By John Ryan
Like it or not, the U.S. federal government is in the middle of a major upheaval. Everything and anything, no matter how well established by time or precedent, can be questioned. It’s unlikely that the policy parameters of federal finance for water infrastructure will be unaffected.
At some point the upheaval will end and specific new policy directions will emerge. There’s risk – previously unthinkable proposals to cut much of federal lending for infrastructure are no longer impossible, though still unlikely. But there’s also opportunity.
Recent Congressional Hearing
The U.S. House of Representatives’ Water Resources and Environment Subcommittee recently held a hearing, “Water Infrastructure Financing: WIFIA and the Clean Water State Revolving Fund,” that highlights some of the dynamics of the current situation. One notable exchange between Rep. Garamendi (D-Calif.) and Rep. Knott (R-N.C.) captured what I think is the fundamental tension driving the federal upheaval.
Rep. Garamendi used his time, not for questions, but to forcefully argue that the extent of the current administration’s funding cuts and downsizing at the U.S. EPA and U.S. Army Corps of Engineers render discussions of improvements to WIFIA and other federal water financing programs pointless. Who can tell what’s under the chainsaw next? Pushback on the overall direction of federal policy is what’s required.
Rep. Knott replied, with equal force, that it’s time to recognize that federal resources have become critically constrained. Fixing crumbling water infrastructure and ensuring clean water are of course priorities, but the old approach of simply expanding federal program funding and staff levels hasn’t worked and can’t be continued.
The Representatives’ viewpoints appear to be completely opposed. But in fact, they agree on one thing: the federal upheaval is real. This means the approach to developing federal water financing policy and resource allocation needs to be re-examined. Only then is there a context for specific arguments to defend program funding or to propose specific program modifications.
White House’s FY2026 budget request could see SRFs reduced by 90%
A Process of Questioning
What would such a re-examination look like? We can use two observations from the same hearing’s expert witnesses to illustrate how the process might work – and how it could lead to a realistic proposal in a new federal policy world.
One witness, Mike Matichich of Jacobs Engineering (representing the U.S. Chamber of Commerce) listed the many strengths of WIFIA in his testimony. Regarding possible improvements to the loan program, he suggested enabling WIFIA to offer smaller borrowers interest rates at about a 35% discount to the program’s current U.S. Treasury statutory baseline. The goal of such sub-UST rates would be to make WIFIA loans more accessible to smaller projects and to allow WIFIA to match some of the loan terms that SRFs routinely offer.
Matichich is certainly correct about WIFIA’s strengths and that sub-UST rates are a powerful tool that should be considered. But here the questioning must begin. Relative to the credit subsidy funding required for WIFIA’s high quality loans with UST rates (about 1% of loan amount), loans with sub-UST rates are very expensive. In effect, such loans have a grant component of as much as 10% to 20% of initial principal. Is WIFIA set up, in terms of procedures, staffing, or experience to award a multiplicity of small grants? A lot of information and analysis is required to determine the credit worthiness of projects that need a sub-UST financing rate to proceed. Is heavy-duty risk management a current WIFIA strength? Sub-UST rate loans will undoubtedly be popular. But if program funding is limited, what are the policy principles by which this scarce resource will be allocated? And so on.
Another expert witness, Jeff Walker, representing the Council of Infrastructure Financing Authorities (a major SRF advocacy group) as its immediate past president, pointed out in his testimony that the decentralized, state-level nature of SRFs is a major strength, relative to federally centralized bureaucratic management. I think that’s especially true when dealing with smaller borrowers and smaller projects that need more heavily subsidized financing. In those cases, local knowledge, prioritization, customization and risk management all go a very long way toward an efficient and cost-effective allocation of resources.
But again, we must ask questions. SRFs need much more financing capacity to meet the huge challenges of U.S. water infrastructure renewal. More lending capacity means more SRF capitalization. Must 80% of this come solely from federal grants? Most SRFs are either sub-optimally leveraged or not leveraged at all, despite having access to the tax-exempt bond market. There are no intrinsic or prudential reasons for this; explanations are found in operational factors like staffing and scale. The net effect is that a dollar of federal funding is far less effective in terms of additional financing capacity than it could be. Yes, decentralization may mean more efficient local lending to small borrowers, but does it necessarily entail inefficient capitalization? And, again, so on.
To be clear, both witnesses are fundamentally correct in their observations: WIFIA sub-UST rates ought to be considered as a powerful tool, and SRFs’ decentralized nature ought to be seen as a major strength. In pre-upheaval times, that might have been enough to get the ball rolling. Questions about potential weaknesses or inefficiencies would have been seen as minor technical matters to be dealt with later by the agencies or programs.
But in our post-upheaval world, detailed questioning of federal economic actions, current and proposed, will almost certainly take a more central role in policymaking and allocation of resources. Fortunately, water infrastructure is so obviously a national public good that federal involvement itself will remain unquestioned. And finance is so critical to infrastructure renewal that deploying indisputable federal strengths in this area also has a generally strong case. But details about specific proposals regarding program strengths (or weaknesses) and efficiency (or inefficiency) will matter. Proposals for modifications or increased funding that address questions from the start about why the federal government should be involved and how the action is cost-effective will have a better chance in the new world.
Going Forward: An Opportunity to Re-Propose Sub-UST Rates
The process is not all a defensive grind. Questioning also provides an opportunity to develop and present an innovative or compelling solution. This can be illustrated by connecting the two topics raised at the hearing, WIFIA sub-UST rates and SRFs. I’ve written about the connection here before. There are two main background elements of the story.
First, WIFIA has become a remarkably successful loan program primarily because it lends to large water agencies for low-risk projects. Since such agencies generally have high investment-grade ratings, WIFIA’s credit subsidy funding requirements are very low relative to loan volume and even federal transaction processing is relatively efficient. But these agencies typically issue in the tax-exempt bond market, so WIFIA’s UST-based loans don’t really represent much of an interest cost saving. Instead, applicants are attracted by WIFIA loan features (interest rate risk management, long loan term, repayment flexibility, etc.) that can’t be easily found in the bond market. In effect, WIFIA’s strength is in developing loan features that can be efficiently and cost-effectively deployed in low-risk loans to highly rated borrowers.
Second, WIFIA’s current loan features, which largely benefit borrowers with construction programs, aren’t that important to SRFs. This likely explains why uptake on the SWIFIA section of WIFIA, added in 2018, has been limited to a few large SRFs that already leverage with tax-exempt debt. Sub-UST rates for SRFs were proposed in the original SWIFIA bill, but not with the aim of improving the funds’ capital efficiency. Rather, the purpose was to provide additional federal capital to small SRFs apparently disadvantaged by the current population-based allocation formula – no doubt a well-intentioned goal, but a bit of a backdoor method. Unsurprisingly, the proposal got serious pushback on the arbitrary nature of sub-UST eligibility and the unjustified cost. It was ultimately dropped without much of a fight, which strikes me as an indication that even the proposal’s advocates might have thought the criticisms were somewhat accurate.
Proposals for modifications or increased funding that address questions from the start about why the federal government should be involved and how the action is cost-effective will have a better chance in the new world.
But the policy world has changed since 2018, and the same idea can be put in a very different light. Now, the purpose can be explicitly to encourage the efficient leveraging of SRF federal resources by adding a capability to WIFIA, a successful federal program that has a proven track record in deploying unique loan features to highly credit-rated borrowers. There’s nothing arbitrary about eligibility based on sub-optimal leverage.
Now, the cost of sub-UST rates can be evaluated in connection with a measurable outcome in terms of reduced federal grant resources required for a given increase in SRF lending capacity. Evaluating the overall federal outcome shows that sub-UST rates for SRFs might be very cost-effective (more detail here).
And now, WIFIA sub-UST rates can be proposed as a specific, time-limited action intended to help meet the challenge of US water infrastructure renewal while recognizing federal constraints by utilizing existing federal programs with proven strengths. If sub-UST rates incentivize SRFs to overcome operational constraints on efficient capitalization, SWIFIA uptake and SRF leverage will increase. Since these are also measurable outcomes, sub-UST rates can be extended or modified on that basis. If not, the loan feature should expire, and the experience can be used to explore other possible solutions.
Perhaps most importantly, this way of looking at and proposing WIFIA sub-UST rates for SRFs could provide a rare patch of common ground in a government policy process undergoing upheaval. Returning to the exchange in the hearing described above, a proposal that explicitly emphasizes the strengths of existing federal programs is consistent with the kind of anti-chainsaw pushback that Rep. Garamendi wants to see. But at the same time, a proposal to make limited federal resources go further by efficiently utilizing those strengths to achieve an important national objective ought to be more than acceptable to Rep. Knott. Finding that common ground is the real value of policy development that starts with a process of questioning.
John Ryan is principal of InRecap LLC, focused on debt alternatives for the recapitalization of basic public infrastructure. Ryan has an extensive background in structured and project finance, and recently served as an expert consultant to the U.S. EPA. He is a frequent contributor to WF&M on EPA’s WIFIA loan program and related topics.
A timely article that offers a number of useful insights. One point of clarification is that my suggestion in my testimony in the House hearing of lower WIFIA interest rates was for small applicants, not for small projects. I agree that the SRF program is in a number of ways better suited than the WIFIA program for small projects. For the WIFIA program, small applicants are defined as applicants with service populations of 25,000 or less. It is my experience that many communities with service populations less than 25,000 have individual projects or combinations of projects with capital costs of $50-100 Million or more. These communities need relief from the Treasury interest rates because the treatment works these small communities need don’t typically have access to the scale economies that larger systems do. The WIFIA program provides the opportunity for loans of up to 80% of eligible project costs for these small applicants but the Treasury rates, currently above 4% interest, present affordability challenges for these applicants even with the repayment flexibilities of the WIFIA program. The reduced interest rate for small applicants suggested in my testimony would bring the interest rate for WIFIA loans closer to the range that many states offer for SRF loans. The lower WIFIA interest rates would help address the fact that per-capita costs for the required capital programs needed by small communities are typically higher than for others because scale economies in treatment are not available given the treatment plant capacities needed for these smaller systems.