Silicon Valley Bank, Interest Rates & WIFIA

By John Ryan

Rapidly rising interest rates were a primary cause of Silicon Valley Bank’s collapse. Its multiple consequences will almost certainly mark the start of an extended period of interest rate volatility. The Federal Reserve is steering a narrow course between taming inflation and inflicting economic damage.  That’s not easy in an increasingly unpredictable economic, social, and geopolitical environment, as SVB’s sudden meltdown shows. The ride is not likely to be smooth.

Interest rates are of course a key factor in financing long-lived infrastructure projects, both in terms of absolute level and reasonable predictability. In the same way that SVB’s portfolio of high-quality, long-term bonds lost a significant amount of market value when rates rose, the net value of a project will fall when the cost of its long-term financing rises. But that’s not necessarily the main problem. The impact of rising rates can be mitigated by adjusting the project’s financing and funding plan if the rise is relatively gradual and predictable. When rate changes are sudden and unpredictable, however, planning needs to be a lot more cautious, which may result in project delays or even cancellation. Wasn’t U.S. public infrastructure renewal hard enough already?

The Value of WIFIA’s Interest Rate Management Features

Volatile interest rates and an uncertain economic environment highlight the value of loan features offered by the EPA’s WIFIA Program. Federal loan programs are often simply seen as a source of ‘low-cost’ financing, and in many cases that’s basically true. But the U.S. Treasury-based rates offered by WIFIA and related infrastructure loan programs like TIFIA and CIFIA are only ‘low’ relative to debt market alternatives (which are closely correlated to Treasury yields) at a particular point in time.

The real value of WIFIA loans for infrastructure financing cost management is more subtle than just a slightly lower rate than a municipal bond on the day of execution. WIFIA loans have five features that provide predictability and optionality, which can help make project financial planning easier:

  • No exposure to market credit and liquidity spreads: WIFIA’s Treasury-flat interest rate is historically close to the yield on an equivalent tax-exempt bond.  But all debt market alternatives will have credit and liquidity spread components that are sensitive to market conditions. In a volatile economic and financial environment, an unexpected event (e.g., SVB’s collapse and possible contagion) could increase spreads dramatically. A WIFIA borrower is still exposed to underlying U.S. Treasury volatility prior to loan execution, but at least the unpredictable spread factor is eliminated.
  • Penalty-less construction drawdown rate lock: A WIFIA loan can be flexibly drawn during the project’s construction period, always at the single fixed interest rate locked at loan execution for the post-completion permanent financing. At a minimum, the rate lock is a costless hedge. But since a WIFIA loan commitment can be cancelled without penalty, and any principal balance pre-paid at par, a borrower with efficient financing alternatives can use the rate lock as an interest rate option. A costless option on long-term financing in a volatile environment is a great deal, to say the least.
  • Rate lock reset: What goes up will come down. If long-term rates fall after loan execution but prior to any construction drawdowns, WIFIA can re-execute the loan and reset it with a lower rate. The Program is not statutorily required to do this but has done so frequently in the past few years — the feature is effectively established by precedents.
  • Post-completion debt service deferral: Expect the unexpected. WIFIA routinely grants a 5-year post-completion debt service deferral for loans even if a delay in revenues is not anticipated. The deferral can be seen as a kind of insurance for project funding ‘surprises’ around the time of project completion.
  • Permanent financing term: WIFIA’s current maximum term for post-completion permanent financing is 35 years. Including the construction period, the total term can be around 40 years – significantly longer than 30-year bond market alternatives. This financing term is justified for long-lived projects in any case, but it’s especially valuable in the context of other WIFIA loan features. The loan is prepayable at par anytime, so optionality is increased. WIFIA can customize the loan’s amortization schedule to optimize the structure of the project’s other debt financing. And, more subtly, interest rates on maturities beyond 30 years are based on the ‘Treasury flat forward’ convention, so a longer term does not increase the cost.

For most borrowers, all of these features can be efficiently utilized in a WIFIA loan for a large-scale project. The aggregate value in the context of planning predictability and optionality can be significant –and is certainly better than market alternatives. As I’ve written about in prior WFM articles, some features could be improved: A 55-year maximum loan term would enhance the value of WIFIA’s permanent financing, and adding a Limited Buydown would mitigate interest rate risk during the time between loan application acceptance and execution.  Interest rate volatility and uncertain economic conditions will highlight the value of those changes, too.

John Ryan

John Ryan is principal of InRecap LLC and a frequent contributor to WF&M. InRecap is focused on debt alternatives for the recapitalization of basic public infrastructure. Ryan has an extensive background in structured and project finance. He recently served as an expert consultant to the U.S. Environmental Protection Agency and is a frequent contributor to WF&M on EPA’s WIFIA loan program and related topics.

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