UNITED STATES ENVIRONMENTAL PROTECTION AGENCY
ENVIRONMENTAL FINANCIAL ADVISORY BOARD
January 12,2005
Mr. Stephen L. Johnson
Deputy Administrator
United States Environmental Protection Agency
1200 Pennsylvania Avenue, NW
Washington, DC 20460
Dear Mr. Johnson:
The Environmental Financial Advisory Board is pleased to submit the attached white
paper, "Useful Life Financing of Environmental Facilities" for the Agency's
consideration and use.
The mission of the Board includes providing the Environmental Protection Agency with
advice and analysis on issues relating to how to secure the funding necessary to achieve
this country's environmental protection goals. Within this mission, there are several areas
of particular focus for the Board and the EPA such as funding unmet environmental
needs, asset management of existing facilities, impending replacements of existing
environmental infrastructure, and locally generated revenue expansion strategies.
The Useful Life paper addresses the question of whether the capacity of municipalities to
fund environmental needs can be significantly increased by (A) amortizing debt issued to
finance environmental facilities over periods that are reflective of the useful lives of the
financed facilities, rather than (B) using the more typical practice of amortizing the debt
over periods significantly shorter than the useful lives of the financed facilities. A
thorough discussion of the salient points of the two alternatives has resulted in the
following conclusions:
• Use of an amortization period consistent with useful life financing can make
environmental facilities more affordable on a year to year basis, and distribute the
cost of those facilities more equitably across current and future beneficiaries of
the facility. -
• By using the useful life approach rather than a shorter amortization period,
communities can reduce annual debt service costs for new facilities by 10% to
34%.
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• The savings realized from longer amortization periods can be used to fund asset
management or additional capital projects. By using savings to fund, new projects,
the impact of funding those projects on current ratepayers .can be reduced by 12%
to 45% compared to funding the same projects using a shorter amortization .
period.
While it makes no formal recommendations, the Board believes these issues are timely
and pertinent to the financial climate for communities nationwide and encourages the
Agency to support this concept and distribute this paper widely.
Looking ahead, the Board plans to consider whether the issues raised in this paper might
have application to the Agency's continuing oversight of the state, revolving loan
programs for drinking water and wastewater infrastructure.
The Board appreciates the continuing opportunity to provid financial advisory assistance
to the Agency on issues of national importance.
Sincerely,
Lyons Gray ' A. Stanley Meiburg
Chair Executive Director
Cc: Charles E. Johnson, Chief Financial Officer
Ben Grumbles, Assistant Administrator for Water
-2-
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Environmental
Financial Advisory Board
EFAB
Lyons Gray
Chair
A. Stanley Meiburg
Executive Director
Members
Hon. Pete Domenici
Terry Agriss
A. James Barnes
Julie Belaga
George Butcher
Michael Curley
Kelly Downard
Mary Francoeur
Hon. Vincent Girardy
Steve Grossman
Stephen Mahfood
Langdon Marsh
John McCarthy
George Raftelis
Andrew Sawyers
James Smith
Sonia Toledo
Jim Tozzi
Billy Turner
John Wise
Application of Useful Life Financing of
Environmental Facilities
This report has not been reviewed for approval by the U.S. Environmental Protection
Agency; and hence, the views and opinions expressed in the report do
not necessarily represent those of the Agency or any other agencies in the Federal
Government.
Jamuary 2005
Printed on Recycled Paper
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Useful Life Financing of Environmental Facilities
Background
A major area of interest for the EPA is how to create new sources of funding or to leverage
existing sources of funding in order to address the significant unmet environmental needs that
face communities across the country. Such needs include funding both (i) for capital
improvements necessary to achieve compliance with environmental laws and regulations and (ii)
for asset management necessary to ensure that existing facilities are preserved and maintained.
Federal and state funds available to assist localities are limited given current budgetary
constraints. Material increases in local funding can be achieved only by significantly increasing
the rates and charges or taxes imposed on local residents. Other alternatives involve (a) deferring
the construction or acquisition of required capital improvements or (b) deferring necessary asset
management, or both. Thus, the timely achievement of environmental goals and objectives is
constrained by their affordability.
In a January 2003 Forum the EPA introduced its "Four Pillars of Sustainable Infrastructure" to
promote sustainable water infrastructure for the 21st century. The "Four Pillars" includes an
emphasis on better management, full-cost pricing, efficient water use, and watershed approaches
to protection. The foundation of the "Four Pillars" is a focus on better management, to expand
the use of innovative management practices including asset management and useful life
approaches to planning and management.
Both the annual and aggregate cost to a municipality of financing capital improvements are
significantly impacted by the period of time over which any bonds issued to fund such
improvements are amortized. Extending the period over which such debt is amortized can
significantly lower the annual payment. The lower cost realized by extending such period could
be used to fund additional environmental needs. However, extending such period also increases
the aggregate amount of debt service paid by the municipality over the term of the bonds. Also,
the impact of extending the amortization period and of funding additional capital improvements
would be to increase the cost imposed on future residents beyond the period over which such
debt would be amortized if no extension were to occur.
The amortization periods used by municipalities are typically limited by state law. The periods
used are further governed by local law and/or by formal or informal policies used by each
locality, which in many cases are shorter than the periods actually permitted under state law. The
use of shorter periods is also encouraged by bond rating agency criteria which generally view
speedier amortization periods as a positive (but not dispositive) credit factor.
Under federal tax law applicable to tax-exempt municipal bonds, the amortization period that can
be used is limited by the useful lives of the financed facilities. However, in general, the
limitations imposed by both state and local laws and by local policies do not focus on the actual
useful lives of the projects financed, but rather seek to assure a more rapid debt amortization. As
noted above, this results in a higher annual cost for each project. This also results in the cost of
Use fid Life Financing - Page 1
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each project being imposed on only a subset of the residents who actually benefit from it over its
useful life. However, the ratepayers or taxpayers in each year have the benefit of facilities the
cost of which has already been fully amortized by prior generations of residents.
The question addressed herein is whether, in order to make environmental projects more
affordable, it may be better for municipalities to amortize bonds issued for environmental
facilities over longer periods of time more reflective of the useful lives of such facilities, as
opposed to the more typical municipal practice of amortizing debt over a periods much shorter
than the useful lives of such facilities.
Recommendation
The use of extended amortization periods corresponding to the useful lives of the financed
facilities is a reasonable approach both to making environmental facilities more affordable and to
allocation of the costs of environmental facilities among various generations of taxpayers or
ratepayers that benefit from such facilities. Under that approach, all users of environmental
facilities would pay a ratable share of the cost thereof. Extending the amortization period does
not increase the aggregate cost of financing such facilities since the cost to the ratepayers is
independent of the amortization period. Most importantly, affordability of environmental goals
and objectives can be significantly enhanced through improved debt management practices that
reduce the current budgetary impact of funding capital expenditures.
Extending the period over which the costs of environmental projects are amortized more closely
to match their useful lives could reduce annual debt service costs for new facilities by 10% to
34%. Budgetary savings realized from such improved debt management practices can be used to
fund other needs, including additional capital improvements or increased asset management. The
increased cost imposed by both the debt extension and the funding of additional projects on
future ratepayers (as compared to the cost imposed using a shorter amortization period and
without such additional projects) would be similar to the increased cost imposed on current
ratepayers under current debt management practices. Moreover, such future ratepayers would
have the benefit of using the additional facilities financed with budgetary savings. If the
budgetary savings were used for asset management rather than for additional facilities, the cost
increase to future ratepayers would be reduced and such ratepayers should benefit from the
improved condition of the utilities physical plant. Use of an extended amortization period to
make funds available for critical new environmental facilities or to improve asset management,
rather than simply to defer costs to the future, should mitigate any adverse credit impacts arising
from debt extension.
The concept of useful life financing is consistent with several new initiatives in the infrastructure
intensive water and wastewater industry. These include asset management in which utilities are
encouraged to systematically and continuously extend the useful life of facilities via accurate life
history and preventative measurers. Additionally, recent changes in accounting procedures such
as Government Accounting Standards Board 34 encourage regular condition assessment in order
to more accurately identify the current value and future useful life of facilities.
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Many utilities are already moving in the direction of extending the amortization periods of their
debt. However, the purpose of the recommendation contained herein is not to suggest that a
particular approach is correct for all municipalities, but rather that use of an extended
amortization period is an appropriate financial tool for municipalities to consider in conjunction
with their advisors.
The general concept of extending the amortization period for environmental financings more
closely to match the useful lives of the financed facilities may also have specific application in
the context of State Revolving Fund (SRF) financings. Currently, the amortization period for
SRF financings is generally limited to 20 years, by statute for drinking water financings and by
EPA policy for clean water financings. However, the appropriate application of the general
concept to SRF financings warrants additional consideration and is expressly excluded from
recommendation herein.
Discussion
Absent concerns regarding the affordability of critical environmental goals and objectives, their
would be no reason for the Board to suggest reconsideration of current debt management
practices. However, given that the alternatives include (1) deferring or even failing to achieve
such goals and objectives and (2) imposing an untenable financial burden on current ratepayers,
consideration of a revised approach is warranted.
Current Debt Management Practices
Statutory requirements and financial practices regarding funding capital improvements vary
significantly across the country. Statutory provisions in various states authorize municipalities to
fund water and wastewater improvements over a periods as short as 20 years and as long as 40
years or more. Such statutory provisions require that many projects be financed or amortized
over a period shorter than their useful lives.
Moreover, actual financial practices for debt management may be even more conservative than
the applicable legal constraints. In some municipalities, significant portions of the cost of capital
improvements is funded from current revenues. This practice, while appearing financially
conservative, has the impact of minimizing affordability and imposes on today's ratepayers, the
entire cost of improvements that will be used by other ratepayers over many years. The impact
on annual rates and charges of funding a project with current revenue is more than 13 times the
annual debt service on a 20 year bond issue.
Those municipalities whose projects are funded with debt typically amortize the project costs
over a period that is shorter than the useful life of their projects and that is frequently shorter
than the amortization period permitted by law. This practice, while also appearing financially
conservative, reduces affordability since it results in higher current debt service than financing
the same projects over their useful lives. It also imposes a disproportionate share of the project
Use fid Life Financing - Page 3
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costs on the ratepayers during the term of the bonds.
Available data suggests that the expected lives of certain components of water and wastewater
systems exceed the normal financing period of 20 to 30 years by twice or more. Other
components have expected lives consistent with a 20 to 30 year financing term. However, the
actual decision regarding the appropriate financing term of any facilities should be based on the
actual expectation of the borrowing municipality.
Analytic Framework for Evaluating Amortization Options
In evaluating alternative amortization periods for environmental projects, three critical factors
have been considered:
• Aggregate cost of financing the projects using each alternative. A distinction is made
between (A) aggregate cost to a municipality and (B) aggregate cost to the ratepayers
(used herein interchangeably with taxpayers) thereof. As described below, for certain
financing options, the aggregate cost to the municipality overstates the aggregate cost to
the ratepayers, which is the more appropriate measure of aggregate cost in this context.
• Fairness of each alternative in allocating costs among the beneficiaries of the projects.
Fairness of each financing alternative is measured by the extent to which all ratepayers
that benefit from a project or group of projects pay a ratable share of the project costs and
financing costs thereof.
• The effect of each alternative upon the affordability of such projects. Affordability of
each financing alternative is measured by the impact thereof on the annual costs payable
by the ratepayers of the municipality.
We have also considered two other rationale advanced to support the use of shorter amortization
periods:
• That what represent sound financial practices for individuals should also be employed
with respect to public projects, and
• That use of a shorter amortization period creates savings or equity for the benefit of
future ratepayers.
Costs and Benefits of Alternative Amortization Periods
Affordability of Specific Projects
Shortening the financing term for a particular project from 30 years to 20 years results in a 21%
increase in the current budgetary expense during years 1 to 20. However, since the debt would be
fully amortized by year 20, it results in savings to the ratepayers beginning in year 21 equal to
100% of the 30-year debt service. Shortening the term from 40 years to 20 years results in a 34%
increase in budgetary expense in years 1 to 20 and savings beginning in year 21 equal to 100%
of the 40-year debt service. Also, shortening the term from 40 years to 30 years increases debt
Use fid Life Financing - Page 4
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service by 10% in years 1 to 30 and results in savings in years 31 to 40 equal to 100% of the 40-
year debt service. However, as long as an extended financing term does not exceed the useful life
of the project, any future ratepayers whose cost are increased only bear an allocable share of the
cost those projects that they actually use. The debt service calculations reflected in the
percentages shown above reflect the additional interest costs associated with the use of a longer
amortization period.
Aggregate Cost
In addition to the increased costs borne by future ratepayers given a longer amortization period,
the aggregate dollars paid by the municipality for a project are greater if a longer amortization
period is used. Minimizing the aggregate dollar amount paid by a municipality for a project is
often cited as the rationale for a shorter amortization period or even for paying for projects from
current revenues. However, the focus on the aggregate cost to the municipality ignores the real
cost of the project to ratepayers. The cost to the ratepayers of using a shorter amortization period
is actually the same or greater than it would be if a shorter amortization period were used.
For example, contrast two payment options that represent the polar opposite alternatives:
• Scenario I: The entire cost of a project is paid from current revenues in the first year of its
useful life. No debt is issued by the municipality for the project.
• Scenario II: The cost of the same project is financed with debt the full principal amount
of which matures in the last year of the projects useful life, assumed to be 40 years.
If the focus is solely on the cost to the municipality, the cost of funding the project is minimized
in Scenario I. In Scenario I, the aggregate financing cost to the municipality equals the project
cost. In Scenario II, the aggregate cost to the municipality is higher because it includes interest
on the debt for 40 years plus the principal amount of the debt which equals the project cost.
However, if the focus is on the cost imposed upon the ratepayers as a result of undertaking the
project, Scenario II results in an aggregate financing cost that is equal to or lower than aggregate
financing cost in Scenario I. In Scenario I, funding the entire cost of the project from revenues in
year 1 reduces the wealth of the ratepayers by an amount equal to the project cost. So, under
Scenario II, the ratepayers are able to increase savings or reduce debt for an additional 40 years
by an amount equal to the project cost. The additional investment earnings or avoided interest
cost during the 40 year period would almost certainly equal or exceed the tax-exempt interest
cost of the municipality on the debt issued under Scenario II. Thus, the true or net costs to the
ratepayers during the 40 year period are essentially the same in both scenarios - the cost of the
project.
The above example illustrates that the aggregate financing cost of a project from the perspective
of the ratepayers is independent of the period over which the project is financed. The aggregate
cost to the ratepayers is the same whether the project is financed (a) as described in Scenarios I
and II, (b) using level principal amortized over 20, 30 or 40 years, or (c) using level debt service
Use fid Life Financing - Page 5
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over 20, 30, or 40 years. We believe that as a matter of financial policy, the most appropriate
perspective from which to view the cost of environmental projects is the perspective of the
ratepayers, rather than the perspective of the financing municipality. Accordingly, aggregate cost
should not be viewed as a basis for recommending one amortization approach over another.
Fairness
The fairness of any method of debt amortization can be considered both with respect to a
particular facility of the municipality and with respect to all facilities of the municipality in
aggregate. In either case, the fairest amortization method is one that results in a ratable
amortization of costs among all users of the facility or facilities, as the case may be.
Viewing Scenarios I and II, above, from the perspective of intergenerational fairness, the two
scenarios are similarly fair or unfair to the ratepayers in years 1 and 40. In Scenario I, the
ratepayers in year 1 get to use the project for one year and bear the full cost of the project,
including lost investment earnings. Ratepayers in later years get the benefit of the project
without funding any of its cost. In Scenario II, the ratepayers in the final year of the useful live
get to use the project for one year and pay the principal amount of the debt (equal to the project
cost). The debt interest is payable annually over the useful life of the project by the ratepayers
who have the benefit of using the project. The ratepayers prior to year 40 get the benefit of the
project but fund only an allocable portion of the debt interest. If anything, Scenario II produces a
fairer result because the loan interest is allocated fairly among the different generations of
ratepayers. In Scenario I, the ratepayers in year 1 bear the entire impact of the lost earnings or
increased debt required to fund the project.
With respect to a particular facility, a fairer approach would be to use level debt service over the
useful live of the facility. However, for a municipality with ongoing annual financing
requirements that are roughly equal (in constant or inflation adjusted dollars), any amortization
method will (after a ramp up period) result in equal annual financing cost. Examples of the ramp
up periods for various amortization approaches are as follows:
Amortization Method Ramp Up Period
Level debt service over 20 years 20 years
Level debt service over 40 years 40 years
Fund projects from current revenues in year 1 1 year
Fund projects with debt maturing in year 40 40 years
All of the indicated approaches are equally fair to all ratepayers in the years after the respective
ramp up periods. So, even if a particular amortization method may be unfair when viewed with
respect to particular facilities, it may nevertheless be fair when viewed with respect to all
facilities, provided that the costs of facilities are fully amortized during their useful lives.
Accordingly, it is difficult to make significant distinctions between amortization methods based
on fairness.
Equity Accumulation
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Another perceived benefit of funding projects from current revenues is that there is a benefit to
future rate payers as a result of the accumulation of equity funded from current revenues. To
examine that belief, assume in each of Scenarios I and II that the same financing approach has
been used over a 40 year period to finance $100 of project cost in each year. Further assume that
the debt issued in each year under Scenario II has a 40-year bullet maturity.
In year 40, the cost to the ratepayers under Scenario I is $100 (the project cost funded from
revenues of that year). Under Scenario II, the cost to ratepayers equals (i) $100 representing the
principal of the bond issued in year 1 plus (ii) interest on the $3900 of debt issued in years 1 to
39. However, viewed from the perspective of the ratepayers (as opposed to the municipality) the
debt interest is offset by the investment earnings on the $3900 retained by the ratepayers in years
1 to 39. So, the true cost under both scenarios in year 40 is $100. In each succeeding year, the
cost under both scenarios will be identical to the cost in year 40.
Under Scenario II, the costs imposed on the ratepayers in years 1 to 39 were lower by $100
annually and $3900 in aggregate. In Scenario I, the savings or equity accumulation realized from
funding projects with current revenues in years 1 to 39 equals the $3900 in additional costs that
have been imposed on the ratepayers in years 1 to 39. The existence of the equity accumulation
does not reduce the true annual costs to the ratepayers. Also, since the purpose of building the
projects is to use them, not to sell them, no benefit will be realized from a sale of the financed
assets. In fact, no economic value can be realized from the equity accumulation except by
converting to another financing approach. For example, if in year 40, the municipality were to
covert from the approach in Scenario I to the approach in Scenario II, the ratepayers would
realize savings of $100 annually over the succeeding 39 years.
Without a change in financing approach, no ratepayers would ever benefit from the equity
accumulation under Scenario I. Similarly, for municipalities that have used other "conservative"
amortization methodologies in the past (i.e., an amortization shorter than the average lives of the
financed facilities) the only way for any current or future ratepayers to benefit from any equity
accumulation is for the municipalities to adopt a less conservative approach to debt amortization
or to restructure and extend their debt. Preserving the flexibility to move to a lower cost
amortization approach in the future is not a compelling rationale for imposing a higher cost
approach on current ratepayers.
Public versus Individual Financing Approaches
In evaluating the revised approach an issue that arises is why is it prudent and appropriate to the
extend the amortization period for public debt when as individuals we generally consider it
fiscally responsible to accelerate debt repayment. The reason is that the issues which affect and
constrain individual financing decisions are very different from those that govern public
financing decisions. The different issues should rationally result a different approach for public
financings from those that we follow as individuals.
Individual Considerations
• The period for which financing is readily available may substantially shorter than the
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useful life of purchased assets
o Auto financing generally limited to 5 years
o Home mortgages limited to 30 years
o In each case, there is a possibility that the asset may be sold prior to the
amortization of the loan and that the market value may be less than the
unamortized cost
• When we purchase assets, we anticipate that if the assets are held over their useful lives,
the same person will use them during all portions of such lives. Thus, there is no inequity
if the cost is amortized on an accelerated basis. Accelerated payment is in effect a form of
savings for the person who makes the payment. So, any opportunity cost related to
greater expenditure of funds is offset by the investment return.
• The work life of individuals is limited. There is an ongoing risk of unemployment due to
poor health, economic downturns, and the vagaries of the employers business. Even
during periods of continued employment, an individuals income may decline
significantly. So, both from the standpoint of the individual and any creditors, it makes
sense to accelerate the amortization of debt to limit the period of exposure to these risk.
• In cases of houses, which represent an individuals largest investment, it is only necessary
to finance one house. There is no continuing requirement to finance additional facilities.
Public Considerations
• Longer financing terms, such as 40 years, are readily available. The employment and
economic risks associated with extended payment periods for individuals do not exist for
public entities. This fact is reflected in the availability of such longer financing terms.
• The ability of a public utility to raise revenue (in current dollars) grows over time due to
inflation. So, if facilities are financed with level debt service, in later years the same debt
service can be funded with a smaller portion of the utilities revenues. In other words, the
real (inflation-adjusted) cost of funding a particular facility will decline in any event due
to inflation. This phenomenon is further exacerbated in most cases by population growth
so that the lower real costs are spread over a larger number of people.
• The users of public facilities vary significantly over time. So the users who bear
disproportionately high cost in the early years of a shortened financing term are certain to
be different from those who get the benefit of lower real cost during the later years of the
financing term and from those who use such facilities after their financing term. As
discussed above, the choice of amortization period does not affect the aggregate cost to
the ratepayers thereof, but only the allocation of such costs. Rather than being a form of
savings for users of the utility, accelerated payment for facilities is an intergenerational
wealth transfer - (a form of taxation on the users during the early years). Since the
financed facilities will not typically be sold during their useful lives, there is not way for
the users of public facilities to realize an investment return thereon.
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• Unlike individuals, municipalities will typically have ongoing needs for additional
facilities.
Impact of Longer Amortization Periods on Affordability of Ongoing Capital Needs
In order to analyze the impact of various amortization periods over time, rather than only with
respect to particular projects, we analyzed the impact of using 20, 30, and 40 year amortization
periods on various generations of ratepayers over an 80 year period. To reflect the need of a
utility to meet ongoing capital needs, the analysis assumed the issuance in each year of bonds
representing the same amount of purchasing power assuming a 2% inflation rate. So, assuming
the issuance of $100 million bonds in year 1, $108 million would be issued in year 5 and $148
million would be issued in year 21. Based on the above, the aggregate debt service on the bonds
issued during the period was separately calculated for each year given each of the three
amortization periods, permitting a comparison of the impact of each approach in each year over
the 80 year period. In particular, this analysis allowed us to address the concern that the use of a
longer amortization period would over time either (a) exhaust an issuers debt capacity, resulting
in an inability to fund future capital needs or (b) place an inappropriate financial burden on
future ratepayers by disproportionately increasing their rates and charges relative to those borne
by current ratepayers. The analysis also shows the impact over the entire 80-year period of
applying the budgetary savings achieved by using a longer amortization period to fund additional
projects. Finally, the analysis shows what the impact would be if the same additional projects
were funded using a shorter amortization period.
The results of the analysis support the conclusion that the use of a longer amortization period
consistent with the useful lives of the projects financed would enhance the ability to fund critical
environmental needs today without unreasonably burdening future ratepayers:
• Using a 20-year amortization period increases the aggregate debt service payable by
ratepayers in years 1 to 20 by 21% versus debt service using a 30-year period and by
34% versus debt service using a 40-year amortization period. On the other hand, the
annual dissavings to ratepayers beyond year 20 from using a longer amortization period
represent 13% and 24% of the aggregate debt service, that would be payable if a 20-year
amortization period were used. Put differently, using a 20-year amortization period
imposes a 21% or 34% increase on ratepayers today (through year 20) in order to avoid
imposing a lesser increase (13% or 24%) on future ratepayers who also have the benefit
of using the financed facilities. In each case, the percentages are calculated versus the
more favorable option for the particular generation of ratepayers (i.e., aggregate 20-year
debt service for future ratepayers and either 30-year or 40-year debt service for current
ratepayers.)
• Similarly, using a 30-year amortization period increases the cost to ratepayers in years 1
to 30 by 11% versus 40-year debt. The annual dissavings to ratepayers beyond year 30
from using a longer amortization period would also be 11%. So, using a 30-year
amortization imposes an 11% increase on ratepayers today (through year 30) in order to
avoid imposing a similar increase on future ratepayers who also have the benefit of using
the facilities finances. Again, the percentage increases are calculated versus the most
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favorable option for the particular generation of taxpayers (i.e., aggregate 30-year debt
service for future ratepayers and 40-year debt service for current ratepayers).
• Even without regard to the ability to fund additional needs, we would be tempted to
conclude that the use of a longer amortization period would result in a more equitable
distribution of costs among various generations of ratepayers. The longer amortization
period reasonably allocates the cost of environmental facilities among all users thereof.
Although future ratepayers would bear higher costs than if a shorter amortization were
used, they would have the benefit of additional facilities and would only pay an allocable
portion of the cost of facilities they actually benefit from.
• If the savings realized in years 1 to 20 by using a 40-year amortization period, rather
than a 20-year period, were used to fund additional projects, the projects funded in each
year during that period could be increased by 34%. In total, the increase is equivalent to
six additional years of funding. As a result of the increase in projects financed, aggregate
debt service payable in years 1 to 20 would be equivalent to the higher debt service on
20-year debt, i.e., 34% higher than for 40-year debt. Aggregate debt service after year 20
would be higher than it would have been if 20-year debt were used and no additional
projects were funded by an amount that exceeds 34% in several years and peaks at 40%
of the 20-year debt service with no additional projects. However, in those same years,
the percentage increase in aggregate debt service payable by future ratepayers as
compared to 40-year debt service without any additional projects, does not exceed 15%.
Substantially less than the 34% increase borne by current ratepayers. If the same
additional projects were funded using 20-year debt service, the result would be a 79%
increase for current ratepayers as compared 40-year debt service with no additional
projects.
• If the savings realized in years 1 to 30 by using a 40-year amortization period, rather
than a 30-year period, were used to fund additional projects, the projects funded in each
year during that period could be increased by 11%. In total, the increase is equivalent to
two additional years of funding. As a result of the increase in projects financed,
aggregate debt service payable in years 1 to 30 would be equivalent to the higher debt
service on 30-year debt, i.e., 11% higher than for 40-year debt. Aggregate debt service
after year 30 would be higher than it would have been if 30-year debt were used and no
additional projects were funded by an amount that exceeds 11% in several years and
peaks at 16% of the 30-year debt service with no additional projects. However, in those
same years, the percentage increase in aggregate debt service payable by future
ratepayers as compared to 40-year debt service without any additional projects, does not
exceed 5%. Substantially less than the 11% increase borne by current ratepayers. If the
same additional projects were funded using 30-year debt service, the result would be a
23% increase for current ratepayers as compared 40-year debt service with no additional
projects.
Our analysis of the impact of (a) using a longer amortization period and (b) applying the
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budgetary savings from to fund additional projects suggests the following:
• This approach would substantially moderate the impact of funding additional projects on
current ratepayers. In would reduce by more than 50% the impact on current ratepayers
of funding such projects versus funding them using a shorter amortization period.
• This approach would not inappropriately burden future ratepayers. The cost of each
project would be fairly allocated among those who benefit from it. The aggregate cost
increase borne by future ratepayers who also benefit from the additional facilities would
not be disproportionate relative to the aggregate cost borne by current ratepayers.
• Funding of such additional projects using a shorter amortization period would place a
disproportionate burden on current ratepayers.
Useful Life Financing - Page 11
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strategies will be necessary for addressing the challenges we face in maintaining our
nation's water infrastructure. <
The Agency is working in partnership with the States, water utility industry and
other stakeholders to ensure sustainability of water and wastewater systems. This
includes promoting water efficient products, full cost pricing of water and wastewater
services, management techniques for reducing long-term costs and improving
performance and expanding watershed approaches to identify effective local
infrastructure solutions. EPA refers to these four focus areas as the four pillars of
sustainability, as noted in your paper.
Using useful life financing is an approach that falls within the aegis of the four
pillars. Specifically, EPA's advocacy of better management practices should include
examining different amortization periods for new infrastructure. Full cost pricing will
include an examination of current financing practices and its relationship to rate
structures.
While I understand that useful life amortizing would reduce the year-to-year debt
service payments, I believe it is important to further study current industry practices. The
paper mentions that current industry practice is to use debt amortization periods far
shorter than the useful life of the project. Further study should be conducted into the
reasons short term financing is used instead of useful life financing and whether useful
life financing can be applied in situations where a single bond is used to finance multiple
pieces of a project with different useful Eves. A conference of industry representatives
could be convened by EFAB to examine in greater detail the situation on the ground, how
a more efficient system of financing infrastructure can be implemented, and how this can
be dovetailed with the four pillars of sustainability.
Thank you again for providing this valuable input. I encourage you to continue
examining innovative methods for closing the nation's water infrastructure funding gap,
and look forward to hearing recommendations in the future. If you have any questions or
wish to speak further about this issue, please contact James A. Hanlon, Director, Office
of Wastewater Management, at (202) 564-0748.
Benjamin H. Grumbles
Assistant Administrator
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