United States
Environmental Protection
Agency
Office Of Water
(4204)
EPA 832-B-97-003
February 1997
vvEPA
State Match Options For The
State Revolving Fund Program
-------
-------
EPA 832-B-97-003
February 1997
STATE MATCH OPTIONS FOR THE
STATE REVOLVING FUND PROGRAM
U.S. Environmental Protection Agency
Office of Wastewater Management
Municipal Support Division
Washington, D.C.
-------
-------
REPORT CONTENTS
I. INTRODUCTION 1
II. DESCRIPTION OF MATCH OPTIONS 3
Option I: General Appropriations From Available Funds 3
Option II: General Obligation Debt . 4
Option II-A: G.O. Bond Proceeds 4
Option H-B: G.O. Debt Repaid with SRF Revenues 5
Option II-C: G.O. Bond Placed in SRF 6
Option III: State Match Revenue Bonds 7
Option IV: Pledged Repayments From State Loan Programs 9
Option V: Local Contribution 10
HI. EVALUATION OF MATCH ALTERNATIVES . 11
1. Cost to SRF 12
2. Cost to Communities 13
3. Administrative Complexity 14
4. Predictability/Reliability 16
5. Frequency of Use 17
Conclusion 18
-------
LIST OF FIGURES AND TABLES
Figure 1 - State Appropriation Option
Figure 2 - State Match from G.O. Bond Proceeds
Figure 3 - G.O. Debt Repaid with SRF Revenues
Figure 4 - G.O. Bonds Placed in SRF
Figure 5 - SRF Match Revenue Bonds
Figure 6 - Pledged Repayments from State Loan Program
Figure 7 - Local Contribution
3
4
5
6
7
9
10
Table 1 - Evaluation Criterion - Cost to SRF
Table 2 - Evaluation Criterion - Cost to Communities ....
Table 3 - Evaluation Criterion - Administrative Complexity
Table 4 - Evaluation Criterion - Predictability/Reliability ..
Table 5 - Evaluation Criterion - Frequency of Use
.12
13
14
16
17
-------
I. INTRODUCTION
The 1987 Amendments to the Clean Water Act (CWA) fundamentally changed the
way the federal government provides financial assistance for water pollution control facilities.
The CWA replaced the Construction Grants program with the State Revolving Fund (SRF)
program, a state controlled and operated program to provide loans and other financial
assistance for water pollution control projects. All fifty states and Puerto Rico are operating
successful SRF programs. To date, nearly $20 billion in funds have been committed to SRF
programs. As of June 1995, SRF programs provided more than 3,200 loans totaling
approximately $14.5 billion for eligible water pollution control assistance.
The CWA requires states to provide matching funds to capitalize the SRF program.
To participate in the program, states must provide an amount equal to or greater than 20
percent of federal capitalization grants. In keeping with the objective of providing states with
maximum, flexibility in designing SRF programs, the CWA allows states to provide match
from a variety of sources. For example, match payments may be cash deposits made directly
from state accounts or may come from proceeds of SRF bonds that are repaid with SRF
interest earnings.
Since the beginning of the SRF program, most states have relied upon general fund
appropriations as their source of match. However, in recent years the use of bonds as the
source of state match has become more popular. For fiscal year 1996 SRF capitalization
grants, seventeen states are using bonds for match.
There are a variety of factors that states consider when selecting a source for SRF
matching funds. For example, states with unfavorable economic conditions might find it
somewhat difficult to provide SRF match from available resources, and as a result, may look
for other match sources. Conversely, states that are experiencing high levels of growth and
strong economic conditions may have little trouble committing cash and future appropriations
to meet SRF match requirements. Also, some states may, as a matter of policy, wish to
further capitalize their SRFs by providing match in excess of the required 20 percent.
As conditions change states may find it necessary to reexamine their approach to
providing matching funds. Should states use bonds for match? Are there other viable match
options? This report is intended to help states that are asking these questions to review state
match options. The report identifies and evaluates seven different state match options and
discusses each option's effect on the SRF over time. The match options presented are also
applicable to the new Drinking Water State Revolving Fund Program established by the Safe
Drinking Water Act Amendments to 1996.
on SRFState MatcA Options
Page J
-------
There are two primary sections that follow this introduction. The next section (Section
II) of the report identifies and describes the various match options. Section IE analyzes the
effect of different options on the SRF.
Report on SRF State MatcA Options
Page 2
-------
II. DESCRIPTION OF MATCH OPTIONS
This section of the report describes alternative approaches that a state may take to
provide match. The section addresses seven different match options that are in use today or
have been used in the past by states. Reviewing these alternative approaches will help SRF
managers determine which options are applicable and/or practical for their state.
Option I: General Appropriations From Available Funds
Many states (e.g., Hawaii and Virginia) use general appropriations from available
funds as their match source. In many cases, state legislatures committed funds for the full
initial SRF capitalization implementation period (through 1994) based on federal authorized
funding levels authorized in the CWA and expected state allotments.
Figure 1 presents the flow of funds for the state appropriation match deposit process.
States deposit match funds before or at the same time the SRF receives the federal grant
payment. A federal grant payment is an increase to the funding ceiling available to the SRF
and reflects projected project funding commitments.
U.S. Treasury
(Capitalization
Grants)
Payments -
Repayments-
SRF
State Treasury
(Match)
- Paymen
Loans and Other
Forms of
Assistance
When
the source of
state match is
general
appropriations,
match deposits
are most often
cash deposits.
This is a benefit
to the SRF
program
because the
interest earnings
on the match
funds remain in
the SRF and will be available for loans or other financial assistance.
A state may also use a "Letter-Of-Credit" (LOG) mechanism to provide state match.
In this approach, a state establishes a process similar to the federal process used to draw SRF
funds as project construction proceeds. A LOG is a funding commitment pledged by the
Administrative
Costs
figure / - State Appropriation Opt/on
Report on. SRF: State Match Options
fage 3
-------
state. As project construction progresses, SRF programs convert LOG funds to cash and
disburse them to communities, who in turn pay vendors for work performed.
Using cash appropriations as the source of state match can result in funds being
available for use by the SRF earlier than under other options. A potential disadvantage of this
option is the risk that a state legislature might reverse or modify its decision to provide
appropriations within the agreed to time schedule delaying the capitalization grant award.
Option II: General Obligation Debt
General Obligation (G.O.) debt of a state is comprised primarily of state bonds that are
backed by the general taxing authority of the state. There are three different match options
that use G.O. debt. Their effect on the SRF varies in terms of costs and administrative
complexity.
Option II-A: G.O. Bond Proceeds
First, a state may issue G.O. debt and deposit the proceeds into the SRF for match. States
repay the G.O. bonds with revenues collected in the future (e.g., state income tax). The state
backs the bonds with its "full faith and credit."
In other
words, the state
pledges to raise
the necessary
funds through
taxation and
other revenue
sources to
repay the
bonds. States
using this
approach
include
California and
Pennsylvania.
This option
differs from
using
appropriations.
'ayments-
-Repayments-
SRF
Match Payments
'(Bond Proceeds)"
Loans and Other
Forms of
Assistance
Administrative
Costs
G.O. Bond
Proceeds
G.O.
Bond Holders
figure 2 - State MatcJ] from G.O. Bond Proceeds
Report on SftF State MatcJi Options
Page 4
-------
When a state uses G.O. debt, it pledges to repay the debt from future general fund revenues.
In contrast to several other bond options described in this report, the bonds are not repaid
from SRF interest revenues so the match funds remain as capital available for program uses.
This option may result in additional managerial and administrative costs related to tracking the
use of funds and demonstrating compliance with Internal Revenue Service regulations. A
potential disadvantage of this option is the risk that a state legislature might reverse or modify
its decision to appropriate funds that are scheduled to come from G.O. bond proceeds due to
budget shortfalls.
Option II-B: G.O. Debt Repaid with SRF Revenues
A second approach that uses G.O. debt requires the SRF to pay the debt service for the
general obligation debt. Figure 3 illustrates the G.O. match bond cash flow process.
Wisconsin, Nevada, and Texas use this approach.
Because the
state backs the
G.O. debt with
its full faith
and credit, the
bond interest
rate is usually
lower than if
the SRF issued
revenue bonds
which would
be secured by
the revenues
of the program
(Option III -
described in
next section).
In addition,
the use of
G O bonds figure 3 - G.O. Debt flepaJd m'tJ] SflF Revenues
can benefit the
SRF through lower issuance costs, and by avoiding the need for a separate reserve fund within
the SRF.
Loans and Other
Forms of
Assistance
Administrative
Costs
G.O.Bond
Debt Service.
t
G.O. Bond
Proceeds
G.O.
Bond Holders
fiepori oji SRF State Match Options
Page 5
-------
In cases where SRF programs establish reserve funds for G.O. match bonds, the rate
on the G.O. bonds may be even lower than the state's G.O. bond rate and the bonds are likely
to sell more quickly on the market. Texas has used this approach in the past and found
investors to be very receptive to a G.O. bond with an additional reserve fund in the SRF.
As with all match bond options, SRF program regulations require that only the interest
portion of SRF loan repayments and interest earned on SRF accounts be used to repay the
G.O. bonds. A state must demonstrate that program interest earnings are sufficient to repay
the match bonds. This requirement ensures that one of the fundamental principles of the SRF
program, that a state will provide matching capitalization that will be available for continued
SRF uses, will be met.
Option II-C: G. O. Bond Placed in SRF
Connecticut and Michigan have used a different version of the G.O. debt option. The
state deposits a G.O. bond in the SRF and pays principal and interest into the SRF to retire the
bond. The best way to understand this option is to compare it with G.O. bond options just
described. In the other G.O. bond options, states sell bonds to investors, deposit the net bond
proceeds in the SRF as match funds, and then pay off the annual bond payments with general
fund revenues.
U.S. Treasury
(Capitalization
Grants)
ayments-
^epayments-
Bonds Placed in SRF-
SRF
State
Match Payments
"(Bond Retirement)
Loans and Other
Forms of
Assistance
In
Connecticut, the
bonds are placed
in the SRF and
the state pays
annual debt
service directly
to the SRF
program (Figure
4). The
difference
between this
option and other
G.O. bond figure 4 - G.O. Bonds Placed in SXF
options (e.g., see
Option II-A) is that the state makes semiannual debt service payments to the SRF program
instead of outside investors.
Administrative
Costs
Report on SRF Stale Match Options
-------
Under this approach, the principal portion of the bond payment made to the SRF
serves as a match deposit. This approach eliminates the G.O. bond issuance costs that the
state would normally incur. The approach also benefits the SRF program if the bond payment
from the state general fund to the SRF includes interest payments in addition to the principal
payment.
To ensure that this approach is comparable to the other bond approaches several
requirements must be met. First, the bonds must be an irrevocable commitment by the state to
make match deposits into the fund. Second, the debt service schedule of the bonds must be
typical of revenue bonds. Third, if loan default occurs in a leveraged program, the SRF must
draw from both federal funds and state match funds to cover the default. This will ensure that
cash draws of federal and state funds remain proportional to overall investment in the SRF.
Fourth, for each year that this approach is in use a state must submit documentation of bond
cash flows as evidence of compliance with the SRF regulations. Fifth, the bond must receive
a bond rating in the same fashion as other G.O. debt. It is important to note that the bond
payment schedule must be sufficient to cover the state share of costs of construction as it
occurs. This option provides several benefits to states including eliminating interest costs
associated with issuing debt. A potential draw back is that this option has not been widely
used in states and, as a result, it may take additional up-front work to explain and gain
approval for its
use.
.Payments -
Repayments-
Cash Flow
If Bonds Issued
By State
SRF
Net Bond
Proceeds
(Match)
Debt Service
(SRF Interest
Earnings)
SRF Revenue
Bond Holders
Loans and Other
Forms of
Assistance
Administrative
Costs
Option III: State
Match Revenue
Bonds
In cases
where states
cannot provide
match funding
from available
resources outside
the SRF, revenue
bonds may be
issued directly by
the SRF and the
net proceeds from the bonds can be used for match. EPA regulations allow SRF programs to
issue bonds to acquire match and use SRF interest earnings to retire the bonds (Figure 5).
Interest funds to retire bonds come from the interest portion of SRF loan repayments and
figure 5 - SftFMatcJ] Revenue Bonds
fieport on SKF.State.Match .Options .
-------
interest earned on SRF accounts. SRF programs cannot use the principal portion of loan
repayments, capitalization dollars, or other state match dollars to retire match bonds. The net
bond proceeds that are committed as state match must be retained within the SRF and used
for future SRF eligible funding activities (e.g., loans, guarantees, etc.). Thirteen states are
now using SRF revenue bonds for match (AL, NE, CO, MT, ND, SD, AZ, IN, OH, IA, KS,
MI, LA).
As Figure 5 illustrates, states that use revenue bonds as the source of match take two
different approaches to issuing bonds. Some states issue the bonds outside the SRF through
existing state bonding mechanisms and deposit the net proceeds from the sale into the SRF
(broken line box in Figure 5). Other states give the SRF direct bonding authority and issue
the bonds directly from the SRF.
Using revenue bonds as the source of state match allows states to capitalize their SRF
without tapping into other state resources. However, the disadvantage of the option is that
states loose some flexibility in setting the interest rate on SRF loans. This is the case because
the SRF loan interest rate will need to be high enough to provide funds to repay the SRF
revenue bonds. In addition, programs that tap into the SRF to repay bonds will reduce the
purchasing power of their SRF program. Fund interest earnings from loans and investments
that could have been used for new loans would be reduced by the amount needed to repay
SRF revenue bonds.
Report on SRF State Match Options
Page 8
-------
Option IV: Pledged Repayments From State Loan Programs
SRF programs may use loans from preexisting state programs as a source of state
match. A preexisting loan portfolio may generate both cash and credit (of future principal
repayments) toward meeting the state match requirement. Georgia, Utah and New Jersey are
using this approach. Different requirements exist for loans before and after March 7, 1985,
(the date that The Water Quality Act of 1987, which established the SRF program, was
introduced in the
U.S. Senate).
i Repayments-
'ayments-
SRF
Loans and Other
Forms of
Assistance
Administrative
Costs
State Loan
Principal/Repayments
Used As Match
Note: Different rules apply for pre-existing loans made before March 7,1985,
and after Man* 7. 7985
For loans
made from
preexisting loan
programs after
March 7, 1985,
the amount of
outstanding loan
principal can be
credited in full
toward the state
match if the
projects met
Clean Water Act
requirements in
effect at the time
of the loans. As
the state receives
repayments of
principal which it claimed for credit, those funds must be transferred to the SRF. The interest
portion of the repayments for loans made after March 7, 1985 must be deposited in the SRF
and may be used for matching requirements only as they are received.
For loans prior to March 7, 1985, only repayment amounts (both principal and
interest), as they are received, can be counted toward state match. Credit for match is given as
the repayments are received and deposited into the SRF.
figure 6 - Pledged Repayments from State Loan Program
fieport on SXF State Match Options
Pageff
-------
Option V: Local Contribution
States that are having difficulty identifying a source of state match could use an
approach that requires loan recipients to provide an upfront local contribution equal to 20% of
the total loan. To date, Colorado is the only state that has used this approach. Colorado
charged a local contribution amount to loan recipients and used the contribution to meet the
state's SRF matching requirement. These local contributions are cash payments made by loan
applicants to secure the loan. Figure 7 illustrates the cash flow process for this option. States
need to provide an assurance that the local contribution funds are committed to the SRF at the
time of capitalization grant award. Funds from the local contribution would need to flow into
the SRF on a schedule that complies with SRF cash draw regulations. At the latest, the local
contribution
would need to be
deposited into the
SRF to meet
match
requirements as
the SRF draws
cash from
through the
federal cash draw
process.
U.S. Treasury
(Capitalization
Grants)
Payments -
-Repayments-
SRF
State
Local Contribution..-
Loan Recipients
Administrative
Costs
figure 7 - Local Contribution
Although
this option
requires loan
recipients to provide funds "up front," the scenario could still result in savings to the recipient
if the SRF loan rate is significantly lower than the market interest rate available to the loan
recipient. This is the case even if the community borrows the local contribution funds.
However, this approach could result in municipal complaints that the state is not obtaining the
match funds from "state funds" and the SRF program could become less attractive to local
borrowers.
Report on SRF State Match Options
Page JO
-------
III. EVALUATION OF MATCH ALTERNATIVES
This section of the report presents an evaluation of match alternatives. Each
alternative is evaluated based on the following criteria:
1. Cost to SRF - Does the option use SRF revenues that would otherwise be available
for eligible SRF assistance?
2. Cost to Communities - Does the option result in additional costs or higher interest
rates for communities?
3. Administrative Complexity - How complex is the match source to administer?
What skills are required?
4. Predictability/Reliability - Is there certainty that match will be available when
federal grant payments are made?
5. Frequency of Use - Has the option been popular or unpopular between top state
decision makers?
Separate tables for each evaluation criterion display each match option's relative effect on the
SRF.
It should be noted that the ratings given for each option do not impact EPA's
willingness to accept or reject any one of these options. The purpose of the ratings is to give
states a general idea of the evaluation criteria to use when considering different state match
options.
Report oji SRF State MatcA Options
Page 11
-------
l.CosttoSRF
Match option costs include interest costs for borrowing match funds, planning and
implementing the match option, and continuing administration costs that occur for the option.
The review of match options assumes that the goal is to meet the CWA statutory requirements
at the least cost to the SRF. Table 1 displays the relative cost to the SRF for each option.
Issuing SRF revenue bonds is the highest cost option. It is higher in cost because SRF
interest earnings are used to repay debt. Issuing bonds from the SRF often requires skills and
legal authority that SRF programs must acquire. G.O. debt that is repaid with SRF revenues
generally will have lower interest costs because G.O. bonds are viewed as less risky, and
administrative costs will be lower because another state program manages the bond issuance
process.
The final cost of each of the options will vary depending on the interest rates available
for different options. An analysis that establishes the present value of the annual cash-flows
for each match option will provide state specific information to support a state's selection
process.
r
Match Option :
General Appropriations
G.O. Debt Proceeds
Deposited in SRF
G.O. Debt Paid with SRF
Revenues
G.O. Bond Placed in SRF
SRF Revenue Bonds
Fledged Repayments from
State Loan Programs
Local Contribution
Fable 1: Evaluation Criterion - Cost to £
High
X
Moderately
High
X
Average
SRF
Moderately
Low .
X
X
X
X
•••••••••••••••MMMMMM
Low
X
ffeport on SRF State Ma ten Options
Page
-------
2. Cost to Communities
Match options have different cost impacts on communities. Table 2 displays the
relative cost to communities for each option. The options that require a higher SRF loan
interest rate to generate revenues to repay debt used for match have a higher cost impact from
a community perspective.
Issuing SRF revenue bonds and using loan contributions are the higher cost options
relative to the others presented. Using revenue bonds for match requires that the SRF loan
rates be high enough to generate interest earnings to repay the debt. Loan contributions could
require a significant up-front payment by communities that would not occur with other
options. G.O. Debt that is repaid from the SRF would result in a moderately high impact to
communities because, while SRF loan interest rates would need to be sufficient to generate
funds for bond payments, G.O. debt is normally less costly than SRF revenue bonds.
Table 2: Evaluation Criterion - Cost to Communities
Match Option
General Appropriations
G.O. Debt Proceeds
Deposited in SRF
G.O. Debt Paid with SRF
Revenues
G.O. Bond Placed in SRF
SRF Revenue Bonds
Pledged Repayments from
State Loan Programs
Local Contribution
High Moderately
\ High
X
X
X
Average
Moderately
Low
Low
X
X
X
X
; Report oj] SRF State Match Options
Page 13
-------
3. Administrative Complexity
The administrative complexity of a match option depends on level of specialized skills
required to implement and manage the match source and the amount of coordination required
between state agencies, SRF loan applicants, and specialized private sector firms (e.g.;, bond
counsels). Table 3 summarizes the administrative complexity of the match options.
Generally, the administrative complexity of a match option will be greatest when
bonds are used. However, using G.O. bonds is generally less complex than using SRF
revenue bonds. Normally a state's finance department is responsible for the technical aspects
of the G.O. bond issuance and repayment process. SRF managers are left with the
responsibility to process loans and transfer any payments from interest earnings to a state
account used to retire G.O. bonds.
Table 3: Evaluation Criterion - Administrative Complexity
Match Option
General Appropriations
G.O. Debt Proceeds Deposited
in SRF
G.O. Debt paid with SRF
Revenues
G.O. Bond Flaced in SRF
SRF Revenue Bonds
Pledged Repayments from
State Loan Programs
Local Contribution
High
X
Moderately
High
X
X
Average
X
X
X
Moderately
Low
Low
X
Report on SfiF State Match Options
Page 14
-------
Using revenue bonds for match results in a higher level of complexity because SRF
managers are required to interact/coordinate with several different specialists during the
process. These include:
• Underwriters/Investment Bankers
• Bond Counsels
• Financial Advisors
• Bond Rating Agencies
Managing program operations may become more complex when using bonds for
match. Tax law restrictions on expenditure timing, arbitrage earnings/reporting, and use of
funds require specialized management skills (internal and/or external). Requirements of the
debt structure such as debt service coverage levels, and use of reserve funds also increase the
management complexity.
The last three options listed in Table 3 are average in complexity because, while they
require additional coordination and management, they do not present the same challenges as
issuing bonds.
Report on SffF Stale Match Options
Page 15
-------
4. Predictability/Reliability
The predictability/reliability of a match alternative reflects the level of confidence there
is that the funds will be available to the SRF to meet match timing requirements. Table 4
summarizes the predictability/reliability of match options. With most options, SRF managers
have control over the timing of funds. For example, bond issuance can be timed to
correspond with the SRF's grant payment schedule to ensure that funds are deposited on or
before the scheduled grant payment date.
SRF program managers have less control over the flow of funds in the last two options
listed in Table 4. When using pledged repayments from state loan programs, the SRF may be
dependent on loan recipients from other programs making on-time payments. When using
local contribution as the source of state match, the availability of match funds will be
dependent on the loan closing process.
Table 4: Evaluation Criterion - Predictability/Reliability
••••••••^••^^^^•••••••••••••••••^•^•••^H
Match Option
General Appropriations
G.O. Debt Proceeds Deposited
in SRF
G.O. Debt Paid with SRF
Revenues
G.O. Bond Placed in SRF
SRF Revenue Bonds
Pledged Repayments from
State Loan Programs
Local Contribution
jfigh ;
X
X
X
Moderately
High
X
X
', Average
X
X
Moderately
Low
Low
Report on SRF Slate Match Options
-------
5: Frequency of Use
This criterion guages how the match options have been accepted by state and EPA
decision-makers. The ranking in Table 5 partially indicates the level of use of the individual
options. Frequently used options can generally be viewed as acceptable to decision-makers.
Table 5: Evaluation Criterion - Frequency of Use
Match Option
General Appropriations
G.O.Debt Proceeds
Deposited in SRF
G.O. Debt Paid with SRF
Revenues
G.O. Bond Placed in SRF
SRF Revenue Bonds
Pledged Repayments from
State Loan Programs
Local Contribution
••••. ' tiigh ' •'-':'• :
X
X
;- ;;: Medium "•
X
•-' • ; .':••' Low '• •
X
X
X
X
foport on SfiF State Match Options
'•-. Page 17
-------
Conclusion
The SRF program provides critical funding to address the country's continuing water
pollution problems. States that capitalize their SRFs through appropriations will be rewarded
over time with higher SRF funding levels. However, should a state be unable to provide funds
directly to the SRF, other state match options are available for use.
The "best" match option for each state will depend on the unique conditions confronting
each state. When reviewing match options states should consider criteria including cost to the
SRF/communities, administrative complexity, reliability, and overall historic acceptability.
Report an SRF Slate Match, Options
Page 18
------- |