Environmental Financial Advisor}' Board
Environmental Protection Agency
JAN 30 (998
Mr. Robert Perciasepe
Assistant Administrator for Water (4101)
Environmental Protection Agency
401 M Street S.W.
Washington, D.C. 20460
Mr,
We are pleased to provide you with a technical report of the Environmental
Financial Advisory Board (EFAB) entitled: "Why Longer Loan Terms Are Prudent
for SRFs." The report presents the argument for permitting longer loan terms for
loans made by the State Revolving Funds, as encouraged in the Conference Report
for the Agency's fiscal year 1998 appropriations bill.
If you wish to discuss this report or if we can be of any other assistance, please let
us know.
u
Robert O. Lenna <-*-*ohn C. Wise
Chair, EFAB Executive Director, EFAB
cc: FredHansen(1102)
Sallyanne Harper (2710)
Michael Ryan (2731)
Cynthia Dougherty (4601)
MichaelB. Cook (4210)
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Environmental
Robert Lcnna
Chair
John Wise
Executive Director
Members
Hon. Pete Domcnici
George Bulchcr
Pete Butkus
Michael Curley
Michael Deane
Linda Dcscano
Peter Emerson
Deeohn Ferris
Stiocklcy Gardner
Evan I lenry
Anne Pcndergrass 1 lill
Stephen Mahfood
Langdon Marsh
John McCarthy
George Kaflclis
Arthur Ray
Heather Ruth
Sonia Toledo
Jim To/zi
Mary Ellen Whilworth
Robin Wiessmann
Joseph Young
Elizabeth Ytell
Why Longer Loan Terms
are Prudent for SRFs
This report has not been levicwed 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.
December 1997
Primed on Recycled Paper
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Why Longer Loan Terms are Prudent for SRPs
Environmental Financial Advisory
November 1997
The recently-enacted HUD appropriation bill incorporated by reference Committee language
which underscores the importance of loan structuring flexibility for Stale Revolving Funds
(SRFs). Specifically, the Committee submitted that it:
"is aware of the financial difficulties many municipalities and regional water authorities
face as they undertake projects to modernize their sewer and water systems in order to
comply with the Federal Water Pollution Control Act. , , , absent the enactment of long-
term legislative reforms ... it is appropriate to seek other, non-legislative forms of relief
for communities struggling to meet the financial requirements of compliance with the
Act, and that in fact, such non-legislative relief could reduce the need to continue
providing direct assistance.
The Committee notes in this connection thai, , , . reimbursements to SRFs . . . stretched
out over a longer period of time will result in lower annual debt service, thereby making
it easier for municipal water authorities (and their ratepayers) to afford the costs of
projects mandated by the Act."
Through this language, EPA is being encouraged by Congress to permit longer terms for loans
funded with leveraged SRF bond proceeds, which have traditionally been limited to 20 years.
Programmatically, longer loan terms provide a number of benefits to leveraged SRFs: (i) a better
alternative to grants; (ii) a better fit with the life of assets financed; and (iii) a strong incentive for
environmental projects to get under way.
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Longer loan terms provide SRF administrators with additional flexibility in managing loan
service burdens for borrowers saddled with financing large environmental programs. As
illustrated by the chart below, a 30 year loan reduces annual costs to a borrower by 34% in
comparison to a 20 year subsidized loan. The chart illustrates the impact on annual loan service
requirements from a $100 million 20 year loan subsidized at 50% of market versus a 30 year loan
with the same subsidy level Total payments on the 20 year loan total $138 million while
payments on the longer 30 year loan total $154 million, an increase of approximately 12%.
However, the lower annual payments associated with the 30 year loan can make a large project
affordable. A 34% reduction in annual loan costs is significant by any measure, particularly
when considering that no additional SRF subsidy dollars are required and that 100% of the loan
principal returns to the SRF.
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Comparison of 20 and 30 Year Loan Service
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, ——30 Year Loan Service J
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The Safe Drinking Water Act explicitly provides for 30 year loan terms for disadvantage;!
communities. From a programmatic perspective, longer loan terms are preferable to direct loan
subsidies (i.e. grants), which are also allowed for disadvantaged communities under the Safe
Drinking Water Act, Loan subsidies have a permanent impact on the lending capacity of the
SRF and run counter to the philosophy that was used to establish SRFs in the late 1980s. Longer
loan terms are consistent with the philosophy that established SRFs initially and do not run the
risk of reversing the good work done by states in accustoming localities to a loan, rather than a
program.
Longer Term
SRFs finance capital intensive projects with long useful average lives. Projects financed by the
Clean Water and Drinking Water SRFs include treatment plants, distribution systems, and
storage facilities, among others. These assets, some of which may last as long as 100 years, are
traditionally financed by water and sewer authorities through 30 or even 40 year debt. The
limitation on SRP loans fails to recognize the fact that many of these large, capital intensive
projects will pay for themselves over a time horizon well in excess of 20 years.
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Municipalities and water and sewer systems — the principal borrowers of SRF moneys — operate
in an environment where rate increases are highly publicized and the financing of expensive
environmental projects is debated because of the burden imposed on to ratepayers. The
availability of longer Joans for SRF-cligible projects will make them more affordable and will
provide a strong incentive for a larger amount of projects to be financed at an earlier point in
time given a budget of palatable rate increases.
Longer Loan Terms area IMfenQption than Otlmr ..... A)imyjil>kJ.,oaii Structures
EPA's Clean Water Act SRF Guidance allows for the structuring of "balloon" loans which come
due in a large payment, rather than in serial maturities over the life of the loan. The Guidance
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states that balloon loans may be offered provided that the structure is included in the Intended
Use Plan and the in question can prove there is no adverse impact on the SRF. A balloon
loan, depending on its final maturity, will have an average life in excess of the average life on a
thirty-year loan structured to provide for annual payments and level debt service. Thirty-year
loans are likely to have no impact on the lending capacity for leveraged SRFs.
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Loans longer than twenty years expose SRFs to the credit of the underlying borrower for a more
extended period of time. As a result, SRFs may want to limit structuring longer loan terms for
borrowers with stable credits and investment ratings. Longer loans to borrowers which do
not meet this criteria may require additional security from the borrowers or incremental
monitoring by SRF administrators.
The ..... Impact of Longer Loan. Terms on Leveraged ..Programs is ..Minimal
The 20-year limitation on loan terms may make sense for SRFs which do not leverage and whose
only resources for continuing loan activity are federal grants, state matching funds and loan
repayments. However, SRFs which actively use leveraging frameworks are already making
more funding available than is possible from the direct lending of federal grants and state
matching funds. In other words, leveraged programs provide greater near-term funding,
counteracting the slower pace of "recycling" resulting from longer loan terms.
C.Q iic I u sio.n a ml Jiecomm cndatittng
SRFs, borrowers and the environment can all benefit from greater flexibility in the structure of
SRF loan terms, SRF loans that more closely match the life of the assets financed is financially
prudent. Longer term loans also meet important environmental objectives — lower annual debt
burdens for municipalities will provide incentives for more environmental projects to be built
upfront.
We encourage the Agency to move as far forward as permitted by the directive of the
Appropriations Committee in implementing longer loan terms as an alternative for SRFs which
leverage their capitalization grants. Longer loan terms are appropriate for projects with useful
lives exceeding 20 years. In addition, longer loan terms should be made available to credit-
worthy borrowers facing large mandates.
We also recommend that, given the significant benefits that would result from longer loan terms,
EPA work jointly with the whose leveraged programs cannot implement longer loan terms
under existing law to secure amendments that will permit the universal application of this
technique,
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