Plugging a Hole in the United States' Spiraling Water Debt

Nov. 1, 2011
Fall season in North America signals the arrival of cooler weather and shorter days.

A number of U.S. municipalities are in danger of filing for bankruptcy protection. Kathy Shandling looks at the latest funding tools to address infrastructure funding challenges in the region, including special purpose vehicles (SPVs) as used in China and Australia.

Fall season in North America signals the arrival of cooler weather and shorter days. To a younger generation, this time of the year marks the start of festive holidays like Halloween and Thanksgiving. To corporate America, October marks the beginning of fourth quarter and a final push to achieve select profit goals for the calendar year.

And to the U.S. government, October 1 represents the start of the new fiscal year. It has been three years since the Lehman Brothers' bankruptcy and the crash of the global stock markets. Despite billions of dollars and euros in stimulus funds from select governments, the world economy continues to be on shaky ground led by the potential default of one to two European countries.

The U.S. economy is not immune. Currently U.S. unemployment rate stands at 9.1%. The credit rating of the U.S. government has been downgraded by Standard & Poor's. Tax base has been reduced. The Dow Jones Industrial Index has fallen 12.5% since August 1. And the U.S. deficit has grown. All of this has contributed to a push for tighter budgets now being supported by a majority in the U.S. Congress. While the final federal budget for Fiscal Year 2012 is still being negotiated, it is generally acknowledged and recognised that the end product will call for budget cuts across the activities and operations of the federal government. And the water/wastewater infrastructure and service sector will certainly be impacted. The proposed federal budget for Fiscal Year 2012 issued earlier by the White House/OMB allocates the US EPA with US$9.0 billion, a decrease of 13% or US$1.3 billion from last year's budget.

Impact on water and wastewater sectors

It is important to note that the State Revolving Fund (SRF) program is hit hard by the proposed FY2012 federal budget generated from the White House. It decreases the federal contribution to the SRF program by nearly US$950 million (38%) while simultaneously supporting a long term federal goal to provide about 5% of total water infrastructure spending and to encourage more efficient system-wide planning.

Since Congressional budget negotiations are still in full swing, it is anyone's guess what the final FY2012 federal budget will look like and what the exact impact will be when it comes to funding the investment needs of the water/wastewater infrastructure and service sector.

According to the latest set of U.S. EPA-generated infrastructure investment needs surveys, the U.S. water and wastewater sectors now require almost US$700 billion in investment over the next twenty years (a significant increase versus previously released surveys). Additionally, the overall financial health of U.S. municipal governments continues to be shaky which limits the ability to generously issue bonds to cover either the operating costs and/or the infrastructure investment needs of municipal water/wastewater systems. And not all U.S. municipalities have set up an independent, robust investment-grade rated Water Finance Authority that operates autonomously from the general coffers of a municipal government.

There are also a handful of municipalities endangered of filing for bankruptcy protection, such as Harrisburg, Pennsylvania. The town of Central Falls, Rhode Island filed for bankruptcy in August. And earlier this year, Boise County in Idaho filed for Chapter 9 protection. The largest potential municipal bankruptcy in the history of this country was narrowly averted in Jefferson County (Alabama) in mid-September after lenders agreed to new terms to settle and refinance the county's US$3.14 billion debt.

The strange irony – Jefferson County's massive debt was the result of a very flawed attempt to refinance bonds that had been issued to fund a court-ordered rehabilitation to its failing sewer system.With federal grant financing no longer a secure option, the available government contribution to the SRF program being diminished, and municipal as well as state bond financing on risky footing, what are the latest funding tool(s) to help address the growing infrastructure investment needs of the country's municipal water/wastewater systems? Are the country and its municipalities finally experiencing a wake-up call for a mandate to develop/implement an expanded menu of funding options for municipal water/wastewater infrastructure projects and services?

Alternative Funding Tools and Funding Sources

It is evident to economists, politicians and financiers around the world that sustainable competitive societies require top-notched infrastructure systems – energy/power, transportation, ports, and of course water.

So what other funding vehicles can the country embrace that would benefit ongoing infrastructure expansion and renewal, particularly for municipal water/wastewater projects and services?

1. Rate Increases - The rates in the U.S. for both potable and wastewater services are some of the lowest in the world, certainly among the middle-income nations. U.S. municipalities need to adopt an evolving rate structure that moves towards full cost recovery. On average, water rates in the U.S. are roughly 50-60% lower than rates charged by EU countries. The increased revenue from higher rates could be set aside specifically for infrastructure investment.

2. Municipal Lease Financing - Municipalities need to embrace lease financing structures to help finance the installation of new technology or replacement equipment within the operations of a water and/or wastewater system. Rather than issue a bond or borrow money to finance the implementation of new equipment, a municipality can enter into a contract in which the technology/equipment provider will extend the upfront financing (for a fee). Via a municipal lease financing structure, a municipality could acquire all the equipment it needs for a particular project or service and spread the cost of the equipment over time versus acquiring new equipment on a pay-as-you-go basis.

3. Project Finance - Municipalities should open the door to project finance structures that involve long-term financing of infrastructure projects based on the projected cash flows of the project, rather than the balance sheet of the project sponsor. Project finance involves a private sector sponsor who has entered into a long-term contract with the municipality to design-build-finance-operate a given project for a period of years before transferring the project and its operations back to the municipality.

The financing is typically secured by all of the project assets, including the revenue-producing contracts. Project lenders are given a lien on all of these assets, and are able to assume control of a project if the project company has difficulties complying with the loan terms.

There are only a handful of U.S. municipal water/wastewater projects that have entered into a project finance contract with a private sponsor/developer. Some examples include Santa Paula, California and Franklin, Ohio as well as Cranston, Rhode Island in which the upfront financing for the project was provided by the private sector sponsor.

4. CAPES/SPV (Special Purpose Vehicle) model - The CAPES model enables a municipal water system to be placed into a joint ownership – shared by the local government and a private sector sponsor or investor. This kind of arrangement has not yet taken place in the U.S.. Tax laws would need to be modified in order to enable the special purpose vehicle to access both taxable and tax-exempt funding options.

The model is widely used around the world where a partnership is formed between a local public authority and an international private company. Many of the European infrastructure companies have championed this model in countries like China and Australia.

In Mexico, the SPV model has included ownership/investment partnerships that involved a three way joint venture – an international private company, a local private company, and a local municipal government.

5. Private Activity Bonds (PAB)- The PAB product allows a municipality to issue a tax-exempt bond for the purpose of financing special qualified projects, like infrastructure projects, that are being led by a private sponsor. These bonds are used to attract private investment for projects that offer public benefit since this type of a bond results in reduced financing costs because of the exception of federal tax.

Currently there is a volume cap on the number of PABs that can be issued by a single municipality. There is a valid argument for removing the cap for those private sponsored water/wastewater infrastructure projects that benefit the municipality in order to facilitate more cost effective financing of much needed water/wastewater project renewals.

The good news is that there is the remote chance that a bi-partisan bill will be passed this year. Known as the Sustainable Water Infrastructure Act of 2011, it would remove the state volume caps on private activity bonds for public-purpose water and wastewater projects. It is predicted that the volume cap removal will facilitate the addition of US$50 billion in private capital for municipal water/wastewater projects.

6. PACE Bond Program- The Pace Bond program stands for property assessed clean energy and water bonds. It is an initiative that began at the state level – over 24 states created PACE enabling legislation allowing a municipality to issue a bond in which the proceeds are loaned out to homes and buildings to offset the upfront costs associated with implementing energy and/or water efficiency retrofits. The loans would be paid back via an annual assessment on the property tax bill over a 15-20 year time frame.

7. National Infrastructure Bank - Known as the National Infrastructure Development Bank Act of 2009, it sought to leverage private sector dollars to invest in transportation, energy, telecommunications and the critical environmental/water infrastructure projects. Its mission is to provide investment opportunities that would supplement current federal programs creating jobs, spurring economic growth and rebuilding an infrastructure system for the 21st century.

The latest version of a Congressional bill (H.R. 402) is referred to as the National Infrastructure Development Bank Act of 2011. It was introduced in January 2011. The purpose remains the same – to create and fund a bank that would direct public and private dollars toward infrastructure projects of national or regional significance.

9. WIFIA - Earlier this year, the American Water Works Association (AWWA) and Water Environment Federation (WEF) introduced the concept of WIFIA (Water Infrastructure Financing Innovations Authority). Modeled after the existing TIFIA program, WIFIA would serve as a vehicle that would provide low-cost capital to water utilities that need to invest in infrastructure funds and to provide low-cost capital to the SRFs.

WIFIA would better enable projects and SRFs to obtain financing at potentially less cost than going to the credit market. Essentially, WIFIA would become a means for water projects to secure low-interest loans and credit than otherwise available. WIFIA would access funds directly from the U.S. Treasury at Treasury rates and use those funds to support loans and other credit mechanisms for water projects. The loans would be repaid to the Treasury with interest.

Most importantly, WIFIA would better ensure a streamlined approach to financing. And it would reduce the cost of leveraging the SRF programs. Currently only 27 states leverage their respective SRF programs in the bond markets. WIFIA will enable more states to do so which will generate more funds to invest in water/wastewater infrastructure projects.

Future predictions

It is impossible to look into a crystal ball and identify the exact menu of additional options available in the near future to fund municipal infrastructure projects. Will there be a push for an expanded use of project finance and lease financing mechanisms to fund the implementation of much needed new technology, replacement equipment, or water/wastewater system renovation?

Likewise, will this country witness the adaption of the PACE Bond initiative and the PAB cap removal call-to-action or even the implementation of increased rates? Will the SPV model cultivate greater recognition and more extended use? And will large scale institutional initiatives like WIFIA and the National Infrastructure Bank actually become a reality sooner rather than later?

What is clearly evident – without investing in appropriate infrastructure projects, municipalities and the country as a whole cannot continue to remain competitive and economically prosper. And without an expanded menu of funding options, it will be difficult to achieve the updated sustainable municipal water and wastewater infrastructure systems. Stay tuned. WWi

Author's note: Kathy Shandling is the executive director of the International Private Water Association (IPWA), set up in 1999 to serve as a conduit between the public and private sector players. Email: [email protected]

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