This post is the first of three on the topic. The second is here, and the third here.
The ‘Limited Buydown’ provision in TIFIA and CIFIA loan program legislation allows a loan’s construction period interest rate lock to be set at application, not loan execution, as in the WIFIA program. That’ll be an especially useful feature for carbon pipelines, but it might use a lot of discretionary appropriations. This long post sets out the context and risks associated with that.
WIFIA’s Off-Budget Post-Execution Rate Lock
A WIFIA loan’s construction period interest rate lock is one of its most valuable features. In effect, it works as an interest rate option, both on construction draws and (more importantly) on the loan’s post-construction permanent financing phase. The option is costless to the borrower, but potentially very expensive for federal taxpayers if rates rise during the lock period. However, under FCRA budgeting methodology, this cost is not WIFIA’s problem. The water program’s lock begins at loan execution when the loan’s interest rate is set at then-current Treasury rates. Hence, the required discretionary appropriation (the ‘credit subsidy’) for the loan’s cost is only about its expected credit loss, a small amount for WIFIA’s highly rated borrowers. If Treasury rates rise between loan execution and final drawdown, the discounted present value of Treasury’s funding loss shows up as a positive adjustment to the credit subsidy amount (an ‘interest rate re-estimate’) that is automatically authorized (under FCRA’s ‘permanent indefinite authority’) and receives a mandatory appropriation covering Treasury’s loss. The accumulated balance of these mandatory appropriations is recorded in an off-budget account, and WIFIA’s discretionary appropriations are not affected.
The theory behind this special budget treatment appears to be that post-execution interest rate changes are an exogenous and uncontrollable factor for federal loan programs and will likely balance out over time, as both positive and negative interest rate re-estimates should occur. I think the reality is much more complicated in WIFIA’s case, but that’s another topic.
TIFIA’s and CIFIA’s (Likely) On-Budget Limited Buydown
TIFIA and CIFIA loans offer the same construction period rate lock feature with the same FCRA budget treatment after execution – with one crucial difference: For these programs, the loan’s execution interest rate can be set at what it would have been if the loan had been executed on its application date, if that’s lower than the current Treasury rate, up to a maximum 1.50% reduction.
This pre-execution rate lock (or more precisely, ‘collar’) is called a ‘Limited Buydown’ in the legislation for both programs. The language is not very detailed in TIFIA’s case but has apparently been interpreted to include the application date trigger. In CIFIA’s law, the application date (or a somewhat equivalent execution of a ‘master credit agreement’) is explicitly defined as the relevant start point.
The name of the provision, introduced in the TIFIA section of the 2012 MAP-21 act, is a bit odd – the ‘limited’ part is clear enough (the 1.50% limit), but the ‘buydown’ seems to derive from a home mortgage feature whereby the borrower can lower their rate with a payment. In the loan program’s case, the lender is doing the ‘buying’. The provision is probably more accurately described as a ‘limited loan interest rate reduction’ or more transparently as a ‘limited sub-Treasury rate adjustment’. Perhaps a Congressional TIFIA drafter in 2012 had worked on FHA legislation and thought that ‘buydown’ was a quick way to convey the concept, since the net effect (a lower loan rate) is the same? Or was the name intentionally a bit obscure because the provision is in essence a kind of grant in a loan program that is otherwise generally funded at Treasury cost? In any case, for CIFIA legislation the name was almost certainly simply inherited, even if the concept clearly got more focus.
Although the pre-execution rate collar is limited to 1.50% and has relatively more optionality than the post-execution rate lock, both have substantially the same type of benefit to the borrower and cost to the federal lender. A WIFIA loan’s rate lock over a five-year construction period when rates are rising will cost federal taxpayers about the same as a two-year CIFIA or TIFIA rate collar followed by a post-execution rate lock on a three-year construction period. In both cases, the federal government has committed to the interest rate on a 35-year loan five years before Treasury funds it. If rates have risen, the borrower receives the same benefit, and the taxpayer gets stuck with the same economic cost.
But there is almost certainly a huge difference in federal budgeting between the two. As noted above, the cost of the post-execution rate lock is covered by FCRA’s indefinite budget authority and gets buried in off-budget accounts. The cost of the pre-execution rate collar, however, is not likely to receive that free pass. Instead, I expect it will need to be apportioned from the program’s available discretionary appropriations when the loan is executed. FCRA language and established methodology is straightforward about estimating and budgeting for the cost of a loan (including the cost of a sub-Treasury interest rate) when it is executed. I can’t see any reason why the pre-execution start point of the limited buydown provision would make any difference to that.
Does this matter? Not to WIFIA and Probably Not to TIFIA
The additional on-budget cost of the pre-execution rate collar is not necessarily important per se. The loan is going to require some credit subsidy anyway and the cost of the rate collar just adds to that amount. However, when the aggregate additional amount of subsidy required by the full application of the limited buydown feature is high relative to the available appropriations because rates have risen, the feature could impede loan executions at the reduced rates the borrowers expected.
Obviously, WIFIA won’t have this budgeting issue because the pre-execution rate collar is not included in the program’s statute. But it’s interesting to consider what might have happened if it did. The sophisticated financial staffers at WIFIA’s highly rated water agency borrowers would have immediately seen the collar’s value and timed their applications accordingly, aiming for low points in UST rates. WIFIA hasn’t had any problem attracting applicants without the rate collar. With this feature, the volume of applications certainly would have increased or at least been accelerated. The program’s loan volume is very high relative to its appropriations (more than a 50:1 ratio), a sustainable path because the high quality of the program’s borrowers requires only a small amount subsidy for expected credit losses. But there’s not much headroom. Even a slight increase in the percentage cost of the loans would impact WIFIA’s ability to execute loan volume as planned. The cost of pre-execution rate collars during the 2020-2022 timeframe, if they had been offered, would probably have been many times WIFIA’s available appropriations.
A loan program’s likely response in this hypothetical situation would presumably be to restrict rate adjustments under the limited buydown provision to whatever budget authority was available (if any) after an adequate amount was allocated for planned loan executions at unadjusted rates. Such rationing is possible because the buydown language in both TIFIA and CIFIA laws is explicitly permissive, not prescriptive, for program administrators. How such subsidy rationing would be implemented practically in this situation, especially over a multi-year period, isn’t at all clear, however. There’d certainly be disappointed borrowers.
That still may not have mattered in WIFIA’s case. An un-disappointed borrower is not a policy objective for federal infrastructure loan programs – a completed infrastructure project is. The important question about possible cutbacks in limited buydowns should be simply whether the borrower’s project can go forward or not. The vast majority (or even all) of WIFIA’s water infrastructure projects to date would have gone forward with or without a WIFIA loan in the first place (a fundamental policy topic that should get more attention). In that low-impact outcome context, the additional benefit of a pre-execution rate collar, or the failure to deliver that expected benefit, would have made no significant difference to US water infrastructure renewal, regardless of WIFIA borrowers’ feelings.
The same net result is the likely outcome at TIFIA, though for different reasons. I believe TIFIA’s limited buydown provision has been utilized at least a few times. But I doubt that it created any serious budgeting issues because TIFIA’s loan execution volume is quite slow relative to its appropriations and much of the program’s activity took place when rates were generally falling. Even if the program’s budget headroom for limited buydowns becomes more restricted in the future, a cutback in the rate adjustments isn’t likely to stall the borrowers’ projects. Most of the cost benefit of a TIFIA loan comes from the avoided spread between the program’s UST rate and a BBB-ish private-sector project finance loan, which will range from 0.50% to as much as 2.00%. That’s valuable and might be an important factor enabling a transportation project, which is the right policy outcome. A limited buydown, in contrast, is closer to a ‘nice to have’ as opposed to ‘need to have’ with respect to the viability and timing of these types of projects. This is especially true due to the relatively small proportion of a TIFIA loan in a project’s capital stack – the statutory limit is 49% of project cost, but program policy has further limited that to about 33%.
If TIFIA’s limited buydown becomes restricted or even zeroed-out in a budget year, that might make a difference to project economics and perhaps even to some minor aspects of final project design. But I doubt that the effect will be enough to stop the project altogether, borrower disappointment notwithstanding. Hence, for TIFIA, the limited buydown is likely not a critical feature to the program’s policy outcomes – it may be utilized if the budget headroom is there, but probably not a showstopper if there isn’t.
It Might Matter a Lot for CIFIA
In contrast to WIFIA and TIFIA, a possible rationing of CIFIA’s limited buydown provision will probably matter, because (1) the provision is likely important for CIFIA projects, and (2) although the new program has a high level of credit subsidy appropriations, that might get used up surprisingly quickly by even a slight rise in rates.
Apparently, though not explicitly, CIFIA is really all about midwestern carbon pipelines. There are three big ones in development that get a lot of press, with a rough total cost of about $10 billion. The point of these pipelines is to monetize 45Q carbon tax credits, something which is now easier and much more lucrative with the passage of the Inflation Reduction Act. I’m guessing that other pipelines are or will soon be planned. A lot of financing for a relatively new sector will need to be found, and project sponsors will want to move quickly.
Although the basic form of CIFIA follows its similarly named predecessors, the carbon program appears to have been designed within the framework of federal credit rules to facilitate financing for exactly this pipeline development situation. Unlike WIFIA and TIFIA, CIFIA can offer financing for 80% of project cost, regardless of size. And, although the projects must (of course) be creditworthy, an investment grade rating is not required. Assuming the project developer is putting in the 20% balance as straight-up equity, CIFIA is in effect a ‘one-stop, one-step’ financing program – put in a good application, check the well-established federal crosscutter boxes, and you get approval for the only loan you need.
That’s just as well, because getting the pipeline built appears to be anything but a one-stop process. Actual construction is likely straightforward and won’t take too long once started – about two years, even for the big ones. But securing all the easements and rights-of-way across thousands of miles of privately owned, agriculturally productive, and savvily managed property looks like a nightmare. Moreover, it’ll be intrinsically time-consuming. Two or three years is publicly mentioned, but I’m sure outcomes will vary widely. Progress mainly depends on multiple price negotiations, then on bureaucratic processes for the last steps if eminent domain is required, all with a steep trade-off between time and money. In that process, project economics could swing wildly from expectation.
It’s easy to see why a pre-execution rate collar would be critical in this phase of carbon pipeline development. Project economics will also be highly sensitive to the interest rate on the permanent financing. Capping that volatile factor at the start of the process of securing rights-of-way would stabilize the numbers for pipeline cost and define clearer limits for the process’ time/money trade-offs. Waiting until loan execution to set the permanent financing rate, when all the contracts are basically done and trade-offs set in stone, could result in some nasty surprises. It’s no surprise that when the CIFIA legislation was being drafted, someone took particular care to define the limited buydown provision in detail – it’s intended to be used.
Mind the Discretionary Appropriation Gap If Rates Rise
Since the current interest rate environment is uncertain and expected to get worse, I’d guess that the three big pipelines (which are now in the process of rights-of-way negotiations) will put in CIFIA applications as soon as the program’s doors open. There’ll likely be some other, smaller projects applying, too. It’s therefore possible that CIFIA will have roughly $10 billion of financing subject to pre-execution rate collars by year end, from the projects currently underway. That’s a big number on which to set rate collars for 35-year loans fixed-rate loans. But CIFIA has $2.1 billion in appropriations over the next five years, so the FCRA impact on the program’s budget should be easily absorbed if rates rise in the next few years, right? Right?
I’m not so sure. Obviously, there isn’t much specific data to work with, but if a few assumptions are basically correct, avoiding subsidy rationing at CIFIA might be a near-run thing if rates rise – even a little — over the next few years.
- Let’s assume that $10 billion of applications accepted this year result in $10 billion of executed loans towards the end of 2024, when the project developers to get their rights-of-way and contract negotiations finalized. At that point, the program should have $1.5 billion of appropriations available, the accumulated balance of scheduled authorization (the total, $2.1 billion, becomes available over a five-year schedule, accumulating until expended). That’s the green line in the chart below.
- Also assume that the $10 billion of loans will require 8% or $800 million to cover the subsidy for projected credit losses. This is higher than TIFIA (about 6% for minimally investment-grade loans) and much higher than WIFIA (less than 1% for that program’s average Aa3/AA- loans). But 8% seems about right for unrated and likely sub-investment grade project finance loans to a relatively new sector, or in any case reflective of OMB’s perception of the risk thereof. This part of the subsidy is not related to interest rates – hence ‘Non-Interest Subsidy’ in the chart.
- The final assumption is that the applications were all set with a relevant US Treasury rate (the 20Y UST, approximately reflecting weighted average loan life) of 2.75%. I know that’s lower than the current yield, but it’s chosen to illustrate a point about change, not levels. And because – who knows? A few months in the current volatile economic and political environment is a long time. It could be the actual 20Y UST rate in the near future. Or rates might rise dramatically instead, and the 20Y UST goes from current 3.75% to 5.25%, with roughly the same effect on the illustrative model. One thing looks for sure – CIFIA will not be setting limited buydown rates in a calm and predictable world.
- If the 2.75% 20Y UST rate at which the applications were assumed to be set is higher two years later at loan execution, the lowered discounted present value of the loan will require additional subsidy in an equally higher amount, per FCRA methodology. That’s the ‘Subsidy Due to Rate Change’.
The chart summarizes what happens if the 20Y UST rises between the application and execution dates. If no change from 2.75%, then the only subsidy required is the $800 million for projected credit losses, well within CIFIA’s available appropriations. A rise to 3%? A little tighter, but still some headroom. To 3.25%, an unremarkable rise of 50 bps. over two years? Things get interesting.
If the relevant rate rises above 3.25% in this illustration case, CIFIA will probably need to start the kind of messy subsidy rationing mentioned above. The simplest step would be to delay loan execution a few months until the FY 2025 appropriation of $300 million becomes available. But what if rates keep rising during and after the delay? At 3.5%, the $1.8 billion is used up, and at 3.75%, the total subsidy required exceeds the $2.1 billion initially authorized. Note that this is all for the original 2022 applications. Presumably, there’ll be others in the meantime, soon requiring at least the 8% subsidy at execution for the non-interest part, for which they’ll presumably have a priority claim.
In this hypothetical scenario, the limited buydown would cause CIFIA to run out of appropriations for loans to just a handful of pipelines if rates rise by about 1% over two or three years – again, well within recent experience and only two-thirds of the 1.50% limit.
The math is no mystery. Anyone who has ever dealt with the valuation of long-term, fixed-rate bonds and loans knows that their discounted present value, or price, is very sensitive to interest rate changes. Was the 1.50% limit in MAP-21 determined by Congressional staffers after modelling various scenarios? Not likely. The provision’s original proponents might have known the potential benefit of a wide collar, and even suggested the number, but the Congressional staffers probably settled on 1.50% because it sounds benign – properly prudential but not overly restrictive – until you do the math. In any case, CIFIA got the buydown provision and its limit by inheritance, and (with the inheritors properly appreciating its value for pipeline development, and making sure details were included this time) that’s now the law.
Failing in the Core Mission
If CIFIA’s available credit subsidy needs to be rationed with respect to the limited buydown, there will of course be disappointed borrowers. As discussed above, that shouldn’t matter much in itself. But unlike the typical projects financed by WIFIA and TIFIA, for CIFIA’s carbon pipeline projects I think the impact may go well beyond disappointment and affect the program’s policy outcomes. Paying an unexpectedly higher interest rate on the project’s permanent financing, after all the contract negotiations have been finalized with an expectation of a lower rate, could wreak havoc on a highly leveraged project’s economics. Whether that’s enough to stop the project altogether obviously depends on a lot of specific factors and isn’t broadly predictable. My guess is that full showstopper situations will be rare. Perhaps there’ll be some capital restructuring and even contract re-negotiations – painful, but not fatal.
However, if rationing ever occurs or even comes close, future CIFIA applicants may not put a lot of faith in the limited buydown provision. That may have a marginal impact on the program’s volume of applications and closed loans, the usual (and somewhat specious) soundbite measure of a loan program’s success. But I think it will also negatively affect a much more fundamental aspect of CIFIA’s potential success – the effectiveness of the program to accelerate the volume of carbon sequestration, compared to what it would have been if CIFIA never offered limited buydowns.
As described above, a pre-execution rate collar helps pipeline developers make better – and presumably faster – decisions about the numerous time/money trade-offs that’ll be required to secure the project’s rights-of-way. Without it, the project’s economics are less certain, and money perceived to be scarcer. The trade-off then tilts towards extending the time involved before construction starts – lengthier, hard-ball negotiations and more chance of eminent domain proceedings. Every delay has a quantifiable impact in terms of tons of carbon that could have been sequestered if the pipeline had been there to carry them.
The loss of 45Q revenue from those un-carried tons is the type of disappointment that goes with the territory of almost all project development when things get delayed. But from the CIFIA program’s perspective, there is perhaps a unique policy aspect to minimizing delays. WIFIA’s water projects and TIFIA’s transportation projects will marginally enhance a long-established stock of basic public infrastructure, the need for which is unquestionable. A few years of delay on specific projects financed by those programs won’t make any difference to the programs’ long-term policy rationale. In contrast, CIFIA’s infrastructure projects are all about climate change mitigation – a policy area where time is very much of the essence.
In theory, every ton of carbon not emitted into the atmosphere will mitigate climate change, and the sooner the better, starting today. CIFIA’s policy objectives are doubtless more pragmatic, but time is still a central focus, for at least two reasons.
First, there’s the political context. The obvious need to renew US water, transportation and other basic public infrastructure will cut through almost any level of federal political polarization or dysfunction – if anything, it might become a rare area of growing bipartisan agreement. That’s not at all true for any federal initiatives involving climate change, to put it mildly. I don’t think anyone can predict what future policy in this area will look like, especially for specialized climate change mitigation infrastructure, the need for which is intrinsically less visible than it is for climate resilient investment in basic infrastructure. Stakeholders in this sector need to make hay while the sun shines, and they’ll expect CIFIA to help produce results with the level of appropriations the program currently has. Future top-ups to CIFIA’s funding bucket are by no means assured, regardless of carbon pipeline development demand.
Second, time is really at the heart of CIFIA’s entire reason for being. The basic economics of carbon pipelines look fundamentally creditworthy. Carbon producers, especially ethanol plants, have an immediate and continuing need for large-scale sequestration. The sequestration locations are many miles away, but carbon pipeline construction and operations are straightforward. Once the carbon gets there, it’s monetizable at a firm price, $85/ton, through 45Q credits. That kind of story is eminently financeable in the private-sector debt markets, specifically with project finance bank syndicates, though the process might take some time. Yes, a CIFIA loan will be cheaper, but the current 45Q price should make the whole operation lucrative enough – what’s the point of an additional federal program to indirectly deliver more of the same incentives?
The answer, I think, is that faster and more certain, not solely cheaper, financing is the primary purpose of CIFIA. That’s reflected in two of the program’s notable differences to its WIFIA and TIFIA predecessors – the ability to finance 80% of project cost and the lack of an investment-grade requirement. It’s also reflected in the evident attention that was paid to the language in the limited buydown provision. Carbon pipeline developers will want to move fast but with as much certainty as possible. CIFIA’s role is to deliver financing in a way that uniquely meets those two goals. The program’s lower interest rate is simply the usual side-benefit you get with federal credit, not the main event.
I don’t know whether CIFIA was consciously designed from the start with this purpose in mind. The program’s industry proponents probably had a clear idea about what they wanted, but began the process (again, with an eye towards speed) with pre-existing federal infrastructure loan program models and added the necessary technical-seeming modifications. The precise federal policy rationale and objectives for CIFIA was not their problem. I’d guess that federal policymakers didn’t put much thought into those either, and simply assumed that CIFIA would automatically incorporate the policy aspects of WIFIA and TIFIA, like a new flavor in an established consumer brand.
Regardless of CIFIA’s history or nominal policy objectives, however, the program will be evaluated by its stakeholders with respect to what it appears to be promising carbon pipeline developers in terms of faster and more certain financing. If interest rates rise over the next few years, the limited buydown provision could be an important aspect of delivering on that promise. In this context, any inability to execute loans at the interest rate expected by applicants due to a lack of available subsidy appropriations would be a major failure for the program. It will be the kind of failure that has specific and quantifiable consequences for the affected projects, possibly including a delayed start to construction due to contract re-negotiation, and I’m sure that the borrowers won’t be shy about describing them.
More importantly, such a failure may impact perceptions among existing and future applicants about what overall level of certainty the program provides for the terms of an executed loan, not only with respect to the limited buydown, but other aspects of loan economics that aren’t precisely prescribed and required in the program’s legislation. If CIFIA fails to fully deliver on the limited buydown rate, what else might the program fail to deliver? Timely loan execution? OMB and other approvals? Acceptance of environmental reports? Common-sense loan covenants and documentation? The list goes on and on, all based on a long history of borrowers’ experience of things that go wrong at federal loan programs.
If carbon pipeline developers lose the faith that CIFIA will deliver speed and certainty, the program will have failed in its core mission. I see the limited buydown provision as a central part of what the program is expected to do. It’s not the only thing, but the provision is relevant to the first and perhaps most difficult part of the show, securing easements and other rights-of-way for pipeline construction. CIFIA’s stakeholders, especially including program administrators, need to keep an eye on how rising rates might affect available discretionary appropriations. However technical and abstract these FCRA mechanics might seem, a budgetary shortfall at CIFIA is a gap that’s well worth minding.