By John Ryan
Stakeholders of the U.S. EPA WIFIA loan program will recall that the program ran into a serious-sounding issue about correct budgeting a few years ago. The issue arises when a WIFIA loan is made to an infrastructure project that has some degree of federal involvement. Federal activities cannot receive the same Federal Credit Reform Act (FCRA) budgetary treatment that WIFIA invariably uses for its loans. How was the program ensuring that loans for federal activities were excluded from its FCRA-based budget?
Since this question didn’t have a clear answer at the time, Congress in late 2019 instructed WIFIA, jointly with OMB and Treasury, to develop classification criteria to distinguish loans that could receive FCRA treatment and those that could not, due to federal involvement in the project being financed. Non-FCRA WIFIA loans, regardless of being completely eligible in every other way, would become ineligible due to the application of the criteria.
Apparently, there was some delay in producing the classification criteria by the spring 2020 deadline. Congress, through the appropriations process, took a surprisingly hard line on the matter and threatened to effectively defund the program. That got some media attention. But the criteria were duly published shortly thereafter, threats withdrawn, and the expected WIFIA appropriations delivered. By the end of 2020, the issue was apparently resolved.
Not There Yet
In fact, the outcome of this issue in 2020 was closer to truce than a permanent solution. The correct budgetary treatment of WIFIA loans to projects with federal involvement is not a settled matter. WIFIA’s current classification criteria can basically be ignored by state and local drinking and wastewater agencies. This sector forms the vast majority of WIFIA’s applicants to date and is represented by the program’s original advocacy groups. It’s not surprising that they’d be willing to accept a quick (and to them, largely irrelevant) fix to keep the program funded. But that’s not the case for those water infrastructure sectors where federal involvement, due to history or scale, is a constant factor. Projects in these sectors have to date not been frequent WIFIA applicants. But they’re clearly eligible for loans in WIFIA’s statute and would significantly benefit from their features. Yet the program’s non-statutory budget classification criteria could effectively render many of them ineligible.
The issue is now highly focused due to the recent funding and 2022 implementation of rules for the USACE’s Corps Water Infrastructure Finance Program (CWIFP), a section of the WIFIA statutory framework. CWIFP projects will frequently have some active or historical federal involvement, and the FCRA issue could be especially restrictive to this program’s application volume.
The inadequacy of WIFIA’s current criteria has been recognized by CWIFP stakeholders. In June 2022, The Water Infrastructure Finance, and Innovation Act Amendments of 2022 (HR 8127), was introduced in Congress. Section 7 of this bill proposes a simple statutory fix to the FCRA issue based on the non-federal sources of loan repayment. In the bill did not pass in the prior Congress but will almost certainly be re-introduced. Hearings and debate about such a legislative fix are likely in 2023.
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WIFIA’s Current FCRA ‘Criteria’
In June 2020, the currently applicable criteria were published in the Federal Register as WIFIA Criteria Pursuant to the Further Consolidated Appropriations Act, 2020. Even on the surface, there appears to be an intrinsic difficulty in using them. Despite the Congressional directive language and the Federal Register title, these are not in fact ‘criteria’, but eighteen questions that imply criteria being applied offstage. What was the reason for this somewhat non-transparent approach? Does this reflect some uncertainty at OMB and EPA about how the criteria are supposed to work, other than giving WIFIA the ability to reject a project application with practically any degree of federal involvement? A recent GAO report describing OMB’s thinking about this FCRA issue is consistent with this interpretation. Perhaps also the huge pressure to get something published by a deadline was a factor?
Correct FCRA classification is important and there’s nothing wrong with asking a federally involved project applicant to provide more information. But for the practical purpose of efficient classification by the program – and, perhaps more importantly, self-screening by project applicants – OMB’s questions don’t shed much light on how the information will be used to determine FCRA treatment in specific cases because the evaluation criteria are only implied, not stated. Trying to guess the criteria OMB is using from the questions simply makes an inherently difficult process even more complicated and less predictable.
Six Explicit Criteria Based on Primary Sources
As an alternative, it should be possible to develop explicit FCRA criteria based on the same sources that Congress directed EPA and OMB to use in 2020. These include FCRA law of course, but the primary source is what FCRA law itself was ultimately based on, the 1967 Report of the President’s Commission on Budget Concepts. Related and more recent reports from the CBO and GAO on federal budgeting also shed light on the FCRA issue.
The budgeting principles that surfaced in those reviews are clear, consistent with each other, and precisely applicable to the FCRA non-federal issue. The necessary FCRA criteria for federally involved projects – I think there are six – seem to flow naturally from them. If my interpretation of them is incorrect, at least this approach provides a more defined framework for future development than OMB’s questions alone.
There are two key principles from the 1967 report. The first, and most fundamental, is that any federally connected economic activity not subject to external, non-federal discipline should be included in the federal budget. The second, central to FCRA, is that federal program loans require separate treatment in the budget because they include a repayment obligation and most of the loan’s cash flows will reverse over time. FCRA methodology essentially excludes the loan’s reversing cash flows and includes only the net amount as a subsidy in the cash-based budget. Implicit in this methodology is that the reversing cash flows can be properly excluded from the cash-based budget solely because they are subject to external, non-federal discipline. If they are not, the loan can’t be included in the budget’s separate FCRA section – in effect, the first principle prevails. I think this is precisely what FCRA law intended in its definition of a direct loan to a “non-Federal borrower under a contract that requires the repayment…”
With these two principles, FCRA screening criteria can be narrowly focused on the substantive borrower and (more importantly) the substantive source of repayment. Who benefits from the loan and who is obligated to use their resources to repay it? In the real-world of infrastructure non-recourse project finance, the two are usually the same. The first and most fundamental criterion is very simple — loan repayment must come from a non-federal entity using non-federal resources for that repayment.
Even in a complex project financing, the source of loan repayment will be explicit, thoroughly documented and extensively analyzed (e.g., by rating agencies). This criterion should produce an unambiguous result quickly and efficiently using easily accessible information. Secondary criteria focused on the independence of the repayment decision and the connection between loan benefits and repayment sources can be used to refine the evaluation in equally efficient ways. Optional criteria can confirm that a loan’s FCRA treatment will not interfere in other program eligibility standards or policy objectives and that the federal participant’s budget will be consistent with the results. These explicit, principle-based criteria should produce predictable and unambiguous results, allowing potential applicants to self-screen effectively.
Here is the list, with reference to the principles behind each:
1). There must be a substantive obligation to repay the loan.
According to the 1967 Report, the distinguishing characteristic of a loan and the basis for its separate (i.e., eventually FCRA) treatment in the federal budget is the obligation to repay. This obligation must be defined and substantial – if it’s not, the loan is effectively a grant and not eligible for FCRA treatment. Obviously, a creditworthy WIFIA loan will automatically qualify for this one.
2). The substantive obligation to repay the program loan must be from a non-federal entity using non-federal resources.
In the 1967 report, the core principle of budget inclusion for an activity is the fact that it is not ‘subject to economic disciplines of the marketplace’ and hence must be subject to the internal discipline of the federal budget. For the FCRA non-federal issue, the term ‘marketplace’ is logically expanded to include non-federal economic actors like local or regional communities and their agencies. The external discipline principle can be extrapolated to FCRA: If a program loan’s repayment cash flows (net of subsidy) are not subject to the discipline of non-federal entities deciding to use their non-federal resources to pay them, then those cash flows are federal and must be subject to the internal discipline of the cash-based budget. The substantive non-federal obligation to repay is the key factor, not the nominal characterization of the borrower.
3). The substantive obligation to repay must be an independent decision by the non-federal entity and not compelled in some way by the federal government.
If the use of federal sovereign power is subverting the external discipline that non-federal entities would otherwise bring to bear on an activity, then the activity becomes federal and should be subject to the internal discipline of the federal budget. If the activity in question is a program loan, it shouldn’t be eligible for FCRA treatment. This is consistent with a CBO report’s scoring criteria about the exercise of federal sovereign power. But for FCRA, it should be interpreted precisely in connection with the non-federal entity’s decision to repay the program loan. If a federal participant uses sovereign power to help create or even enable a very useful project, that does not necessarily determine that a non-federal entity will agree to repay financing associated with it.
4). The non-federal entity obligated to repay the loan is also the primary beneficiary of the capital improvements financed by the loan’s proceeds.
Unless there is an explicit statement of philanthropic or patriotic intent, it probably can be safely assumed that a rational non-federal entity will only agree to repay the program loan for its own benefit. But I think for federal infrastructure loan programs, which primarily finance specific capital expenditures, confirmation of this can (and should) be made more explicit, especially in the case of large multi-part projects. There should be a more-or-less direct connection between the use of loan proceeds for construction of those parts of the project benefiting a non-federal entity and the same entity’s obligation to repay the loan. Notwithstanding any eminent domain power, scale economies, or efficiencies that a federal participant might bring to the project, the benefit-cost metrics of a large basic infrastructure project are necessarily limited by physical reality and the cost of construction. Connecting the use of program loan proceeds and the non-federal entity’s benefits will help ensure that there’s some rough parity between the two, and that the non-federal entity’s decision to repay is substantive in terms of the allocation of real resources.
5). FCRA treatment should be evaluated independently of the loan program’s other federal policy objectives, eligibility requirements or selection criteria.
The 1967 Report makes it clear that FCRA is a unique section of the federal budget and intended for a very specific purpose. Its only policy objective is to ensure that a loan’s non-federal repayment cash flows don’t distort the cash-based federal budget. FCRA decisions shouldn’t influence, or be influenced by, other loan program factors. FCRA treatment shouldn’t be used as an indirect way to insert new selection criteria about a project’s overall level of federal support, change the program’s statutory eligibility requirements, or reinforce unrelated federal budgeting objectives like legislative scoring.
6). FCRA treatment for a specific loan must be consistent with the federal participant’s budgeting treatment for all equivalent project non-federal debt.
Notwithstanding a FCRA decision’s siloed position within the program for a specific loan, it should be consistent with the federal budgeting by the federal participant for other project debt with equivalent terms (e.g., purpose, security, seniority, source of repayment, recourse to the project, etc.). If the federal participant is properly including such equivalent debt in its cash-based budget, that indicates that the debt’s repayment is not subject to external discipline. The program loan should not be differentiated in this respect just because it comes from a federal loan program and FCRA treatment should be disallowed. Likewise, if the federal participant is properly excluding the project’s equivalent debt in its cash-based budget, a program loan should receive FCRA treatment. To put it more generally, to avoid double counting and budget gaming, all the federal agencies involved in a project should have the same position on whether the repayment of the project’s debt is subject to external discipline and therefore may be excluded from the federal cash budget. FCRA treatment for a program loan to the project (if one is applied for) is just an extension of this position for a federal lender. If the project is issuing tax-exempt bonds (which can’t have a direct or indirect federal guarantee, per IRC 149 (b)), the IRS’s position should also be consistent with federal budgeting because the same basic principles apply in this case.
Interpreting EPA and OMB’s 18 Questions with the Six Explicit Criteria
With these six FCRA criteria, EPA’s and OMB’s questions can be interpreted in a focused way that will guide a potential WIFIA applicant to provide the information necessary for determining correct FCRA treatment for the proposed loan. Since the explicit criteria are based on the same sources that EPA and OMB were directed to use, they should be consistent with the implied criteria being used for final decisions about a loan’s budgetary treatment. If a loan applicant encounters an unexpected result, these explicit criteria can also be used as the basis of an appeal. Until there’s a better (perhaps statutory) solution, using explicit, principle-based criteria may be the most practical way for WIFIA and CWIFP loan applicants to address the FCRA issue.
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.
