Frequent readers of our blog will know that we often discuss the gap that exists between the need for capital investment in the water/wastewater sector, and the availability of both the necessary capital as well as the ability to repay debt. Indeed, our most recent blog post, Water Rate Affordability (Dec. 26, 2011), presents a case that the ability to pay (i.e. affordability) is shrinking along with decreasing household incomes and rapidly expanding water/wastewater utility bills. Meanwhile, the need to finance existing and new infrastructure remains a major industry need as our post on Nov. 6, 2011 shows (WWEMA Presentation on Water Industry Trends). In yet other posts, we discussed the findings from the 2006 Community Drinking Water Survey conducted by the USEPA; the findings in that report suggest that most water utilities (we can assume that wastewater utilities follow the same trend) do not recover enough money from their operations to pay for normal operating expenses. In other words, the survey says that most utilities operate in the red (note: this finding was true for government owned utilities, but not privately owned ones).
On December 16, 2011, the American Water Works Association (AWWA), Water Environment Federation (WEF), and Association of Metropolitan Water Agencies (AMWA) released a joint statement for the Senate Subcommittee on Water and Wildlife called “Our Nation’s Water Infrastructure: Challenges and Opportunities.” A link to the joint statement is provided here (and bottom of page) so you can read it in its entirety. In summation, the statement calls for formation of a Water Infrastructure Finance and Innovation Authority (WIFIA). The plan calls for lowering the cost of capital – or more specifically, the cost of borrowing – for municipal water/wastewater agencies. It would do this by accessing funds directly from the US Treasury which, in turn, would be pooled and lent to municipal agencies for a very small markup to the prevailing long-term US Treasury rate. It basically turns the US Treasury into a direct lender, a bank, for municipal water/sewer agencies. In other words, rather than relying on the municipal bond market as a financing source, local governments could access WIFIA financing and have their borrowing costs reduced (some would say “subsidized”) to levels slightly above long-term Treasury rates.
The policy statement cites lack of access to affordable funding as an argument in favor of the formation of WIFIA. No doubt, the leaders at AWWA, WEF, and AMWA are hearing very loudly from their members about the lack of availability of credit (something echoed by every sector of the US economy at present). The chart below, from American Water Intelligence’s web site (click the image to go there) demonstrates the issue of market access (or perhaps, participation). Since the credit market implosion in 2008, water and sewer bond issuances have declined sharply with significant declines in the first two quarters of 2011 as banks and investors have been forced to reassess their risk exposure in all sectors, including municipal finance. Since the end of the Build America Bond program, the market participation has been even lower.
Debt is also becoming relatively more expensive. Based on data compiled by The Bond Buyer, the yield spread between the 30-Year US Treasury and the Bond Buyer’s revenue bond index has grown 113% since the end of the Build America Bond program in 2010. Worse, the current spread between the Treasury and the revenue bond index is higher than in the three years leading up to the 2008 credit crisis. In 2006-07, revenue bonds rates were even lower than the Treasury bond’s. Those spreads are troublesome…for those municipal agencies that can still gain access to the markets. Credit downgrades and tighter issuing standards can limit access to the credit markets exactly the same way lending standards can limit access to mortgages for regular folks. The fact that the amount of municipal water/sewer bonds issued in 2011 was far lower than the same periods in the previous three years is perhaps partly an indication of a tightening of market access to primary issuers. Regardless, it does seem that credit for municipal water/sewer bonds is tougher now than in the recent (pre-crisis) past, and increasingly expensive too.
Our Take: Regardless of the financing vehicles available, it seems clear that water and sewer utilities will need to first be in a position to repay any debts incurred. WIFIA , like similar ideas forwarded to Congress before, is not a grant program. Repayment will be expected in order to make the program work much like existing State Revolving Fund programs work today. Although if approved, WIFIA would lower borrowing costs for some utilities, the largest impact on customers’ bills is not the low interest rate, but rather the repayment of principal, which depends more on the term structure of the bonds. One of the downsides we’ve seen with many SRF programs has been the required 20-year term structure vs. the market’s willingness to finance long-term assets for 30 years. That seemingly small difference in term structure means principal repayment is increased by 50%. For some utilities, 50% higher principal payments is a worthwhile trade-off since it results in building equity in the financed assets at a faster rate (like repaying your mortgage on a 15-year schedule instead of 30), but it will also result in higher rates all things considered.
If you are considering borrowing money, no matter what the financing source, it is an extremely good idea to work out the impact on your rates in a utility financial plan (StepWise offers them at a flat charge) and understand what will happen with your rates before you apply.