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Public or private, the question is: how to pay for it?

Infrastructure funding tools for the water/wastewater infrastructure project arena

December 1, 2012

According the U.S. Environmental Protection Agency (EPA), there is close to a $1.0 trillion infrastructure investment need in this country’s water and wastewater systems over the next 20 years. More importantly, it is anticipated that there will be a 20-year infrastructure capital-investment gap of $102 billion for drinking water systems and $122 billion for wastewater systems. The operations and maintenance gap is even larger — $161 billion for drinking water systems and $148 billion for wastewater systems.

The days of unlimited available grant financing for these water/wastewater-related infrastructure investments and renewals are over. No longer can federal government or state governments provide endless funding resources to cover these costs. An era has arrived when new funding tools/funding options need to be explored and embraced by municipalities across the country.

What are the available options for funding the much needed water/wastewater-related municipal infrastructure project renewal and/or expansion?

Certainly, select traditional funding options are still available such as the State Revolving Fund program and municipal bonds. Since its inception in 1987, the Clean Water State Revolving Fund has extended over $65 billion cumulatively in loans and grants to municipal wastewater projects and initiatives. The Drinking Water State Revolving fund was established in 1997 and has also extended billions in loans and grants to municipal water projects and initiatives — roughly $23.7 billion cumulatively.

And while the municipal bond market has hit some rough patches with the Jefferson County, Ala., bankruptcy situation, along with notable municipal bankruptcy filings in California and Pennsylvania, municipal bonds still represent a prominent financing source for municipal water and wastewater projects and ongoing operations.

Given the growing infrastructure investment needs in this country, the State Revolving Fund program and the municipal bond market should no longer be embraced as the only primary source of funds for municipal water/wastewater systems. What are the other currently or potentially available funding tools that are applicable to the water/wastewater infrastructure project and service/operations sector?

Public-Private Partnerships

U.S. municipalities across the country need to more effectively embrace public-private partnerships (PPP) within the water/wastewater infrastructure arena. And PPPs open the door to a broader option of funding tools, including private-activity bonds. Presently, less than 13% of the country’s municipal water systems are owned, operated or leased to a private sector water/wastewater operator.

With all the ongoing cries of financial distress by U.S. municipalities, it is hard to understand why more local governments have not sought to embrace PPP options that can better access a broader array of funding tools/resources. Despite the success of a number of municipal water/ wastewater-related PPP arrangements including Santa Paula, Calif., Franklin, Ohio, Bensenville, Ill., Aurora, Colo. and Burlingame, Calif., municipal governments surprisingly have not yet sought to proactively embrace PPP arrangements for the financing and delivery of sustainable water and wastewater operations.

Understand that PPP contracts can take the form of a number of structures/arrangements. A water/wastewater PPP contract can simply be a straightforward O&M contract operating agreement. It could also be a contract laid out in one of the following formats: design-build, design-build-operate, design-build-operate-finance, construction manager at risk or concession/lease arrangement (DBOFT/DBOOFT/DBOLFT). Some of these PPP formats involve outside financing and a lease/ownership for a defined period of time.

It is anyone’s guess what catalyst ultimately will jumpstart PPP contract initiatives — of any version — in this country since neither the ongoing success of current PPP contracts nor the evolving financial predicaments of numerous municipalities around the country has noticeably triggered an active leap towards additional water/wastewater PPP opportunities, particularly those kind of PPP contracts that bring additional funding tools and resources to the equation.

Private Activity Bonds

In general, a private activity bond is recognized as a bond issued by, or on behalf of, local or state government for the purpose of financing the infrastructure project of a private sponsor that will serve the local public good. PABs are essentially tax-exempt bonds that are issued by local or state governments on behalf of a private developer in order to extend less costly tax-exempt financing for qualified projects that could serve the local public good, such as infrastructure projects.

Currently, there is a volume cap in place when it comes to the amount of PABs that can be issued by a state or community. Water projects compete with other infrastructure-related projects for access to PABs. For years, legislation has been introduced in Congress to remove state volume caps on private activity bonds for water and wastewater projects, a move that would allow greater private investment in water infrastructure. Recently, the latest effort to include the volume cap removal failed when a particular rider that was attached to a Congressional budget bill was deleted from the final draft of the bill. There is always next year to keep the fight moving forward in support of the volume cap removal. Meanwhile, it is useful to note that airport, high-speed rail and solid waste disposal industries already are exempt from existing PAB caps. Why it has been so difficult to gain an exemption for the water/wastewater project sector is anyone’s guess.

National Infrastructure Bank

In recent years, there has been endless discussion in Washington, D.C., about establishment of a national infrastructure bank. And major associations representing the water industry have called for a standalone water infrastructure bank. This kind of bank can play a critical role in lowering the cost of infrastructure investments and increasing the availability of lower-cost capital.

A water infrastructure bank could be used to lend funding for large water infrastructure projects of national or regional importance. It would also serve to reduce the cost of leveraging for State Revolving Fund (SRF) programs. The bank would be able to provide guarantees for large infrastructure project loans or SRF bond issues in order to lower interest rates for the projects.

Sadly, the concept of a more generic national infrastructure bank or specific water infrastructure bank has been put on the backburner. This is unfortunate since a specialty infrastructure bank could help jumpstart the infrastructures that are very much needed in this country. These infrastructure projects would not only contribute to job creation but ultimately to the development and maintenance of a long-term sustainable competitive society that can better attract global corporate business development. Companies do not like to set up operations in regions that do not provide appropriate supporting infrastructure.

Infrastructure Finance and Innovation

In addition to supporting cap removal for private activity bonds issued for water-related projects, the various water-related associations and lobby organizations also support formation of a Water Infrastructure Finance and Innovation Authority (WIFIA). Essentially, WIFIA would be modeled after the successful Transportation Infrastructure Finance and Innovation Act (commonly called TIFIA).

This proposed Authority would help lower capital costs for water utilities. It would provide loans for those larger projects that SRFs cannot address. WIFIA would be able to access U.S. Treasury funds in order to provide not just low-interest loans, but also loan guarantees, or other credit support to local communities. The loan repayments — with interest — and guarantee fees would flow back to WIFIA and into the Treasury — again, with interest. Eligible water infrastructure projects would include water, wastewater and wet weather related projects. It is interesting to note that the WIFIA proposal recommends the ability of private firms to have access to WIFIA funds via the sponsorship of the local water utility — specifically private firms that have entered into concession agreements with a utility.

Bottom-line, the creation of a Water Infrastructure Finance and Innovation Authority (WIFIA) — modeled after the successful transportation program known as TIFIA — offers a modern, effective means to help increase the nation’s level of investment in water and wastewater infrastructure, and at the lowest possible cost to the federal government.

PACE Bond Program

The property assessed clean energy — and water — bond program known as PACE was launched in California back in 2008 to enable local governments to issue bonds that would finance renewable energy/energy-efficiency projects along with water conservation/water reuse projects on private property that is subjected to local government property taxes, such as residential, commercial and industrial properties. The core purpose of the PACE Bond program was to better address a major barrier for energy and water efficiency, reuse or renewal retrofits — the large upfront cost.

The PACE program involves the ability of a local government to create an improvement district, issue a bond (secured by property within the district) and use the bond proceeds to help private property owners fund renewable energy/energy-efficiency projects as well as water reuse/water efficiency projects. Property owners repay the loan (and the debt service on the bond) via an assessment that is part of their property tax bill.

The PACE program should be viewed as a powerful tool for municipal governments to stimulate the local green economy (and create jobs) while providing a competitive financing program for residential and commercial/industrial property owners to retrofit for energy and water efficiency.

Unfortunately, PACE program hit a wall in 2010 after a federal regulator, FHFA, challenged the program and instructed home mortgage lenders/purchases not to hold mortgages tied to PACE loans.

While the ability to provide PACE Bond loans to residential homeowners has been stalled, municipalities are beginning to move the program forward on behalf of commercial and industrial property owners — the bigger users of water and energy. And, there are no regulatory obstacles in place for the commercial and industrial arena. Recently, California has put in place new legislation that is specifically focused on the implementation of a PACE Bond program for non-residential buildings and large multi-family residential type buildings that are not tied to FHFA. Known as CaliforniaFirst, the program will help finance energy and water improvements on properties that are not subjected to FHFA guidelines, including commercial and industrial buildings.

Special Purpose Vehicles

Around the world, many countries have embraced the SPV model for financing and developing a local infrastructure project. An SPV, a special purpose vehicle, is nothing more than a joint ownership arrangement between the local municipal authority/government and a private company in which joint ownership of a municipal infrastructure project or institution is established.

A municipality’s water authority could be “corporatized” in a manner that the local municipality still owns the majority of the stock, while a minority share is sold to a private infrastructure investment firm or private infrastructure company or institutional investor. The private partner is then promised some kind of minimal annual return from their investment.

This kind of arrangement gives the local water authority a new source of funding, via the shares sold to the private partner. This arrangement can also open up the options of future funding sources — sources exclusively accessible to the municipality as well as sources exclusively accessible to the private sector investor/operator.

To implement an SPV model in the United States, tax laws would have to be modified in order to recognize the SPV partnership as a unique vehicle with special access to a variety of funding tools and with a distinct tax status. Dialogues about this model have been pursued both at the state and federal level. To date, nothing has been put in motion to actively help implement the SPV concept as a viable joint infrastructure ownership and finance arrangement when it comes to municipal and/or state water/wastewater infrastructure operations and services.

Concluding Observations

The federal, state and municipal governments in the United States need to proactively begin to explore expanded options for financing the country’s much needed infrastructure renewal and expansion. Federal grant resources can no longer be viewed as the exclusive source of funding for the nation’s infrastructure projects.

The big question: What one incident or collection of incidents will ultimately serve as the critical catalyst for municipalities around the country to enthusiastically embrace public-private partnership structures for water/wastewater infrastructure projects and services coupled with a recognized acceptable menu of funding tools that is no longer strictly focused on grant financing? Stay tuned.