The WIFIA Loan Program Can Go Far. It Should Go Together.

By Chad Praul & John Ryan

“If you need to go fast, go alone. If you need to go far, go together.”

Classic proverbs about everyday life aren’t usually relevant to topics like innovative federal financing for U.S. public infrastructure renewal. But here’s an exception:  the U.S. EPA’s Water Infrastructure Finance and Innovation Act (WIFIA) loan program has rapidly developed an independent niche in the debt capital markets for large, highly rated public water agencies. That’s an impressive achievement and a solid foundation for future growth. Yet the program needs to go much farther to realize its full potential. As the proverb says, when you need to go far, go together. In WIFIA’s case, that means going together with other sources of policy and impact-oriented infrastructure finance that are headed in the same direction.  And one of the best ways for the program to work together with innovative capital is already in WIFIA’s toolbox – the capability to provide U.S. federal guarantees on loans and bonds.

A Fast Start, But with Narrow Impact

WIFIA has already followed the first part of the proverb, moving fast and alone to establish its credibility as a new federal program. Since WIFIA became operational in 2018, it has successfully sourced and executed a loan and loan commitment portfolio of $13.3 billion to date, almost exclusively with large and highly rated U.S. public water agencies that are financing basic infrastructure renewal projects. This is a particularly surprising outcome since these agencies, with an average long-term credit rating of Aa3/AA-, have very cost-effective financing alternatives in the tax-exempt municipal bond market. WIFIA was able to compete successfully with this well-established debt capital market by essentially offering one unique thing and doing a great job delivering it – costless interest rate management for lengthy infrastructure construction project periods.

Offering a uniquely valuable product to highly qualified borrowers is a great way to start up a new federal financing program. However, the impact is almost certainly very narrow. A costless interest rate option doesn’t have the scale or catalytic nature that can enable an investment in infrastructure that wouldn’t have happened anyway. Instead, the most likely outcome is a slight overall reduction in the cost of a project’s financing, which in turn likely results in a slight decrease in future water rates. Again, this is not a bad outcome – public infrastructure agencies need all the federal support they can get. But it’s not enough to achieve WIFIA’s bigger mission.

Sharing Uncertainty is the Mission

Uncertainty is at the core of the climatic, environmental and social challenges that are impeding U.S. public infrastructure renewal. Compared to the post-WW2 era when most of our current public infrastructure stock was designed and built, a much higher level of uncertainty and risk will simply need to be incorporated in project design and funding decisions if large-scale infrastructure renewal is going to happen.  But that does not mean that the local community or agency jurisdiction of each project must bear the full brunt of its potential cost. Uncertainty and risk can be shared among a much broader group of stakeholders in U.S. infrastructure renewal. Facilitating such sharing for the US water sector defines WIFIA’s fundamental purpose.

Going Together

As you would expect for a well-managed federal program that’s had a great start, the U.S. EPA and WIFIA recognize that the program must develop more impactful loan products. A recent EPA press release about WIFIA’s current round of selected projects describes the program’s loans as “innovative financing tools” and highlights several private water companies and smaller communities as borrowers. EPA and WIFIA are open-minded to innovation and are headed in the right direction to accomplish a bigger mission. 

It’s a long and challenging road, however. There’s no doubt that EPA and WIFIA can rely solely on federal taxpayers and in-house expertise. But going alone is neither necessary nor optimal in this case. Perhaps exactly in response to the increase of uncertainty and risk in the infrastructure sector, there’s now a very large and growing pool of investment capital that is willing to share that uncertainty and is able to design the tools to do it effectively. 

The scale of this pool of capital is now in the trillions of dollars, much of it directed towards debt financing. There is an overlapping range of segments specializing in specific issue areas and a spectrum of appetite for uncertainty and risk. Climate bonds are a particularly large segment, as is the generalized ESG-oriented investment field. But one segment may be especially relevant to WIFIA’s mission, impact capital. Impact investors are focused on measurable real-world outcomes. As such, their investments, usually in the form of an environmental or social impact bond, are necessarily somewhat customized to specific situations, exactly as WIFIA’s loans are.

Moreover, in contrast to typical market participants, profit maximization is not the sole or even predominant objective of many impact investors. Instead, they’re seeking the same or similar types of beneficial environmental and social outcomes as WIFIA itself. Obviously, WIFIA’s policy rationale as a federal program discourages competition with this source of capital. But the Program shouldn’t ignore it either.  Impact investors are effectively another stakeholder group willing to share the uncertainty and provide expertise for innovation, especially on the financial technical aspects. WIFIA and impact investors are on the same long road – why not go together?

Developing WIFIA’s Federal Guarantee Capabilities

The most immediate approach by which WIFIA and impact capital can work together is to develop an as-yet unutilized tool that’s already within WIFIA’s statutory authority – the ability to attach a U.S. full-faith-and-credit guarantee to an investor-owned loan or bond. In contrast to a direct loan funded by the U.S. Treasury, a federal guarantee can be designed to cover only specific uncertainties and risks, leaving all the other with the investors. There’s much scope for optimization with this tool because risks can be precisely allocated to the party best suited to handle them. A WIFIA guarantee can allocate a relatively low-risk baseline to federal taxpayers, creating an investment framework on which investors can add innovative performance and outcome-oriented features. The approach is best illustrated with a few examples:

  • Principal-Protected Impact Bond: For many environmental or social issues in the water sector, a minimal level of funding or revenues may be relatively certain over the long-term (e.g., lead pipe replacement programs) but the precise timing, returns or outcomes are still very uncertain at the outset. A WIFIA guarantee for a principal amount (based on the present value of minimal funding) can be the basis of a principal-protected environmental or social impact bond where the risk of faster repayment, upside return or positive outcomes can be borne in innovative ways by the investors. Principal protection will be especially attractive to philanthropic impact investors who have wide latitude for outcome-based returns as long as the repayment of principal is assured.
  • Long-Duration Climate Resilience Bond: Climate adaptation for U.S. water infrastructure involves decision that must be made today for an additional investment that will have value only decades in the future. Long-duration financing (outside the typical bond market limit of 30 years) can help extend and match the funding requirements with the timeframe of maximum utility. A WIFIA guarantee on principal and minimal interest of a 40-year bond will certainly ensure the marketability of the instrument and provide a valuable imprimatur of EPA validation. But perhaps more importantly for innovation, a WIFIA-guaranteed climate bond can also be customized to include features (e.g., performance returns based on actual future climate conditions) for investors interested additional risk sharing or hedging other investments. WIFIA is well positioned to facilitate such developments, including some role for federal taxpayers as well.
  • Impact Fund Capitalization: Perhaps the most potentially effective way a WIFIA guarantee can be used is to support the capitalization of impact funds that make loans to smaller borrowers for small-scale projects and programs. WIFIA can take a portfolio perspective on the uncertainty and risk of the loan commitments to be included in the fund. Those that a federal lender is well-suited to absorb (a baseline of principal and interest repayment, perhaps expanded by specific policy objectives) can be covered by the WIFIA guarantee. This brings the value of diversification and scale economies to bear on fund capitalization, and efficiently leverages the innovative performance features that the fund’s impact investors seek to offer. And apart from the financial efficiencies, WIFIA will achieve a broader and more diverse range of policy outcomes, especially to smaller borrowers and highly innovative pilot projects. In turn, the fund will benefit from EPA’s involvement, both directly from expertise and indirectly through a highly credible validation.

Conclusion

The EPA’s WIFIA loan program is poised for growth – and as importantly, it’s headed in the right direction. Impact investment is on the same road. There are clearly plenty of purely financial and theoretical reasons that the two should work together towards common objectives while bringing different strengths to bear. But the classic proverb adds an overarching aspect to this – we need to go far to enable the right outcomes for U.S. water infrastructure renewal. It’ll be a long and difficult journey, but the destination is important. Go together.


Chad Praul, P.E., is director of the domestic portfolio at Environmental Incentives, a small business that empowers people to improve the impact and effectiveness of environmental policy and programs. He has management experience developing conservation strategies for regulatory and restoration programs and major environmental organizations.

John Ryan is principal of InRecap LLC. 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 WIFIA topics.

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