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Kentucky League of Cities Kentucky American Water
2015 Water Infrastructure Summit
WATER INFRASTRUCTURE FINANCING:
WIFIA and P3
Stephen D. Berger
Wyatt, Tarrant & Combs, LLP
(502) 562-7299
October 14, 2015
Water Infrastructure Financing Has a Long History
Yale University recently received 136.20 euros ($153) in interest on a perpetual bond issued in 1648 from Dutch water authority de Stichtse Rijnlanden. The 1,000 guilder-bond ($509), which is written on goatskin, is one of the world’s oldest bonds that still pays interest.
Yale, which has an endowment of $23.9 billion, paid 24,000 euros to acquire the bond in 2003 as an artifact. The university contacted the authority to collect the interest. The bond was issued to pay for a small pier on the Netherlands’ Lek River.
Introduction
Congress has recently been considering several new legislative options to help finance water infrastructure projects, including projects to build and upgrade drinking water treatment systems.
This presentation examines one particular option: the “Water Infrastructure Finance and Innovation Act” (WIFIA) program, which Congress authorized as a pilot program in the Water Resources Reform and Development Act of 2014.
WIFIA is modeled after an existing program that assists transportation infrastructure projects (e.g., highways, bridges, tunnels)--the Transportation Infrastructure Finance and Innovation Act (TIFIA) program. The TIFIA program has most often been used, and the WIFIA program is expected to be used most often, in combination with a Public-Private Partnership (P3) transaction structure.
Potential Benefits of WIFIAProponents of the WIFIA approach, including water utility organizations, cite several potential benefits:
WIFIA could provide credit assistance to large water infrastructure projects that otherwise have difficulty obtaining financing.
Because WIFIA would access funds from the U.S. Treasury, the mechanism could lower the cost of capital for local government or private sector borrowers developing water infrastructure projects.
WIFIA assistance would have much less of a federal budgetary effect than conventional project grants that are not repaid (such as annual federal capitalization grants to SRFs), because only the subsidy cost of a loan (representing the presumed default rate on loans) would be scored. Thus, if only an average 10% subsidy cost is charged against budget authority, a $20 million budgetary allocation theoretically supports $200 million in loans.
To be eligible for assistance, projects must be determined to be creditworthy with a revenue stream for repayment, thus limiting the federal government’s exposure to default and also encouraging private capital investment (for example, via a P3).
Disadvantages of WIFIA
On the other hand, opponents of the WIFIA program, including organizations that represent state environmental agency officials, cite several concerns:
Implementation of WIFIA will not occur until Congress appropriates funds to cover the subsidy cost of the program, which has not yet happened.
Under WIFIA, decision making for financing of water infrastructure projects would shift from the state and local level to federal officials (the EPA, in the case of drinking water projects).
Funding for a WIFIA program would likely have a detrimental effect on federal support for established and successful State Revolving Fund (SRF) programs that provide the largest source of water infrastructure assistance today--for example, the Kentucky Drinking Water State Revolving Fund (DWSRF).
While WIFIA is intended to assist large and costly projects, the majority of water infrastructure needs are for smaller projects. Especially if SRF assistance is decreased, these smaller projects would face significant financing challenges.
The WIFIA program does not now permit the combination of WIFIA funding with tax-exempt bond proceeds.
Local Government Demand for Water infrastructure Projects
The responsibility for providing water infrastructure in the U.S. falls primarily on local governments rather than the federal or state government.
According to the most recent estimates by the states and the federal EPA, funding needs for water infrastructure total $676 billion over the next 20 years.
Local governments thus face formidable challenges in providing adequate and reliable water infrastructure.
Local Government Funding for Water infrastructure Projects
The principal funding mechanism that local government have been using for water infrastructure is the issuance of tax-exempt municipal bonds, including SRF loans funded in part by tax-exempt bonds issued by state government finance authorities (e.g., the Kentucky Infrastructure Authority for the KY DWSRF)
Public-private partnerships (P3s) are long-term contractual arrangements between a public agency (such as a city or county government or municipal utility) and a private company and have to date provided only limited capital financing in the water sector. While they are increasingly used in transportation and some other infrastructure sectors, especially P3s that involve private sector debt or equity investment in a project, to date most P3s for water infrastructure have involved only contract operations for operation and maintenance rather than capital financing of the design and construction of the infrastructure project
Operation of the TIFIA Program for transportation infrastructure projects has generated interest in developing a similar program for water infrastructure.
The WIFIA Program (1)
Under the WIFIA five-year pilot program authorized (but not yet appropriated) by Congress, EPA is authorized a total of $175 million over 5 years (beginning with $20 million in FY 2015 and increasing to $50 million in FY 2019) to provide credit assistance for drinking water projects.
As is the case with TIFIA, WFIA credit assistance will usually be provided in the form of loans at interest rates pegged to the U.S. Treasury rates for loans of the same maturity.
WIFIA loans can be for up to 35 years after project completion, repayment need not begin until five years after project completion, and the amortization schedule can be flexible
Thus, the WIFIA program will provide funding at a low cost to the borrower, because the 30-year Treasury rate is likely to be even less than the rates on tax-exempt municipal bonds of comparable maturity
The WIFIA Program (2)
For WIFIA assistance, projects must have eligible project cost ≥$20 million or ≥$5 million in rural areas (population of ≤25,000).
WIFIA assistance is available to eligible project sponsors including (1) a state or local government, (2) a private sector entity developing a project endorsed by a state or local government, or (3) a state infrastructure financing authority (such as KIA) for a group of eligible projects.
The maximum amount of the WIFIA loan is generally limited to 49% of eligible project cost
Except for certain projects in rural areas, the total amount of federal assistance (WIFIA and other federal sources) may not exceed 80% of a project’s cost.
The WIFIA Program (3)Activities eligible for assistance under the WIFIA pilot program include project development and planning, construction, acquisition of real property, and carrying costs during construction.
Projects eligible for WIFIA assistance, in the drinking water sector, include community drinking water facilities, projects for enhanced energy efficiency of a public water system treatment works, repair or rehabilitation of aging drinking water systems, water recycling projects, or a combination of such projects.
EPA will determine eligibility based on a project’s creditworthiness and dedicated revenue sources for repayment. Selection criteria will include the national or regional significance of the project, extent of public or private financing in addition to WIFIA assistance, use of new or innovative approaches (e.g., P3), the amount of budget authority required to fund the WIFIA assistance, the extent to which a project serves regions with significant energy development or production areas, and the extent to which a project serves a region with significant water resource challenges.
WHAT IS APUBLIC-PRIVATE PARTNERSHIP?In essence, a PPP is a long-term contract between a public agency (the federal government, a state or local government, or a government-owned entity) and a private sector party (typically a consortium of private sector entities) in which:
the public agency leverages the private sector party’s skills and resources to perform all or significant aspects of a project (e.g., financing, design, construction, and/or O&M)
the public agency and the private sector party share the risks and rewards of the project
the public agency retains some degree of control over the project (either through ownership of the project or contractual provisions restricting the private sector party).
Possible Advantages of P3s
risk transfer
avoids underbidding
· public private partnership may be the only
feasible way to develop the project shorter construction periods
· reduces government debt technical expertise
budget relief minimizes waste
cost savings
better project O&M
better performing assets revenue generation
Possible Disadvantages of P3s
high transaction costs loss of an ongoing revenue source
higher financing costs higher user fees
loss of operational control
When Should P3s be UsedTo determine when a public-private partnership is the best method for developing a particular infrastructure project, public agencies typically evaluate:
Whether the proposed project will provide a service or product that is best provided by the government.
Amount of the capital investment required to develop, operate, and maintain the project.
Whether the public agency can afford to lose the revenues it would receive if it operated the project.
The amount of any upfront payment the public agency will receive and the intended use of that payment.
Whether the public agency has or will have the funds necessary to operate the project on an ongoing and long-term basis.
The technical and technological requirements of the project.
Whether a private sector party may be a more efficient service provider.
Whether the private sector party can be monitored to assure that the service is being properly provided to the public.
Types of P3s
Examples of P3 structure include the following.
Design, Build (DB)
DB is the most basic of the PPP structures (and the most commonly used in the U.S.) and allocates the fewest obligations and risks to the private sector party. In this structure:
The private sector party designs and constructs the project for a fixed fee payable by the public agency.
The public agency is responsible for financing but saves the costs and time of entering into separate contracts for the design and then the construction of the project.
The public agency owns the asset and is responsible for O&M.
The public agency can either enter into an O&M agreement with a private sector party or do the O&M using internal resources.
Design, Build, Operate (DBO)
The DBO structure is similar to the DB structure, except that the private sector party also operates the project. Operating a large-scale project often requires a lot of technical expertise and significant investment in personnel. This structure enables the public agency to shift this responsibility to the private sector party. The public agency is responsible for financing the project's construction and for its maintenance.
Design, Build, Maintain (DBM)
The DBM structure is similar to the DB structure, except that the private sector party also maintains the project. The public agency pays an agreed amount for these services and if more funds are required, it is typically the responsibility of the private sector party. Maintenance of the project can be expensive and being able to shift responsibility for repairs to the private sector party can result in significant cost savings to the public agency. In addition, knowing that the private sector party will be responsible for maintaining the project may result in the project being built to a higher standard to reduce maintenance costs.
Design, Build, Operate, Maintain (DBOM)
In the DBOM structure, the private sector party is responsible for (and bears the risks associated with) the design, construction and O&M of the project. The public agency retains ownership of the project and is responsible for financing the construction of the project. The private sector party may be paid from the project's end users or the public agency. The advantage of the DBOM structure over the DBO and DBM structures is that both operation and maintenance of the project are already provided for. In cases where the public agency is responsible for either or both of these, it may not have the funds available in its annual budget to do so, resulting in the project falling into disrepair.
Design, Build, Finance, Operate (DBFO)
This structure is similar to the DBO structure except that the private sector party is also responsible for financing the project. Ownership of the project remains with the public agency. The private sector party may be paid by the public agency or from fees collected from the project's end users.
Design, Build, Finance, Operate, Maintain (DBFOM)
Under the DBFOM structure, the private sector party is responsible for designing, building, financing, operating and maintaining the project for a specified period. In this structure, the project is owned by the public agency. The private sector party may be paid by the public agency or from fees collected from the project's end users.
Design, Build, Finance, Operate, Maintain, Transfer (DBFOMT)
This structure is similar to the DBFOM model, except that the private sector owns the asset for the term of the PPP agreement after which ownership, operation, and maintenance are transferred to the public agency.
Build, Operate, Transfer (BOT)
In a BOT structure, the public agency grants to a private sector party the right to construct a facility according to agreed design specifications and to operate the project for a specified time. The private sector party does not own the project. In exchange for assuming these obligations, the private sector party receives payment from the public agency or the project's end users. In some cases, the private sector party may provide some of the financing for the project. At the end of the contract period, operation of the project is transferred to the public agency. However, the public agency can elect to renew the PPP agreement with the private sector party.
One difference between this structure and any of the structures in which the private sector party also designs the project is liability for the design risk. Because the public agency was either involved in determining the design or provided the design for the project, it bears some or all of the liability for any design flaws.
Concessions
In a concession, the public agency sells to a private sector party the right to operate and maintain an existing project for a specified time, which may be for as long as 99 years. In exchange for operating and maintaining the project, the private sector party is entitled to receive payments from the end users of the project (for example, water user charges). In this structure, the public agency continues to own the project assets and control of the project reverts to it at the end of the concession term.
Structuring Payments under a PPP Agreement
The payments the private sector party receives for performing its obligations under the PPP agreement may be structured several ways.
The payment structure used depends on:
The party who will assume the demand and collection risks
The amount of the user fees
The private sector party may be paid:
A fixed fee by the public agency once the project is ready and available for use
A variable fee by the public agency based on the public's usage of the facility
A fee by the project's end users
A combination of any of the above
Availability- Based PPPs
In this fee structure, the public agency makes payments to the private sector party once the project or facility is available for use (subject to compliance with the agreed performance criteria and standards). The public agency bears the demand and collection risks under this structure because the amount it pays to the private sector party does not change even if the project is not used to the extent anticipated. The public agency may be able to offset the availability fee with user fees received from the public. However, whether or not it actually collects these fees has no effect on its payment obligations to the private sector party.
As a result, this fee structure relies (and can impose significant pressure) on the public budget. However, paying availability fees over the life of the project may be preferable to making the capital investment necessary to build the project.
User Fee PPPsIn this structure, the end users pay the private sector party for the use of the facility (for example, bridge tolls, or water or sewer use fees). As a result, the private sector party bears the demand and collection risks.
To mitigate these risks, private sector parties:
Conduct extensive demand studies to determine the level of use that can be reasonably expected.
Require the public agency to agree not to build a competing project or implement legislation that may adversely affect demand.
May require that the public agency guarantee a certain level of use and make payments to the private sector party if such minimum amount is not achieved.
Include in the PPP agreement extension or renewal provisions to allow the private sector party sufficient time to recoup its investment and earn a return.
QUESTIONS