By John Ryan
The WIFIA Loan Program recently announced that it has reset the interest rates on two undrawn loan commitments originally made in mid-2018. The fixed rate on a $135 million loan to Orange County Water District and a $614 million loan to San Diego Public Facilities Financing Authority (PFFA) were reset downward from about 3.1 percent and 3.3 percent, respectively, to around 1 percent, reflecting the steady decline in the Treasury curve since the loans’ first-rate setting.
Is this a big deal?
The reported numbers are certainly dramatic – the two press releases claim total future interest cost savings aggregating over $370 million. The discounted present value of these savings is probably closer to about $270 million, but that’s still huge relative to the loan amounts.
It’s Complicated
If this sounds too good to be true, it’s because…the reality is more complicated. These eye-popping numbers are based on the implicit assumption that without the reset the WIFIA loans would certainly have been drawn at the original rates and not prepaid at any point. That might be true for borrowers who have no alternatives, as in the classic image of visionary but impecunious developers relying on loan programs for innovative projects. But not only does WIFIA require a minimum rating of investment-grade, these two borrowers in particular are very highly rated public water agencies. This type of borrower frequently uses short-term financing for construction and keeps the undrawn WIFIA loan commitment as a long-term hedge. The fact that it’s undrawn means a reset doesn’t cost federal taxpayers anything because the U.S. Treasury hasn’t yet funded the loan.
But it also means that such a borrower can still consider alternatives for drawn financing. And they do – constantly. Highly rated water agencies typically issue in the muni bond market. After the COVID-19 liquidity scare earlier this year, that market is wide open again for high-quality paper – especially water revenue bonds. If WIFIA had not done the reset, there’s not the slightest chance that either of these sophisticated water authorities would have forgone selling tax-exempt bonds to eager buyers at slightly over 1 percent and instead drawn their 3-plus percent WIFIA loan commitments. Yet, the giant savings numbers assume that they would do just that.
Still, the reset WIFIA loan does provide significant value. It’s exactly as if both borrowers had simply cancelled their original commitments in 2019 and went through the WIFIA process again for a planned closing that reflected current, much better rates. The value of the reset loan is the same as for any other borrower executing a new WIFIA loan commitment under current rates. Very roughly, that present value is currently about 15 to 18 percent of the WIFIA loan amount for highly rated borrowers, or well over $100 million for both loans in aggregate, relative to their muni alternatives. This is better than the WIFIA benefit level in 2018 (when muni and Treasury rates were closer), so OCWD and SDPFFA have definitely improved their WIFIA alternative by updating their loans to reflect both lower absolute rates and higher relative value. But the core of the story is that current WIFIA loan benefits are a great deal. The reset itself is not the source of this value – it’s only an efficient transactional pathway that reduced cost and uncertainty by combining a cancellation and re-processing into one step.
On a transactional level, the reset story is pretty straightforward, notwithstanding the understandably simplified reporting: WIFIA loan benefits are especially good right now and the WIFIA Program is very effective at delivering them, even when that requires an innovative approach.
Value and efficiency. See?
Infrastructure loan programs do work. That deserves a press release or two. Make sure that Congress gets a few copies.
A More Fundamental Story
On a more fundamental level, however, the story doesn’t end there. The resets also raise the kind of question that successful private-sector lenders don’t need to answer but successful federal loan programs do: What exactly is the national-level purpose of efficiently delivering significant loan benefits to highly rated public water authorities? Is it limited to improving or accelerating physical water infrastructure? Or is it more generally to improve the water authorities’ fiscal situation, something that can redound to the benefit of a local community but may or may not impact its physical water system? If both, then in what proportion or priority? There likely are or could be good public policy answers to all of these questions, especially in the context of COVID-19 economic recovery and federal assistance to hard-pressed state and local infrastructure agencies. But the mission should be clarified. The reset transactions are an opportunity to start that process.
The classic understanding of the program’s mission is all about improving physical water infrastructure. It’s easy to imagine how initial WIFIA loan commitments might influence decisions about water project design or schedule. Those commitments are made when project construction hasn’t yet started or is at an early stage. Even for a highly-rated water authority, the unique features of a WIFIA loan relative to muni bonds might make a longer construction phase or an extended loan term appear more cost-effective. The loan’s lower debt service might allow some enhanced technology to be squeezed into the project’s budget. Or, simply prompt an earlier project start date. None of these things may be critical for the project going forward, a hardline interpretation of the mission. And it’s possible that WIFIA loan benefits in specific cases might be directed towards lower water rates instead. But at this stage in the project there’s a clear potential connection between the WIFIA loan and some positive impact on the project itself. That’s classic enough, yes?
In the same way that water infrastructure isn’t built simply to be financed, WIFIA doesn’t exist simply to make loans.
Resetting the rate on an existing WIFIA loan commitment, however, doesn’t fit easily within even this flexible mission interpretation. When a reset occurs, construction has been proceeding for several years and project plans are presumably fully finalized. There will have been a big change from original assumptions on one major project cost component, interest rates – now they’re significantly lower. Current debt market alternatives are also much better than the original WIFIA loan commitment. A reset to current rates is required to make the WIFIA loan competitive with them. But why is this necessary? The original loan commitment already did its job in helping launch the project. The fact that that turned out to be an undrawn standby role because interest rates fell doesn’t change the positive influence that the WIFIA loan commitment might have on project design or schedule at the time it was made. And now that the market can deliver a ton of unexpected savings compared to original financial projections, does the project need any more assistance? Hasn’t the mission been accomplished?
A Bigger Mission
Maybe it’s actually a bigger mission. In the same way that water infrastructure isn’t built simply to be financed, WIFIA doesn’t exist simply to make loans. Both the loan program and the infrastructure it finances belong in the context of their ultimate purpose – better water resources for communities. And “better” means a lot of things that can be accomplished with the type of specialized features that a federal loan program can deliver cost effectively. For physical infrastructure, a lower cost of financing can mean more timely, efficient, technologically advanced, resilient and greener projects, at least on the margin.
But the cost savings from a WIFIA infrastructure financing can also be directed to the community itself: making water more affordable and ensuring equitable access to it, training and job security for water personnel, catching up on system-wide deferred maintenance and likely many other uses not directly related to the financed project itself. This is permissible – WIFIA requires that loan proceeds must be spent on a project’s qualified capital expenditures, but loan benefits, which are relative to each borrower’s alternatives (e.g. munis) have no strings attached. Since almost all WIFIA borrowers are local public-sector agencies, private-sector windfalls are unlikely – if the cost savings don’t go into the project, they’ll end up elsewhere in the agency’s service community.
It’s likely that the potential $100 million-plus cost savings that OCWD and San Diego got from the WIFIA resets will be used, at least in part, for something other than improving their specific projects. It’s also likely that the classic infrastructure mission is not being strictly followed in the many other WIFIA loans that won’t need a reset when rates stabilize or rise – it’s just more obvious in the reset ones. But the “bigger mission” – benefits directed toward infrastructure and community in accordance with local prioritization – is clearly a good outcome. For COVID-19 local economic recovery, it’s probably a better mission than the classic one. A bigger mission clearly is permitted and already quietly occurring. Why not embrace it?
John Ryan is principal of InRecap LLC. InRecap is focused on debt alternatives for the recapitalization of basic public infrastructure. John has an extensive background in structured and project finance. He recently served as an expert consultant to the U.S. Environmental Protection Agency. He has written a series of recent articles for WF&M on the WIFIA program. Views expressed in this article are solely those of the author.
