China Environment Forum Value and Credit Mechanics of U.S. Government Sponsored Funding - PowerPoint Presentation

1. China Environment ForumValue and Credit Mechanics of U.S. Government Sponsored Funding Models: The Clean Water and Drinking Water State Revolving Funds(“the SRFs”)Woodrow Wilson CenterJim Gebhardt, U.S. EPANovember 17, 2015

2. TopicsI. The State Revolving Fund Model: Program Value and Model Designs Credit Mechanics of Pooled and Single Borrower Financing Structures 2

3. The State Revolving Fund Model: Value and DesignIts Value in Supporting National Clean and Safe Drinking Water GoalsFunding secures Triple-A Market Access for States and Below Market Rate Financing for Local governments and other qualified borrowers Financial benefits provide a powerful inducement for local officials to secure SRF assistance to build prioritized projects 3

4. The State Revolving Fund Model : Value and DesignSRF Program - Overall Model DesignFederal Government annually capitalize state administered revolving funds subject to: States contributing a minimum 20% matching share Funds are used to provide financial assistance from capital base including bonds secured by federal and state contributions4

5. Basic SRF Financing ModelsStates predominantly rely on:The Direct Financing Model which is limited to direct lending of federal and state contributions (program equity); andThe Leveraged Financing Model which issues bonds secured by program equity and makes loans with borrowed proceeds and invests equity in additional pledged SRF loans or bond reserves5

6. Basic SRF Model Cash FlowsThe Direct Financing Model ($100)State Matching Contributions(20% of Federal Draw)Annual Federal AppropriationState Revolving FundEquity Account(includes Retained Earnings)SRF Financing Recipient(s)$100 of Financing Proceeds provided from Equity Account to Recipient for SRF Eligible Project CostsRepayments of principal and interest6

7. Basic SRF Model Cash FlowsLeveraging: Standard Reserve Model Assumption: $100 of Equity is Used to Secure $200 of BondsReserve model depends on availability of high quality investments. Benefits single borrower transactions that have weak bond ratings.Master Financing Indenture houses all bond series issued pursuant to its terms. Clean Water and Drinking Water Financing Program operate out of the same financing indenture and cross-pledge program assets to maximize credit value. State Revolving FundEquity Account(s)(includes Retained Earnings)Private InvestorsSRF Bonds (Series 1 thru n)$100 deposits and releasesof SRF Equity from pledgedreserve as financings originate and are repaid$200 Exchange of Cash and Bonds With Investors as Bonds are Issued and repaid with 4% interest, inclusive of 4% interest on pledged reserveSRF Financing Recipient(s)$200 of Bond Proceeds for SRFEligible Projects at 2% blended rate and recipient repayments of principal and interest Pledged Reserve Invested at 4% (net of arb. payments to Treasury)Master Financing IndentureEquityBond Proceeds7

8. Basic SRF Model Cash FlowsLeveraging: Blended Loan Model Assumption: $100 of Equity is Matched with $100 of BondsBlended Loan Model is not dependent on quality of third-party investments.Master Financing Indenture houses all bond series issued pursuant to its terms. Clean Water and Drinking Water Financing Program operate out of the same financing indenture and cross-pledge program assets to maximize credit value. State Revolving FundEquity Account(s)(includes Retained Earnings)InvestorsSRF Bonds (Series 1 thru n)(4% Cost of Funds)$100 deposit with scheduled releasesof SRF Equity from repayments as bond funded loans are repaid$100 Exchange of Cash and Bonds With Investors as Bonds are Issued and repaid with 4% interestSRF Financing Recipient(s)$200 exchange of Bond and Direct Proceeds for recipient loan at 2% blended rate and recipient repayments of principal and interest. Pledged Direct Loans(0% Cost of Funds)Master Financing IndentureEquityBond Proceeds8

9. SRF Financing Models: Sources & UsesSources & UsesDirect Financing ModelLeveraged Blended Loan Rate ModelLeveraged Reserve ModelSources:         Equity$100$100$100Bond Proceeds$0$100$200     Total Sources$100$200$300    Uses:       Investments    Reserves/Escrow  $100 Investment Fund   SRF Loans$100$200$200    Equity Savings(available for additional project support)   Total Sources$100$200$300    Project to Equity Ratio1:12:12:19

10. II. Multi-borrower and Single borrower Financings10

11. Credit Designs and Bond RatingsMulti-borrower Pool FinancingsProgram resources dominate bond rating determinationsLoan participants are secondary provided there are many and they are largely investment gradeSingle borrower FinancingsBorrower’s credit rating dominatesProgram resources can add incremental credit value 11

12. Multi-borrower and Single borrower FinancingsMulit-borrower Master Financing Indenture IndentureMaster Financing Indenture with Series 1 to n and borrowers 1 to n12 Multiple series of bonds issued under supplemental indentures are treated as one series of bonds with one portfolio of borrower loans for rating purposes. Equity investment in each series is cross-pledged to all other series upon scheduled release assuring deep over collateralization of bond debt service. Ratings agencies assign high value to large, diverse portfolios.Series 1S2S3S4S5Series n

13. Pooled and Single Recipient FinancingsProgram Credit Design with Dedicated Large Recipient Financing Indenture13State Revolving FundEquity Account(s)MFI for Pooled FinancingsMFI(s) for Single Recipient(s)MFI – Master Financing IndentureCross-Pledge of Releasing Equity. Cross-pledge gives bondholders subordinate lien on releases from respective indentures. Cross-pledge is a credit positive.

14. Pooled and Single Recipient FinancingsThe Value of Developing Separate Financing Strategies for Large Single RecipientsPooled financings originated under Master Financing Indentures have allowed SRF Administrators to bundle loans from successive bond series into well diversified portfolios that merit triple-A rating designationsThe triple-A ratings are largely a function of the high level of collateral provided by the leverage factor and the distribution of credit exposure across many local government loan recipients relative to rating agency triple-A stressed loss assumptionsHowever where a large recurring credit recipient is included in the financing indenture its’ credit could limit the pooled credit rating.If the credit is strong (i.e., double-A or better) than the impairment of triple-A rating strength is low (Wisconsin and Rhode Island include large recipients in pooled financings).If credit strength is not strong (i.e., >double-A) than pooled ratings are at risk of being capped at less than triple-ADedicated indenture can isolate risk of any current or future large credit impact on the programmatic credit represented by the pool financing vehicle 14

15. Fully Integrated SRF Credit Design - “The Full Buildout”Equity Lien Structure That Accommodates Multiple Product OfferingsShort and Long-TermEquity Investment AccountsDerivative Contract Obligations(Termination Payments)Outstanding Single Recipient MFIMFI - Senior Lien BondsCommercial PaperMFI - Subordinated Lien (Third Party Guarantees)Equity Deposits toEquity Releases DepositedBack to Equity Accounts Equity Deposits to15Pro-rata Pledge of AvailableEquity to MFI Senior and Subordinate LiensMFI – Master Financing Indenture

16. Appendix Financial Assistance Authority Underthe Clean Water and Safe Drinking Water Acts, as AmendedUSEPA Financial Advisory Board; Selected SRF Reports16

17. SRF Financial Assistance Authority Under the Clean Water ActFrom Title VI, Section 603 (d)Except as otherwise limited by State law, a water pollution control revolving fund of a State under this section may be used only— (1) to make loans, on the condition that— (A) such loans are made at or below market interest rates, including interest free loans, at terms not to exceed the lessor of 30 years and the projected useful life (as determined by the State) of the project to be financed with the proceeds of the loan; (B) annual principal and interest payments will commence not later than 1 year after completion of any project and all loans will be fully amortized upon the expiration of the term of the loan; (C) the recipient of a loan will establish a dedicated source of revenue for repayment of loans; (D) the fund will be credited with all payments of principal and interest on all loans; and (E) for a treatment works proposed for repair, replacement., or expansion, and eligible for assistance under subsection (c) (1), the recipient of a loan shall – (i) develop and implement a fiscal sustainability plan…(2) to buy or refinance the debt obligation of municipalities and intermunicipal and interstate agencies within the State at or below market rates, where such debt obligations were incurred after March 7, 1985;(3) to guarantee, or purchase insurance for, local obligations where such action would improve credit market access or reduce interest rates;(4) as a source of revenue or security for the payment of principal and interest on revenue or general obligation bonds issued by the State if the proceeds of the sale of such bonds will be deposited in the fund;(5) to provide loan guarantees for similar revolving funds established by municipalities or intermunicipal agencies; (6) to earn interest on fund accounts;17

18. SRF Financial Assistance Authority Under the Safe Drinking Water ActFrom Title XIV, Section 1452(f)Except as otherwise limited by State law, the amounts deposited into a State loan fund under this section may be used only—(1)to make loans, on the condition that- (A)the interest rate for each loan is less than or equal to the market interest rate, including an interest free loan; (B) principal and interest payments on each loan will commence not later than 1 year after completion of the project for which the loan was made, and each loan will be fully amortized not later than 20 years after the completion of the project, except that in the case of a disadvantaged community (as defined in subsection (d)(3)), a State may provide an extended term for a loan, if the extended term— (i) terminates not later than the date that is 30 years after the date of project completion; and (ii) does not exceed the expected design life of the project; (C) the recipient of each loan will establish a dedicated source of revenue (or, in the case of a privately owned system, demonstrate that there is adequate security) for the repayment of the loan; and (D) the State loan fund will be credited with all payments of principal and interest on each loan;(2) to buy or refinance the debt obligation of a municipality or an intermunicipal or interstate agency within the State at an interest rate that is less than or equal to the market interest rate in any case in which a debt obligation is incurred after July 1, 1993;(3) to guarantee, or purchase insurance for, a local obligation (all of the proceeds of which finance a project eligible for assistance under this section) if the guarantee or purchase would improve credit market access or reduce the interest rate applicable to the obligation;(4) as a source of revenue or security for the payment of principal and interest on revenue or general obligation bonds issued by the State if the proceeds of the sale of the bonds will be deposited into the State loan fund; and(5) to earn interest on the amounts deposited into the State loan fund.  `18

19. SRF Credit Design and Product OptimizationSelect SRF Reports USEPA Financial Advisory Board “Utilizing SRF Funding for Green Infrastructure Projects,” January 2014;“SRF Investment Function: Current Status and Prospects for Enhancing SRF Sustainability,” February 2011; and“Relative Benefits of Direct & Leveraged Loans in SRF Programs,” August 2008.See: www2.epa.gov/efab/envirofinance/publications#srfs19

20. Contact Informationgebhardt.jim@epa.gov(202) 564-0323 (O)(202) 734-1607 (C)Water Finance Center Website:water.epa.gov/infrastructure/waterfinancecenter.cfm