It became clearer in the course of doing the FCRA Non-Federal Series that a lot of the apparent ambiguity of FCRA treatment for loans to federally involved projects appears to stem from imprecise language. This post will sketch out two definitions that will be useful going forward, a ‘federal project’ and a ‘non-federal interest’ in a federal project.

Federal Project

The term ‘federal project’ occurs throughout the FCRA issue. First, I think it’s important to clarify what the term does not refer to — a federal facility.

A federal facility is built to facilitate federal operations. It sometimes might look like public infrastructure, although the scale is usually smaller (e.g., office buildings, housing). But the primary end-user and direct beneficiary is federal government itself. The asset can be owned by a non-federal third party (like a real estate developer) and used by the government under some sort of contractual arrangement (like a lease). Most importantly, contractual payments will be federally sourced.

I can see that federal facilities owned by third parties would pose a problem for federal budget treatment and CBO legislative scoring. The same consolidation issue arises in private-sector FASB accounting, especially capital vs. operating lease classification. Most of the examples in the CBO Report involve lease-type contracts on federal facilities and CBO resolves their scoring treatment with what are effectively FASB 13 lease principles. If the third-party owner of a federal facility sought a federal loan to finance the asset, FCRA treatment for the loan would likely depend on the same factors.

But none of this should be relevant to FCRA treatment at federal infrastructure loan programs for the fundamental reason that federal facilities shouldn’t be eligible program borrowers in the first place. A federal facility will presumably help the government achieve beneficial public outcomes, but it’s not the end product, especially with respect to public infrastructure. Since statutory eligibility requirements at federal infrastructure loan programs focus on direct public benefit, it’s hard to imagine how a federal facility as defined above would ever comply. FCRA treatment is a moot question.

In contrast, a federal project can be defined as an infrastructure project with federal involvement but where the primary end-user and direct beneficiary is the non-federal community or region in which the infrastructure is located. Such projects will often be statutorily eligible for federal program loans — hence the importance of the FCRA non-federal issue.

But the leasing principles that apply to scoring and FCRA treatment for federal facilities do not apply for federal projects. As defined above, the primary beneficiaries of a ‘federal project’ are non-federal communities, and the relationship between the project and its non-federal beneficiaries should be the basis for FCRA classification. That requires defining another concept.

A Non-Federal Interest in a Federal Project

Imagine a federal infrastructure project that is completely built, owned, operated and paid for by a federal agency. Simple, yes? Every cash flow associated with this project will be included in the cash-based federal budget.

This project will of course benefit the local or regional community is some way. And no doubt they’re happy to see it paid for by national taxpayers. Completely rational.

But now let’s say that the federal agency won’t get enough federal funding to build the project, only a part. That agency could simply cancel the project. Or it could go the project’s beneficiaries and ask them to pony up some funding to get it done. The community could then decide, in its own self-interest and again with complete rationality, to the provide the balance. But they won’t simply write a check — they’ll want a long-term contractual agreement covering various aspects of the project to ensure they’re getting their money’s worth.

The project gets built with the community’s financial support. In one sense, it’s still a ‘federal project’, but now there’s a real and quantifiable ‘non-federal interest’ in the project. That interest may be large or small, it might involve some degree of operational control, it may or may not cover specific physical parts of the project. All those aspects will be determined (most likely in great detail) by the contract between the federal agency and the community. But one thing is certain — the project is no longer wholly federal, and federal budgeting should reflect that fact.

Let’s go further. Assume that the community can’t write a big check to pay for its share of the project’s construction cost in a lump sum upfront. But they’re willing to make payments over time under the long-term contract and their creditworthiness is good. With that contractual obligation for cash flow, the project can finance construction costs. The non-recourse lenders aren’t looking to the federal agency for repayment (there’s explicitly no recourse to the agency) or even to the collateral value of the project’s physical assets (there’s no resale market) but solely to the community’s ability, most usually through taxes or regulated user fees, to pay under the contractual obligations. What’s actually being financed here? The federal project? Not really, even though that’s where the money will be spent. Rather, it is the non-federal interest that is being financed — and the debt is non-federal.

The federal government provides various subsidies to non-federal debt for infrastructure projects that benefit the public. The biggest one by far is the tax-exemption on the debt’s interest — the basis for the tax-exempt municipal bond market, of course. Such tax-exempt debt can’t be directly or indirectly guaranteed by the federal government. If the community in our example were to seek tax-exempt financing for their non-federal interest in the federal project, they’d have to demonstrate that the source of repayment was exclusively non-federal. In most cases, that should be straightforward — the lenders will ensure that the contract is explicit about where’s the money is coming from, and the community’s taxpayers will probably have a say in approving it. Let’s assume that the non-federal interest in our example qualifies for tax-exempt financing.

There’s another way that the federal government subsidizes infrastructure with a public benefit — federal infrastructure loan programs. These programs are much smaller than the tax-exempt bond market and their interest rates aren’t generally much better. But the program loans offer various features (loan term, rate management, flexibility, etc.) that can’t be found in the bond market. The community in our example decides to seek a federal program loan in addition to their tax-exempt bonds to finance their interest in the project. The project — and therefore their interest in it — appears to be statutorily eligible for such a loan, and they make an application.

It is only at this point — not before, not with presumptions about ‘federal’ projects, not with respect to the project’s history or statutory eligibility — that FCRA treatment becomes relevant. Now FCRA criteria can be applied on the specific facts about the community’s non-federal interest. Questions and requests for additional information about that interest should be expected — just as they were for the tax-exempt qualification. And equally, the answer should be straightforward in most cases. A program loan to finance a genuinely non-federal interest in a federal project should receive FCRA treatment.

Going Forward

The more general point here is this: In the next few months. there’s likely to be a lot of discussion about the FCRA non-federal issue. Precisely defining these two concepts — a federal project and a non-federal interest in it — at the outset will make the issue and possible solutions much clearer.

In a prior post, I raised the idea that CWIFP should be allowed to lend to revolving funds that in turn lend to smaller dam rehabilitation and removal projects. This was based on an analogy to WIFIA’s explicit ability, reinforced by SWIFIA legislation, to make loans to SRFs. This post will sketch out that idea a little further.

Analogous Policy Objectives

The federal government has a lot of genuine strengths as a large-scale lender to US public infrastructure projects – cost-effective interest rate management, loan terms far longer than market, structural flexibility, etc. – that go beyond just offering cheap loans.

Large projects can utilize these features efficiently in large loans from federal programs. Smaller projects usually can’t, for any number of eligibility and transactional reasons. Yet smaller projects are the ones that would benefit most from financing alternatives.

There are two ways to address this. One is to add special provisions and policy objectives to federal infrastructure loan programs to ensure that small loans to small projects (especially in disadvantaged communities, etc.) are also being done. This approach is not ideal. Small-scale project financing is not a federal strength – arguably, it’s a weakness, or at best highly inefficient. And there is inevitably an element of federal centralization that not everyone agrees is the best way to support US local infrastructure renewal.

I think the other solution is much better, both in theory and in practice – have the federal program make large loans (with all their useful features) to local public-sector or policy-oriented lenders who in turn make loans to their local small projects. More efficient, less centralized, broader eligibility [1]. That’s the goal of SWIFIA. The DOT’s TIFIA has something similar.

Analogously with these established precedents, especially with respect to policy objectives and implementation efficiency, CWIFP should be able to make loans to local funds that will specialize in small dams.

Under Current WIFIA Statute

CWIFP doesn’t have explicit authority to do this under current WIFIA law. Even if some SRFs could make loans to small dams (e.g., as part of a larger state infrastructure bank), WIFIA loans to SRFs are limited to drinking and clean water projects specified in the CWA legislation.

But there is possible path in WIFIA’s eligible projects section, §3905.10:

A combination of projects secured by a common security pledge, each of which is eligible under paragraph (1), (2), (3), (4), (5), (6), (7), or (8), for which an eligible entity, or a combination of eligible entities, submits a single application.

Paragraphs 1 and 8 are relevant to dams and specifically noted in CWIFP’s site, as is this paragraph 10.

The interpretation of a “common security pledge” is central. A group of different projects getting together to apply for a single large WIFIA loan but with each offering separate security for the loan won’t work.

But if a separate eligible entity (the §3904 list includes various forms suitable for financial role) plans to lend individually to separate, eligible projects, then the “combination” occurs only at that entity. The security pledge that the lending entity will offer for a WIFIA loan is “common” is the sense that the one pledge covers the entity’s entire portfolio.

It needs to go further, however. If the lending entity is a thinly capitalized shell in which the only real security is in the individual loans, then the common pledge is not substantive. But that arrangement would probably fail WIFIA’s creditworthiness tests anyway. To get to an investment-grade standard on a relatively small and chunky portfolio of loans, the lending entity will need a fair amount of real capital beneath the WIFIA loan — federal or state grants, philanthropic, subordinated impact investor tranches, maybe even a slice of private-equity. A WIFIA loan is limited to 49% of the aggregate project cost — that’s probably the maximum amount of investment-grade senior debt possible in this situation, so I think it’s safe to assume that all other capital is subordinated in some way.

Now the common pledge for the senior WIFIA loan will have independent value, not just a pass-through of the individual loans. The “combination” at the lending entity is now also substantive — security in the individual projects is being combined into a single asset (the loan portfolio) and shared in various ways among the lending entity’s investors and WIFIA. It’s worth pointing out that security pledges in this kind of small loans are really about contractual cash flows (from local taxes or user fees), not the value of tangible collateral. In effect, completely fungible cash flows are being combined and shared without regard to individual loans.

I think this approach should comply with the letter and spirit of the language in §3905.10, especially since it effectively requires that the lending entity works in basically the same way as an explicitly eligible SRF. But it’s not bulletproof by any means. The language can be interpreted with a conservative slant, extrapolating “common” to mean full cross-collateralization, for example. And there’s always the basic rule of the disinclined bureaucrat – whatever is not expressly and literally permitted is prohibited.

Statutory Paths

Increasing the certainty of CWIFP’s ability to lend to small dam funds will involve a statutory change. Possible paths would range from minor word changes in §3905.10 (e.g., clarifying that “combination” and “common” requirements are satisfied by a lending portfolio) to full-blown SWIFIA-like statement with new definitions.

In the near-term, however, I think any proposed changes should be very limited until the demand for, and utility of, CWIFP loans to funds becomes clearer. It’s still early in a long-term process of program development and evolution. Perhaps the best way for now is simply some version of a study of the topic like the one proposed for collaborative delivery in Section 4 (b) of last year’s HR 8127. The study could include an assessment of the need for small dam finance, how revolving funds could address this need, various structural alternatives, and finally, required legislative changes for implementation.

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Notes

[1] This is recognized to some extent by the program itself. From page 16 of the current WIFIA handbook:

By including multiple projects in a single loan, borrowers gain:

Financing certainty for all the included projects expected to be constructed in a 5-year period. Borrowers can request disbursements for any project included in the loan immediately following closing until one year after substantial completion of the final project.

The ability to use WIFIA loans to finance smaller projects that would not individually meet the WIFIA program’s minimum project cost requirement, $5 million for small communities and $20 million all other communities.

Adding a 55-year term and a limited buydown to WIFIA loan features will be useful to CWIFP’s overall mission for large-scale water management and dam rehabilitation projects.

But the removal of obsolete dams, especially the smaller ones, might benefit from a few additional features.  While dam rehabilitation will presumably result in a continuing infrastructure asset with some identifiable economic benefits (e.g., electricity generation, water supply, flood control, etc.), dam removal will primarily result in environmental restoration – a very different kind of asset, closer to a pure public good with social, not necessarily economic, value.  Federal financing towards that objective might have a unique role to play, which justifies consideration of additional features.

Here are three quick ideas for special dam removal loan features, based (as always) on existing federal financing precedents:

• 75-Year Term:  Ecological and environmental restoration to the status quo ante presumably has a useful life of – forever, right?  A loan term of 75 years will have lower debt service requirements than the currently proposed 55-year term for long-lived economic infrastructure.  The DOT’s TIFIA already offers 75-year terms for some transportation assets.  It’s even more justifiable for environmental restoration assets.

• 10-Year Debt Service Deferral:  WIFIA currently permits the program to delay debt service payments for up to five years after project completion.  That’s 14% of the current maximum loan term of 35 years.  The same percentage for a 75-year term is about 10 years.  The practical purpose is to allow the community to see environmental restoration in a very long-term perspective, with minimal short-term impact on the local budget.

• Loans to Small Dam Removal Revolving Funds:  WIFIA’s ability to lend to clean and drinking water state revolving funds was made explicit and slightly enhanced with the addition of various features collectively called SWIFIA.  SRFs are very important to smaller projects that can’t access market financing efficiently or need extra, non-market support.  SWIFIA loans allow the SRFs to leverage their capabilities, so that grant funding goes further.  Analogously, CWIFP could be explicitly permitted (even encouraged?) to do the same for loans to revolving funds that could be established, perhaps using a combination of federal, state, and philanthropic grants, specifically for small dam removal.  There’s also an important separate rationale in this case — the availability of CWIFP loans might be a key factor in getting such funds established in the first place.

I noticed on the site for HR 8127 that a CBO Cost Estimate for the bill hasn’t yet been done.  Not surprising considering it’s still in an early stage of the process.

If or when a cost estimate is done, presumably there’ll be some review by CBO’s Joint Committee for Taxation (JCT) for any impact on federal tax revenue that the proposed WIFIA amendments might have.  The tax revenue impact comes from JCT’s assumption that when WIFIA makes a loan for 49% of the cost of a public-sector water project, the project will issue tax-exempt bonds (which wouldn’t have been issued otherwise) to finance some, or all, of the 51% balance.

Recent JCT Tax Revenue Cost Estimates

In the America’s Water Infrastructure Act of 2018 (S 2800), the tax revenue hit to WIFIA due to assumed tax-exempt issuance was $2.6 billion over ten years — much higher than the program’s discretionary appropriations for the period. From my analysis of the numbers, it appears that JCT made the maximum assumption that every $49 of WIFIA lending will result in $51 of tax-exempt bonds.  Based on WIFIA’s actual loans to highly rated public water agencies for essential, non-optional projects, this is almost certainly wrong.  In fact, the opposite assumption that WIFIA loans displace tax-exempt bonds if far more consistent with the program’s results to date. Here’s a post I did at the time: Yes, Get WIFIA’s Budget Scoring Right. Underlying analysis here — The Economic Cost of WIFIA’s Current Loan Portfolio Part 2: Federal Tax Revenue Impact — and a one-page letter, Letter to JCT on WIFIA Assumptions.

JCT also scored the Infrastructure and Investment Jobs Act of 2021(HR 3684) about $1 billion cost for tax-exempt issuance assumed to be caused by grant funding to SRFs. It was assumed that SRFs would leverage the additional capital with tax-exempt bonds. While this is a plausible — and arguably hoped for — outcome, it doesn’t reflect the long-standing reality that few SRFs consistently use leverage or that they might borrow from SWIFIA instead, which has no tax revenue impact. Here’s a post on that: WIFIA Loans to SRFs Will Pay for Themselves.

What I did not see in the CBO/JCT cost estimate for the IIJA is any reference to a tax revenue impact of the $75 million funding for the Corp’s WIFIA section, CWIFP. I could be missing something — perhaps the correct estimate is elsewhere? But if not, it raises a question about why this additional funding for WIFIA loans doesn’t have the same type of tax revenue impact that JCT assumed for other WIFIA spending in S 2800. It’s possible that the funding amount and potential impact was simply immaterial in the context of the giant IIJA — CBO/JCT would have had plenty else to do. However, if JCT consciously decided that CWIFP loans have a different tax revenue impact than other WIFIA loans, what was the basis of their decision? The $75 million will be used to support loans for rehabilitating dams owned by “state, local government, public utility, or private” entities and any federal ownership is disqualifying. Based on ownership, and the program’s minimum investment-grade standard and public sponsorship requirements, a lot of CWIFP projects should in theory be able to issue tax-exempt bonds. A CWIFP loan is generally limited to 49% of project cost, so 51% will need to be financed elsewhere, just as in typical WIFIA loans. Perhaps JCT is assuming that CWIFP dam projects, even if creditworthy, will be more idiosyncratic and complex than typical WIFIA water system projects, and hence more likely to seek capitalization (state grants or loans, P3 equity, etc.) outside the tax-exempt market. That assumption likely reflects reality to some extent — certainly more so than JCT’s overall assumptions about other WIFIA loans.

Tax Revenue Impact of 55-Year Term Amendment

With the above background, there are a few points to consider in anticipation of CBO/JCT’s cost estimate for HR 8127.

The only item in the bill that would seem to affect future spending is the amendment in Section 6 that authorizes unspecified appropriations for CWIFP for 2022-2026. I don’t know how CBO looks at this, but with regard to the tax impact of possible increases in CWIFP funding, I would guess that JCT will take a view consistent with IIJA scoring — it’s either immaterial or CWIFP loans do not cause more tax-exempt debt to be issued. But not necessarily — it’ll be interesting if they take a different position for HR 8127.

The FCRA amendment and other clarifying items about small communities, eligibility for transferred and congressionally authorized projects, and collaborative delivery will likely accelerate CWIFP applications — and maybe even add a few to EPA’s WIFIA program. But I don’t think these will have either a spending or tax impact since they don’t change the level of authorized appropriations.

The maturity date amendment in Section 5 will probably be seen by CBO/JCT in the same way — that it affects only program utilization but not spending or tax impact. But I think that is not quite correct. This is because the 55-year maximum term will apply to EPA’s WIFIA loans (which JCT has assumed will cause more tax-exempt issuance), not just CWIFP (where they apparently don’t). Currently, WIFIA loan terms aren’t that different from those for bonds in the tax-exempt market, regardless of project useful life. But for long-lived projects, a 55-year WIFIA loan at UST pricing will be significantly different than a 30-year tax-exempt muni bond. A highly rated public water agency financing an essential long-lived system (e.g., pipe replacement) might decide that a WIFIA loan with a 35-year term was not worth the effort and to go with 100% muni bonds to finance the project. A 55-year WIFIA loan could change their decision to a 49% WIFIA/51% muni bond mix — in effect, the WIFIA loan’s longer term is causing tax-exempt issuance displacement. And that results in more, not less, federal tax revenue.

The same concept would apply if a limited buydown amendment is added to HR 8127. There is no equivalent to the limited buydown in the muni bond market, and the usefulness of the feature might prompt water agencies to opt for a WIFIA loan instead of bonds. There’s a general principle here, I think — for EPA WIFIA’s highly rated public agency borrowers, the more non-market features a WIFIA loan has, the more likely it will be used to displace tax-exempt market bonds. This is already demonstrable from WIFIA’s success to date with the post-execution construction rate lock and reset, features that allowed the program to compete head-on against muni bonds right from the start. Adding more features will augment this competitive advantage, increasing tax revenue while providing financing that should improve US water infrastructure.

I don’t know the protocols behind a congressional request for a CBO/JCT cost estimate on a bill. But if it’s possible to request a specific focus, that might be worth doing for HR 8127 with respect to the tax revenue impact of the 55-year term. At least it would surface JCT’s underlying assumptions about WIFIA and CWIFP, and perhaps they’ll be open to revising their models to incorporate WIFIA’s actual results to date and take a more data-driven approach going forward. At best, the cost estimate for HR 8127 might include revised estimates of tax-exempt issuance for WIFIA altogether, a negative overall cost for the bill, and positive implications for future infrastructure loan program development.

Three federal infrastructure loan programs – WIFIA, TIFIA and CIFIA – collectively offer loan features that are useful and effective for long-term infrastructure financing.  Usually, the features are provided through a program loan made directly to a qualifying project.  But there’s also an indirect path – WIFIA and TIFIA can lend to water state revolving funds (SRFs) and rural state infrastructure banks (RSIBs), respectively.  These entities then can make separate, smaller loans that incorporate or reflect the program loans’ features.

In these cases, the ‘wholesale-to-retail lender’ approach has some sector-specific policy objectives.  For the SRFs, the goal is to encourage leverage at smaller, unleveraged funds, thereby increasing the impact of federal grant funding.  A more expansive effort was proposed by the SRF-WIN Act in 2018, but it did not pass.  For RSIBs, there’s a significant interest rate subsidy (50% of UST base), in effect providing a federal grant to states for their rural sectors.

Mass-Producing Loan Features and Outsourcing Transaction Origination

But now that the federal program lending to state lenders approach is statutorily established and (to some extent) utilized, there’s a more generalized way to look at it.  The programs’ loan features are essentially financial, not sectoral.  They have been designed and approved to provide a type of financing to US infrastructure that will encourage overall infrastructure policy outcomes – sustainability, resilience, social and economic goals, accelerated renewal, etc.  The features can work towards these goals at specific projects regardless of whether they’ve been delivered directly by the program or indirectly by another lender that has received a program loan.  In many ways, incorporating these financial features is the easiest part of loan origination and execution – they get written into the documents with more-or-less standard language and operate in much the same way for all loans.  Unlike other aspects of federal infrastructure loan program transaction processing, loan financial features can be mass produced.

In this context, federal infrastructure program lending to state lenders is a type of outsourcing that can deploy financial features based on federal capabilities to a wider range of infrastructure projects than the programs can do on their own.  Given the huge scale of the US infrastructure renewal challenge, especially relative to the size of federal infrastructure loan programs, shouldn’t such outsourcing be an overall policy objective regardless of specific sectoral applications?  If the loan features are useful in encouraging infrastructure outcomes, can be mass produced with existing federal capacity, and are deliverable through other public-sector lenders that are already originating infrastructure investments, then why not?

Infrastructure Pension Obligation Loan Program

There are likely various ways to implement outsourcing federal infrastructure loan features, ranging from simply expanding existing processes (e.g., more funding and features for SWIFIA, WIFIA’s SRF section) to an open program for all qualified lenders, including those in the private sector.  For this post, I’d like to sketch out one that would involve state-level public-sector pension funds.  I think this will illustrate the potential of outsourcing even within the public sector but also highlight some of the challenges.

State pension funds certainly have scale and investment capabilities.  There are about 300 funds with about $4 trillion of assets.  Obviously, most of their investment operations aren’t connected to financing long-term infrastructure projects, which would likely fit into their private market fixed-income and alternative buckets – maybe 1% or 2%?  Still, that small percentage is about $40-80 billion in portfolio volume, roughly the current aggregate capacity of TIFIA, WIFIA and CIFIA combined.

There’s no question that the investment teams of state pension funds would know how to utilize the financial features of federal infrastructure loans.  The harder part is how to attach and ensure compliance with both standard federal crosscutters (e.g., Davis-Bacon, NEPA, tec.) and infrastructure policy objectives (resiliency, sustainability, etc.).  And there will be a related question about how the benefits of the loan features should be shared between the pension fund and the ultimate borrowers.  The benefits should motivate both the pension fund and the borrower to implement policy outcomes that wouldn’t have happened otherwise – but how to split them?  Is rigorous oversight necessary to prevent windfalls to either?  Pensions and borrowers will obviously make arms-length decisions based on self-interest, so there’s an element of market discipline on the borrower side.  To the extent that potential windfalls accrue on the pension side, it’s worth pointing that these are public-sector funds, so the ultimate beneficiaries are the state’s citizens.  That’s not so different from a typical WIFIA loan where it’s unclear whether the benefits are improving the infrastructure project or simply being used to reduce the community’s water rates.

Federal infrastructure loans to state pensions could be implemented through special sections in existing sectoral programs, as WIFIA and TIFIA do for SRFs and RSIBs, respectively.  But perhaps the potential scale and specialized aspects of the lending would justify a separate program.  To simplify the illustration of the concept, especially in connection with comparison to state pensions’ bond alternatives (discussed below), this post will assume the latter as a ‘Infrastructure Pension Obligation Loan program’ or IPOL.

Not a Bailout

There’s one thing to make very clear right from the start – the IPOL program is not intended as a bailout [1].  US public pension underfunding is a serious issue. It rightly gets a lot of public discussion, including the possibility of a federal bailout at some point, something underscored by a recent $36 billion rescue of private, multi-employer plans.  More specifically, a 2020 proposal for federal infrastructure lending to pensions was explicitly intended to alleviate pensions’ underfunding, with the infrastructure focus being essentially a bipartisan side-benefit.  Despite the proposed program’s WIFIA-like acronym, the proposal got no traction and apparently little attention.  But the political dynamics are there.

Because political temptation to mix and match separate issues will always exist, the IPOL should be designed with anti-bailout characteristics.  The focus should be explicitly and solely about federal infrastructure policy objectives and how state pensions (regardless of their unfunded status) can help implement a federal loan outsourcing approach – the infrastructure projects are the point, not the loan delivery mechanism.  Pension qualifications, basic subsidies and federal appropriation levels should reflect that focus – a high minimum investment-grade rating (perhaps AA/Aa2?) and US Treasury flat minimum pricing should allow IPOL program credit subsidy leverage to be about 100:1, as it is in WIFIA.  Even a $50 billion program would require only about $500 million in discretionary appropriations – that’s enough to encourage policy-oriented infrastructure lending, but it’s not bailout territory. 

IPOL Loan Features

As with other federal infrastructure loan programs, the IPOL’s central mechanism to implement policy outcomes is the value of program loan features. For those, the place to start is what’s already established and offered at WIFIA, TIFIA and CIFIA. There are seven that I think are especially relevant.

Four of the features concern interest rate management during transaction origination and portfolio management thereafter:

• UST Rate Lock: As noted above, basic pricing should be the applicable US Treasury rate at loan execution. More importantly, loan drawdowns at this fixed rate would be optional within a period of years (maybe 3-5?) to allow the pension fund to originate and process investments.  The post-execution rate lock during drawdown is a common feature at the three existing programs, but it was expanded at WIFIA in construction financing terms for long-term capital improvement programs at utilities, not just specific projects. Portfolio assembly is analogous [2].

• Rate Lock Reset: The IPOL program can reset of the rate lock if Treasury rates fall before drawdown. This is not statutorily required, but it’s an established procedure at WIFIA and TIFIA.

• Limited Buydown: The program can set a limited interest rate cap at the date a loan application is accepted, which may be months or even years before loan execution. This permissive feature is statutory in TIFIA and (with additional details) at CIFIA, though currently absent in WIFIA for some reason.

• No Cancellation or Prepayment Penalties: This is a standard feature in all three existing programs.

Three other features involve non-pricing aspects of the loan:

• 55-Year Term: TIFIA offers loan terms of up to 75 years for projects with long useful lives and a 55-year term is being proposed for WIFIA. Assuming that the pension is building a long-duration portfolio in an actuarial context of 60-70 years, an IPOL term of 55 years (at least?) would seem to be analogously justified.

• Credit Rating Based on Portfolio or Pension Recourse: As mentioned above, IPOL loans should require a high investment grade rating. The rating may be based on the expected (and demonstrable) rating of the portfolio when funded or, more practically, on recourse to the pension. Most states are rated at least AA/Aa2 and generally backstop pension obligations.

• 80% Portfolio Leverage: CIFIA offers loans of up to 80% of project cost and the same leverage was proposed in the SRF-WIN act for SWIFIA loans. If IPOL’s goal is to outsource in scale, a high leverage ratio would make sense when combined with high minimum credit quality described above.

IPOL Loans vs. POBs

The value of WIFIA loans to highly rated public water agencies is assessed by a comparison to their debt market alternatives, tax-exempt revenue bonds. In the same way, federal IPOL loans should be compared to the state pensions’ financing market alternative, pension obligation bonds, or POBs. Despite the pensions’ public-sector status, POBs aren’t tax-exempt. As a result, direct arbitrage is rare, and POBs are used by only a few states to leverage equity returns, a somewhat risky strategy which depends a lot on market timing. IPOL loans cannot be used for that purpose — the benefits of the loan features (most notably the UST interest rate and rate lock) should be directed towards (and perhaps limited to) low-risk, long-term infrastructure investments like highly rated private placements. Some positive return should be expected to provide motivation for policy implementation but as discussed above, not excessive windfalls.

The risks of POB issuance are well-recognized. IPOL loans should have a far lower risk profile — here’s a comparison with GFOA’s current advisory on POBs (click on to enlarge):

Next Steps?

At this point, the concept of outsourcing transaction origination to deploy federal infrastructure loan features is a thought experiment and the IPOL program simply an illustration. This post is really just an initial outline for future discussions if there’s interest — which I think there will be.

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Notes

[1] More precisely, not more of a ‘bailout’ or subsidy than federal infrastructure loans are already in terms of transfer payments to specific communities. Possibly less, if loan features are explicitly designed and assessed in terms of real-world infrastructure additionality.

[2] Readers of this site might wonder how including this and the other interest rate features will not lead to the FCRA loss ratchet described in previous posts on WIFIA’s economic cost. A good question that, if it’s ever raised by policymakers, perhaps ought to be answered in the context of fairness as opposed to logic. Federal infrastructure loan programs should work with the funding tools at hand, including FCRA subtleties, on an equitable basis as long as the fundamental goal of improving US public infrastructure is furthered. Realpolitik, in other words.