United States
Environmental Protection
Agency
Office of Water
Washington, DC 20460
x°/EPA Reference Guide
On State Financial
Assistance Programs
February 1988
EPA 430/89-88-8004
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This guide was produced for the United States
Environmental Protection Agency under Contract
Number 68-01-6920 and Grant Number T901588-01-
0. The document was written by Patti Shafer, Claire
Gesalman, Maggi Elliott and Amy Marasco of Roy F.
Weston, Inc.,; Paul L. Shinn, Lawrence W. Pierce
and John E. Petersen of the Government Finance
Research Center of the Government Finance Officers
Association; and James W. Pagan and Lisa Cole of
JWF Associates. The project was managed for EPA
by the Planning and Analysis Division, Office of
Municipal Pollution Control.
The views, opinions and conclusions contained herein
are those solely of the authors and not necessarily
those of the Environmental Protection Agency, Roy
F. Weston, Inc., the Government Finance Research
Center, the Government Finance Officers Association
or JWF Associates.
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Table of Contents
Executive Summary 1
Introduction: Context for This Guide 5
Part 1 - Getting Started: Designing a Financial
Assistance Program 7
5fep 1: Organize a Team to Develop the Program 7
Step 2: Assess the State's Needs 8
Step 3: Identify Key Legal and Economic Factors 10
Step 4: Review Sources of Funding and Potential
Financial Assistance Mechanisms 11
Step 5: Develop the Program Structure 12
Step 6: Implement the Program 12
Part 2 - Exploring Funding Sources and
Financial Mechanisms 17
Overview of Part 2 17
Six Main Funding Sources Can Support Wastewater Needs T7
General Fund Appropriations 18
Bonds 19
Dedicated Taxes 22
EPA Capitalization Grants 23
Loan Repayments from an SRF 24
Other Federal Sources 24
In Conclusion: Funding Sources 25
Four Basic Financial Assistance Options Have Been Used
Effectively 25
Bond Banks 25
Loan Programs 28
Grants and Subsidies 29
Credit Enhancements 30
Summary of Financing Mechanisms 30
Planning the Financial Operation of Your Assistance Program 34
In Conclusion 39
Appendix 41
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Executive Summary
Overview of the Guide
This guide is intended to provide information to help
States in the initial stages of developing a financial
assistance program. The first part, "Getting
Started," is aimed at States that are just beginning to
consider developing a financial assistance program. It
summarizes the steps that need to be taken, including:
1. Organizing the program development team,
2. Assessing the state's needs,
3. Identifying the key legal and economic factors,
4. Reviewing forms of financial assistance,
5. Developing the program structure, and
6. Implementing the program.
The second part, "Exploring Funding Sources and
Financial Mechanisms," is intended for all States,
regardless of the status of their current programs. It
presents more detailed information on the funding
sources and financial mechanisms that can be used in
a State assistance program and provides additional
information on the effects of tax reform. While Part 2
is more technically-oriented than Part 1, it is
recommended reading for States at any stage in
program development, because it reveals the range
and complexity of issues involved in securing and
distributing funding for wastewater treatment. The
Appendix lists documents available from EPA to help
States establish and operate financial assistance
programs. The remainder of this Executive Summary
describes the key points made in the two parts of the
document.
Getting Started
Several States have recognized that they need to
develop additional financial assistance programs to
meet the wastewater treatment needs of the future.
At least 18 States have financing programs that would
provide the basis for a federally capitalized State
Revolving Fund (SRF). Others have developed
financial assistance programs that employ a com-
bination of financing mechanisms such as grants,
loans, interest subsidies, and bond insurance and
guarantees.
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Although Federal guidance and regulations are still
being developed, States can take several steps to
ensure adequate funding of wastewater treatment in
the future, whether that funding of SRFs is secured
via Federal SRF programs or broader State-based
financial assistance programs.
The first step in financial program development is
usually to organize a team that will conduct the initial
assessment and determine the structure of the
program. To ensure a well-rounded analysis, many
States have established a team with representatives
from the key agencies and interest groups that will be
affected by the program. While broad representation
offers many benefits, the group should not be so
cumbersome that it will prolong the assessment
process.
The team's first task is to develop a profile of the
State's needs and existing capabilities, after which it
should identify the factors that drive or constrain the
shape and direction of the program. Using all the
information gathered to this point, the team must now
shape the vehicle that will deliver financial assistance
to communities within the State. The sources of
funding as well as the mechanism for funding must
be determined. Both of these concerns are discussed
in detail in Part 2.
Program implementation is often the most difficult
and time-consuming step in the process. Part of the
challenge is in moving from the technical to the
political arena. Although the form of the assistance
program will vary from state to state, it will, in all
likelihood, require some legislative or executive action
for implementation.
Exploring Funding Sources
and Financial Mechanisms
Each State has options to consider and choices to
make in securing the funds necessary for its financial
assistance program. The key to making these decisions
is to understand the circumstances under which one
or more funding source will meet program needs now
and in the future. This guide describes and compares
some of the major sources of funds that States now
have available to finance wastewater treatment
projects:
General fund appropriations,
Bond proceeds,
Dedicated taxes,
EPA capitalization grants,
Loan repayments to an SRF, and
Other Federal sources.
Each funding source can be used alone or in
combination with others to provide direct loans and
grants, credit enhancements, and technical assistance
programs, and to fund program operations. Each has
its particular applications, advantages, and
shortcomings [see Table 3 in Part 2 (pages 26 and 27)
for a summary].
Four basic forms of financial assistance for local
wastewater projects have been used effectively around
the country. Most of them are based on participation
in the tax-exempt bond market, where the State either
borrows money itself to lend or give to local
governments, or helps the local governments borrow
directly by offering enhancements or interest rate
subsidies. The most common types of financial
assistance that have been used by States are:
Bond banks,
Loan programs,
Grants and subsidies, and
Credit enhancements.
Assistance program financing involves a cycle in
which the State's financing sources and the assistance
offered to local governments are interdependent.
Some forms of assistance work better with some
financing sources than others, and vice versa. In
considering different program structures, it is
important to make sure that State funding and
assistance methods are compatible. The forms of
assistance the State offers will be determined by a
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number of factors influenced by policy development
and assessment processes. Whether a State can afford
to offer only a limited variety of assistance programs
or a more comprehensive program will depend on its
defined needs and ability to raise funds.
Designing and developing a State financial assistance
program for wastewater construction is a challenging
process. While this guide can point the way to
program success and point out requirements and
pitfalls, the program developer has an even greater
resource at hand: the advice and knowledge of people
to be found at all levels of government and in the
private sector. This resource is invaluable to a
successful program. It should be cultivated carefully
and consulted frequently.
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Introduction:
Context for this Guide
Recent legislative events are bringing about large-
scale changes in wastewater funding. Since 1972, a
significant amount of the money spent on
construction of wastewater treatment facilities has
come from the Environmental Protection Agency's
construction grants program. Recent changes in the
Water Quality Act of 1987 however, further shift the
responsibility for financing wastewater treatment
facilities away from the Federal government back to
States and local communities. The amendments to the
Clean Water Act will phase out construction grants,
providing instead seed money to initiate State
Revolving Funds (SRFs). In addition, changes under
the Tax Reform Act of 1986 are causing State and
local governments to reevaluate their programs for
financing capital projects.
Several States have recognized that they need to
develop additional financial assistance programs to
meet the wastewater treatment needs of the future. At
least 18 States have financing programs that would
provide the basis for a Federally capitalized SRF.
Others have developed financial assistance programs
that employ a combination of financing mechanisms
such as grants, loans, interest subsidies, and bond
insurance and guarantees.
States can take several steps to ensure adequate
wastewater funding in the future, whether that
funding is secured via Federal SRF programs or
broader State-based financial assistance programs.
These steps are discussed in the following sections.
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Parti
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Part 1
Getting Started:
Designing a Financial
Assistance Program
Step 1: Organize a Team to Develop
the Program
The first step in financial program development is
usually to organize a team that will conduct the initial
assessment and determine the structure of the
program. To ensure a well-rounded analysis, many
States have established a team with representatives
from the key agencies and interest groups that will be
affected by the program. A broad-based team
approach can serve several useful functions during the
assessment:
The combined experiences and expertise add
balance to the assessment process and enhance
the ultimate design and implementation of the
assistance program.
Early political support can often influence the
program's enactment; team members may have
political leverage in their particular spheres of
interest to help promote the program.
A broad base of support may enhance acceptance
by communities that should participate in the
program.
Table 1 (page 9) identifies some typical organizations
that could be represented on the assessment team as
well as the roles they can play. The team should
include representatives from the diverse groups that
will be affected by the program. These include:
State Officials - Representing the
environmental agency, finance office (e.g.,
treasurer's office, finance director, etc.), the state
attorney general's office, Governor's office,
economic development office,
Local Officials - Representatives of large and
small communities as well as their public interest
groups such as the municipal league, county
association,
Legislative Branch - Key legislative members
and/or staff (selected for influence as well as
committee interests),
Private Sector - Those that will workwith the
program such as bond counsel, investment
bankers, accountants, financial advisors,
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Academic, Research and Other
Organizations -Those that work with and
provide technical and management assistance to
local governments, and
Industry - The chamber of commerce, trade
groups representing developers, engineering
firms.
While broad representation offers many benefits, the
group should not be so cumbersome that it will
prolong the assessment process. Some States organize
a relatively small task force that meets periodically
with a larger "advisory group" created to review
progress and provide input. This consulting group
can also help in the transition to program
implementation, serving as the foundation for the
advisory group that can oversee program
administration.
Step 2: Assess the State's Needs
The team's first task is to develop a profile of the
State's needs and existing capabilities. This analysis
should include several elements:
1. Identify potential recipients of funding,
2. Estimate the types and magnitude of needs that
can be addressed through a financial assistance
program, and
3. Assess the State's current capabilities for
implementing and managing an assistance
program.
Identify Potential Recipients
Depending on how the State is organized, potential
participants in the program might include counties,
cities, towns, boroughs, and townships, as well as
special districts or authorities that provide wastewater
services to their constituents.
The team should identify these participants and
develop key indicators for each that provide well-
organized information in such areas as:
Size,
Geographic location,
Economic vitality,
Fiscal strength, and
Financial capability (what communities can
afford).
These indicators will help the State develop profiles
on participants that are based on their local conditions
and needs. This information can be used to tailor a
financial assistance program accordingly.
Estimate Program Needs
As the team identifies participants, it should simul-
taneously assess the magnitude of their wastewater
treatment needs and the type of assistance they will
require. The basis for this needs evaluation often
already exists. Inventories of wastewater treatment
needs have been conducted by the State's
environmental regulatory agencies or for the Federal
Needs Survey. Other programs, such as Farmers
Home Administration, Community Development
Block Grants, or State programs may have related
surveys. This information should be reviewed and
updated, if needed. If no surveys exist, or if they are
incomplete, the team should compile one. The needs
must be quantified and projected over the time period
of the program, in terms of types of treatment needs
and capital costs.
As part of this assessment, needs can be ranked in
terms of their effect on:
Water quality,
Public health, and
Economic development.
These priorities, together with the profiles developed
for the participants, will help the State tailor an
assistance program that is consistent with the State's
overall goals.
Assess State Capabilities
When building a program, it is essential to
understand and evaluate the role that the State will
play in helping local governments meet their
wastewater treatment needs. The State's capability to
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Table 1
Potential Assessment Team Members and Their Roles
Team Member
Contribution
State officials including
representatives of the:
Environmental agency
Finance offices
Attorney general's office
Governor's office
Economic development agency
Local officials including
representatives of:
Large and small commu-
nities
State municipal leagues and
trade associations
Legislative branch
Private sector, including
representatives of:
Bond counsel
Investment bankers
Accountants
Financial advisors
Can help determine State's
priorities, establish
financing limitations,
respond to legal questions.
Can help determine
local priorities, respond
to state concerns,
represent wide section of
local interests.
Can represent constituents' concerns and
create political leverage for enacting program.
Can identify "real world"
concerns of financial markets.
Academic, research and other
similar organizations
Industry, including
representatives of:
Chamber of commerce
Trade groups
Developers
Engineering firms
Can help in analysis;
provides perspective on the
needs and concerns of a
cross-section of local clients.
Can provide industry "real
world" concerns; provide
technical oversight
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perform the desired role should be examined from
several different perspectives:
Administrative Capabilities - State agencies
and staff that are capable of administering an
assistance program (e.g., the environmental
department, State finance office).
Technical Resources - Public and private-
sector resources that can provide financial and
technical support (e.g., assess technical
applications, structure loan agreements).
Financial Capability - The State's ability and
willingness to finance the program.
At the same time, the State must evaluate its goals so
that the program may be designed with an eye toward
meeting State objectives. Goals may include
improving water quality, promoting economic
development, increasing (or decreasing) State support
of local government capital formation, or equalizing
tax and/or user charge burdens between and among
communities.
Step 3: Identify Key Legal and
Economic Factors
Legal and economic factors will have a considerable
effect on the shape and direction of the program.
Consideration should be given to:
1. Federal laws,
2. State constitution and laws,
3. Financial and economic conditions, and
4. Market conditions.
A thorough understanding of these factors will enable
the State to establish an assistance program that has
the flexibility to meet changing conditions and
requirements.
Analyze Federal Laws
Federal laws will affect the shape of State assistance
programs significantly. The Water Quality Act of
1987 has the most direct impact where a State is
developing a financial assistance program that
includes an EPA-capitalized State revolving fund
(SRF). EPA will be offering "Federal Capitalization
Grants" that underwrite program start-up, and
several requirements are attached to those grants. The
State will have to establish legal mechanisms to
ensure that the SRF and all repayments are used in a
manner consistent with the requirements of the Act.
The specific requirements will be developed as part of
EPA's initial guidance and any subsequent
regulations. As States begin to develop their
programs, these minimum Federal requirements need
to be carefully addressed.
Other provisions of the 1987 Water Quality Act may
also affect the State's program. For example,
compliance deadlines need to be considered in
establishing eligibility requirements and setting
priorities for community assistance.
Recent changes in the Tax Reform Act of 1986 are
also likely to affect the development of a financial
assistance program. For example, new arbitrage
requirements will restrict the availability of
investment income from certain program funds, and
the definition of private activities may limit the use of
State funds for certain projects. Part 2, which
examines funding sources in detail, presents the
ramifications of new tax law provisions for various
sources of wastewater construction funds.
Examine State Laws
At the State level, legal and constitutional constraints
often affect the form of a financial program.
Limitations on the State's authority to borrow funds,
caps on interest rates, or referendum requirements to
issue debt may affect the type of funding mechanisms
available to the State. In addition, most States impose
some restrictions on how their local governments and
State agencies are organized and how they finance
their activities. These restrictions may affect the
program design.
Flexibility has been a key element of responsive and
effective programs for many States. If legislation is
written so tightly that only one form of assistance is
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possible, the program will not be responsive to other
local needs. Furthermore, if the legislation provides
assistance only in response to one economic or
financial condition, it risks becoming unresponsive as
conditions change. Ideally, a program will be created
with adequate flexibility so that it can remain
responsive to financial, economic, and environmental
conditions.
Assess Financial and Economic Conditions
Financial and economic conditions frequently provide
the impetus to create a financial assistance program.
Yet they can also create constraints, either during
program development or at some point during its
implementation. Part 2 provides more detail on the
different forms of assistance and their appropriateness
for various conditions.
It is essential to build a program flexible enough to
respond to different and changing financial and
economic conditions. For instance, a program created
to help local governments in times of high interest
rates might also be structured to provide a different
form of assistance when rates are lower and local
market access easier. A program component is
typically created to help small local governments raise
funds by borrowing from the State (often at more
affordable interest rates). Such a concept does not
always target every community in need, however, and
those that cannot afford to pay market interest rates
should also be assisted, perhaps with interest rate
subsidies or grants.
The analysis of economic growth may lead to program
design decisions that also further pollution abatement.
For example, if it is determined that economic growth
is constrained because of the inability of local
governments to provide wastewater treatment,
program initiatives can be tailored accordingly. If
other conditions such as high unemployment exist,
then wastewater treatment improvements could be
used to attract new employers or encourage existing
employers to expand their services.
Evaluate Market Conditions
Financial market conditions will also shape the
program. A State with a high credit rating and
positive name recognition in the municipal bond
market can offer market access at an attractive rate to
communities with low or no credit ratings. Or, a State
can offer efficient market access to local governments
that need to borrow relatively small amounts of
money and find entering the market independently
too expensive and time consuming.
Step 4: Review Sources of Funding
and Potential Financial Assistance
Mechanisms
Using all the information gathered to this point, the
team must now shape the vehicle by which funding
will be delivered. The sources of funding as well as
the mechanism for funding must be determined.
Both of these concerns are discussed in detail in Part
2. Possible funding sources include:
General fund appropriations,
Bond proceeds,
Dedicated taxes,
EPA capitalization grants,
Loan repayments, and
Other Federal programs.
Several forms of financial assistance have been used
effectively by States around the country. Usually a
State borrows money to lend (or grant) to local
governments or helps the local governments borrow
directly by offering credit enhancements or interest
rate subsidies.
The most common types of financial assistance that
have been used by states include:
Bond banks (which provide access to better
credit ratings),
Loans (such as SRFs),
Grants and subsidies, and
Credit enhancements.
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The team should analyze these alternatives within the
framework of the State's needs and capabilities and
determine the forms of assistance that will be most
appropriate for their program. The loan and credit
enhancement programs are consistent with the State
revolving fund (SRF) program established under the
Water Quality Act of 1987, provided the State
complies with the requirements of the Act.
Step 5: Develop the Program
Structure
At this point in the analysis, the team should have a
clear understanding of the basic elements suitable to
its financial assistance program, including the:
Goals of the program,
Magnitude and priority of the needs,
Requisite financial resources,
Factors that shape or limit the program,
Existing state capabilities, and
Forms of assistance that seem most appropriate.
Once the process of identifying and analyzing the
issues attached to each of these elements is complete,
it is important to review the proposed program as a
whole, to be sure that the different strategies are
coordinated effectively.
Step 6: Implement the Program
Program implementation is often the most difficult
and time-consuming step in the process. Part of the
challenge is in moving from the technical to the
political arena. During the development of this guide,
many State assistance programs were reviewed and
several case studies made. State staff consistently
agreed that program success requires careful
marketing, planning, consensus-building, and timing.
An implementation plan solidifies all of the previous
planning activities. It should:
Identify audiences that must be sold on the
program,
Identify legislative mechanisms needed to enable
the program, and
Define the implementation steps that should be
followed.
Sell the Program to a Broad Audience
As more and more States create financial assistance
programs, it is becoming increasingly clear that
successful implementation requires broad-based
support. This support must come from many
quarters, as shown in Table 2 (page 13).
Identify Enabling Legislative Mechanisms
Although the form of the assistance program may
vary, it will, in all likelihood, require some legislative
or executive action for implementation. These
activities can delay program start-up, especially if an
amendment to the State constitution or a voter
referendum are required.
The quickest way to implement a program may be
through executive order. This approach may be
politically or legally impractical, however, considering
the broad-based support needed for the program's
success. Most States have relied on passage by the
State legislature. While this avenue allows the highest
degree of tailoring to current circumstances, it can
require a substantial amount of time to complete the
legislative process and respond to public and
community concerns. Nonetheless, in the long run
this effort is likely to ensure a politically feasible
program.
Taking the legislative route does not mean the State
must build a program from scratch. It may be
possible to modify existing programs rather than
create an entirely new entity. This will depend, in
part, on the type of State programs that currently
exist. An existing loan program may be expanded to
provide the mechanism for wastewater treatment
financing, or a new program can be modeled after an
existing program.
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Table 2
Solicit Program Support From Many Areas
The Legislature That Will Enact the Program -
Failure to develop bi-partisan support in the
legislature has slowed and stopped the development of
several State programs.
State Agencies - Good working relationships must
be established with corresponding State agencies
having a direct or supporting role in the State
assistance program. Frequently activities such as
technical reviews, money management and the like
will be conducted by other State agencies.
Local Communities - Implementation is not just
administration, but participation as well. Strong local
support is needed if the program is to be utilized.
Fears of State intrusion and loss of local fiscal
independence can hamper implementation.
The Public - Direct support from the public may be
necessary. For example, a State referendum may be
required to authorize some component of the
program, such as incurring additional debt.
The Private Sector - The private sector will most
certainly be involved in the program both directly and
indirectly. Most State programs rely on outside
resources such as financial advisors, bond counsel,
engineers, and the like. In some instances, these
groups, fearing a loss of business, have delayed
implementation of State assistance programs.
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Define Implementation Steps
Developing a comprehensive, step-by-step plan is
important to ensuring the successful implementation
of a State assistance program. It is vital to think
through the specific steps in the process, assign
responsibility for their completion, develop a
schedule, and establish procedures for monitoring and
controlling progress.
The specific steps needed to implement an assistance
program will vary from State to State depending on
existing conditions and the results of the assessment.
However, the experience of several States has revealed
some typical activities:
Identify and inform key supporters in the State
legislature, agencies, municipal organizations,
and professional societies who are in a position to
sponsor and promote the program.
Prepare a report to the legislature summarizing
results of the needs analysis and detailing
recommendations for the program.
Draft enabling legislation (constitutional
amendments as needed) and lobby for its
passage.
Obtain commitments for initial funding (seed
money) to begin operations.
Develop an organizational plan, select core staff,
and prepare operating budgets.
Negotiate cooperative agreements with agencies
that will support operations.
Retain outside experts as required, such as
financial advisors, bond counsel, tax advisors,
and accountants.
Prepare program procedures for project
selection, application, monitoring, and control.
Obtain program funding through initial bond
offering, an appropriation, dedicated taxes, or
grants.
Initiate the application and selection process.
Develop a reporting system to monitor and
control the program.
The experience of other States has revealed that
implementation of a financial assistance program can
be complicated, politically sensitive, and time
consuming. The keys to success are broad-based
support and acknowledgment of how long the task
may take. Planners must work quickly and efficiently
to gather timely information and be prepared for a
sometimes long implementation process.
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Part 2
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Part 2
Exploring Funding
Sources and
Financial
Mechanisms
Overview of Part 2
Part 2 describes the operations of a financial
assistance program in more detail. The first section
discusses options the State might choose for financing
the program. The second covers forms of financial
assistance to local governments. Each section
compares the advantages and disadvantages of the
available options. The final section describes how
financing options and financial assistance fit together
to the benefit of both the State and its local
governments.
Six Main Funding Sources Can
Support Wastewater Needs
Each State has options to consider and choices to
make in securing the funds necessary for its financial
assistance program. The key to making this decision is
to understand the circumstances under which one or
more funding sources will meet program needs now
and in the future. This section describes and
compares the six major sources of funds that States
now have available to finance wastewater treatment
projects:
1. General Fund Appropriations,
2. Bond Proceeds,
3. Dedicated Taxes,
4. EPA Capitalization Grants,
5. Loan Repayments to a State Revolving Fund
(SRF), and
6. Other Federal sources.
It is important to note that these funding sources are
not a comprehensive list of all available financing
mechanisms. Other funding sources may be identified
by individual States and by localities within each
State, depending on legal, economic, and
administrative considerations.
Each funding source can be used alone or in
combination with others to provide direct loans and
grants, credit enhancements, and technical assistance
programs, and to fund program operations. The
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discussion that follows analyze these funding sources
from the perspective of how well they meet three
criteria:
Feasibility as measured by the legislative
practicality, the complexity (and related costs)
associated with initiating and operating the
program, and the overall fiscal impact on the
State.
Equity as measured by the fairness in directing
specific sources of funds to the construction of
local wastewater treatment facilities (i.e.,
beneficiary-based charges), and the burden
placed on different economic classes of residents.
Stability and Self-Sufficiency as measured by
the ability of funding sources to meet program
needs in response to changing economic and
market factors.
This general discussion is summarized in Table 3
(pages 26 and 27) which briefly shows the pros and
cons of each funding source.
The Tax Reform Act of 1986 had major implications
for virtually every sector of the American economy.
One such change involved altering some of the rules
for State and local governments. Tax reform
considerations might affect the use of two potential
SRF financing sources: dedicated taxes and bonds.
The effects on dedicated taxes are indirect and
probably minor. In the case of bonds, though, tax
reform considerations may play an important part in
how your financial assistance programs are structured
and projects are selected. A complete discussion of the
impact of tax reform on these two financing sources
appears in the section relevant to each.
General Fund Appropriations
Annual appropriations from general tax receipts can
be used as an ongoing source of funds. General funds
are not a guaranteed or dedicated funding source for a
wastewater treatment program, because the legislature
must appropriate funds each budget period.
Appropriations have more readily been allotted by
State legislatures as "seed" money to capitalize
program start-up, to cover program shortfalls, to meet
operating expenses, to fund technical assistance
activities associated with financial support, or to
increase program capital in future years.
Appropriations Are A Good Source of Program Start-
up and Operating Funds
An important element in the early success of any
financial assistance program is to dedicate sufficient
funds to initially capitalize the program. Meeting
program goals in a timely manner can depend on
taking advantage of the momentum gained during the
program's development. The State's commitment,
current financial health, and competing demands on
upcoming appropriations, however, must be
considered in determining whether general fund
appropriations are a feasible source of start-up funds.
Bond-based programs (bond banks or pools, discussed
on pages 19 and 21) may also benefit from start-up
appropriations. Such initial capitalization can cover
the costs of preparing and issuing the bond offering
that initially funds the program.
A start-up appropriation may be needed to staff the
program, write necessary regulations and create
application procedures, and publicize the program.
Up to four percent of an EPA Capitalization Grant
can, through 1994, be used for paying the costs of
administering a SRF. If an appropriation is not
available, funds may have to be diverted from direct
financial assistance to cover operating expenses. If a
legislature feels that a financial assistance program for
revenue-producing projects should quickly become
administratively self-sufficient, operating funds in
future years may be derived from service charges
imposed on borrowers in the form of a fee or small
increase in interest rates.
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Appropriations Are Not Generally Used as a Sole
Funding Source
Although annual appropriations made by State
legislatures may be used as an ongoing source of
funds for financial assistance programs, there are
several problems with using appropriations as a
program's sole funding source:
Competing demands on the annual appropriation
process may preclude a steady source of future
funds.
A legislature may view wastewater treatment as
too localized a benefit to justify ongoing
appropriations of general fund resources.
Lawmakers may feel that a financial assistance
program for revenue-producing projects should
be financially self-sufficient.
Bonds
Bonds are the most popular means of securing funds
for the construction of wastewater treatment facilities.
Like a home mortgage, bonds stretch out payments
for new facilities over a period of 10 to 30 years. Bond
proceeds are primarily used as a source of funds for
bond banks or direct loan programs. They have been
used for "leveraging" monies in revolving loan funds
or providing grants and interest rate subsidies.
Leveraging is the technique of issuing bonds to be
repaid from one of the other financing sources in
order to provide more project funding sooner than
would otherwise be possible.
The source of bond payments to investors depends on
the type of bond that has been issued (another term
for bond payments to investors is "debt service",
which simply means the interest payments on the
bonds, and bond principal as bonds are retired). The
three common bond types are:
General obligation bonds, which are secured
by the State's full faith and credit and taxing
ability; payments are made directly from the
State's general fund.
Revenue bonds, which are secured by the
revenues generated by project operation. Thus,
debt service is paid from project revenues. In the
case of traditional revenue bonds issued by
communities to build single projects, project
revenues are user charges paid by customers. In
the case of a State program that funds many
different projects, project revenues may include
loan repayments from communities and special
revenues such as dedicated taxes and EPA
Capitalization Grants.
Double-barrelled bonds, where debt service
payments may also come from a combination of
these two sources (taxes and project revenues).
In this case, the bonds are secured first by
project revenues, then by the full faith and credit
of the State, should project revenues not be
sufficient to repay the bonds.
Regardless of the bond type used, bonds always work
in partnership with another funding source that will
be dedicated to repayment.
Bonds May Be A Stable Means for Program Funding
General obligation and revenue bonds are
traditionally used by State governments to obtain
long-term funds for the construction of capital
facilities, such as wastewater and water projects,
because these projects provide Statewide benefits for
present and future users. Bonds may not be a good
source for providing program start-up or operating
funds, however, because the need for repayment
diverts funds from direct financial assistance and
because these costs cannot be recovered to make
future debt service payments.
Because the State is a tax-exempt entity, the interest
it pays on bonds issued for public purposes (see the
discussion on tax reform, pages 21-22) is exempt from
taxes for the investor and interest rates are thus lower
than private-market, taxable rates. This feature can
make State-issued bonds an attractive source of
program funds. Furthermore, the income from bond
issues will reduce the need to access large
appropriations from the general fund to continually
finance projects.
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It is important to note that interest rates paid on a
bond issue vary a great deal as a result of the issuer's
credit rating. A credit rating reflects the adequacy of
the pledged security (payment source). Standard and
Poor's and/or Moody's Investor Service are national
rating agencies that determine State credit ratings.
The perceived risk of a State's ability to meet its
payment obligations will determine the interest rate
and potentially the success of selling a bond issue.
The riskier the bond, the lower is its rating, and the
more likely that the seller will have to offer a high
interest rate.
In general, a State will have a credit rating higher
than most of the municipalities in the State. This is
because states have a broader tax and revenue base to
tap for repayment of bonds. It is this differential
between State and local credit ratings that make bond
banks attractive to municipalities. In some instances,
large or wealthy municipalities may have a bond
rating equal to or better than the State's. State
assistance may be less attractive to these localities.
General Obligation Bonds Can Bring The Lowest
Interest Rates
The primary advantage associated with general
obligation (GO) bonds is that they carry the lowest
available interest rate of any State bond offering
because they are backed by the State's
"full faith and credit" pledge. This backing means a
bond issue is secured by an unconditional pledge of
the State's ability to levy taxes to meet principal and
interest payments. It is important to note that use of
the State's general obligation pledge may be limited
by the State's debt ceiling or by the State's desire to
protect the quality of its credit rating.
Additionally, GO bonds can provide a secure source
of funds for financial assistance programs because
they have a clearly defined funding level established
by prior voter or legislative approval. A disadvantage
of GO bonds, however, is that the same definitive
nature of the GO bond may limit program growth
because the authority to issue additional bonds
usually involves additional voter or legislative
approval.
Nevertheless, a long-term commitment by the
legislature to issue GO bonds can provide a financial
assistance program with a continuing and secure
source of funds.
Revenue Bonds Are Self-Supporting
Revenue bonds obligate the State to manage the
repayment of loans from specifically designated
sources. They are considered "limited obligation"
bonds because there is no full faith and credit pledge
of the State. Some states attach a "moral obligation"
to revenue debt. A moral obligation by the State
implies that the legislative body intends to make
appropriations sufficient to cure any deficiency in
revenues needed to meet debt service requirements.
The difference between moral obligation and general
obligation bonds is that in the former case, the
legislative body has no legally enforceable obligation
to pay such debt service.
Revenue bonds are payable exclusively from the
revenues produced by a project (user and hook-up
fees or assessments) or from loan repayments from
municipalities. Consequently, non-revenue producing
programs (e.g., grant programs, interest rate
subsidies, technical assistance activities) cannot be
funded from revenue bonds.
The major advantages of issuing revenue bonds are:
While new GO bond issue would generally
require legislative or voter approval and could
consume some of the State's borrowing capacity,
revenue bonds generally do not require voter
approval or count against a State's debt limits.
Those benefitting from the project ultimately
pay for the facility through user fees. Thus,
revenue bonds may be the most equitable means
for financing a wastewater treatment program
that benefits several government jurisdictions.
The major limitation of revenue bonds is their
generally higher interest rate because they are
inherently a riskier investment than GO bonds (no
State full faith and credit pledge). This could divert
more funds from the construction of a facility to pay
20
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the higher interest demanded by investors and,
consequently, cost the municipality borrowing the
money more to construct the project. Some States
have used a "moral obligation" pledge for their
revenue bonds. This pledge, not nearly as strong as a
general obligation security, gives future legislatures
the power to back defaulted revenue bonds from
current appropriations, but does not compel them to
do so. Table 3 on pages 26-27 identifies the
advantages and disadvantages related to both general
obligation and revenue bonds.
Tax Reform Has Affected Bond Issues
The Tax Reform Act of 1986 restricted State and
local governments' freedom to issue tax-exempt
bonds. The two provisions that directly affect bond-
financed revolving funds are arbitrage limitations and
private-activity restrictions. States that are
contemplating a bond issue to finance their revolving
funds must consider the impacts of these provisions
in structuring the issue.
Arbitrage Limitations
Arbitrage is the practice of borrowing funds in the
tax-exempt market and temporarily investing the
proceeds at (higher) taxable interest rates. State and
local governments have traditionally used arbitrage
earnings during construction of new projects to
reduce the amount of funds that must be borrowed.
The Tax Reform Act contains strict restrictions on
arbitrage earnings, and abiding by them will
complicate all State programs that are wholely or
partially financed by tax-exempt bonds. The
overriding rule is that issuers must rebate to the
Federal government "arbitrage" earnings generated if
bond proceeds are not spent on construction within 6
months after bonds are issued. Arbitrage earnings
may be roughly defined as the difference between the
yield on the investment in bond proceeds and the
yield on the bonds.
This reform effectively limits arbitrage earnings and
in many cases will increase the amounts that a State
will have to borrow in order to fund a given dollar
amount of projects. In the past, many revolving funds
and bond banks have used arbitrage earnings to
finance their bond issuance costs and fund
administrative costs. These expenditures will now
have to be financed either by borrowing additional
funds or through ongoing appropriations. It will also
increase recordkeeping responsibilities for any loan
program that is tax-exempt bond-financed. In many
instances, the fund manager will require assistance
from either the State treasurer, an outside consultant,
or a microcomputer software package to keep track of
arbitrage earnings.
Arbitrage restrictions will have a particularly severe
effect on "blind pool financing," in which the SRF
borrows funds without knowing in advance which
projects they will finance. The advantage of a blind
pool for the State is that funds are available to local
borrowers as soon as their projects are approved and
they are ready to spend money. The alternative is a
"designated pool," in which the State issues bonds
after projects are approved and after local
governments have awarded construction contracts.
These pools reduce the benefits to local government
by adding substantial delays to the financing process,
but they also reduce the chances that the State will
fail to comply with the Federal tax laws. States must
now decide whether quick funding access and
cumbersome arbitrage restrictions are better than
slower access and easier arbitrage compliance.
States that wish to offer the "immediate financing"
alternative offered by blind pools will have the
following options under the Tax Reform Act:
Operate blind pools financed by bonds but limit
or rebate arbitrage earnings on the unloaned part
of the pool. The program manager and financial
advisor will have to determine whether this
option is economically feasible in a given
situation.
Use bonds only to finance designated pools, but
reserve a portion of other financing sources (e.g.,
EPA Capitalization Grant or State
appropriation) for blind pools. This option
would result in a considerably smaller amount of
money available for blind pool financing.
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Private-Activity Restrictions
In addition to the arbitrage restrictions, the Tax
Reform Act contains "private-activity" restrictions
that affect the tax exemption of interest on bonds for
projects that provide significant benefits to private
persons or firms. The Act defines a distinction
between "governmental" and "nongovernmental" or
"private-purpose" bonds.
A bond is non-governmental if an amount equal to or
greater than 10 percent of bond proceeds is used to
assist trade or business by persons other than a State
and local government, and 10 percent or more of the
principal or interest on bonds is secured by money or
property used in such trade or business. The
definition of a private-purpose bond is one in which
an amount equal to the lesser of $5 million or 5
percent of the bond proceeds is used to make loans to
a non-governmental person.
In the case of wastewater treatment facilities, private-
activity restrictions would apply if the facility is to be
privately-owned, if a private firm uses more than 10
percent of the facility's capacity, or if the facility is
operated by a private firm under a service contract
that does not meet the following requirements:
The contract term (including options) is no more
than five years;
At least 50% of the compensation is on a
periodic, fixed-fee basis;
Fees are not based on net profit; and
The local government may cancel the contract
without penalty after 3 years.
A facility that is operated under a contract that meets
all four of these criteria would be defined as a
governmental purpose.
If a bond is a private-activity security as determined
by the above tests, the interest income on it is subject
to taxation unless it is provided with a specific
exemption ("exempt activity bond"). Sewage facilities
are an exempt activity, but bonds that are defined as
non-governmental (as in the case of bonds that
finance a "privatized" plant or finance a plant with
22
one or two very large private customers) must
compete with other exempt activity bonds for an
allocation under a statewide volume cap to remain
tax-exempt. Private-activity bonds that do not fall
under the volume cap would be taxable.
Pending regulations that implement the Tax Reform
Act, it is not clear whether private-activity restrictions
on bond financing apply to every project or to the
State's consolidated bond issue as a whole. The advice
of a qualified bond counsel should be sought on the
specific effects of tax reform before bonds are issued.
If it appears that some projects to be financed from
the program might be defined as private-activity, the
following options could be explored:
Finance private-activity projects from non-bond
sources such as the EPA Capitalization Grant,
general fund appropriations, or dedicated taxes.
Sell taxable debt to finance private-activity
projects.
Dedicated Taxes
A supplement or alternative to using general fund
appropriations or bonds is the authorization of
continuing appropriations by dedicating one or more
specialized taxes to a program. These include income,
sales, severance, and property taxes. Taxes can be
used for program capitalization or as a source of bond
repayments.
However, the use of taxes as a funding source raises
questions of: (1) fairness or equity; (2) the effect that
changing economic conditions can have on a
program's long-term self-sufficiency; and (3) the
overall State fiscal impact. These criteria can be in
conflict, and value judgments may differ as to which
are most important. Some taxes can be difficult to
justify beyond the fact that they raise needed program
funds.
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Dedicated Taxes Can Be Used as a Partial or
Sole Funding Source
Part of an existing tax, increases of a current tax, or a
new tax can be dedicated to support loan or grant
programs. In some instances, dedicated taxes have
been used in combination with other sources, such as
bonds, to finance a State's program.
Dedicated taxes may provide a more stable source of
program funding than general fund appropriations,
because taxes generally may not be subject to the
annual legislative budget process. In addition, the
administrative burden and costs associated with
dedicating a tax to a program are minimized when
States divert funds from existing sources, rather than
creating new tax authorities.
The Tax Reform Act of 1986 limited individual
taxpayers' ability to deduct State and local sales taxes
from Federal income taxes. This change makes sales
taxes comparatively more expensive to taxpayers. It is
possible that it will become politically more difficult
for State and local governments to implement or
increase sales taxes, so some States may favor other
fully deductible taxes (income and property taxes) as
financial assistance sources.
EPA Capitalization Grants
The Water Quality Act of 1987 changed the
fundamental nature of the construction grants
program by allowing, and then requiring a State to
use project grant funds to capitalize State revolving
funds (SRF). This guide provides general information
on the capitalization grant program. However, States
are encouraged to refer to the Water Quality Act itself
and the initial implementing guidance to be issued
by EPA.
The Act allows States to convert part of their
allotment of construction grants monies to SRF "seed
money" beginning in Fiscal Year 1987. After Fiscal
Year 1990, project-specific grants will be phased out
entirely in favor of capitalization grants to SRFs.
Federal capitalization grants will end in 1994.
States must deposit an amount equalling 20% of the
Federal capitalization grant. The match must come
from State funds, but the State has flexibility to
decide where these funds will come from. Bond
proceeds are likely to be one acceptable source for the
State match. While the EPA capitalization grant may
not be used to make grants to communities, it may be
used to make loans at or below market interest rates,
to purchase credit enhancements on behalf of local
governments, or to provide security for State bonds
issued to finance the revolving funds.
When applied to projects, the capitalization grant,
repayments of loans from the grant, and State match
must first be used to assure maintenance of progress
toward compliance with the enforceable deadlines and
requirements of the Clean Water Act, including the
municipal compliance deadline of July 1, 1988.
EPA Capitalization Grants Provide a Stable Base for
the Fund
Because the Water Quality Act authorized revolving
fund capitalization grants through Fiscal Year 1994,
this source provides relatively certain funds (subject
to annual appropriations by Congress). Further, once
the State receives a capitalization grant it must
guarantee that the loan repayments (principal and
interest) return to the fund. Unlike bonds, general
fund appropriations, and dedicated taxes, EPA funds
are not subject to legislative or voter approval.
Thus, these funds can be used as the primary source
of capital for the SRF, supplemented with State funds
as necessary. EPA funds cannot be used for grants,
but may be used for loans, bond banks, or credit
enhancements. The SRF program provides the State
with more flexibility in selecting and funding projects
than existed under the construction grants program.
EPA Capitalization Grants Have Limitations
EPA capitalization grants have three drawbacks as
funding sources for SRFs:
They will be discontinued after 1994.
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They may not be used to make grants, nor may
any monies in a Federally capitalized SRF be
used as grants.
Spending an amount equal to each Federal
capitalization grant is governed by a range of
Federal "Title II" regulations, including user
charge system requirements, and regulations
governing prevailing wages and environmental
review.
Many States are considering the establishment of
separate assistance programs to provide grants, or to
avoid Clean Water Act requirements.
Loan Repayments From an SRF
Initial and continuing capitalization of a program can
be achieved through any of the mechanisms described
above: general fund appropriations, bonds, or
dedicated taxes. Loan repayments only constitute a
funding source after a revolving loan fund has been
initiated.
Loan Repayments Can Create A Self-Perpetuating
Funding Source
Loan repayments can provide an excellent source of
funds for future loans while eliminating or reducing
the need for further appropriations, dedicated taxes,
or bond issues.
The major advantages of using loan repayments as a
funding source for subsequent program loans are:
After initial capitalization, loan repayments can
provide a self-sufficient source for future loans;
reducing future dependence on State funds and
bonds.
Using loan repayments as an ongoing funding
source can make a State program independent of
less dependable revenue streams such as Federal
grants and annual State appropriations.
Whether a State program can be financed solely from
loan repayments depends upon many factors. It is
critical to analyze how proposed operating and
24
lending strategies will affect the self-sufficiency of the
program:
State interest rate ceilings can limit the interest
charged to borrowers. Interest charges are the
principal source of additional loan funds; rates
that are too low can deplete a fund over time.
For example, assume a State has capitalized a
portion of the revolving loan program with bond
proceeds requiring interest payments of 7
percent. If the State loans the funds to localities
at a rate limited to 6 percent, the State will
experience a depletion of resources as it pays out
more interest than it takes in. Inflation and
climbing interest rates will effect the interest
paid by the State, and as a result will require
higher interest from localities. A mix of interest
rates should be maintained at levels that make
the program marketable and allow for revenue
sufficiency.
The length of time borrowers have to make loan
repayments (loan maturities) may affect the self-
sufficiency of a program. While loan maturity
schedules must address the borrower's capacity
to make timely payments, the repayments must
flow back in sufficient amounts to allow timely
new loans. Additionally, the Water Quality Act
requires that all loans made from a Federally
capitalized SRF be repaid within twenty years.
There is a direct trade-off between fund self-
sufficiency and level of assistance offered to local
governments. If the State decides to offer
interest subsidies to communities, it must also be
prepared to finance the resulting shortfalls; that
is, more money will be going out in the form of
assistance than coming back in the form of
repayments.
Table 3 on pages 26-27 identifies the advantages
and disadvantages related to loan repayments.
Other Federal Sources
Grant and loan financing from Federal agencies other
than EPA has played an important part in financing
wastewater treatment projects in the past, especially
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in low-income or rural communities. The most
common funding sources have been loans and grants
from the Farmers Home Administration (FmHA),
Community Development Block Grants (CDBG),
administered by the Department of Housing and
Urban Development, and general revenue sharing.
The latter source was recently discontinued and the
other two have been cut back, but are still available.
These sources are generally made available to local
governments rather than the State. Because they
reduce demands on State funding, however, they
should be considered as key elements in the State's
overall funding strategy for wastewater facilities. It is
also possible that some FmHA and CDBG funds
could be diverted to the SRF, but each State will have
to make the determination in conjunction with legal
counsel and with the State agency that administers
the Federal grant and loan programs.
In Conclusion: Funding Sources
The preceding discussion has presented the five major
sources available to fund a financial assistance
program: general fund appropriations, bond proceeds,
dedicated taxes, loan repayments, and EPA
Capitalization Grants. Each has its particular
applications, advantages, and shortcomings (see Table
3, pages 26-27 for a summary). One or a mixture of
these funding sources can provide the flexibility to
meet program needs and respond to changing
economic and market conditions. The key is to
construct a program that addresses assistance needs
and any restrictions or limitations set by a State's
constitution or the program's authorizing legislation.
It is not possible to make a final decision regarding
where the money will come from to finance a program
without considering the forms of financial assistance
the State can offer. This issue is discussed in the
second section of Part 2, which follows Table 3.
Four Basic Financial Assistance
Options Have Been Used Effectively
The forms of assistance a State can provide its local
governments will be determined largely by the results
of previous efforts: assessing the State's needs and
resources (see Part 1: Getting Started), and evaluating
the funding sources available to the State (the first
section of Part 2, above). This section of Part 2 is
directed at identifying appropriate forms of
financial assistance.
The following sections highlight the characteristics of
each option, its major advantages and disadvantages,
and important criteria to consider during program
development.
Four basic forms of financial assistance have been
used effectively around the country. Most of them are
based on participation in the tax-exempt bond
market, where the State either borrows money itself
to lend or give to local governments, or helps the local
governments borrow directly by offering
enhancements or interest rate subsidies.
The most common types of financial assistance that
have been used by States are:
1. Bond banks,
2. Revolving loan programs,
3. Grants and subsidies, and
4. Credit enhancements.
Bond Banks
Frequently, local governments need to borrow money
for their wastewater treatment facilities but are not
able to do so in the national bond market because of
inexperience and Jack of expertise, the small size of
the borrowing, or a poor local credit rating. As a
result, several States have created municipal bond
banks to provide communities an entrance into the
bond market.
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Table 3
Summary of Funding Sources
General Fund
Appropriations
Advantages
Provide a source of start-
up funds not requiring
repayment.
Provide a source of initial
or continuing program
operating funds.
Large early capitalization
will enhance buying power
of the fund over time.
Allow greater interest rate
subsidization.
Disadvantages
Competing State resource
demands may undermine
reliability of this source
of funds.
Legislature may consider
wastewater treatment too
localized a benefit to
justify on-going support.
Legislature may balk,
believing that the
wastewater treatment
program should be sup-
ported directly from pro-
ject revenue.
General
Obligation
Bonds
Provide statewide benefits
to present and future users.
Interest paid on bonds is
exempt from taxes.
GO bonds generally carry
the lowest available
interest rate.
Not a good source for
start-up funds since they
must be repaid.
GO bonds may limit program
growth since they are usually subject
to voter or legislative approval.
Revenue
Bonds
Do not use up
the State's borrowing
capacity.
Generally do not require
voter approval.
Generally carry higher
interest rates since
they are not backed by the
State's full taxing authority.
Are more subject to
Tax Reform Act limitations
and require increased reporting.
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Table 3 (Continued)
Summary of Funding Sources
Dedicated
Taxes
Advantages
Can provide a stable fund-
ing source not usually
subject to annual budget
process.
Administrative costs are
minimized where States
divert funds from existing
tax sources.
Disadvantages
May be considered
politically undesirable
since all residents do not
benefit from a facility.
Changing market and
economic conditions may
lead to an unstable fund-
ing source.
EPA
Capitalization
Grants
Provide a source of start-
up funds not requiring
repayment.
Authorization through 1994
provides financing depend-
ability.
Provide flexibility at
State level in selecting
projects to fund.
Not to be used for grants.
Funding ends after fiscal
year 1994.
Spending of EPA grants
must respond to Title II
regulations.
Loan
Repayments
Can make program self-
sufficient by providing
source of future loans.
Can make a State program
independent from Federal
grants and annual State
appropriations.
State interest rate ceil-
ing may limit the interest
charged to borrowers,
potentially limiting level
of future loans.
Loan repayments may not
flow back in sufficient
amounts to meet program
needs in timely fashion.
Other Federal
Sources
Can reduce amounts com-
munities must borrow
through bonds or receive
from State sources.
The amounts available to
individual communities
are limited.
Future funding expected to
decrease.
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Bond banks usually are structured in one of two ways.
In the first, States sell bonds in the national bond
market and then use the proceeds to purchase bonds
from local communities. In the second, several small
issues are pooled into one large bond issue (a "bond
pool") that can be sold on the national market.
As described in the earlier section of Part 2, bond
pools may either be "blind," in the sense that specific
projects have not been identified when the State sells
its bonds, or "designated," as in the case of pooling
many issues for projects that have already been
identified. It is worth re-emphasizing that arbitrage
restrictions will have a particularly severe effect on
"blind pool financing". "Designated pools" reduce
the benefits to local governments by adding
substantial delays to the financing process, but reduce
the chances that the State will fail to comply with the
Federal tax laws.
Although bond banks are usually not backed by the
"full faith and credit" of the State, they are typically
secured by several sources, such as:
Repayment agreements with the local
communities,
Debt service reserve funds, in which the State
deposits part of the bond proceeds or funds from
other sources in a fund pledged to repay bonds if
other sources are inadequate,
"Moral obligation" pledge of the State (i.e., a
nonbinding pledge to use future State
appropriations to repay bonds if necessary), and
Liens on certain State payments to local
governments such as State-aid appropriations or
sales tax revenues, often called "aid
interceptors."
The major advantage of a bond bank is that it
provides small communities with access to national
bond markets, utilizing the State's credit rating,
which usually provides lower interest rates and
issuance costs.
The major disadvantage of bond banks is that their
utility is often limited to small communities with poor
credit ratings. Small communities with good ratings
may access the bond market on their own, and large
communities with poor ratings can overwhelm the
capacity and credit rating of the bond bank, leaving
no loan capacity for other communities and/or
damaging the bond bank's rating. In addition, bond
banks do not create a permanent funding pool, i.e.,
revenues are used to repay the bondholders rather
than to fund new projects. As a result, bond banks
must constantly go back to the bond market for
additional capital.
Loan Programs
Over the years, many States have provided loan
programs to help local communities finance
wastewater treatment facilities. Often these loan
programs were not self-sustaining. They were funded
with State appropriations or State-issued bonds; the
loan payments were not retained by the program but
were returned to the State's general fund or used to
fund other programs. As a result the loan programs
continually faced the political challenge of being
reauthorized.
More recently, States are developing revolving loan
funds that are intended to be self-supporting. A
revolving loan fund is a program that lends to
communities at interest rates that can range from
equal to current rates that the State faces on its debt,
to loans that require little or no interest payment.
The differences between revolving loan funds and
bond banks depend on how each program is
structured. In general, however, the differences are:
Revolving loan funds recycle the same funds
while bond banks access the capital markets
regularly and use the loan repayments to pay
back their bondholders.
The security of the revolving fund is generally
limited to a pledge of specific revenues such as
loan repayments and normally does not include
the full faith and credit or moral obligation
pledge of the State.
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Funds used by bond banks are limited to the tax-
exempt bond market, while revolving loan funds
may use appropriations, dedicated taxes, or other
sources of funds as well as the bond market to
fund the program initially.
In a true revolving fund, all loan repayments
from communities are available to make
additional loans. In many bond banks,
repayments are used to pay debt service on the
State bonds. Future loans from bond banks can
be made only after more State bonds are sold.
The major advantage of a revolving loan fund is its
potential for long-term self-sufficiency. Once it is
capitalized, loan repayments are used to replenish the
fund and make loans for future projects, thereby
leveraging the State's financial resources.
A disadvantage, or limitation of a loan program is that
it may not address the needs of communities that do
not have the financial capability to repay a loan,
regardless of the interest rate charged or the length of
the payback period.
In practice, few State revolving funds operate on a
"true" revolving basis, with loan repayments
maintaining the fund at a level that would allow it to
operate in perpetuity. Generally, State revolving
funds are combined with other financing techniques,
such as bond banks, to provide the State with more
flexibility in addressing both the needs of the
municipalities and the continuity of the State
program.
Grants and Subsidies
Direct grants for construction that do not require
repayment by the local communities have been part of
many States' financial assistance programs for years.
Grants
There are three basic types of grant programs:
Straight grants are awarded on the basis of a
straight percentage of construction cost to the
community.
Directed or targeted grants are used by a
State to provide additional assistance to specific
types of communities.
Sliding-scale grants award different
percentages of assistance to communities on the
basis of a set of evaluation criteria such as need,
type of project, or community income.
The major advantage of grants lies in the ability to
target substantial financial assistance to communities
that lack the financial capability to fund their
wastewater treatment facilities.
The major disadvantage is the serious strain grants
place on the State's financial resources. Grants have
none of the self-perpetuating characteristics of a
revolving fund. Under the Water Quality Act of 1987,
EPA capitalization grants may not be used to make
grants to communities. A State that wants to provide
grant funding must do so from its own resources.
Interest Subsidies
In addition to grants for construction, some States
have provided grants in the form of subsidies to
reduce net interest costs. Depending on bond market
conditions, particularly in times of high interest rates,
an interest rate subsidywhere the State pays part or
all of the local interest obligationmay be a solution
to helping a local government borrow funds. The
similiarity between interest rate subsidies and grants
can be quite striking since, in most cases, the State is
providing direct funding for a project.
Interest rate subsidies are often temporary features of
State assistance programs. As market conditions
change (i.e., as interest rates decline) and local
governments can borrow economically and meet their
obligations on their own, some of the funds set aside
for subsidies may be diverted to another program
element. Building this sort of flexibility into a
program can ensure that it remains responsive.
Interest subsidies have the advantage of leveraging
the State's financial resources to assist a larger
number of projects. While the State is providing total
29
-------
direct funding with a construction grant, an interest
subsidy requires the community to pay all of the
principal amount of the cost and as much of the
interest expense as it can afford. This allows the State
to efficiently target its program to communities with
the greatest financial need.
Although interest subsidies may help marginal
communities, they will not necessarily provide enough
financing for communities that cannot afford the basic
capital costs, regardless of the interest costs. Since
financing major capital needs generally requires entry
into the municipal bond market, this type of program
tends to ignore communities that have only small
project needs.
Credit Enhancements
In general, credit enhancement is a form of security
added to a borrowing that makes the transaction
stronger (lessens the credit risk to the investor) and
provides the borrower with lower costs of borrowing.
Typical credit enhancements include:
Municipal bond insurance - Several different
companies offer insurance that guarantees
bondholders that their investments are safe in
the event the borrower defaults.
Lines of credit - Generally available from
financial institutions such as commercial banks,
these make funds available to investors if the
borrower cannot meet its obligations due to
short-term cash flow problems. The line of credit
assures the investor of the issuer's constant
liquidity.
Letters of credit - Also available from financial
institutions, these represent an unconditional
pledge of the bank's credit to make principal and
interest payments on the issuer's debt.
State credit assistance - In effect, the State
guarantees all or part of a local borrowing.
The major advantage of a credit enhancement is in its
ability to reduce investment risk, which results in
lower interest rates. As with interest rate subsidies,
the State is also able to leverage large amounts of
capital costs without a major capital outlay. However,
enhancements are very susceptible to market
conditions. In the past, some States have had
difficulty finding financial institutions that would
provide credit enhancements at rates that would make
them attractive.
Figure 1
Bond Bank Type I
Direct State Purchase of
Local Bonds
State uses inibal proceeds
to purchase bonds
from localities
Localities pay debt
service back to state
©
Initial bond proceeds
based on state
credit rating
©
State pays interest &
principal to investors
from funds repayed
by localities
"Enlarged Diagram in Appendix"
Summary of Financing Mechanisms
The pages that follow summarize the pros and cons of
the four financing mechanisms described above and
give real-world examples of each.
Bond Banks
Advantages
Useful tool in States with many small local
governments that lack the experience in the bond
market, may be unrated, or have a poor credit
rating.
Enables a State to use its national visibility to the
benefit of a number of smaller units of
government.
Local governments benefit from relying on the
State's credit as well as achieving economies
through the
"pooling" of issuance costs.
30
-------
Central staff plans, issues, and administers debt
in cooperation with local governments. This staff
can serve as a resource to bond bank participants
as well as other local governments.
Disadvantages
The State's credit is used for projects that are
not its direct responsibility. Consequently, the
State's capacity to borrow for its own projects
may be impaired.
May not be useful to local governments that have
established themselves as regular borrowers
without the State's involvement.
To keep the bond bank operative, the State may
have to establish costly debt service reserves in
the event of a local government default.
Figure 2
Bond Bank Type II
State Intermediary Bundles Numerous
Local Issues for Sale at or Near State-Backed
Interest Rates
©
Intermediary pays debt
service to investors
from funds repayed
by localities
G
Initial
Bond
Proceeds
"Enlarged Diagram in Appendix"
Current Examples
Seven statesAlaska, Maine, Nevada, New
Hampshire, North Dakota, Oregon, and Vermont
currently have bond banks. Several other States,
including Massachusetts, have considered creating
bond banks, and at least one state (New York) has
empowered a bond bank that has not yet been
activated.
Figures 1 and 2 show the organization and operation
of the two types of bond banks.
Loan Program
Advantages
Can be self-sustaining, if set up as a revolving
fund, and leverages State resources by recycling
the same monies.
Can be used to meet a wide diversity of needs.
Can be combined with other assistance
programs.
Criteria can be established to target segments of
the program to local governments meeting
specific eligibility criteria.
Payback period, interest rate, etc. can be tailored
to meet the specific needs of local governments.
Flexibility allows fund to provide grants to those
communities unable to repay even at no interest.
Federal capitalization grants can be used for
initial funding of a loan program.
Disadvantages
Despite flexibility, may not be able to meet all of
the needs of the State.
Administration of the fund may be complicated.
Late or non-payment of loans may destroy the
selfsufficiency of the fund.
Communities not meeting eligibility criteria will
not benefit.
Current Examples
An example of a program that includes a revolving
loan fund, as well as other forms of assistance, is the
New Jersey Environmental Infrastructure Trust. It
provides low or no interest loans to pay for 65% to
100% of the local share of costs and does so at flexible
repayment terms and at variable interest rates.
The Washington Public Works Trust Fund provides
low-interest loans, although it also will provide no-
interest loans for natural disaster and hardship cases.
In addition, the fund can also guarantee all or part of
local loans.
31
-------
Figure 3
Revolving Loan Program
O
Initial capitalization
fro m appropr ia t i ons
or partially from
bond issue
Loans to localities
from initial capitalization^
Repayments to state
(recycled funds)
Recycled funds from
local repaymets used ,
to make new loans \
State
Additional *
appropriations
' Additional appropriations in some form are required to fill gaps left by
defaults by local governments or grant/subsidy aspects of the program
"Enlarged Diagram in Appendix"
The Ohio Water Development Authority (OWDA)
lends to local governments at or near market rates;
however, part of the program is designated for
"hardship" cases that receive subsidized loans
beginning at 2%. This program contains elements of a
revolving fund as loan repayments provide capital for
new loans and can ensure the continuation of the
OWDA.
The Pollution Abatement Authority of Kentucky
issues tax-exempt revenue bonds. Proceeds are then
loaned to local entities who pay the costs of issuance
on a pro rata basis. Funds can be advanced against
loans during the planning and construction phases of
the project while a bond sale is being prepared. An
application for a loan must be accompanied by
feasibility studies documenting the ability to pay as
well as a fee schedule sufficient to meet the obligation.
Figure 3 illustrates the organization and operation of a
revolving loan program.
32
Grants and Subsidies
Advantages
Can be set up to help as broad or narrow a group
as desired.
Provide financing to local governments unable to
finance their own project either in the bond
market or from State no-interest loans.
Can be targeted to assist certain, specific phases
of a project such as construction or the purchase
of equipment to perform a specific function.
Disadvantages
May influence a local government to become
overly reliant on the State.
Can be very costly to the State.
State may have to limit the number of types of
eligible grantees and may not be able to meet all
of the needs in the state.
Current Examples
California's Clean Water Bond Law of 1984 provides
$250 million for State matching grants and for low-
interest State loans to grantees receiving less than 75%
Federal assistance under the EPA's construction
grants programs. A supplemental state grant program
also exists for qualifying small, needy communities.
Figure 4 shows the operation of a grants program and
Figure 5 illustrates the way interest subsidies work.
Figure 4
Grants
,
Government '
Straight Grants
requiring no repayment
4
"' Government
'Enlarged Diagram in Appendix"
-------
Figure 5
Interest Subsidies
Government'
Part or all of Interest
''' State
Government
Debt Service
Bondholders
"Enlarged Diagram in Appendix"
Credit Enhancements
Types
Municipal Bond Insurance - Insurance
companies guarantee bondholders that
investments are safe in the event the borrower
defaults.
Lines of Credit - Financial institutions such as
commercial banks make funds available to
investors if the borrower cannot meet its
obligations due to shortterm cash flow programs.
Letters of Credit - Financial institutions
provide an unconditional pledge of the bank's
credit to make principal and interest payments
on the issuer's debt.
State Credit Assistance - A state guarantees
all or part of a local borrowing.
Advantages
Can lower the cost of borrowing to an issuer.
Generally strengthens a borrowing. If the risk of
a project is considered too great by investors, an
enhancement will reduce the risk and
consequently reduce borrowing costs.
The State's assistance can be provided either by
securing an enhancement on its borrowing or by
helping the local governments secure their own
enhancements.
A loan guarantee can be granted rather quickly
once all State criteria can be met.
Loan guarantees also can be obtained at no dollar
cost to the State.
Federal Capitalization Grants can be used to pay
for credit enhancement instruments.
Disadvantages
Credit enhancements can be very costly and,
may not be cost effective.
Investors or rating agencies will analyze the
provider of the credit enhancement as well as the
issuer.
Insurance companies are sensitive to market
conditions; they are sometimes anxious to
assume municipal credit risks and sometimes
unwilling to, regardless of the premium
payments they could receive.
By providing a guarantee the State is extending
its credit and potentially impairing its own
ability to borrow.
The State must balance its desire to assist local
governments that face obstacles in market access
with the need to protect the State's credit.
33
-------
Figure 6
Credit Enhancements
State backs local borrowing with full faith and credit pledge*
aafci;-
©
Debl
Semce
©
Provides financial
guarantee behind
local government
debt lo investors
^
State assists
local government
in the purchase of
Bond Insurance.
% Line of Credit
Hi;
0
Proceeds --.
©
Payments m
case of default
Bondholders
or illiquidiiy
* By providing a full faith and credit pledge, the state essentially provides a backing similar to bond
insurance or other privately backed enhancements Thus, private mechanisms are unnecessary
"Enlarged Diagram in Appendix"
Figure 6 shows how the credit enhancement
mechanism works.
Current Examples
The Utah Water, Wastewater and Drinking Water
Bonding and Loan Program included the creation of a
"Security Account" that was only to be used to obtain
commercial credit enhancements for local
governments.
New Hampshire offers a guarantee program for local
bonds sold to finance wastewater treatment systems
backed by the State's full faith and credit, and the
State imposes a limit on the amount of guaranteed
local principal and interest outstanding at any one
time.
Planning the Financial Operation of
Your Assistance Program
After evaluating needs and financing options, but
before proposing legislation (if necessary) and
implementing an assistance program, it is a good
exercise to model the operation of the program with
different financing sources and assistance options.
This process should involve representatives of the
environmental agency, the agency that will handle
program financing, andif bond financing is
involvedan independent financial advisor and bond
counsel. This effort should yield a recommended
package of financing sources and assistance plans,
together with a long-term forecast of resources,
expenditures, and fund balances. This section
discusses some of the considerations in designing
alternative financial options.
The Forms of Assistance Offered to
Communities Should be Based on Identified
Needs in the States
Part 1 stresses the importance of assessing wastewater
funding needs before implementing an assistance
program. With the results of this needs assessment
viewed through the lens of the State's political
climate, the State can narrow down the potential
financing sources and methods of assistance. The two
most important questions emerging from the needs
assessment are:
1. Are the most pressing needs eligible for
assistance from an EPA-financed revolving
fund? and
2. Are most communities in need of assistance
capable of repaying a loan?
If the answer to the first question is "yes," an EPA-
assisted revolving fund may suffice to meet
wastewater needs. However, if State interests go
beyond compliance with the Clean Water Act, to
financing expansion and promoting economic
development, the State may wish to establish a
separate fund as well.
34
-------
The answer to the second question will help
determine what combination of the four types of
financial mechanisms the State should offer. If most
communities with facilities needs are in good financial
condition, market-rate loans (from either a bond bank
or a revolving fund) and credit enhancements may be
adequate to meet local wastewater needs. If some
communities cannot afford to pay market interest
rates, the State should consider supplementing these
forms of assistance with interest rate subsidies and/or
grants.
State efforts to tailor the forms of assistance to the
needs of communities may have to be tempered by
political realities.
Gaining approval for a program that provides interest
subsidies or grants and requires ongoing State
appropriations may not be possible. Similarly, the
legislature may not be interested in a program that
affords communities fairly easy access to the open
bond market. Part of the analysis of financial options
for an assistance program, therefore, entails balancing
the needs of communities and the political viability of
a program that meets those needs.
There is a Direct Tradeoff Between the Type of
Assistance Offered to Communities and the Self-
Sufficiency of the Fund
In a perfect world, States would have sufficient
resources to meet all local wastewater treatment
financing needs on terms that are favorable to local
governments. In the real world, program developers
must explore the range of possibilities available for
equitably meeting the large number of wastewater
projects that compete for funding.
The financial assistance program that would be the
most attractive to communities is 100% grant
financing. Failing that, grants for part of the project
cost are next most desirable, followed by no-interest
loans, subsidized interest, credit enhancements, and
market-rate loans or bond banks. It should come as
no surprise that this hierarchy of assistance programs
runs from the most costly to the State to the least
costly. This trade-off is illustrated in Figure 7 (page
36), which compares local and State costs for each of
the options described.
The local share of costs is zero when the State
provides a full grant, and 100% when the locality
borrows from the State at the State's rate, or issues
debt based on its own credit rating. Other financing
options, including subsidized loans and credit
enhancements, display some level of cost sharing
between the State and locality.
Figure 7 (page 36), describes a continuum from full
State funding to full local funding. Where a State's
financial assistance program is placed on this
continuum will be critical to the program's structure,
operation, andultimatelyits success. In making
this determination, it is vital to assess:
The financial capability of communities,
The State's ability to subsidize local costs,
The likelihood of permanent State
appropriations and/or multiple bond issues to
finance the project,
The readiness of communities to accept a higher
portion of the burden of financing wastewater
facility construction, and
The economy and financial markets that you
face.
The program ultimately selected will undoubtedly
involve a certain degree of compromise between full
State funding and full local funding. Most States will
develop a program that covers more than one point on
the continuum, because different types and levels of
assistance will be offered to different communities.
Funding Sources and Forms of Assistance Must be
Compatible
Assistance program financing involves a cycle in
which the State's financing sources and the assistance
offered to local governments are interdependent.
Some forms of assistance work better with some
financing sources than others, and vice versa. In
considering different program structures, it is
35
-------
Figure 7
Sample Assistance Strategies
Assumptions: Cost of plant = $5 million
Local share financed by 20-year bonds at 8%
State share financed by a revolving fund
made up of 20% EPA grant, 5% State
appropriation, 75% 20 year bonds at 7%
Cost of insurance^ 2% of bond value
Insurance reduced interest costs by 1%
Life-cycle costs are total costs for life of bonds/loans
STATE AND LOCAL SHARE OF COSTS
Financing Offered by
State
100% Grant
50% Grant
No Interest Loan
3. 5% Interest Loan
Bond Bank w/Loan
at State Rate
Credit Enhancement
No State Assistance
Financing at Time of
Construction
State
Share
$5,000,000
$2,500,000
$5,000,000
$5,000,000
$5,000,000
$100,000
$0
Local
Share
$0
$2,500,000
$0
$0
$0
$5,000,000
$5,000,000
Life-Cycle Costs
State Share
(Gross)
$8,300,000
$4,150,000
$8,300,000
$8,300,000
$8,300,000
$166,000
$0
State Share
(Net of Local
Repayments)
$8,300,000
$4,150,000
$3,300,000
$1,700,000
$0
$166,000
$0
Local
Share
$0
$5,100,000
$5,000,000
$6,600,000
$8,300,000
$9,400,000
$10,200,000
MEASURES OF EFFORT
100% Grant
50% Grant
No Interest Loan
3.5 % Interest Loan
Bond Bank w/Loan
at State Rate
Credit Enhancement
No State Assistance
Life Cycle Cost Per Dollar
of Construction Cost
State Local
$1.66
$0.83
$0.66
$0.34
$0.00
$0.03
$0.00
$0.00
$1.02
$1.00
$1.32
$1.66
$1.88
$2.04
Percentage of Total Costs
State Local
100%
45%
40%
20%
0%
2%
0%
0%
55%
60%
80%
100%
98%
100%
36
-------
important to make sure that State funding and
assistance methods are compatible.
One obvious example of incompatibility is a program
that uses EPA Capitalization Grants as a major source
of funds and offers grants to communities. This type
of program would not comply with requirements of
the Water Quality Act of 1987. Similarly, a program
that relies on the sale of bonds backed solely by loan
repayments will not work well if interest subsidies are
offered. In this case, the State would either have to
default on its bonds or dip into other resources to
meet debt service payments. As a general rule, the
closer the State wants to get to the top of the
hierarchy mentioned above (i.e., more grant funding
and fewer market rate loans), the greater the necessary
commitment of State resources relative to local
resources.
Long-Term Financial Performance Must Be Forecast
Before Program Implementation
After assessing needs, the political climate, and
options for financial operation, it is wise to forecast
the long-term financial performance of one or more
alternate programs. Policy makers and program
managers must get a clear picture of how the program
structure affects the financial viability of the revolving
fund. To portray that realistically and attractively,
program developers should create a simple financial
model that forecasts all sources and uses of funds for
each year of program operations.
A microcomputer spreadsheet program is a valuable
aid to preparing a long-term forecast for the revolving
fund. Figure 8 (page 38) shows a 20-year forecast for
a typical revolving fund that was prepared with such a
spreadsheet program. In making such a forecast, it is
important to use conservative (i.e., pessimistic)
financial assumptions to prevent an unexpected
shortfall once the program is in place. Some ways to
assure conservative enough data are:
Assume low interest rates for earnings on fund
balances.
If the program involved reserves for bond funds
or other purposes, assume that interest on such
reserves must remain in the reserve fund rather
than being available for assistance to
communities. Most bond issues require such an
arrangement.
Do not assume that the State will receive full and
timely repayment of loans to local governments.
This model should be constructed to allow the
projection of program operation under different types
of program structures and a variety of assumptions
related to economic and market conditions. A model
designed for this kind of "sensitivity analysis" allows
policy makers to test possible program operation
under a variety of scenarios, and generally provides a
more rational and informed discussion among
program designers. EPA has developed a software
model that allows the comparison of various funding
levels to evaluate how State needs can be met over a
20-year period. For information on this model, please
contact Jim Werntz or Jamie Bourne at (202)
382-7256.
Sources of financing may include EPA Capitalization
Grants, State appropriations, bond proceeds,
dedicated taxes, loan repayments, and interest
earnings. Uses include grants and loans to
communities, purchases of credit enhancements on
behalf of local governments, interest payments on
bonds, and administrative costs.
The forms of assistance the State offers will be
determined by a number of factors that are influenced
by policy development and assessment processes.
Whether a State can afford to offer only a limited
variety of assistance programs or a more
comprehensive program will depend on its defined
needs and its ability to raise funds. All of the
assistance programs discussed in Part 2 can work
independently, but a more comprehensive program
can be presented if different forms of assistance are
offered jointly.
37
-------
Figure 8
Sample Revolving Fund
Financial Forecast
SOURCES
Year
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
Year
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
Beginning
Balance
$0
$410,000
$1,817,400
$3,831,674
$6,458,891
$9,705,180
$12,061,731
$11,499,649
$8,999,745
$5,552,643
$20,983,869
$14,962,208
$9,473,130
$4,521,961
$16,144,081
$10,800,222
$5,995,724
$1,735,981
$11,766,441
$7,340,005
Grants to
Communities
$0
0
0
0
0
0
0
0
0
2,000,000
2,000,000
2,000,000
2,000,000
2,000,000
2,000,000
2,000,000
2,000,000
2,000,000
2,000,000
EPA
Capitalization
$5,000,000
7,000,000
7,000,000
7,000,000
7,000,000
6,000,000
3,000,000
1,000,000
0
0
0
0
0
0
0
0
0
0
0
0
Loans to
Communities
$5,000,000
8,000,000
8,000,000
8,000,000
8,000,000
8,000,000
8,000,000
8,000,000
8,000,000
8,000,000
8,000,000
8,000,000
8,000,000
8,000,000
8,000,000
8,000,000
8,000,000
8,000,000
8,000,000
8,000,000
State
Appropriation
$1,000,000
2,000,000
2,000,000
2,000,000
2,000,000
1,500,000
1,000,000
500,000
0
0
0
0
0
0
0
0
0
0
0
0
Credit
Enhancements
$250,000
250,000
250,000
250,000
250,000
250,000
250,000
250,000
250,000
250,000
250,000
250,000
250,000
250,000
250,000
250,000
250,000
250,000
250,000
250,000
Bond
Proceeds
$0
0
0
0
0
0
0
0
0
20,000,000
0
0
0
17,500,000
0
0
0
15,000,000
0
0
USES
Debt Service
on Bonds
$0
0
0
0
0
0
0
0
0
1,880,000
1,880,000
1,880,000
1,880,000
3,525,000
3,525,000
3,525,000
3,525,000
4,935,000
4,935,000
4,935,000
Loan
Repayments
$0
963,300
1,556,100
2,148,900
2,741,700
3,334,500
3,927,300
4,520,100
5,112,900
5,705,700
6,298,500
6,891,300
7,484,100
8,076,900
8,669,700
9,262,500
9,855,300
10,448,100
11,040,900
11,633,700
Administrative
Costs
$400,000
400,000
400,000
400,000
400,000
400,000
400,000
400,000
400,000
400,000
400,000
400,000
400,000
400,000
400,000
400,000
400,000
400,000
400,000
400,000
Interest
Earnings
$60,000
94,100
108,174
128,317
154,589
172,052
160,617
129,996
89,997
255,526
209,839
149,622
94,731
220,220
161,441
108,002
59,957
167,360
117,664
73,400
TOTAL
USES
$5,650,000
8,650,000
8,650,000
8,650,000
8,650,000
8,650,000
8,650,000
8,650,000
8,650,000
10,530,000
12,530,000
12,530,000
12,530,000
14,175,000
14,175,000
14,175,000
14,175,000
15,585,000
15,585,000
15,585,000
TOTAL
SOURCES
$6,060,000
10,467,400
12,481,674
15,108,891
18,355,180
20,711,731
20,149,649
17,649,745
14,202,643
31,513,869
27,492,208
22,003,130
17,051,961
30,319,081
24,975,222
20,170,724
15,910,981
27,351,441
22,925,005
19,047,105
Ending
Balance
$410,000
1,817,400
3,831,674
6,458,891
9,705,180
12,061,731
11,499,649
8,999,745
5,552,643
20,983,869
14,962,208
9,473,130
4,521,961
16,144,081
10,800,222
5,995,724
1,735,981
11,766,441
7,340,005
3,462,105
38
Assumptions: State sells 20-year bonds at 7% interest
State makes loans to localities at average interest rate of 5%
Fund balances earn interest at 6% with average turnover of funds of 2 months
95% of loans are repaid to state
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A prime benefit of good program design will be
leveraging opportunities afforded to local
governments. Leveraging can manifest itself in many
ways: it may arise from the economies of scale
provided by participating in a program that offers
pooled financing opportunities. A local government
with a small borrowing need or a low (or no) credit
rating stands to benefit from getting its funds from
the State, which can borrow more efficiently. A State
revolving fund also offers a high degree of leveraging.
In this case, a local government has access to lower
cost money, and helps other local governments who
benefit from the repayment of the earlier loans.
The new State focus on financing of wastewater
treatment and the additional forms of assistance may
result in improved local credit ratings around the
State, improved national and market perception of the
State as a result of the assistance effort, improved
environmental quality, or enhanced economic
development, which can be encouraged by providing
adequate infrastructure for growing communities.
This is another, more subtle, form of leveraging.
In Conclusion
Designing and developing a State financial assistance
program for wastewater construction is a challenging
process. Many of the basic steps and elements are
presented here, but it is impossible to cover the range
of circumstances across all 50 states. Even though it
may borrow concepts from other designs, each State's
program is unique. It must be tailored through
skillful examination and attention to needs, laws,
alliances, and economics.
While this guide can point the way to program
success and point out requirements and pitfalls, the
program developer has an even greater resource at
hand: the advice and knowledge of people to be found
at all levels of government and in the private sector.
This resource is invaluable to a successful program. It
should be cultivated carefully and consulted
frequently.
State officials interviewed for this guide agreed on the
importance of tailoring an assistance program to the
particular goals, needs, and characteristics of each
State. This can best be accomplished by following the
six steps identified in Part 1 of this guide. Those steps
outline an approach that begins with an assessment of
the wastewater treatment needs of the State and
builds a program that is based on the State's financial
and management capabilities and is directed to meet
identified needs. This goal-oriented approach is
preferable to one that puts the cart before the horse
by designing a program without defining its goals.
Like the managerial structure of the assistance
program, the financing sources and assistance offered
should be matched to circumstances in a given State.
Each State will have to evaluate its preferences in how
to use EPA funds, bond proceeds, appropriations,
loan repayments, and other sources to fund the
program. It will also have to decide whether to offer
loans, grants, credit enhancements, or subsidies to its
communities. As discussed in the final section of Part
2, these financial decisions cannot be made
independently; financing sources and project
assistance must mesh to develop a program that is
financially sound and logical.
As EPA grants for construction are phased out, States
find themselves faced with the responsibility for an
increasing share of wastewater treatment financing.
Some States have already acknowledged this
transition and have developed programs to meet their
own needs. The work already accomplished by these
States, together with the Capitalization Grants
provided for in the Water Quality Act of 1987, will
help all States develop flexible, customized programs
to meet their wastewater treatment needs for years to
come.
39
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Appendix
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Appendix
Available Information and Assistance
Materials From EPA's Office of
Municipal Pollution Control
1. State Alternative Financing Programs for
Wastewater Treatment, January, 1986.
2. State Revolving Funds: Financing Clean Water,
State Legislative Report, NCSL, May, 1987.
3. State Revolving Fund Simulation Model and User
Guide, September 1987.
4. Initial Guidance: State Water Pollution Control
Revolving Fund, 1/88.
5. Study of the Future Federal Role in Municipal
Wastewater Treatment, December, 1984.
6. Technical Assistance Works in Tennessee,
Municipal Technical Advisory Service (MTAS),
University of Tennessee, 1987.
Please direct requests to:
James Werntz or James Bourne
U.S. EPA (WH-546)
East Tower, Room 1121
401 M St. SW
Washington, D.C. 20460
(202) 382-7256
41
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Figure 1
Bond Bank Type I
Direct State Purchase of
Local Bonds
Local
Governments
State uses initial proceeds
to purchase bonds
from localities
Localities pay debt
service back to state
State
Government
Initial bond proceeds
based on state
credit rating
State pays interest &
principal to investors
from funds repayed
by localities
Bondholders
42
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Figure 2
Bond Bank Type II
State Intermediary Bundles Numerous
Local Issues for Sale at or Near State-Backed
Interest Rates
Debt
Service
Local
Government
Bond
Proceeds
Localities repay
loans to state
State purchases
bonds from
localities
Debt
Reserve
Fund
State Financial
Intermediary
(bundles numerous
small issues)
Debt
Service
Intermediary pays debt
service to investors
from funds repayed
by localities
Bond
Proceeds
T
State general or
moral obligation
pledge
State
Government
Initial
Bond
Proceeds
Bondholders
43
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Figure 3
Revolving Loan Program
Loans to localities
from initial capitalization^-'
Repayments to state
(recycled funds)
Recycled funds from
local repaymets used , .
to make new loans '
rnment
* Additional appropriations in some form are required to fill gaps left by
defaults by local governments or grant/subsidy aspects of the program.
44
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Figure 4
Grants
Straight Grants
requiring no repayment
4-
Government
45
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Figure 5
Interest Subsidies
Local
Government
Part or all of Interest
State
Government
Debt Service
Bondholders
46
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Figure 6
Credit Enhancements
State backs local borrowing with full faith and credit pledge*
Local
Government
Debt
Service
Provides financial
guarantee behind
local government
. debt to investors
Proceeds
Bondholders
Insurance
Company
or
Financial
Institution
State assists
local government
in the purchase of
Bond Insurance,
. Line of Credit.
State
Government
Payments in
case of default
or illiquidity
* By providing a full faith and credit pledge, the state essentially provides a backing similar to bond
insurance or other privately backed enhancements. Thus, private mechanisms are unnecessary.
47
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