible.

WIFIA already has the inside track on loan term, relative to the other two financing sources. The muni bond market is essentially limited to financing terms of 30 years, due to its unique retail investor base. SRFs are generally less than that. In contrast, WIFIA, offers a 35-year term after construction completion, including an optional 5-year debt service deferral and considerable flexibility for a customized amortization schedule that accommodates other, shorter-term project debt. That’s a useful combination of features, and probably accounts for a significant part of the CFOs’ interest in the program.

As a first, practical step, why not just expand WIFIA’s capabilities in these three features? Sometimes if some is good, more actually is better. Long term lending is in fact a federal strength and it’s economically efficient to utilize that comparative advantage as much as possible. More specially:

• Extend WIFIA’s maximum loan term to 55 years (at least) for qualified projects with long-lived assets. More on that here: Update on Extended WIFIA Term — Same Story, Different World

• Extend the 5-year deferral period to 7-10 years, for qualified projects and systems. Federal comparative advantage in this feature is…well, also a little more complicated with respect to accruing interest at a previously locked rate. But the impact is minor compared to the same complication that arises with the rate lock during construction. The marginal economic cost is low — in effect, most of the horse is already out of the barn. If some systems find a longer deferral period useful, why not?

• Consider allowing an interest-only loan amortization schedule as a default option for highly rated borrowers. This can be subject to program approval of the systems’ expected prepayment plans, which will probably be bounded by their credit rating agency targets anyway. Why not give these uber-prudent borrowers additional flexibility and focus program credit analysis resources on the tougher cases?

As readers of this site know, I think there’s quite a few approaches to unlocking the program’s full potential. But the three outlined here are the simplest and probably have the broadest applicability in the context of the SOTWI survey. It would be interesting to see additional specific questions about financing sources in the 2023 SOWTI survey, the input process for which apparently starts in late 2022. Even by then, the economic and financial outlook may have changed, and likely not for the better.

In a recent EPA webinar on funding availability at the WIFIA Program, several questions came up about combining SRF and WIFIA loans for specific projects.  This is of course allowed and frequently done.  The WIFIA team noted several differences between a Program loan and what might typically be offered by SRFs.  SRF loans vary by state, but in general they’re shorter in term – about 20 years maximum, versus WIFIA’s 35-year post-completion term.  Within that term, WIFIA can be very flexible about amortization schedules that effectively accommodate the SRF loan’s shorter and usually more strict schedules – a point that the team especially emphasized.

WIFIA’s five-year debt service deferral option after project completion was also highlighted as an example of the Program’s unique flexibility in loan structuring.

Other differences were discussed — loan forgiveness is sometimes offered by SRFs but not by WIFIA, SRF pricing varies a lot compared to WIFIA’s US Treasury flat rate, etc.  But WIFIA’s longer term and the deferral option appear to be primary synergistic benefits of SRF/WIFIA loan combinations at the project level.

I’ve written about the benefits of large-scale WIFIA loans to the SRFs themselves in prior posts and articles.  Fund capitalization from a ‘wholesale’ lender (WIFIA) to ‘retail’ lenders (SRFs) will play to their respective strengths, maximizing overall economic benefits and efficiency.  In theory, WIFIA should specialize in the wholesale role exclusively.  But reality is never quite so simple, and if an SRF/WIFIA combination works at the project level – and gets stuff built – that’s also a good outcome.  As such, it’s worth a quick look at some hypothetical numbers showing why the combination works.

Assume a $100 million project in a large community that can qualify for both a WIFIA and a local SRF loan.  The interest rate on both is 3.0%, (about the current 30-year US Treasury yield), significantly less than the borrower’s market alternatives.  The project is very long-lived, but the SRF loan’s maximum term is 20 years with required level-payment amortization.  The loans are compared below at the time of project completion.

The borrower’s first option is to simply to borrow $100 million from the local SRF, which has available capacity.  The blue bars are the SRF loan balance – the red line is the annual post-completion debt service:

The SRF-only loan will work, but the borrower would prefer to minimize debt service in the early years of the project. A longer term WIFIA loan for the full $100 million is not possible of course — for a large community, the statutory maximum amount is 49% of project cost. But the two loans can be combined, with the SRF loan providing the 51% balance. The yellow bars show the WIFIA loan balance, and the blue line is the annual debt service of the combined loans (the red line from the prior chart is included for comparison):

This combination gets closer to the borrower’s preferences — debt service is essentially halved for the first five years with the WIFIA deferral option. For years 6 through 20, the WIFIA loan is in interest-only mode, reducing debt service by about 25%. Starting in year 21, level payment amortization of the WIFIA loan continues for the next 15 years at about the same level.

If the borrower was looking for even lower debt service in the very long term, a combination with a 55-year WIFIA loan would be even better, were that available — as it might (and should) be in the future. The green line shows debt service for this case:

The above charts provide a quick visual demonstration of the fundamental benefit of the combination — lower debt service in the early years. But a real comparison should reflect how much the borrower values the near-term cash savings versus paying debt service for a longer period. In specific situations, there are usually plenty of real-world reasons that such a comparison doesn’t need much (if any) quantification beyond the dollars saved, a five-year planning horizon, for example. However, to do it correctly — if only in order to defend the decision — a classic Value for Money (VfM) analysis is required. This essentially involves a present value (PV) comparison of the cases over their full terms, using a discount rate that ideally reflects all the preferential and goal-oriented aspects of the situation.

That’s often difficult in the real-world, but it’s easy enough in this simplified, hypothetical analysis. The valuation baseline is the SRF-only case. The chart below shows the cost of financing of the two combination cases (WIFIA 35-year and 55-year loans, respectively) compared to that baseline using different discount rates:

Note that if the borrower’s discount rate was 3.0% (the interest rate on both loans) the net benefit would be zero — the cost of financing is exactly the same for all cases, regardless of WIFIA’s term and deferral options. But that’s certainly not realistic — the reason the borrower was considering SRF and WIFIA loans in the first place was because their rates are subsidized in comparison to market alternatives. Let’s say those market alternatives average about 4% at a minimum — already the borrower can save about $4 million PV with the WIFIA 35-year combination case (and even more in the 55-year case). As the borrower includes risk factors (a local recession, for example) in the discount rate, the benefit of a longer term rises further. I’d guess that the typical discount rate for tax or rate-funded public infrastructure projects for long-term cash flow is at least 200 bps. higher than the risk-free, US Treasury rate — so about 5% here, for an $8 million saving (8% of project cost) in the 35-year WIFIA loan combination. In a word – plenty.

Interestingly, one ‘risk’ that usually needs to be considered in a VfM analysis is that interest rates might fall dramatically in the future but a make-whole pre-payment penalty effectively prevents project debt refinancing. It’s possible that SRF loans sometime require such penalties, but WIFIA certainly does not — prepayment is fully optional and penalty-less — and in a long-term timeframe that matters much more.

This is a quick update of the analysis of WIFIA’s FYE 2021 loan portfolio with respect to interest rate re-estimate exposure. At FYE 2021, the portfolio included 59 loans and loan commitments totaling about $11.5 billion. Since then, the program has added 29 loans totaling $3.8 billion, but these are not included in this update, nor are any further commitment drawdowns. They will be included in a FYE 2022 update later this year. For various reasons, it’s not likely that the additional loans or drawdowns will materially change the scale of the FYE 2021 portfolio’s interest rate exposure.

The biggest update of course is the rise in interest rates since autumn last year. The most relevant rate, 20YR UST, averaged 3.48% for June 2022, up 1.49% from the September 2021 average. This rise was much, much faster than the CBO’s projections:

If all of the FYE 2021 loan commitments were drawn on June 30, 2022, realized funding losses would be about $2.4 billion, or about 20% of the portfolio:

That translates into future mandatory appropriations that dwarf the program’s discretionary appropriations:

Of course, these funding losses are unrealized, and WIFIA is not a private-sector bank with a limited capital base. A lot could change:

• Interest rates could fall back to low levels before the loan commitments are drawn. This might happen in a deflationary recession.

• A stagflationary recession or even prolonged high inflation will probably mean higher rates, but in that case the real value of future mandatory appropriations will be reduced.

• Disruptions in private debt markets might result in later loan commitments being drawn and amortized at relatively high rates, resulting in funding gains that offset the FYE 2021 portfolio’s losses. This would require WIFIA to suspend its reset policy, but that’s presumably possible, as it’s not legislatively required.

No doubt there are other possible outcomes — we live in uncertain times. Still, the scale of potential funding losses relative to what Congress thought were the necessary discretionary appropriations for the program is a red flag. As described in the FYE 2021 analysis, these giant off-budget losses point to a FCRA budgeting loophole that should be recognized and addressed.

To be clear, there’s nothing wrong with federal infrastructure loan programs offering interest rate management products — they’re likely to be more valuable than ever. And Treasury certainly has the capability and economies of scale to provide them at the lowest possible cost to the US taxpayer. But to make such products sustainable, their cost has to be correctly assessed and put on the discretionary budget. Otherwise, unpleasant surprises are virtually certain.

It’s a simple change. WIFIA’s current maximum loan term is 35 years post-construction. That should be extended to at least 55 years for long-lived water infrastructure projects.

The topic has been covered in previous posts: WIFIA 55-Year Loan Term (September 2020) and Extended Term for WIFIA Loans (February 2021).

Same Story

The basic story hasn’t changed. Although interest rates are significantly higher than before, the benefit of a 55-year term WIFIA loan relative to a 35-year term one is about 6% lower PV of debt service, or about $6 million for a $100 million project. The other numbers (minor FCRA cost increases, lower tax-expenditure) are also about the same:

The primary driver of the increased benefit – a longer term’s relatively greater utilization of US Treasury flat-forward pricing – also remains the same:

There’s even a bill in Congress, the Water Infrastructure Finance and Innovation Act Amendments of 2022, that has precisely the same language for a 55-year term as the WIFIA Improvement Act of 2020 did. (There are other things in the 2022 bill, too, but that’s a topic for another post.)

Different World

What’s changed – a lot – is the outlook for the economic, political and social context in which US water infrastructure renewal will develop in the coming years. Federal infrastructure loan programs are likely to be an increasingly important federal policy tool in more challenging conditions. Here’s a recent post: Hard Times Ahead.

In the relative optimism of recent years, extending the maximum term of certain loans in a small sectoral program for large water utilities might have seemed…well, not exactly a compelling priority, regardless of logic or potential benefits. I think it was seen as a minor change for some Western water management projects that had other issues with the WIFIA program (federal budgeting) and useful only to a regional constituency. The WIFIA Improvement Act of 2020 went nowhere.

A pessimistic outlook will – or at least, should – change that perception. Yes, it’s still a minor change and only applicable to long-lived water projects. But more relevant in a tough environment:

• Local funding will be even scarcer, especially for types of infrastructure where it’s easier to kick the can and defer renewal – like stormwater systems. These projects tend to be mainly composed of long-lived, structural assets which could support and benefit from a 55-year loan term. As more water agencies look for WIFIA loans to mitigate the effects of higher interest rates and inflation, they’ll be plenty with long-lived assets. And they’ll be looking for every penny of benefit they can get. That constituency will be national in scale and highly motivated.

• Federal infrastructure loan programs will need to expand their capacity but also their capabilities. Not big, transformational changes (that’ll be impossible) but many small, specific modifications to loan products that have predictable benefits. Extending WIFIA’s maximum term is a perfect example of what’ll be required. As such it can serve as a demonstration that, despite overall political polarization and dysfunction, at least one area of federal policy can be successful. It shouldn’t be difficult — TIFIA just extended their maximum term (to 75 years, no less) in the 2021 IIJAA. A win for WIFIA’s maximum term will encourage more of what will work.

• More subtly, longer terms for infrastructure loans help shift the focus to the long run, where it belongs, and away from a business-as-usual mindset. That focus matters for evaluating investment in climate change, long-term environmental sustainability and quality of life for future generations. It’s no secret that the ESG agenda doesn’t seem to have the kind of consensus behind it as it did recently – a trend that is likely to get worse. An extended term for WIFIA loans is a small step in the right direction.

A lot of decisions about US public infrastructure will need to happen in the near future. That’s not a choice. For the past decade at least, there was reason for optimism that those decisions would include additional investment for sustainability, social goals and climate change adaptation.

But suddenly, that optimism doesn’t look so justified anymore, as yet more articles like this appear. Now it seems almost certain that funding for anything other than bare bones replacement will face economic, political and social headwinds.

Local infrastructure funding will have to deal with anxious tax and rate payers that are already beset with inflation and slow growth. Federal funding, so recently looking bright, could dry up in a wholesale change in the political environment and changing priorities.

Right or wrong, that’s how it is. Hard times mean a focus on short-term, just-good-enough solutions. Unfortunately, climate adaptation investment only has really obvious value in the long-term.

Is there any way to make it easier to include long-term value in today’s public infrastructure decisions, at least from a federal perspective? I think federal infrastructure financing programs could help a lot. A long-term policy perspective comes naturally to programs that offer loans with terms of 40 years (WIFIA) or even 75 in some cases (TIFIA). Apart from low interest rates, stretching out amortization schedules and other structural refinements mean that short-term funding impacts can be minimized. And future repayment comes when the value of additional investment is seen (perhaps even welcomed) in real time.

If only from a practical, realpolitik viewpoint, I also think federal infrastructure loan programs are worth extra attention right now. The programs have solid bipartisan support and usually fly way beneath our polarized political storms. They’re easy on the federal deficit and easy to expand in size and capability, given the federal government’s unique strengths as a long-term lender. Several are operating successfully already, a proven base to work with and a model for copies, like CIFIA.

Maybe there’s better news ahead. But despite my natural optimism, something tells me that the next few years are going to be challenging. We shouldn’t give up on continuing positive climate change policies, of course. But it’s time to start looking for practical solutions to keep that positive direction going in more difficult times.