United States Office of Municipal EPA 430/W-88-009
Environmental Protection Pollution Control (WH-546) September 1988
Agency Washington, DC 20460
Water
?xEPA
Letter of Credit
How is it Used
in EPA's State Revolving
Fund Program?
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Table of Contents
Introduction 1
What is the Purpose of This Brochure? 1
What is a Federal Letter of Credit? 2
Has the Program Been Used Before? 3
How Does it Work? 4
Why is the Letter of Credit Approach
Being Used For the State Revolving Fund Program? 5
Converting the Letter of
Credit to Cash....... 7
Definitions 7
How the Funds Flow 8
General Principles 9
General Rules For All Forms of Assistance 10
Specific Rules For Various Forms of Assistance 14
Loans 16
Refinance or Purchase of Municipal Debt. 19
Purchase of Insurance 22
Guarantees 23
Leveraging of State Bonds 26
Administrative Costs 31
How Secure is the Grant? 32
Executive and Congressional Action 32
EPA Actions 33
Leveraged Loan Program: An Alternative....... 34
Appendices
Appendix A Glossary of SRF Terms
Appendix B Excerpts From the Initial Guidance
Appendix C JRS Notice 88-54
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Introduction:
What is the Purpose of this
Brochure?
The 1987 Water Quality Act markedly changed the way the
nation finances wastewater treatment facilities. In a transition
to State and local self-sufficiency, the dean Water Act
(CWA) was amended to phase out EPA's Construction
Grants program and establish the State Revolving Fund
(SRF) program. Congress authorized $8.4 billion in
capitalization grants as seed money for establishing the
State Revolving Funds. Under this SRF program, the Letter
of Credit (LOG) is used by the Environmental Protection
Agency (EPA) to transfer funds awarded to States under
Capitalization Grants.
This brochure is designed to supplement EPA's Initial
Guidance for State Revolving Funds (January 1988) by
explaining in more detail EPA's Letter of Credit system. In
particular it will address the following questions:
What is a Federal LOG?
Has it been used before?
How does it work?
Why is the LOG being used for the State Revolving
Fund Program?
How will a State draw cash from its LOG?
How secure is the LOG?
This brochure is organized to answer these questions.
Because a number of terms and phrases have particular
meaning when applied to the LOG program, they are
highlighted in the brochure and defined in the appendix. In
addition, the appendix contains key provisions of the SRF
Initial Guidance and Notice 88-54 from the Internal Revenue
Service regarding the continued tax-exempt status of State
and local bonds issued as part of the SRF program. Finally,
the inside back cover contains a list of persons to contact if
you have additional questions.
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What Is a Federal Letter
of Credit?
The Federal LOG was first instituted in 1964 as a cash
management tool which enabled recipients of Federal
grants and contracts to draw down cash as needed. In 1979,
the system was converted to an electronic payment
mechanism which linked the Treasury, the Federal Reserve
and the Federal agencies into one network. Through this
mechanism, formally referred to as the Letter of Credit -
Treasury Financial Communications System, recipients of
Federal funds can obtain cash from the Treasury through an
expedited procedure.
The purposes of the LOG are to improve cash management
of Federal payments, to expedite cash transfers when
required, and to provide more timely and accurate reporting
on Letter Of Credit transactions.
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Has the Program Been
Used Before?
In Fiscal Year 1987 alone, LOG processed approximately
155,000 payments transferring over $102 billion to States.
The Letter Of Credit - Treasury Financial Communications
System is a well tested and effective mechanism for the
rapid transfer of funds.
Last year, over 45 Federal agencies used LOG including:
Health and Human Services - to transfer funds under
its Welfare and Aid to Families with Dependent
Children programs;
Agriculture - to transfer funds under its Food and
Nutrition program;
Federal Fjnergency Management Agency (FEMA) -
to transfer cash quickly to States during an emergency;
National Science Foundation - to transfer funds for
research grants; and
Environmental Protection Agency - to transfer funds
to States under its Clean Water Act Sections 205(g)
and 106 and other grant programs.
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How Does it Work?
As shown on Figure 1, the process of transferring Federal
funds to the State Revolving Fund actually began when
Congress passed the Amendments to the Clean Water Act
authorizing $8.4 billion through the year 1994 to capitalize
the SRF program. Annually, Congress must appropriate
funds for each fiscal year for the SRF program, as it does for
all of the Federal government. The Office of Management
and Budget (OMB) apportions these funds to the designated
agency, in this case the Environmental Protection Agency
(EPA). The EPA makes allotments to the individual States
using the formula established in the Clean Water Act Upon
approval of the State's grant application, EPA obligates the
funds to each State in the form of a capitalization grant It
should be noted tha{ a.11 grants and payments under the grant
are made with previously appropriated filTlds and are not
dependent on future appropriations.
After awarding a capitalization grant, the EPA and the State
establish a new or increase an existing EPA Letter of Credit
in the bank selected by the State and approved by the U.S.
Department of Treasury. Obligated funds are then paid to
the States using the LOG The LOG allows the State to draw
its capitalization grant funds as cash directly from the
State's bank. During this process the EPA only reviews the
request for account accuracy, i.e. to verify that the LOG
Figure 1
Transfer of Federal Funds to SRF
Step 2:
Appropriation
(Each Year)
Step 3:
Apportionment
Stepl.
Authorization
(Mult-Year)
Obligates
(Awards
Capitalization
Grant)
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balance is sufficient EPA does not consider the justification
of the request until it conducts its annual audits and reviews
of the SRF program. If EPA does not respond to the request
for verification, the Treasury automatically pays the
requested amount Thus, unless EPA takes exception to the
request, the LOG system always pays the requested amount
As a SRF assistance recipient incurs costs under the SRF
program, it submits a request to the State for disbursement.
The State then submits to its bank a request for cash draw
from the LOG to cover the Federal share of the incurred
costs. When the SRF incurs costs directly, for example
administrative costs, the State would submit a similar cash
draw request
Using the LOG system, the bank submits the request to
Treasury. No later than the next business day, Treasury
will deposit the requested amount in the SRF account. This
quick response is possible because cash draw approvals are
subject only to account and signature verification and
because the balance of funds in the LOG is accessible for
draw-down at the time of the request The programmatic
validity of the request is not reviewed by EPA at this time.
At a later date when an audit and review are performed, the
State will be called upon to demonstrate that cash draws
were made in accordance with the cash draw rules in the
grant agreement
Why is the Letter of Credit
Approach Being Used for the
State Revolving Fund Program?
Through its experience with the Construction Grants
Program, EPA recognized that from the time the grant is
made, it takes five to seven years to construct a wastewater
treatment plant Since the Construction Grants Program
reimburses communities for actual expenses, funds leaving
the Federal Treasury were spread out over this five to seven
year period. Figure 2 shows how construction grants have
historically been paid out
The Clean Water Act directs EPA to provide States with
SRF capitalization grant payments over the two year period
following the grant award. However, if the States were to
draw cash in an amount equal to the grant award within the
two year period instead of at the historical construction rate,
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there would be a significant increase in the rate of Federal
outlays for this program. This increase would be
approximately $3 billion in the first five years of the
program.
The intent in using the Letter Of Credit payment mechanism
is to make the capitalization grant funds available when
needed for actual construction related costs. By using the
LOG mechanism for the SRF program, EPA will ensure
that:
A payment mechanism is used that is tested, proven
and well understood;
Federal cash outlays are managed efficiently; and
Disbursements are made quickly to respond to the cash
needs of the States and local recipients.
Through the LOG mechanism, EPA will make funds
available, up to the total amount of the capitalization grant,
during the required two year period based on a schedule
negotiated between EPA and the State. The LOG will be
converted to cash, as costs are incurred, no later than the
next business day following a cash request This will reduce
the impact on the Federal budget but at the same time
provide cash immediately when requested.
Figure J
Historical Cash Outlay Rate
for Title II Projects
Years From Award of Grant
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Converting the Letter
of Credit to Cash
Definitions
To understand how the LOG will work with the SRF
program, several key terms must be understood.
Figure 3
Converting the Letter of
Credit to Cash
LOG Ceiling
Cash Draw
Payments A payment is an action by EPA to increase the
amount of funds available for cash draw in the Letter of
Credit (i.e., the ceiling). Through payments, the EPA
makes funds available to the State up to the amount of the
capitalization grant A payment is not a transfer of cash to
the State but only an authorization making funds available
for transfer to the State when a cash draw request is
submitted A payment schedule, indicating the timing and
size of the payments to be made, will become part of the
grant agreement between EPA and the State.
Cash Draw A cash draw is the transfer of cash from the
LOG to the SRF. Upon a State's request for a cash draw, the
Treasury will transfer funds to the SRF account established
in the State's bank through the LOC-TFCS. The SRF or the
assistance recipient must first incur a cost, but not necessarily
disburse funds for that cost, in order for cash to be drawn
against the LOG.
Disbursements A disbursement is the transfer of cash
from the SRF to the assistance recipient. The State provides
EPA annually with a schedule of estimated disbursements
for the upcoming fiscal year.
Binding Commitments Binding commitments are legal
obligations by the State to the local recipient that define the
terms for assistance under die SRF. The State must enter
into binding commitments in an amount equal to 120% of
each quarterly payment within one year of receiving the
payment
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How the Funds Flow
After a State has obtained its grant and selected a bank in
which to establish the Letter of Credit, it is ready to
capitalize its SRF and provide various forms of financial
assistance to municipalities. Based on a negotiated payment
schedule, EPA mates payments to the LOC which increase
the amount of capitalization grant funds available for cash
draw. At the time of a Federal payment the State shall
provide its match either in cash or through a payment to its
own letter of credit or similar financial arrangement. At the
time of each cash draw from the LOC, the State shall be
responsible for providing its cash match (see page 12 for a
discussion of State match).
Figure 4 illustrates the cash flow into and out of the SRF
using the LOC. It is important to note that cash will be
provided from the LOC to the State Revolving Fund no later
than the next business day after EPA receives a valid
request Cash draws are virtually automatic, since they are
subject only to account and signature verification and the
balance of funds accessible for draw down in the LOC at the
time of the request
Figure 4
Flow of Cash Through SRF
Federal State Local
jjj^Contractor
Local
Recipient
» Request for Cash
f Flow of Funds
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General Principles
EPA has developed specific rules for LOC operations as
they apply to the SRF program. These rules were developed
to ensure that the requirements of the SRF will be met and
are based on the following principles:
I All payments to the LOC will be made over a period
not longer than two years after the grant is awarded
n Binding commitments must be entered into no later
than one year after a payment is received
in Cash draws will not be permitted for a particular
project until a State has entered into a binding
commitment for that project
IV When cash is needed to pay for construction related
costs, the LOC can be converted to cash as quickly
as those construction costs are incurred.
V Cash will be available only up to the level of
payments made to the LOC.
VI Each form of assistance has its own set of cash draw
rules, and they cannot be intermixed
The following section describes the general rules that apply
to all forms of assistance and the specific rules that apply to
particular forms, together with several examples of payments
and cash draws for each form of assistance.
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General Rules for All
Forms of Assistance
Before proceeding with the payment and cash draw rules for
the various forms of assistance, it is important to understand
the rules regarding timing and proportionality.
Timing of Payments and Cash Draws
All the payments to the State will be made no later than:
8 quarters after the capitalization grant is awarded,
or
12 quarters after the funds are allotted to the State,
whichever occurs first. TTie allotment date is the date funds
are made available to the States. In addition, a capitalization
grant must be awarded to the State no later than the fiscal
year following the fiscal year in which the funds are
appropriated.
Figure 5 .
Timing of Payments
10/
Allotment Date -»
Example #1
Example #2
88 1/
\
1
99 1
(Grant Award
Payments over
8 Quarters
t ' :
t 1 . !.'!.«
91 10
*- Last Possible
Payment Date
(8 Quarters from
Grant Award)
'91
2 3 4 5 6 7 8 9 10 11 12
9/90 10/91
Grant Award-*
I
* t
^ Payments over
4 Quarters '
L'. . ':
...:" « :. ..:.» »
-Last Possible
Payment Date
(12 Quarters
from Allotment)
1 2 3 4 5 6 7 8 9 10 11 12
10
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Therefore, EPA will make payments over a maximum of
four to eight quarters, depending on the date of the grant
award.
Examples
Consider the following examples using the time line OR
Figure 5, to understand how die number of quarters will
be calculated for payments under die LOG.
Example 1. Funds are allotted to State X in October
1988. In January 1989, the State is awarded a
capitalization grant Payments will be made over a
period not longer than eight quarters before January,
1991( i.e., eight quarters after the capitalization grant is
awarded).
Example 2. Funds are allotted to State X in October
1988. In September 1990, die State is awarded a
capitalization grant, at die end of die two year period of
availability. Payments will be made over four quarters,
i.e., within 12 quarters after funds are allotted
The payment schedule, negotiated between EPA and die
State, is largely dependent on die State's projected rate
of entering into binding commitments. EPA will increase
the amount of funds available for cash draw in die LOG
according to the Schedule of Payments contained in the
grant agreement negotiated with the State. At die time of
a Federal payment die State shall provide its match either
in cash or through a payment to its own letter of credit or
similar financial arrangement At die time of each cash
draw from the LOG, die State shall be responsible for
providing its cash match.
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Proportionality
The SRF or assistance recipient must first incur a cost, bu
not necessarily disburse funds for that cost, in order ft
cash to be drawn against an LOG. For each incurred cos
EPA will allow a cash draw for its proportionate Feden
share (83%) as will the State (17%). Like the timing rules
these proportionate shares are based on Title VI of th
Water Quality Act The Act stipulates that the State wi
deposit in the SRF an amount equal to at least 20% of th
total amount of the capitalization grant Therefore, for an
incurred cost, cash can be drawn from the Federal LOG fc
EPA's proportionate share:
Proportionate Federal share:
capitalization grant = 100 = 83%
Fed grant+State match 100+20
Proportionate State share:
State match = 20 - 17%
Fed grant+State match 100+20
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State Overmatch: Some States may choose to deposit into
the SRF more than the required 20% match. In order to
determine the proportionate Federal share in an overmatch
situation, the State may identify a group of projects
approximately equal to the amount of the capitalization
grant plus the required 20% State match. The State can then
draw cash from the UOC for 83% of the incurred cost of the.
selected group of projects. The State cannot draw against
the LOG for other projects funded by the overmatch and it
cannot change an identified project once it has begun to
draw cash. Alternatively, an overmatch can be treated the
same as the required match and be applied to all SRF
projects. If, for example, the State deposits 40% into the
fund (20% required match and an additional 20% as
"overmatch"), then the proportionate shares are as follows:
Proportionate Federal share:
capitalization grant = 100 a 71%
Fed grant+State match 100+40
Proportionate State share:
State match = 40 = 29%
Fed grant+State match 100+40
Guarantees and Leveraging: Where capitalization grants
are used to provide an increased amount of assistance
through the use of leveraging and guarantees, special
proportionality rules apply. In these cases the Federal
proportionate share is based on the ratio of the sum of the
Federal grant and the State match used as security or
guarantee to the total amount guaranteed or secured.
Examples of this calculation are contained in the guarantee
and leveraging sections (see pages 23-30). The concept of
proportionality was developed to ensure that the State and
FJ*A deposited the required share at the proper time and in
the proper amounts.
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RllleS for VariOUS FomiS Based on these general principles and rules, EPA established
t specific payment and cash draw rules for the following
Of Assistance forms of assistance:
Loans
Refinancing and Purchase of Municipal Debt
Purchase of Insurance for Local Debt
Guarantees of Local Debt or Sub-State Revolving Funds
i
Leveraging by Providing Security for State Bonds
Administrative Costs
These rules are summarized in Rgure 6.
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Figure 6
Summary of Payment and Cash Draw Rules
General Rule
PAYMENT
Starting No Sooner Than One Year Before the
State Enters into the Binding Commitment
Within 8 Quarters of Capitalization Grant or
12 Quarters After Funds Are Allotted
CASH DRAW
Proportionate Federal Share - 100/120
83%
Loans
Based on the State's Schedule of Binding
Commitments
Proportionate Federal Share of Incurred
Construction Costs
For Eligible Incurred Prebuildng Costs,
Cash May Be Drawn Once the Loan is
Made
Refinancing and
Purchase of Local
Debt
Only Projects for Which Construction Was
Initiated and Debt Incurred After
March 7, 1985
Based on The State's Schedule
of Binding Commitments
Constructed Projects
For Eligible Incurred Prebuildng Costs,
Cash May Be Drawn Once the Loan is
Made
Equal Amounts Spread Over the Maximum
Number of Quarters (4 to 8) Up to the
Proportionate Federal Share
Non-Constructed Projects
Same as Loans - Based on Proportionate
Federal Share of Incurred Costs
Insurance
Based on the State's Schedule'of Binding
Commitments
As Premiums Are Due
Guarantees of
Local Debt
Based on the State's Schedule of Binding
Commitments
Non-Default Condition
Modified National Historic Title II Rate, or
Proportionate Federal Share of Actual
Incurred Costs
Default Condition
Immediate, Up to the Portion of the LOC
Dedicated to Guarantee
Leveraging of
State Bonds
Based on the State's Schedule of Binding
Commitments
Non-Default Condition
Modified National Historic Title II Rate, or
Proportionate Federal Share of Actual
Incurred Costs
Default Condition
Immediate, Up to the Portion of the LOC
Dedicated to Security
Administrative Costs
One Payment at the Time of the Grant Award
Up to One Quarter in Advance
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LOANS
Loans
States may use the SRF to provide loans to municipalities
which must be repaid to the SRF within 20 years. Hence the
term "revolving fund," since money is constantly being
loaned out or repaid to the fund. Figure 7 illustrates the flow
of funds into and out of the SRF. Payment and cash draw
procedures affecting this flow are as follows:
Payment & Cash Draw Rules
The payment for each loan will be based on the State's
Schedule of Binding Commitments. The schedule must
demonstrate that the State expects to enter into binding
commitments in an amount equal to 120 percent of each
payment (i.e., the commitment must include the 20% State
match), within one year of receipt of each payment.
If the State needs to draw more cash than originally planned,
because loans were made earlier than estimated in the
Schedule of Binding Cornmitments, the schedule can be
amended to accelerate the payments up to the amount of the
capitalization grant
Figure 7
Flow of Funds:
Loan Assistance
(State
government
Contractor
or Vendor
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SLOANS
The State may draw cash from the LOG when the SRF
receives a request from a loan recipient, based on incurred
costs, including prebuilding costs and building costs. An
incurred cost is one that is due and payable or paid. Recipients
do not have to pay the costs in advance.
Prebuilding costs (such as planning and design), which are
associated with the scope of the project being built, may be
included in the loan agreement regardless of when they were
incurred. Building costs, however, must occur after March
7, 1985 to be included within the loan agreement. Project
costs, including those previously incurred, must have met
the appropriate requirements of Title VI to be eligible for
loans.
The State may draw cash against the UOC for the full amount
of incurred prebuilding costs immediately upon entering
into a loan agreement and receipt of a due and payable, or
paid, disbursement request from the municipality. Cash
draws for incurred building costs will generally be treated as
refinanced costs; that is, draws for the Federal share are to
be made in equal quarterly amounts. (See "Refinance or
Purchase of Municipal Debt"on page 19.)
Because the State is required to provide a 20% match, the
cash draw for the proportionate Federal share from the UOC
will be 83% (100/120) of each incurred cost. In instances
where the State match has already been expended, the draw
will equal 100%. For loans, cash draws can be made as fast
as construction proceeds.
Consider the following examples for loan agreements:
Example 1. State X uses its $10 million capitalization grant,
plus a $2 million State match, to fund a SRF loan program.
It anticipates entering into binding commitments with
communities at the following rate:
- First quarter, $1 million
- Second quarter, $6 million
- Third quarter, $5 million
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LOANS
The State will provide its 20% match as cash at the same
time the cash is drawn from the LOG. Thus, an EPA
payment schedule will be negotiated based on 83% of the
estimated loans:
- First quarter, $0.8$ million
- Second quarter, $5.00; million
- Third quarter, $4,17 million
Cash draw requests will be processed as costs are incurred
under the loan agreements.
Example 2. Same as above except that the State actually
enters into $3 million in loans in the first quarter.
The payment schedule will be amended to provide for $2.49
million instead of $0.83 million in the first quarter and cash
draws will still be based on actual incurred construction
costs.
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REFINANCE OR PURCHASE
Refinance or Purchase
of Municipal Debt
To encourage municipalities to proceed with construction
using their own financing before SRF assistance is
available, die SRF may be used to refinance or purchase
local debt obligations. The flow of funds is shown on
Figure 8.
Only projects for which construction was initiated and
debt incurred after March 7, 1985 may be refinanced or
have their debt purchased through the SRF. The intent
of this provision was to allow projects to move forward
while amendments to the Clean Water Act were being
debated and adopted. In addition, only projects financed
with local debt may be refinanced under the SRF. A
debt obligation is interpreted to mean a legally binding
financial agreement entered into by the municipality
which requires repayment
Separate rules have been developed depending on the
stage of construction of projects, or portions of projects,
at the time the loan is made. For eligible projects, the
SRF can be used to refinance or purchase local debt
under the following rules:
Figure 8
Flow of Funds:
Refinancing of Local Debt
h State
government
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REFINANCE OR PURCHASE
Payment Rules
Payments will be based on binding commitments, following
the same rules as the loan program. They may start no more
than one year before the State enters into a binding
commitment.
Cash Draw Rules
For constructed projects, or the completed portion of a
project, the rate of cash draw cannot be greater than equal
amounts over the maximum number of quarters that
payments can be made. For eligible prebuilding costs,
however, cash for the full amount can be drawn from the
LOG immediately as noted under the loan cash draw rules.
The cash draw can be made up to the portion of the LOG
dedicated to the refinancing and purchase of local debt
For projects, or portions of projects, that have not been
constructed, the cash draws will work the same as in the loan
program; that is, cash draws will be based on the proportionate
Federal share of incurred construction cost.
Examples
To understand the application of these rules, consider the
following examples:
Example 1. Gty Q has issued $10 million in debt on
June 1, 1987 and completed construction of its facilities
in June of 1988 prior to the award of the capitalization
grant. The SRF will purchase this debt Payments and
cash draws for this project will be made based on the
Federal share ($83 million}. Cash draws will be made in
equal amounts over the maximum number of quarters that
payments can be made.
20
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REFINANCE OR PURCHASE
Example 2* City Z has issued $60 million in debt on July
1, 1987 to finance construction of its wastewater facilities
and initiated constructioni in September of 1987. At the
time of the loam agreement, City Z will have spent only $35
million on construction. The LOC portion of the SRF can
be used to refinance or purchase the Federal share of the $35
million in equal cash draws over 4-& quarters. The Federal
share of the remaining $25 million will be treated the same
as a loan and cash will be drawn as costs are incurred.
Example 3. City A issued $30 milKon in debt on July 1,
1987, To date there has been no construction. Just like a
loan, payment will be made based on 83% of a binding
commitment and cash can be drawn as costs are incurred
Example 4. City X constructed a treatment facility in 1984
by issuing local revenue bonds. Since the bonds were
issued and construction begun prior to 3/7/85, the project
may not be refinanced through the SRF.
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I INSURANCE!
Purchase of Insurance
The SRF may be used to purchase bond insurance to
guarantee local debt service payments. The flow of funds is
shown on Rgure 9. The following rules apply to payments
and cash draws:
Payment Rules
A Payment Schedule will be negotiated between the State
and EPA based on the State's schedule of binding
commitments, Le., when insurance premiums are due.
Payments may start no more than one year before the State
enters into a binding commitment,
Cash Draw Rules
States may draw on the LOG to obtain cash for the
proportionate Federal share of the insurance premiums as
they come due.
Figure 9
Flow of Funds:
Purchase of Bond Insurance
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GUARANTEES
Guarantees
States may use the LOG to guarantee debt of local recipients
or obligations of sub-State Revolving Funds as shown in
Hgure 10. The U.S. Treasury Department issued notice 88-54
on April 21, 1988, which affirms that the LOG portion of the
SRF is not a Federal guarantee for repayment of bonds issued
by local governments and guaranteed by Federally capitalized
SRF's. As a result, the use of the LOG as a means of payment
will not render the local government bonds taxable. (See
Appendix C for a copy of this notice.)
Because the LOG is being used to fund a contingent liability,
there may or may not be actual cash needs. Since cash draws
are generally allowed only for incurred costs, cash could not
be drawn and funds would not be transferred unless there were
an impending default Therefore payment and cash draw
procedures were established to cover default and non-default
situations as follows:
In case of a default, cash is immediately available up to the
portion of the LOG pledged as the guarantee, and
In case of non-default, cash is drawn from the LOG to the
SRF as construction progresses so that the SRF will eventually
have the cash from the LOG even though the assistance
Figure 10
Flow of Funds:
Guarantee of Local Debt or Sub-State Revolving Debt
Payments
State
Government
Bondholders
(or Sub-State Revolving Fund)
State
Match
_ guarantee
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GUARANTEES
recipient has not received money directly from the SRF.
These procedures and the flow of funds are summarized
in Figure 10 (on previous page), and discussed as follows:
Payment Rules
Payments to the LOG will be made based on the schedule of
binding commitments. Payments start no more than one
year before the State enters into a binding commitment.
Cash Draw Rules
Cash draw rules for guarantiees were developed for two sets
of conditions. In non-default, the rules allow for cash to be
drawn even though the State does not need it to guarantee
debt of a local recipient or obligation of substate revolving
fund. In a default situation the rules make cash available to
protect the holder of local bonds.
Non-default Conditions
To allow for the conversion of the guarantee portion of the
LOG to cash, EPA will negotiate cash draws for the
proportionate Federal share of the guaranteed reserve. The
schedule will be based on the modified national historic
Tide n outlay rate (see Figure 12) or the proportionate
Federal share of the actual incurred construction cost
Default Conditions
If the guarantee provision is triggered because of an imminent
default in debt service payments on the guaranteed debt, the
following procedures will apply:
The State may request an immediate cash draw up to
the total amount of the LOG committed to the guarantee.
If a default results in a reduction but not a complete
depletion of the SRF guarantee reserve, the State may
negotiate a payment and cash draw schedule for the
remaining amount of the guarantee, up to the rate based
on the non-default rules.
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GUARANTEES
Example
State X is using $10 million of its $80 million capitalization
grant to set up a $12 million guarantee fund for a series of
bonds sold by cities to fund the construction of their
wastewater treatment facilities.
Payments based on the following schedule of binding
commitments:
1st quarter - $5 million
2nd quarter - $5 million
The State will also make its 20% match payments to the SRF
on the same schedule:
1st quarter - $1 million
2nd quarter - $1 million
Cash draws from the LOG to the SRF based on the rate
at which construction related costs are anticipated to occur.
Based on this schedule, the State has made cash draws
totaling $.83 million by the end of the third quarter based on
$1 million of incurred costs. The guarantee fund now
contains $1 million.
Default is imminent by Community Y whose project was
substantially delayed and who is unable to pay $4 million in
debt service on bonds that the SRF has guaranteed.
In this instance the State would take the following steps:
Request a cash draw of $2.49 million (83% of $3
million) from the LOC to increase the cash in its
reserve fund to $4 million.
Make the $4 million debt service payment due on the
guaranteed bond, thereby reducing its guarantee fund
from $12 million to $8 million.
Renegotiate the cash draw schedule with the EPA to
receive the remaining $6.68 million based on
proportionate Federal share of incurred costs or the
modified national historical Title H outlay rate.
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LEVERAGING
Leveraging of State Bonds
States may use the capitalization grant/LOC funds as security
for the sale of State bonds. For example, a State may use the
LOG to establish a debt service reserve fund. With this as
security, States can issue State bonds in an amount larger
than the size of the capitalization grant, thereby "leveraging"
the SRF to finance more projects.
If the LOG is used as security for State bonds rather than to
pay incurred costs, there is no need for cash unless there is
a default. Therefore, cash draw rules similar to those
described for the Guarantee of Local Debt apply. These
rules, which convert the LOG to cash in the absence of a
default, are illustrated in Figure 11 and described below.
Payment Rules
Payments to the LOG will be made based on the schedule of
binding commitments, starting no more than one year before
the State enters into a binding commitmenL Binding
commitments refer to the individual loans with the local
recipients, not the security agreement itself.
Figure 11
Flow of Funds:
Leveraging State Bonds
Local
Recipient
Cash to
Pay Invoices
26
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LEVERAGING
Cash Draw Rules
When the State uses the LOG as security for State debt, such
as a debt service reserve, cash draws are not needed to
provide disbursements for incurred project costs. In this
case, the State may draw cash from the LOG according to
the following procedures:
Default Conditions
If the security provision is triggered because of an imminent
default in debt service payments, the State may request an
immediate cash draw up to that portion of the LOG committed
to secure the State bonds.
Non-default Conditions
The State may draw cash as actual construction costs
are incurred for projects constructed with bond proceeds
secured by the LOG Cash draws will be based on the
EPA's proportionate share of the incurred construction
costs, or
As a minimum, the State may draw cash at the rates
shown in Figure 12. It was developed based on the
national historical Tide n ouday rate.
The proportionate share may be determined in either of two
ways:
1. By using a leveraging ratio. This is developed by
dividing the net proceeds of the leveraged bond issue by the
amount of the capitalization grant and State match used as
security for the debt The Federal proportion is then
multiplied by the reciprocal of the leveraging ratio.
27
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LEVERAGING
2. The State may identify a group of projects approximatelj
equal to the amount of the capitalization grant plus the Statt
match and draw cash against the LOG based on th<
proportionate Federal share of the incurred constractioi
costs of those projects. The State cannot draw against th<
LOG for other projects and it cannot change an identified
project once it has begun to draw cash.
Except in default situations, the rate that cash can be drawn
under leveraging shall not exceed equal amounts over 4 tc
8 quarters.
Examples
Consider the following examples:.
Example 1. A SRF is using $10 milHon of its capitalization
grant plus a $2 million State match to secure $36 million of
State Revenue Bonds. If the SRF receives a disbursement
request of $4 million for incurred construction costs, the
State may make a cash draw of $1.11 million from the LOG
based on die following formula:
Leveraging Ratio = Net Proceeds Of State Bonds
Leveraging Portion of Cap Grant* State Match
» $36 million w 3
$10 miHkm+$2 million
Cash Draw
Cash Disbursement x Federal Share
Leveraging Ratio
$4 million x .83
3
a $U1 million
Example 2. Same facts as above, but instead, the State
separately identifies $12 million in projects ($10 million
capitalization grant + $2 million State match). The State
receives a $4 million disbursement request for incurred
construction costs on these projects. It may make a cash
draw against the LOG for the Federal share of $4 milHon or
$3.33 mfflioru
28
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LEVERAGING
Example 3. $8 million of a $10 million capitalization grant
is being used as security to leverage State Revenue Bonds.
A payment schedule was negotiated. A series of loans were
made in the thud quarter, but no actual construction costs
have been incurred by the end of the second year. Therefore,
as a minimum, cash draws are to be made based on the
modified national historical Title n outlay rate as shown on
Figure 12. This table was developed as if all the payments
for the capitalization grant dedicated to the leverage program
were made in the first year.
The State will be allowed to receive cash in a particular year
based on the following formula:
Year One: cash draw « $8 million x 0.07 « $560,000
Year Two: cash draw *= $8 million x 0.35 = $2.8 million
Year Three: cash draw = $8 million x 0.26 = $2.08 million
Year Four cash draw = $8 million x 0.20 - $1.6 million
Year Five: cash draw * $8 milibn x 0.12 -* $960,000
Figure 12
Modified National
Historical Title II Outlay Rate
The fixed rate at which States that Leverage or Guarantee local
debt will be able to receive cash draws is summarized below:
Year
After Payment
Percentage of
LOG Payment
1
7%
35%
26%
20%
12%
1. National Historical cash outlay is
triggered by binding commitments.
2. There is no proportionate Federal share
for calculations under the National
Historical Curve approach.
29
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LEVERAGING
Aggressive Leveraging Exception to Cash Draw Rule
Some States have proposed more "aggressive" leveraging
plans requiring cash quicker than that provided under the
rules described above for the program to be effective. In this
situation, EPA may allow an exception to these rules and
provide for a more accelerated cash draw up to the quarterly
payment schedule. A State contemplating an aggressive
leveraging plan should meet with Regional and Headquarters
staff to explain its leveraging approach as part of its
capitalization grant application. EPA Headquarters will
make case-by-case determinations to allow exceptions prior
to the award of each capitalization grant.
Aggressive leveraging is defined by evaluating the SRF
program against the following criteria:
There are eligible projects ready to proceed in the
immediate future with enough cost to justify the
proposed leveraging;
The absence of cash on an accelerated basis will
substantially delay these projects;
If accelerated cash draws are allowed, the SRF will
provide substantially more assistance; and
The long-term viability of the State program to meet
water quality needs will be protected.
For a particularly aggressive leveraging proposal, the cash
draw rules described previously may significantly frustrate
the State's program.
Approval of an aggressive leveraging plan does not exempt
an SRF from LOG payment rules. Depending upon the
State's leveraging plans, however, the State and EPA will
negotiate an accelerated cash draw schedule. Under this
approach, the quickest rate at which cash can be drawn is
equal payments over eight quarters. For example, State Y
receives a $200 million capitalization grant Under
aggressive leveraging, the State may not draw cash faster
than $25 million/quarter.
30
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ADMINISTRATIVE COSTS
Administrative Costs
The SRF can be used to provide assistance in paying
reasonable costs of administering the SRF (see Figure 13).
Such amounts shall not exceed 4% of all capitalization
awards. The following rules will apply:
Payment Rules
One payment will be made at the time of the grant, based on
the proportionate Federal share of expected administrative
expenses. Payments for administrative expenses may not
exceed 4% of all the grant awards received by the SRF.
Cash Draw Rules
Cash can be drawn no more than one quarter in advance.
Cash draws will be based on a schedule that coincides with
the rate at which administrative expenses will be incurred up
to that portion of the LOG dedicated to administrative
expenses.
Figure 13
Flow of Funds:
Administrative Costs
State Match
State
Government
Incurred
Cost
Administrative
Expenses
31
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How Secure is the
Grant?
Executive *and
Congressional Action
The use of the Letter of Credit in the SRF program has
raised a number of questions from States and the investment
community , particularly regarding its use as security for
state and local debt. In particular, there is concern that
actions by Congress, the President, or EPA might affect the
conversion of the LOC to cash. In order to resolve this
concern, it is important to understand the process through
which Federal moneys are obligated and, in turn, the
possible means of stopping the flow of funds and the legal
remedies available to recover the grant funds for
noncompliance.
Congress authorized at least $8.4 billion to be awarded to
the States for the SRF program between 1989 and 1994.
This authorization is the amount Congress intended to make
available; however, each year Congress can decide to
actually appropriate for the SRF program more or less than
the amount authorized for that year. Each fiscal year the
amount appropriated is allotted to individual states using
the formula provided in the Act.
There are actions taken by Congress or the President that
could possibly stop the flow of appropriated funds to a
State's SRF. The first is Rescission. A rescission is enacted
legislation cancelling a previous appropriation prior to the
time when the appropriated funds would otherwise lapse
(i.e., cease to be available for obligation).
The second is Deferral. A deferral is defined as any action
by the executive branch that temporarily witholds or delays
the obligation or expenditure of appropriated funds. Only
programmatic deferrals, where ,the purpose of the program
is better served if funding is deferred, are allowed. For
example, a deferral could occur if weather conditions made
the scheduled funding of an agricultural program impractical.
Policy deferrals which are intended to alter Congressional
policy objectives are not allowed
Funds have never been rescinded or deferred after
being obligated to a State.
32
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How It Works
As shown in Figure 14, the State enters into loan contracts
for an amount roughly equal to the capitalization grant The
State then pledges the revenue streams from these loans as
security for revenue bonds in an amount somewhat less than
the initial loan amount (the first bond issue). The proceeds
of these bonds are placed into the SRF and a second series
of loans are awarded. The revenue stream from these loans
can then be used as security for the issuance of additional
revenue bonds (the second bond issue).
As this process continues, each additional revenue bond
issue is smaller than the one before, because of the need to
fund debt service reserves, satisfy coverage requirements,
and pay issuance expenses. It is estimated that this technique
would allow States to produce about three times the amount
of loan dollars in the first few years as the original
capitalization grant.
The SRF is replenished through the surplus accounts
established to hold the coverage and debt service reserves.
This is the excess amount repaid by the loan recipients over
the amount required to retire the bonds. If these funds are
not needed to cover a default or other cash shortage problem,
they are deposited into a reserve or surplus account which
is part of the SRF.
Impact of the LOG
As indicated, the Leveraged Loan Plan is not a leveraging
technique, as defined in the payment section of the SRF
Initial Guidance. Therefore, under this system, payments
and cash draws against the LOG will follow the general
rules for loan programs rather than leveraged programs.
Payments will be made over the maximum of 4 to 8 quarters
with a payment schedule based on a demonstration of
binding commitments. Cash draws will be allowed only for
the actual construction costs of the first set of projects. The
State will not be able to draw down against the LOG for
projects built with loans made from the first and subsequent
bond issues.
36
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Appendix A
Glossary of Terminology Used
in the Letter of Credit Approach
Aggressive Leveraging -
Allotment
Appropriation -
Assistance Recipient
Authorization -
Binding Commitments -
Cash Draw -
Deferral -
Aggressive leveraging refers to proposals where the cash draw procedures
discussed as part of the leveraging proposal would significantly frustrate the
State's program to the extent where EPA allows an exception to these rules and
provides for a more accelerated cash draw.
Authority delegated by the head or other authorized employee of an agency to
agency employees to incur obligations within a specified amount pursuant to
OMB apportionment or other statutory authority making funds available for
obligation.
Statutory authority that allows Federal agencies to incur obligations and to make
payments out of the Treasury for specific purposes.
A municipality or other entity which receives assistance under the SRF program.
Legislation which authorizes the appropriation of funds to implement program
activities. It does not provide any money, only the appropriation act itself permits
the withdrawal of funds from the Treasury.
Binding commitments are legal obligations by the State to the local recipient that
define the terms and the timing for assistance under the SRF. The State must enter
into binding commitments in an amount equal to 120% of each quarterly payment
within one year of receiving the payment That is, whenever LOG funds are
committed to assist SRF projects State matching funds must also be committed
at the same time. Since the State match is 20% of the capitalization grant, funds
pledged for binding commitments will be 120% of the .Federal portion of that
pledge.
A cash draw is the transfer of cash from the LOG to the SRF. Upon a State's
request for a cash draw through the LOC-TFCS, the Treasury will transfer funds
to the SRF account established in the State's bank.
A deferral is any action by the executive branch that temporarily withholds or
delays the obligation or expenditure of appropriated funds.
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Disbursements
Guarantee -
Impoundment -
Incurred Cost -
Insurance -
Interest Subsidy -
Letter of Credit -
Leveraging -
Loans
A disbursement is the transfer of cash from the SRF to the assistance recipient
A promise to provide municipal bondholders with full and timely payment of
principal and interest on the municipal debt obligation to the limit of the
guarantee, in the event of default by the municipality. The SRF may not,
however, grant funds to a municipality to fund a reserve account for a municipa
bond issue.
An action or inaction by an officer or employee of the United States that precluder
the obligation or expenditure of budget authority provided by Congress.
Costs that are eligible for disbursement from the SRF including constructior
related costs, administrative costs or costs for any of the forms of assistance
authorized under Tide VI of the Act The SRF or the assistance recipient must
first incur a cost, but not necessarily disburse funds for that cost, in order for cash
to be drawn against the LOC.
Bond insurance, available from a number of insurance companies, to guarantee
debt service payment of municipal debt
The use of funds to reduce the interest cost on State or local bonds by providing
a subsidy for all or part of the interest payment
A Federal payment mechanism that transfers cash to States and other recipient
of Federal assistance using electronic transfers from the Treasury through the
Federal Reserve System.
Leveraging refers to the use of the capitalization grant/LOC as the security for
the sale of State bonds. Leveraging does not include State financing arrange-
ments in which repayment streams, rather than the capitalization grant or LOC,
are used as the primary security for the bond issue.
An agreement between the SRF and the local recipient through which the SRF
provides funds for eligible assistance and the recipient promises to repay the
principal sum back to the SRF over a period not to exceed 20 years. Interest rate
may be established at or below market interest rates and may include zero interes
loans.
Obligation -
Payments -
The commitment of funds that are allotted to a specific State, through a grant or
contract agreement
A payment is an action by EPA to increase the amount of funds available for cast
draw in the Letter of Credit (i.e. the ceiling). Through a payment, the EPA maker
-------
funds available to the State up to the amount of the capitalization grant A
payment is not a transfer of cash to the State but only an authorization making
funds available for transfer to the State when a cash draw request is submitted.
A payment schedule, indicating the timing and size of the payments to be made,
will be entered into between EPA and the State. It will be based on the State's
projection of binding commitments, the rules for cash draws and the use of the
funds.
Proportionate Federal Share - That portion of incurred costs that represents the Federal share, taking into
account the requirement that the State provide a 20% match.
Purchase of Local Debt -
Rescission -
Refinancing -
Withholding -
An SRF may purchase local debt obligations where such debt was incurred and
construction was initiated after March 7, 1985. The SRF may purchase
incremental disbursement bonds from local governments on a schedule that
coincides with the rate at which construction related costs are expected to be
incurred for that project
A rescission is enacted legislation cancelling a previous appropriation prior to the
time when the appropriated funds would otherwise lapse (i.e., cease to be
available for obligation).
An SRF may refinance local debt obligations at or below market rates, where the
initial debt was incurred and construction was initiated after March 7, 1985.
To hold payments for failure to comply with a grant condition. EPA will not
withold cash draws from payments already made.
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Appendix B
Excerpts from SRF Initial Guidance
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EPA
United States
Envi ronmental
Protection
Agency
Office of Water
Off ice of Municipal
Pollut ion Control
Planning and Analysis
Division (WH-546)
Washington. D.C. 2O46O
January 1988
INITIAL GUIDANCE
For
STATE REVOLVING FUNDS
-------
"X
\ UNITED STATES ENVIRONMENTAL PROTECTION AGENCY
WASHINGTON, D.C. 20460
JAN 2 3 ISS8
OFFICE OF
WATER
MEMORANDUM
SUBJECT: Initial Guidance - State Water Pollution Control
Revolving Fund
FROM: Lawrence J. Jensen
Assistant Administrator for Water
t
70: Regional Water Management Division Directors
Regions I - X
State Program Directors
State Water Pollution Control Agencies
Attacked for your use is a copy of the final Initial Guidance -
State Water Pollution Control Revolving Fund, as we 11 as a summary
of our responses to public comments received as a result of the
Notice of Availability published in the Federal Regi ster on
Sept embe r 4, 1987.
This document represents the Environmental Pro tection Agency's
(EPA) approach to implementation of Title VI of the Clean Water Act
(CR&O , until interim final regulations on selected provisions in
this guidance are issued later this year. The release of this
document marts a significant step in the transition of the
responsibility for financing, constructing and managing municipa 1
waste-water treatment facilities from the Federal government to
States and localities. 11 wi 11 assist EPA Regions in their review
of proposed State Water Pollution Control Revolving Fund (SRF)
programs and provide States with initial guidance on applying for
Capitalization Grants.
The attache'd document is a result of public comment on- the
Concept Paper issued last Spring, comments on draft editions of this
guidance from the Office of Municipal Pollution Control's (OMPC)
workgroup, public comments on a final draft noticed in the Federal
-------
Register, and a final public meeting of the CWA steering committee
on October 22, 1987. The comments we received were extremely
helpful in developing this initial guidance document. I appreciate
the cooperation we have received in .preparing this document.
The guidance has been designed to promote flexibility for
States in establishing and operating their SRF programs, within the
bounds of the CNA.. In addition to using their SRF funds to finance
municipal wastewater construction needs, and after the municipal
enforceable requirements have been addressed, States may also use
their SRF resources to finance certain nonpoint source and estuary
program costs. The guidance imposes very few requirements on States
and municipalities beyond those imposed by the CWA itself. This
will allow each State to tailor its program to serve its unique
needs. To distinguish statutory and pending regulatory requirements
from discretionary guidance, the following coventions are used:
requirements to meet statutory or pending regulatory requirements
use the word "must" while recommended methods use the word "should".
To further assist Regional offices and State agencies in
implementing SRF programs, we will be issuing more detailed guidance
including model documents on such activities as intended use plans,
capitalization grant agreements, annual reports, etc., in the' near
future. Regional personnel should direct their questions on this
guidance to: H. Wi 11iam Krame r , Chief, Policy and Analysis Branch,
OMPC or, Alan Hais, Acting Director, Planning and Analysis Division,
OMPC. State representatives should direct their questions to the
Regional contacts identified in Appendix B to the attached guidance.
At tachment
cc: James Elder, OWEP
Wi lliam "Whi 11 ington, OWRS
David Davis, OWP
Michael Quigley, OMPC
Tudor Davis, OMEP
Robert Green, OPPE
Howard Corcoran, OGC
George Ames, OW
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OFFICE OF WATER INITIAL GUIDANCE
STATE WATER POLLUTION CONTROL REVOLVING FUND
(FINAL 1/28/88)
D. Payments
[NOTE: For the purposes of this section, the following definitions
apply: a) payment is an action by EPA to increase the amount of
funds available for cash draw in a le t t er-of -credi t (LOG) (i e
the ceiling); b) cash draw is the transfer of cash from the LOc'to
the SRF; c) disbursement is the transfer of cash from the SRF to
an assistance recipient.]
1. Capitalization Grant Application and Agreement
The process of transferring Federal grant funds to States
begins with Congress' annual appropriation of funds from an
authorization for each' fiscal year. After funds are appropriated
and allotted to the States, EPA obligates the appropriated 'uads
to eacn State for SRF purposes in the form of a " cap i t a 1 i za t i on
grant. All grants and payments under the grants are made with
previously appropriated funds and are not dependent on future
appropriations. Obligated funds are then paid to the States.
A State must include with each application for a
capitalization grant a draft payment schedule based on the State's
projection of binding commitments in its Intended Use Plan The
payment schedule and the specific criteria establishing the
conditions under which the State may draw cash from its LOG
payments must be jointly established by EPA and the State and
included in the capitalization grant agreement. Amendments to the
grant agreement may be negotiated during the year.
With the first application for a capitalization grant a
State must also submit" a schedule (at least by quarters) of
estimated disbursements from the SRF for that Federal fiscal year
In addition, at the end of the third quarter of each Federal
fisca year after the first capitalization grant award, the State
must provide EPA with a schedule of estimated disbursements for
the upcoming Federal fiscal year. This schedule must be developed
consistent with the procedures applicable to cash draws in
paragraph * 4 below and must be at a level of detail sufficient to
allow EPA and the State to develop jointly a forecast of cash
draws from the LOG. The State should advise EPA when significant
changes from the schedule of estimated disbursements are
anticipated. Based on this schedule, States and EPA wi 1 1 jointly
establish a forecast of cash to be drawn from the LOG during the
upcoming Federal fiscal year. This forecast is necessary to plan
the outlay of Federal funds from the title "I program.
2. Payment by Letter of Credit
A separate LOG, for the SRF program only,
e
.
with each State to make capitalization grant payments (see
Appendix E for a de-tailed discussion on how a LOG operates). The
negotiated payment schedule in the grant agreement will establish
Page 24
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OFFICE OF WATER INITIAL GUIDANCE
STATE'WATER POLLUTION CONTROL REVOLVING FUND
(FINAL 1/2S./88)
the timing and amount of increases in the LOG ceiling, up to the
-amount 'of the capitalization grant. Once a payment (increase to
the LOG ceiling) has been made, EPA will not reduce that ceiling.
EPA will only control cash draws against the ceilingt as described
in paragraph # 4 below. The State match can be provided in a LOG
or similar financial arrangement comparable to the Federal LOG.
However, the State match must be provided as cash at the time the
Federal LOG _i s drawn on.
3. Schedule of Payments
All payments will be made no later than the earlier of 3
quarterns after the award of the capitalization grant, or 12
quarters after the date such funds were allotted to the State.
The schedule of payments must be based on the State's Intended Use
Plan, which, must include information on the binding conmitments
eipected to be entered into. Binding commitments must be entered.
into by the SRF in an amount equal to 120 percent of each
payment (LOG increase) within one year of each payment.
4. 'Cash Draw
The policy intent in structuring the LOG process is that
neither the SRF nor the assistance recipients will be required to
provide interim, financing on financial transactions of the SRF.
Transfer procedures are be ing,established that ensure that cash
will be in the SRF account within one day after EPA* s receipt qf a
valid request for cash draw from the State. To effect this one
da.y transfer, EPA will only subject requests to account
verification. No SRF program reviews will be conducted at this
t ime .
Cash draws from the LOG are limited by the ceiling available
in the SRF LOG. However, in the event of an imminent default in
regard to debt service payments to bondholders and resulting need
for a cash draw from a LOG being used as a security or guarantee,
a cash draw and, if necessary, an amendment to the grant agreement
and payment schedule will be processed simultaneously to allow for
an increased cash draw not to exceed the amount of the
capitalization grant. The SRF or the assistance recipient must
fi-rst incur a cost, but not necessarily disburse funds for that
cost, in order for cash to be drawn against the LOG. The State
may draw cash from the LOG for the proportionate Federal share of
eligible costs at the time those costs have been incurred. For
example, if a non-1 eve raged SRF that consists of a SI million LOG
ceiling and 5200,000 in State match receives a request for
disbursement of $120 based on construction costs incurred, the
State may draw cash for S100 from the LOG and the remaining S20
mu s t c ome fr om the State ma t c h.
Page 25
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OFFICE OF WATER INITIAL GUIDANCE
STATE WATER POLLUTION CONTROL REVOLVING FUND
(FINAL 1/28/88)
Under section 603 of the Act, the SRF is authorized to
provide a variety of forms of assistance. The LOG will enable the
State to draw cash from its LOG for each of these types of
assistance, except solely for the purpose of earning interest:
a. Loan Agreements
The SRF may draw cash against the LOG when the SRF receives a
request for cash disbursements from a recipient, based on incurred
construction related costs. If such a cash draw request exceeds th
LOG ceiling, the payment schedule in the grant agreement will be
amended to allow for the request not to exceed the amount of the
capitalization grant.
b. Refinancing and Purchase of Municipal Debt
States may draw agaiast the LCC when: 1) cash is required to
purchase or refinance debt obligations or 2) where the State
purchases incremental disbursement bonds from local governments on a
schedule which coincides with the rate at which construction related
costs are expected to be incurred for that project. In either case,
the am'ount of cash drawn each quarter for purchasing or refinancing
may not exceed the total amount of the grant that will be used for
purchasing or refinancing divided by the number of quarters over
which payments will be made.
c. Insurance and Guarantees
States may draw on the LOG to obtain cash for the purchase of
insurance. In addition, under an SRF guarantee, if the local
obligations being guaranteed experience the need for cash because of
an unanticipated interruption of repayments or imminent default in
regard to debt servic; payments to bondholders, cash can be drawn
against the LOG. The cash draw and, if necessary, an amendment to
the paymment schedule in the grant agreement, up to the amount of thi
grant, will be processed simultaneously. la the event that cash
draws less than the guarantee reserve occur as a result of defaults,
cash draws for the remaining amount of the guarante may be
negotiated up to the rate at which cash draws would' occur as a resul
of construction related costs.
d. Leveraging
For the purpose of this section, leveraging refers to the use
of the capitalization grant/LOC as, the security for the sale of Stati
revenue bonds. Leveraging does not include State financing
arrangements in which repayment streams, rather than the
capitalization grant or LOG, are used as the primary security for thi
bond issue. As in 'c' above, the LOG can be arawn against to proven
imninent default on the leveraged issue.
Page 26
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OFFICE OF WATER INITIAL GUIDANCE
STATE WATER POLLUTION CONTROL .REVOLVING FUND
(FINAL 1/28/88)
When the LOG is used as a debt service reserve, cash draws are
not aeede'd to provide disbursements for the incurred project costs.
In this case, cash may. be drawn from the LOC at a fixed rate which
will be based on the national, historical Title II outlay rate. If
construction costs on projects constructed with bond proceeds are
incurred faster than the fixed rate, cash can be drawn as those costs
are incurred. In that case, cash draws will be based on those
projects funded from the proceeds of the leveraging, up to an amount
equivalent to EPA's proportionate share of the incurred costs. For
example, in a leveraged SRF account consisting of a $100 LOC payment
(serving as the debt service reserve), a 320 State match and 5280
from bond proceeds, a cash disbursement of S40 is requested for
construction costs incurred on any of the projects funded with
leveraged proceeds. In this example, :he fund may draw cash for S10
from the LOC [540 x (5100 / (5230% 520 + 5100))]. A second approach
:o achieve proportionality would be for the State to identify a'group
of pro'jects equal to the amount of the capitalization grant and,
based on the incurred construction cost of these projects, draw cash
against the LOC.in the same manner as a non-1 eve raged program (see
above) .
In the case of particularly aggressive leveraging proposals
where the cash, draw procedures discussed above would significantly
frustrate a State's program, EPA may allow an exception to these
rules and provide for a more accelerated cash draw. A State seeking
an except ion must first demonstrate to'EPA that there are projects
ready to proceed in the immediate future with sufficient costs to
justify the proposed leveraging and that the absence of cash on an
accelerated basis will substantially delay these projects. The State
must also demonstrate that, if accelerated cash draws are allowed,
the SRF will provide substantially more assistance and the long term
viability of the State's program to meet water quality needs will be
protected. Case-by-case determinations to allow exceptions will be
made by EPA Headquarters prior to the award of each capitalization
grant.
The amount of cash drawn each, quarter for a leveraged account
may not exceed the total amount of the grant to be, used for
leveraging divided by the number of quarters over which payments will
be made, except in a default situation as described in 'c' above.
e. Loan Guarantees for Sub-State Revolving Funds
Cash can be drawn against the LOC if the Sub-State revolving
fund experiences the need for cash, as with guarantees in 'c' above,
because of an unanticipated interruption of repayments or imminent
default. In the event that cash draws less than the euarantee
reserve occur a. a a. result or tnis financing cacnaique, oasn a r aws :or
the remaining amount of the guarantee m
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OFFICE OF WATER INITIAL GUIDANCE
STATE WATER POLLUTION CONTROL REVOLVING FUND
(FINAL 1/28/88)
f. Administrative Expenses
Cash can- be drawn against the LOG for administrative expenses
on a schedule that coincides with the rate at which administrative
expenses will be incurred up to four percent of
t he grant s
V." CAPITALIZATION GRANT AGREEMENT
The Capitalization Grant Agreement is the principal
instrument by which the State commits to manage its revolving fund
program in conformi ty wi th the requirements of the Clean Water
Act. The grant agreement contains or incorporates by reference
the Application, the IUP, the agreed upon payment schedule, and
certifications or demonstrations of other agreement requirements
as discussed in Section III above.
In addition to these requirements, the grant agreement should
also include the negotiated terras for effective operation of the
program and should'define oversight activities including the types
of records and reports needed to determine compliance with the Act
and the g.rant agreement, the specific contents and timing of the
Annual Report and EPA review, and the responsibility for
performing audits. The following chart describes how each of the
application and grant agreement requirements should be addressed.
REQUIREMENT
APPLICATION
HOW ADDRESSED
Part 30 Assurances
Established SRF
Ins t rumenta 1i ty
Adequate 205(g)
IUP "
(1) List of Projects
(2) SRF Goals
(3) Activities to be Supported
(4) Assurances and Proposals
- Environmental Review
- 120% binding Commitments
- Timely Expenditure
- First Use
o Enforceable requirements
o Non Enforceable r equ : r smcnt z
- Compliance with Title II
o Proc edur e s
o Projects
(5) Criteria & Method for
distributing funds
Payment Schedule/Schedule of Estimated
SRF Disbursements
cert i fy
document
doc ume n t
certify
propose
de s c r i be
describe
docume'nt /certify
cert ify
cert ify
document
certify
propo s e
doc ume n t
certify
describe
propose
Page 28
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Appendix C
Application of IRC Section 149 (b) to State or Local Bonds Issued in Connection with EPA State Water Pollu-
tion Control Revolving Fund Program
Notice 88-54
This notice provides guidance regarding the application of Section 149 (b) of the Internal Revenue Code to
State or local bonds issued in connection with the State Water Pollution Control Revolving Fund Program
under Tide VI of the Clean Water Act (Program).
t
The Environmental Protection Agency (EPA) is authorized under the program to make capitalization grants to
States to help them establish State revolving funds for financing water pollution control faculties. The States
may use the grants to make loans to local governments to finance the construction of water pollution control
facilities, to establish debt reserve funds for bonds the proceeds of which are to be used to make such loans, and
for various other purposes.
On January 28, 1988, EPA issued final initial guidance relating to implementation of the Program (EPA Guid-
ance). The EPA guidance provides that payment of capitalization grants will be made in the form of a letter of
credit in order to minimize the burden on the Federal Government States will draw down funds under the letter
of credit in accordance with procedures outlined in the EPA guidance. If the grant is used to establish a debt
service reserve fund for bonds, draw-downs generally will occur at a fixed rate based on the national, historic
outlay rate. The draw-down rate will be accelerated if necessary to prevent an imminent default on .the bonds.
Section 149 (b) of the Code generally provides that a State or local bond the payment of principal or interest on
which is guaranteed (directly or indirectly) by the Federal Government or any agency or instrumentality thereof
will not qualify for tax exemption under 103 (a). Regulations to be issued under Section 149 (b) will provide
that payments of principal and interest on State and local bonds will not be considered Federally guaranteed
within the meaning of Section 149 (b) solely by reason of the fact that the debt reserve fund for the bonds (or
principal and interest on the bonds) may be funded with capitalization grants awarded under the Program in ac-
cordance with procedures outlined in the EPA guidance.
This document serves as an "administrative pronouncement" as that term is described in Section 1.6661-3 (b) of
the Income Tax Regulations and may be relied upon to the same extent as a revenue ruling or revenue
procedure. See Rev. Rul. 87-138, 1987-552 I.R.B. 17.
For further Information Contact:
Susan Overlander of the Office of Chief Counsel, Internal Revenue Service, 1111 Constitution Ave., N.W.,
Washington, D.C., 20224 (Attention: CC:LR:T) (202-566-3829, not a toll-free call).
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Acknowledgements
This brochure was produced for the United States
Environmental Protection Agency by JWF Associates.
Graphic and production support was provided by Roy F.
Weston, Inc. and the Government Finance Officers
Association. The brochure was produced under the
management of Lee Pasarew, from EPA's Office of
Municipal Pollution Control and the direction of Mary
McCaffery. Both of their efforts are greatly appreciated.
Several additional members of EPA helped with their
extensive review and comment.
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LIST OF PERSONS TO CONTACT ON THE LETTER OF CREDIT
Region I
(CT,ME,MA,
NH,RI,VT)
Region n
(NJ,NYJ>R,
VI)
Region HI
(DE,MD,PA,
VA,WV,DC)
Region IV
(AL,FL,GA,
KY,MS,NC,
SC,TN)
Region V
(EL, IN, MI,
MN,OH,WI)
Mr. Roger Janson Region VI
Municipal Facilities Branch (AR,LA,NM,
U.S. EPA, Region I OK.TX)
John F. Kennedy Federal Building
Boston, MA 02203
(617) 565-3580
Ms. Leslie Peterson Region YE
Construction Grants Branch (IA,KS,MO»
U.S. EPA, Region H NE)
26 Federal Plaza
New York, NY 10278
(212) 264-3279
Region Vffl
(CO,MT,ND,
SD,UT,WY)
Mr. Les Reed
Construction Grants Branch
U.S. EPA, Region m
841 Chestnut Street
Philadelphia, PA 19107
(215) 597-9910
Mr. John Hagan Region DC
Facilities Construction Branch (AZ,CA,HL
U.S. EPA, Region IV NV,AS,PI,
345 Courtland Street, NE GU)
Atlanta, GA 30365
(404) 347-4491
Mr. Todd A. Cayer Region X
Municipal Facilities Branch (AK,ID,OR,
U.S. EPA, Region V WA)
230 South Dearborn Street
Chicago, IL 60604
(315) 353-2123
Mr. John Cemero
Construction Grants Branch
U.S. EPA, Region VI
1201 Elm Street
Dallas, TX 75270
(214) 655-7120
Ms. Rosalie Minor
Construction Grants Branch
U.S. EPA, Region VH
726 Minnesota Avenue
Kansas City, KS 66101
(913) 236-2813
Mr. Larry Sheehan
Municipal Facilities Branch
U.S. EPA, Region VHI
One Denver Place, 999 18th St
Denver, CO 80202-2413
(303) 293-1557 ,
Mr. Michael Muse
Construction Grants
U.S. EPA, Region IX
215 Fremont Street
San Francisco, CA 94105
(415) 974-8313
Mr. James Werntz
Water Quality Branch
U.S. EPA, Region X
1200 Sixth Avenue
Seattle, WA 98101
(206) 442-2728
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