&EPA
United States Office of Ground Water and
Environmental Protection Drinking Water November 1993
Agency
Innovative Options
For Financing
Nongovernmental Public
Water Supplies' Needs
UNITED STATES OF AMERICA
Printed on Recycled Paper
-------
This publication was prepared for the U.S. Environmental Protection Agency, Office of
Drinking Water, by The Cadmus Group, Inc. under Contract No. 68-CO-0020. The EPA Work
Assignment Manager was James Bourne. The Cadmus Project Manager was Laurie Potter. The
principal author and technical contributor was Tom Spofford, Public Finance for Environmental
Applications of Milton, Massachusetts, a former Associate at Cadmus. The chief editor was
Kenneth Mayo.
The authors wish to thank the many people who provided information and advice in the
production of this document, particularly the individuals from the organizations profiled in this
text who graciously consented to initial interviews and reviewed drafts of the report.
Inclusion in this publication of a particular financing organization, or a specific technique, does
not signify endorsement by the Environmental Protection Agency, and no endorsement is
expressed or implied. Our purpose is to communicate useful alternatives from among many
financing mechanisms that have evolved for addressing the capital needs of nongovernmental
Community Water Systems.
For further information on this publication, please contact James Bourne in the Office of
Ground Water and Drinking Water at (202) 260-5557.
-------
Table of Contents
Introduction „ 5
New Jersey Economic Development Authority 9
Texas Water Development Board ..11
California Safe Drinking Water Bond Law Program 13
Pennsylvania Infrastructure Investment Authority 17
Financing a For-Profit Investor-Owned Water Utility in New York 21
Rural Development Administration Rural Water And Waste
Disposal Loan Program .....25
-------
Introduction
Introduction
The 1986 Amendments to the Safe Drinking Water
Act (SDWA) will profoundly affect financially
strapped nongovernmental community drinking
water systems nationwide. They will have to make large
investments in property, plant, and equipment if they
are to comply with new regulations. Their generally
poor financial condition, however, will make such in-
vestment difficult. Unable to fund improvements out of
operating revenues, many also are unable to borrow
money at affordable rates, if they can borrow money at
all.
Due to their small size and lack of access to capital,
many small systems will find it difficult to finance these
necessary increases. A broad range of financing pro-
grams exist to help governmental entities borrow funds
for capital expenditures at reduced costs. However,
small nongovernmental systems have few possibilities
for funding the capital costs of compliance with the
SDWA Amendments at the same favorable terms. This
publication discusses six financing options available to
nongovernmental Community Water Systems (CWSs).
Many of these mechanisms are targeted exclusively at
nongovernmental CWSs. Others are available to pub-
licly-owned and nongovernmental systems alike.
Thisdocumentdescribesarangeofalternativefund-
ing mechanisms available to assist small, non-public
drinking water systems in financing infrastructure im-
provements needed to stay in compliance with State and
Federal regulations. Many of these mechanisms, as you
will see, target their assistance to nongovernmental CWSs
who would be unable to borrow independently, or who
would not receive terms favorable enough to be an
economically viable project.
Small, Nongovernmental Systems
U.S. Environmental Protection Agency (EPA) de-
fines a CWS as a system that provides water to
at least 15 connections or to the same 25 persons
year-round, A small CWS serves 501 to 3,300 persons,
while a very small system serves 25 to 500. About 87
percent of the nation's 59,200 CWSs are small or very
small; yet they serve only about 10 percent of the popu-
lation. It is interesting to note that 90 percent of the
15300 CWSs that violated drinking water regulations in
FY 1990 were small systems.
As the term implies, nongovernmental CWSs are the
property of individuals or entities other than such gov-
ernmental bodies as municipalities, counties, or special
utility agencies. There are three principal types of non-
governmental CWS:
• investor-owned, for-profit utilities,
• non-profit water providers, including customer-
owned non-profit organizations (known as coop-
eratives) and homeowners' associations, and
• mobile home parks that also operate CWSs.
PageS
-------
Introduction
Roughly half of all CWSs are owned by governmen-
tal entities, and the other half are nongovernmental.
Nearly 94 percent of the nongovernmental CWSs are
small systems. Figure 1 below shows the pattern of CWS
ownership.
FIGURE 1
Ownership of Community Water Systems
(52,000 systems)
D Mobile Home
Parks
CD Other
• local
Governments
I Homeowners
Associations
HI Investor-Owned
For-Profit Utilites
Source: 1986 EPA Survey of Community Water Systems
Figure 2 below shows the percentage of nongovernmen-
tal CWSs that are classified as small and very small
systems.
FIGURE 2
Percentage of Nongovernmental Community
Water Systems Serving 3,300 people or less
(small and very small systems)
Mobile Home
Parks
Homeowners
Associations
Investor-Owned
For-Profit Utilites
10200
;?;: 86%
7700
96%
6200
Source: 1986 EPA Survey of Community Water Systems
The Six Profiles
rTTTrusreportprofiles six quite varied financing mecha-
I nisms which might be appropriate for small drink-
JL ing water systems. Each profile explains how the
mechanism works, how it can help small drinking water
systems, and what types of systems are best served by
that mechanism. The profiles are:
• The New Jersey Economic Development Board's
program of tax-exempt "private activity bond" fi-
nancing;
• The Texas Water Development Board's program of
taxable loans to chartered non-profit water supply
corporations;
• The Safe Drinking Water Bond Law Program of
loansoperatedbytheCaliforniaDepartmentof Water
Resources;
• The PENNVEST loan and grant program of the
Pennsylvania Infrastructure Investment Authority;
» The Water and Waste Disposal Loan and Grant
Program of the U.S. Department of Agriculture's
Rural Development Administration (RDA). This
was formerly a Farmers Home Administration
(FmHA) program; and
« The Shorewood Water Company's financings un-
dertaken by the First Albany Corporation.
Each profile discusses how public and private lend-
ers reduce the risk these financially weak water systems
will fail to repay their loans. Although the techniques
vary from one mechanism to another, they are essential
to ensuring that funds are available for loan to finan-
cially weak borrowers.
Many of the profiles describe the use of tax-exempt
borrowing by governments to provide funds for loan to
nongovernmental water systems. There is a lower rate of
interest for these funds because the buyers of tax-exempt
notes do not pay Federal tax on the interest. Thus, the US
Treasury subsidizes certain capital projects, such as in-
frastructure enhancement, schools, etc. that are for a
public purpose. The use of tax-exempt financing by
private concerns is closely regulated by Federal tax law,
which restricts the volume of such financing and the
types of private organizations permitted to receive it.
Some New Terms
Some of the financial terms used in the profiles may
be new to many readers. The most important
ones are discussed below; others are explained in
the profiles.
Page 6
-------
Introduction
Tax-exempt Financing: Borrowing by State or local
governments at reduced rates because the interest
that lenders receive is exempt from Federal income
tax.
The interest charged on lax-exempt loans is typically
about 2 percentage points less than the rate charged
for loans whose interest is subject to Federal income
tax. That means if the taxable interest rate on a 20-
year loan is 8 percent, a government should be able
to borrow tax-exempt at about 6 percent. Borrowing
at the lower rate saves the government about 25
percent in interest charges over the life of the loan.
In some States, the interest paid by the State and its
local governments is also exempt from State income
tax. This makes tax-exempt bonds and notes even
more attractive to lenders in these States.
Tax-exempt Bond: A government security that earns
tax-exempt interest for the bondholder. A bond is
the government's promise to repay, with interest,
the money loaned to it by the bondholder.
Tax-exempt Private Activity Bond Financing: The use
of tax-exempt borrowing to raise funds for the use or
benefit of any nongovernmental organization, such
as private for-profit water utilities and non-profit
water supply cooperatives. The state allocation
process for this financing is competitive: other non-
governmental organizations seeking the same fi-
nancing mechanism may include non-profit com-
munity development corporations or small manu-
facturing companies. Federal tax law restricts pri-
vate access to tax-exempt financing; however it al-
lows governments to issue tax-exempt private activ-
ity bonds to aid facilities that furnish water. There is
one constraint imposed by the Federal Tax Code:
utility water rates must be regulated by the state to
be eligible for this financing. Typically, for-profit
utilities are rate regulated, while non-profit water
utilities often are not,
Tax-exempt Private Activity Bond Volume Cap: The
maximum amount of tax-exempt private activity
bonds (of all types) that each State can issue annu-
ally, under Federal tax law. The cap is equal to $150
million or $50 per capita, whichever is larger.
To keep such financing below the cap, each State has
a process for determining which eligible projects
will be allowed to finance on a tax-exempt basis.
Often, this determination is made by senior State
financial officials such as the State treasurer's staff,
the State's chief financial officer, or the staffs of State
economic or community development agencies.
» Market Rate: The interest rate charged on borrowed
funds, based entirely on conditions in the credit
markets, with no subsidy to the borrower.
• Below-market Rate: An interest rate lower than the
prevailing market rate. For example, a State agency
may obtain funds at a tax-exempt rate of 6 percent
and loan those funds to private CWSs at 3 percent;
the CWSs benefit from being able to borrow at the
below-market rate.
• Reserves: Funds set aside or "held in reserve" to meet
a potential future need. Borrowers frequently must
have or accumulate reserves to provide a financial
cushion against future events that might jeopardize
their repayment of a loan.
« Bond Rating: An indication of the likelihood that a
bond issuer will default on its obligation to repay the
bond with interest. The higher the rating, the lower
the risk that the loan will not be repaid. The two
broad categories of bond rating are "investment
grade" and "below investment grade."
The credit markets reward relatively low-risk bor-
rowers with low interest rates; riskier borrowers pay
higher rates. The riskier borrowers, those with the
lowest bond rating, pay higher rates—if they can
borrow at all.
Virtually every organization that regularly borrows
in the national credit market has a bond rating, but
many small borrowers do not. Unrated borrowers
lack an important tool for communicating with po-
tential lenders and may be limited to borrowing
from local financial institutions. Borrowers with
very low bond ratings also may find their credit
sources severely restricted.
Many of the profiles discuss mechanisms to provide
loans to borrowers who are unrated or whose bond
rating is below investment grade. Many small, nongov-
ernmental CWSs are unrated.
A Final Word
This publication presents just a few interesting
and, it is hoped, useful examples of the financial
mechanisms in place across the nation. These
examples illustrate that there is little national unifor-
mity. In fact, they emphasize that there is tremendous
variation across states in the availability and effective-
ness of mechanisms promoting capital access for non-
governmental water systems. No single publication
could present the entire range of mechanisms.
Page?
-------
Introduction
For an example of taxable market rate loans, see the
profile of the Texas Water Development Board. Tax-
exempt market rate loans are discussed in the New
Jersey Economic Development Authority and the Fi-
nancing a For-Profit Investor-Owned Water Utility in
New York State profiles. Examples of below-market rate
loans are provided in the profiles of PENNVEST, the
California Safe Drinking Water Bond Law Program, and
the RDA's Water and Waste Disposal Loan and Grant
Program. •
ige8
-------
New Jersey EconomicDevelopment Authority
New Jersey Economic
Development Authority
The New Jersey Economic Development Authority
(NJEDA) provides tax-exempt private activity
bond financing and taxable financing for several
types of projects, including industrial and commercial
developments, and water, wastewater, solid waste, and
other environmental projects. NJEDA is an indepen-
dent financing agency. It is entirely separate from, and
is not supported by, the finances of the State.
Impact of State Law and the Federal Tax Code
No State provisions prevent NJEDA from issuing
tax-exemptprivateactivity bonds forprivately-
owned CWSs. However, restrictions in the
Federal Tax Code limit the types of private sector CWSs
to which NJEDA can lend tax-exemptfunds. One restric-
tion is that a system's rates must be set by or approved by
a governmental body if the system is to qualify for tax-
exempt financing. The New Jersey Board of Public
Utilities regulates the rates of all investor-owned water
systems in the State, regardless of their size. The State
also regulates the four CWSs organized as private
homeowners associations, but it does not regulate rates
for CWSs operated by mobile home parks.' Therefore,
because the Board of Public Utilities does not regulate
rates for mobile home parks, only the rate-regulated
investor-owned systems and the four homeowners asso-
ciation systems would qualify for loans of tax-exempt
funds, under the Federal Tax Code.
How the Financing Works
NJEDA borrows funds on a tax-exempt basis and
then lends the funds to privately-owned CWS,
thereby allowing nongovernmental CWSs to
receive the Federal tax exemption. This method is called
conduit financing. NJEDA pledges to repay its bond-
holders only with payments from its borrowers. Each
loan is secured separately and is entirely unrelated to
every other CWS loan, because NJEDA does not pool its
borrowed funds for relending to CWSs. This last charac-
teristic of conduit financing is important because the
ability to obtain financing is measured by the system's
credit-worthiness. Smaller, financially weaker systems
may not qualify for a NJEDA loan.
At least one small tax-exempt private activity bond
financing was accomplished through a private place-
ment. In such events, financing occurs directly between
a borrower and a lender, without being offered in the
national credit markets. The borrower's bond rating is
not the only credit worthiness measurement used by a
lender in a private placement. The borrower's credit
history and expected revenue stream are other charac-
teristics that must be reviewed by the lender.
1 Based on the results of the first quarter 1989 NRRI survey
which asked 45 state public utility regulators to describe the
extent and manner of regulation of privately-owned water
systems.
™ 9
-------
New Jersey EconomicDevelopment Authority
Loan Activity
The ability of a financing agency to obtain an allo-
cation of its State's private activity bond volume
cap is an important consideration when such
bonds are used to generate loan funds. (Thecapisa limit,
set by Federal tax law, on the amount of private activity
bonds that each State can issue annually. The law sets the
cap at$150millionor $50 per capita, whichever is larger.)
The New Jersey State Treasurer administers the cap
allocation to ensure that the annual volume of tax-
exempt private activity bonds does not exceed the Fed-
eral limit. Historically, NJEDA hasobtained volume cap
allocation sufficient to let it make tax-exempt financing
available for itsnongovemmentalCWSborrowers. Since
1979, NJEDA has made more man $400 million available
to investor-owned for-profit water utilities. It has made
twenty-four loans ranging from less than $1 million to
nearly $100 million, averaging $19 million.
Loan Terms
All NJEDA loans are made at market rates. For
both publicly issued and privately placed
financings, each borrower establishes its credit
worthiness independently of NJEDA. NJEDA does not
provide additional financial assurance for the borrower,
and no governmental body ( state, county or locality)
assumes any obligation to repay, guarantee, or other-
wise support repayment of the loan. The Authority may
advise a CWS on how to obtain credit enhancements
such as a letter of credit or bond insurance, but itdoes not
help the borrower obtain mem. (Typically, such en-
hancements are used to lower the total cost of borrowing
for an entity already judged credit worthy; they are not
used to facilitate access to credit for a borrower who
cannot borrow independently.)
The rates CWSs pay reflect their strengths and weak-
nesses as borrowers, and the tax-exempt nature of the
financing. This essentially means that credit worthy
borrowers may have access to tax-exempt loans through
NJEDA, but unrated borrowers or borrowers rated be-
low investment grade ratings may not. This is borne out
by the program's loan history. Nearly all loans to non-
governmental CWSs have gone to borrowers with in-
vestment grade bond ratings, mostly large utilities, with
access to national credit markets.
Borrowers pay all transaction costs. These one-time
fees include NJEDA processing fees, bond rating fees,
and fees for bond counsel or an underwriter.
Summary
The NJEDA offers tax-exempt private activity bond
financing to all investor-owned CWSs in the State.
Federal Tax Code provisions restrict NJEDA from
offering financing to CWSs organized as mobile home
parks because the New Jersey Board of Public Utilities
does not regulate their rates. CWSs organized as non-
profit homeowners associations can obtain NJEDA fi-
nancing, if their rates are regulated by the New Jersey
Board of Public Utilities. So far, only four such systems
meet mis requirement.
NJEDA's market-rate financing provides no sub-
sidy to its borrowers, other than the modestly lower
interest rate attributable to the exemption of bondhold-
ers' interest income from Federal income taxes. NJEDA
does not help borrowers obtain "credit props" such as
letters of credit that can help weak or unrated borrowers
improve their access to debt financing.
Without subsidized interest rates or help from
NJEDA in obtaining credit enhancements, the weakest
investor-owned CWSs are unlikely to gain access to tax-
exempt private activity bond financing. Therefore, pri-
vate activity bond financing alone cannot cure a
borrower's inability to establish credit worthiness, nor
does it guarantee a borrower below-market interest rates.
These limitations of private activity bond financing re-
flect the fact that it is essentially without subsidy, and
can be provided without appropriations of State funds.
The potential volume of NJEDA financing is con-
strained by the Authority's ability to secure allocations
of private activity bond volume cap. If the demand for
tax-exempt financing exceeded the issuer's cap alloca-
tion, the issuer must choose between issuing taxable
financing or delaying the financing: in expectation that
tax-exempt financing allocation may be available in the
future. •
For More Information:
Frank T. Mancini, Jr.
Director of Investment Banking
New Jersey Economic Development Authority (NJEDA)
Capitol Place One
200 South Warren St.
CN990
Trenton, NJ 08625
Page 10
-------
Texas Water Development Board
Texas Water Development Board
The Texas Water Development Board (TWDB) op
erates a loan program serving governmental en
tides and State chartered non-profit water supply
cooperatives structured under Texas law as "1434 A cor-
porations." There are about 9501434A corporations in
Texas.
Impact of State Law and the Federal Tax Code
The Texas Constitution prohibits the TWDB from
lending to any nongovernmental CWS but a
1434A corporation. That means most of the pri-
vately-owned CWSs in the State cannot borrow from the
TWDB.
Texas' inventory of privately-owned CWSs is the
nation's largest. Asof March 1992, the Federal Reporting
Data System (FRDS) listed 2,959 privately-owned CWSs
in the State. With almost 12 percent of the national
inventory, Texas has more privately-owned CWSs than
every EPA Region except Regions 4 and 6.
To fund its loans to non-profit water supply corpo-
rations, the TWDB issues taxable State bonds. Since
these bonds are not tax-exempt, they are not subject to
the Federal Tax Code provisions that restrict the amount
of funds that can be raised, or the type of private-sector
entity that can borrow those funds. Consequently, any
nongovernmental CWS eligible under Texas State law
can obtain TWDB financing.
TWDB is considering whether to issue tax-exempt
private activity bonds in place of taxable bonds. Tax-
exempt private activity bonds would have lower interest
rates than the interest TWDB pays to investors who buy
its bonds. That, in turn, would reduce the rates TWDB
must charge its borrowers. However, TWDB is con-
cerned that it may not be able to obtain a sufficiently
large portion of the State private activity bond volume
cap to fund its program if it raises loan funds through
tax-exempt debt.
The cap is the maximum amount of private activity
bonds that each State can issue annually. Federal tax law
sets the cap at $150 million or $50 per capita, whichever
is larger. If the TWDB issued tax-exempt private activity
bonds to raise loan funds, it would have to compete with
other nongovernmental financing needs authorized in
the Federal Tax Code to issue tax-exempt debt, such as
sewage treatment, solid waste, student loans, and hous-
ing.
Loan Activity
Since it began providing loans to nongovernmental
CWSs in 1988, TWDB has made 36 loans worth
about $16 million to nongovernmental CWSs. The
Board expects to loan more than $9 million more during
1992, Table 1 shows the program's annual loan activity.
The value of TWDB's loans to nongovernmental
CWSs ranged from $100,000 to $3.9 million. About 75
Page 11
-------
Texas Water Development Board
percent of the 36 loans made or committed through
March, 1992, were worth less than $1 million and aver-
aged about $360,000, The remaining 25 percent were for
more than $1 million.
Loan Terms
Al /2 of 1 percentage point charge is added to the
State of Texas' taxable interest rate reflecting
TWDB's issuance costs and the risk that bor-
rowers may default. Since the State holds a strong AA
bond rating, its cost of taxable debt is close to the best rate
attainable. (It was 8.18 percent in early 1992.) All TWDB's
loans have been made to unrated borrowers, who would
have been unable to secure comparable loan terms on
their own. Borrowing from the TWDB has saved them
significant sums in financing costs.
TWDB requires each applicant to engage a consult-
ing engineer, financial advisor, and bond attorney.
Applicants pay these one-time "transaction costs" from
available funds, or by increasing the size of their loan.
On a small loan, the transaction costs can besizeable. For
example, costs averaged more than 4.5 percent of the
amount of three loans ranging from $150,000 to $350,000.
Successful borrowers normally are issued loan com-
mitments within 45 days of TWDB's receipt of their
application.
Loan Security Provisions
To ensure that loans will be repaid, TWDB imposes
extensive loan security provisions on its 1434A
borrowers. They must grant to TWDB a first lien
on all revenues generated by the system and a pro-rated
first lien mortgage on the total assets of the borrowing
system. If the borrower defaults, these provisions make
TWDB the first legal claimant of system revenues and
system assets for the duration of the loan. TWDB will
"share" a first lien equally with another lender, such as
the RDA, in an arrangement known as a "parity first
lien".
In addition, 1434A borrowers also must meet the
loan security provisions TWDB requires of its other
borrowers. For example, during the first five years of
their loans, all borrowers must set aside from revenues
a debt service reserve fund equal to a year's worth of loan
payments. This fund must be maintained over the life of
the loan.
All borrowers also must meet an "additional bonds
test" before incurring additional debt during the life of
their TWDB loan. To meet this test, a system must collect
in the year immediately before a proposed bond sale net
revenues of at least 125 percent of the annual interest
payments on its TWDB loan and the additional bonds it
plans to issue. (Net revenue is the revenue remaining
after the payment of operating expenses, excluding any
interest expense or depreciation.) The additional bonds
test assures TWDB that the borrower will not take on
additional debt that reduces its ability to repay the
TWDB loan.
The loan security provisions discussed above re-
duce the risk of nonpayment by TWDB's borrowers. The
repayment record of TWDB borrowers is important to
the State for two reasons.
» If TWDB gets borrowers to repay all of the Board's
borrowing costs, TWDB will not require appropria-
tions from the State Legislature for that purpose.
» This "self-sustaining debt' is not considered in at
least one bond rating agency's calculation of tax-
supported state debt. Generally, having less tax-
supported debt may improve a State's bond rating,
although this is not the only, or the most important,
factor in that determination. A higher bond rating
lowers a State's borrowing costs. The State's bond
rating directly influences the TWDB's cost of loan
funds, and thus the costs borne by TWDB's borrow-
ers.
Summary
The TWDB is authorized to lend to roughly one-
third of the privately-owned CWSs in the State.
Its program provides access to fixed rate debt
financing for unrated borrowers who otherwise would
have difficulty borrowing on reasonable terms, if at all.
In addition, TWDB provides quick turnaround time on
loan approval decisions.
TWDB loans provide market-rate financing without
subsidy based on the State's costs of borrowing in the
taxable market. Since Texas' bond rating is a strong AA,
TWDB can obtain nearly the best taxable rates the credit
market has to offer. Although taxable rates are usually
about 2 percentage points higher than tax-exempt rates—
and borrowers must pay that higher cost — raising loan
funds in the taxable credit market has advantages. For
example, TWDB avoids significant Federal Tax Code re-
strictionson loan volume and the typesof systems to which
itcan lend. Thisenhances the Board's ability to serve Texas'
large inventory of nongovernmental CWSs. •
For More Information:
J. Kevin Ward, Asst. Development Fund Manager
Texas Water Development Board
1700 North Congress Ave.
P.O. Box 13231 Capitol Station
Austin, TX 78711-3231
Page 12
-------
California Safe Drinking Water Bond Law Program
California Safe Drinking Water
Bond Law Program
The California Safe Drinking Water Bond Law Pro-
gram (SDWBLP) makes loans to publicly and
privately owned water systems that meet the US.
EPA definition of CWSs and domestic water systems.
Part of a larger State program to fund publicly owned
water systems, the Program is intended to help pri-
vately-owned CWSs that would have difficulty borrow-
ing on their own.
Public and nongovernmental CWSs can borrow from
the program regardless of whether they are organized as
non-profit or for-profit utilities, or in some other form
such as mobile home parks. The Program has loaned
funds to privately and publicly owned mobile home
parks.
Loan funds come from tax-exempt State of Califor-
nia general obligation (GO) bonds. The Program makes
loans at one-half of the State's most recent GO bond
interest rate. (California GO bonds are backed by the full
faith and credit, including the taxing authority, of the
State. Unlike revenue bonds, which are repaid with the
revenues of the projects they fund, GO bonds are repaid
with general tax revenue.)
As of April 1992, the SDWBLP has made 477 loan
commitments to all eligible water systems. Approxi-
mately 22% of the total, or 103 commitments, were made
to non governmental CWS borrowers. Almost $49 mil-
lion has been committed to non governmental borrow-
ers and the average loan is $475,000.
Impact of Federal Tax Code
The Federal Tax Code permits the use of up to 5% or
$5 million, whichever is less, of a tax-exempt
bond sale's proceeds to fund projects of private-
sector organizations. This amount is known as the
"minor portion" of the bond sale.
Loan funds raised from the minor portion of a tax-
exempt bond sale are not counted against the private
activity bond volume cap. The cap is the maximum
amount of private activity bonds that each State can
issue annually. Federal tax law sets the cap at $150
million or $50 per capita, whichever is larger.
The Federal Tax Code requires water utilities to be
rate-regulated to be eligible for private activity bond
financing. In most states, private for-profit water utili-
ties are the only type of private CWSs that qualify.
However, the Federal Tax Code does not restrict the type
of privately owned CWSs that can be financed with
minor portion funds.
The State of California raises all of the funds loaned
to privately owned CWSs through the SDWBLP from the
minor portion of tax-exempt bond sales. The Program's
bond authorization does not distinguish between public
and private CWSs when making loans, and no California
law bars the State from lending tax-exempt bond funds
to privately owned CWSs.
Page 13
-------
California Safe Drinking Water Bond Law Program
To earmark the minor portion of a tax-exempt bond
sale's proceeds for loan to nongovernmental CWSs, the
State must first determine that no other private sector
projects require part of the minor portion. This review to
ensure conformance with the Federal Tax Code's provi-
sions regarding the private sector use of tax-exempt
bond funds is called "due diligence." A routine part of
bond sale preparations, due diligence typically involves
the staff of the State's debt-issuing office, such as the
California Treasurer's Office.
Using the minor portion approach, the amount of
financing available to privately-owned CWSs is deter-
mined by the amount of financing required for other
purposes. Consequently, the supply of loan funds avail-
able to privately-owned CWSs is related only indirectly
to their demand for tax-exempt financing.
Loan Activity
Privately and publicly owned CWSs borrow at the
same rate of interest, one-half the rate paid by
the State on its most recent sale of 20-year, GO
debt. As of March, 1992, California's GO debt was rated
AA .All borrowers pay an administrative fee of 5 percent
of the amount borrowed. The Program also makes some
grants available, but only to especially needy public
sector borrowers.
By the end of April 1992, the SDWBLP had made 477
loan commitments to all eligible drinking water systems
in California. Averaging about $475,000 each, these
commitments totalled almost $49 million. The Program
also had made 103 commitments, about 22 percent of the
total, to nongovernmental CWSs.
State statute limits loan duration to 50 years, but in
practice loans rarely exceed 25 years. The longest loan
period yet approved is 35 years. Program officials will
seek loan durations as low as 10-15 years if they conclude
thatan applicant'scustomers can afford thehigher water
rates necessary to retire the debt rapidly. Officials will
increase the repayment period, or fund some portion of
a public project with a grant, if the project would push
water rates beyond 1.5 percent of the median household
income in the applicant's service area.
Borrowers using the Program generally are unrated,
and typically lack access to debt financing on their own.
Before 1984, need for Program funding was determined
by a "lender of last resort" test. Applicants had to
produce letters demonstrating that conventional lend-
ers were unwilling to lend to them. This test was
discontinued in 1984, but the credit worthiness of Pro-
gram borrowers has not improved substantially.
Applicants who were able to secure normal com-
mercial credit also have borrowed from the Program by
showing that the commercial loan terms were so adverse
their financial stability was jeopardized, or their custom-
ers would face financial hardship.
Loan Security Provisions
A
11 private sector borrowers must retain a third
party fiscal agent to collect loan payments and
transmit them to the State.
A nongovernmental system must also secure its loan
by granting the State a lien on its facilities. The lien gives
the State the right to seize and operate the water system
to produce the revenue necessary to continue loan pay-
ments, or sell it to satisfy the outstanding debt.
Each borrower, public or private, must fund from
rate revenues a debt service reserve fund containing one
year's loan payments by the tenth year of the loan. The
reserve fund must contain two year's worth of loan
payments by then if the borrower's water charges are
based on consumption.
The debt service reserve fund is a common security
feature of tax-exempt revenue bond borrowings. It
ensures that, if a borrower becomes unwilling or unable
to meet scheduled loan payments, debt service will
continue uninterrupted for one year while longer term
remedies are pursued.
The Program may impose additional requirements
on public or privateborrowers. For example, a borrower
may have to maintain and collect higher user charges
than those required to meet scheduled loan payments.
(In other words, the revenues that remain after operating
and maintenance expenses are paid, but before payment
to the debt service reserve fund is made, must be no less
than, say, 125 percent of annual debt service.) Or, the
borrower may be barred from incurring new debt until
it can prove that its revenues exceed, by some predeter-
mined margin, the total annual payments for the
Program's loan and the proposed new debt.
Such loan security provisions complicate the bor-
rowing process, and some requirements, such as the
debt service reserve, may increase user costs. However,
they reduce the lender's risk, which is a key concern
when considering loans to unrated borrowers.
e 14
-------
California Safe Drinking Water Bond Law Program
Summary
The SDWBLP, and California's use of the minor
portion of tax-exempt bond sales to provide
loan funds, make all nongovernmental CWSs in
the State eligible for tax-exempt financing. California's
reliance on the minor portion of bond sales does, how-
ever, limit me amount of money available for loan to
these systems. The Program benefits nongovernmental
CWSs in several ways:
• It provides access to long-term, fixed-rate debt fi-
nancing for borrowers with weak credit standing
who otherwise would be unlikely candidates for
commercial loans.
• It takes advantage of California GO'S strong bond
rating and tax-exempt status by loaning funds raised
through State bond sales. This enables the program
to raise loan funds at favorable rates.
• It conveys to borrowers a substantial interest rate
subsidy, which reduces borrowers' interest costs to
one-half the rate paid by the State.
These benefits effectively convert a nongovernmen-
tal CWS with little chance of borrowing on favorable
terms, if at all, into a system that can borrow at interest
rates far below those paid by a strong public-sector
entity.
The Program requires periodic reauthorization of
State GO bonds to fund loans. General State revenues
also are needed to service that portion of Program debt
(one-half the State's interest costs) not covered by loan
repayment income from Program borrowers.
By imposing on borrowers security requirements
that reduce the risk of default, the Program strengthens
its position as lender. The cost of these measures is the
price borrowers must pay to obtain access to debt financ-
ing and subsidy that otherwise would be unavailable. •
For More Information:
Barbara L. Cross, Chief
Bond Financing & Administration Office
Department of Water Resources
1416 Ninth Street
P.O. Box 942836
Sacramento, CA 94236-0001
Page 15
-------
-------
Pennsylvania Infrastructure Investment Authority
Pennsylvania Infrastructure
Investment Authority
The Commonwealth of Pennsylvania established
the Pennsylvania Infrastructure Investment Au-
thority (PENNVEST) in 1988 to provide low-
interest loans and grants for improvements to water and
wastewater facilities. Unlike most State infrastructure
finance agencies, PENNVEST can lend to privately owned
water systems. Many PENNVEST loans have been
made to privately owned CWSs, although most
PENNVEST loans are made to publicly owned systems.
Capitalization for PENNVEST Water Loans
P
ENNVEST has three sources of funds for its
water and wastewater loan programs:
1. General Obligation Bonds. The Commonwealth
has authorized $675 million in GO bonds to be
provided to PENNVEST. (GO bonds are backed by
the full faith and credit, including the taxing power,
of the issuing government. A GO bond typically is
repaid with general tax revenues of the issuing
government.) These GO bond funds fall into two
categories:
• The first is "revolving" or equity funding. In
this category, PENNVEST has received $375
million that it is not required to repay.
PENNVEST thus is free to re-lend the loan pay-
ments received from its borrowers to fund other
infrastructure projects.
» The second category is "non-revolving" fund-
ing. PENNVESThas received $300 million from
the Commonwealth that it must repay at the
very low interest rate of 1 percent.
2. Revenue Bonds. PENNVEST is authorized to raise
funds by issuing revenue bonds, and by May 1992
the Authority had issued $110 million worth. (Rev-
enue bonds are paid off from the revenues of the
projects mat they fund. In PENNVEST'S case, they
are paid off with the loan repayments received from
borrowers.)
3. Loan Repayments. PENNVEST also may lend funds
from loan repayments that are not used to retire its
revenue bonds and "non-revolving" funding from
the Commonwealth. PENNVEST revenue bond
borrowings include a condition that loan repayment
income (received from its borrowers) must be at
least 154 percent of the loan payments PENNVEST
must make on its revenue bonds. Once that condi-
tion is satisfied, PENNVEST must use any excess
loan repayments to fund its scheduled repayment of
"non-revolving" funds to the Commonwealth. Any
loan repayment income mat remains after these
scheduled repayments are made by PENNVEST can
be used to make new loans.
Page 17
-------
Pennsylvania Infrastructure Investment Authority
Impact of the Federal Tax Code
The Federal Tax Code permits issuers of tax-ex-
empt governmental bonds to use up to 5 percent
or $5 million, whichever is less, of the bond sale
proceeds to fund nongovernmental projects or organiza-
tions. These funds are known as the "minor portion" of
the tax-exempt bond sale.
Loan funds raised from the minor portion of a tax-
exempt bond sale are not subject to the private activity
bond volume cap. The cap is the maximum amount of
private activity bonds that each State can issue annually.
Federal tax law sets the cap at $150 million or $50 per
capita, whichever is larger.
Although the Federal Tax Code limits access to tax-
exempt private activity bond financing to water utilities
whose rates are regulated (which limits the financing to
for-profit water utilities in most States), it does not
restrict the type of private C WS that can be financed with
minor portion funds. As a result, for-profit water sys-
tems, privately owned non-profit systems, and mobile
home parks have access to loans of minor portion dol-
lars.
Much of the funds borrowed by privately owned
CWSs from PENNVEST come from the minor portion of
tax-exempt Commonwealth of Pennsylvania bond sales.
(Some or all of the minor portion of a Commonwealth
bond sale will be set aside for use by PENNVEST.)
PENNVEST also earmarks the full minor portion of its
revenue bond sales for loans to privately owned CWSs.
To set aside the minor portion of a tax-exempt bond
sale for loans to private CWSs, the Commonwealth first
must determine how much of the funds raised by the
entire Commonwealth bond sale will be used by non-
governmental entities. This review to ensure conform-
ance with Federal tax law is part of the bond sale prepa-
rations called "due diligence." Staff of the
Commonwealth's debt-issuing office, such as
Pennsylvania's Office of the Budget, typically are in-
volved in the review. PENNVEST must negotiate with
the Office of the Budget to secure some or all of the minor
portion of a bond sale, since other projects involving
private entities also may make demands on those funds.
(Any State bond-financed project with significant pri-
vate-sector involvement is likely to compete for minor
portion funds.)
When planning a sale of tax-exempt PENNVEST
bonds, PENNVEST officials must conduct a similar due
diligence review to determine what portion of the pro-
ceeds of its own bonds will be loaned to private organi-
zations. A loan to any privately owned CWS constitutes
a nongovernmental use of tax-exempt bond proceeds,
and is subject to the limitations of Federal tax law.
The funds that PENNVEST provides to nongovern-
mental CWSs are obtained from the 5 percent minor
portion of tax-exempt financings.
Loan Activity
PENNVEST made 271 loans totalling $413 million
to publicly and privately owned water systems
from its inception in 1988 to March 1992. Small
systems received 154 loans averaging about $550,000 for
a total of $85 million. Sixty-three loans totalling almost
$49 million have been made to support private-sector
projects in four broad categories:
• investor owned, for-profit CWSs,
• CWSs organized as non-profit homeowners associa-
tions,
» CWSs operated by mobile home parks, and
• industries requiring process water or water for pur-
poses other than the provision of potable water to
residential customers.
CWSs have received more than 75 percent of the
private-sector loans made by PENNVEST, and close to
60 percent of the private-sector loan funds. Many of
these loans havebeen for less than$100,000. At least nine
mobile home parks and six homeowners associations
have received PENNVEST loans.
Interestingly, while PENNVEST provides less than
25 percent of its nongovernmental loans to organizations
that are not CWSs, these loans account for more than 40
percent of the total volume of PENNVEST's nongovern-
mental loans.
Issuance of Private Activity Bonds
to Fund Loans to Privately Owned CWSs
Although PENNVEST can issue tax-exempt pri-
vate activity bonds on behalf of privately owned
CWSs, the Authority has not done so. The
allocation of a portion of the Commonwealth's private
activity bond volume cap for mis purpose cannot be
ensured.
If PENNVEST were to issue tax-exempt private ac-
tivity bonds for privately owned CWSs, the Federal Tax
Code would restrict their use to privately owned CWSs
whose rates are regulated. Although the Pennsylvania
Public Utility Commission regulates all investor-owned
water systems regardless of size, it does not regulate
water rates charged by CWSs organized as homeowners
Page 18
-------
Pennsylvania Infrastructure Investment Authority
associations or mobile home parks. Consequently, it
appears unlikely that PENNVEST would be able to
make tax-exempt private activity bond financing avail-
able to such systems.
Loan Terms
PENNVEST offers privately owned water systems
the same loan terms offered to publicly owned
borrowers. The maximum du ration of most loans
is 20 years. All loans are made at below-market interest
rates. How far below depends on the unemployment
rate of the county in which the PENNVEST-financed
facility is locate.
Interest rates vary from 1 percent to 6 percent in the
first 5 years of a loan. Afterwards, rates very from a
minimum of 25 percent to a maximum of 75 percent of
the Commonwealth's cost of borrowing. For example,
the Commonwealth is paying 6.44 percent interest on the
$250 million of long-term GO bonds it sold in March
1992, On this basis, PENNVEST loans would bear a long-
term interest rate of 1.61 percent to 4.83 percent.
PENNVEST also has limited grant funding available
to further subsidize water system projects. If repayment
of a loan at the minimum initial interest rate of 1 percent
would require a median-income household served by
the financed facility to spend more than 2.3 percent of its
income for water, then PENNVEST will consider grant
financing for the project.
The PENNVEST Program: Key Components
The Commonwealth of Pennsylvania's contribu-
tions deeply capitalize PENNVEST. This deep
capi taliza tion enables PENNVEST to make a high
volume of loans and to provide substantial average
subsides to borrowers. Loans to public and private
borrowers outstanding as of April 1992 bear an average
interest rateof 2.2 percent. Because the Commonwealth's
capital contributions are available to PENNVEST at no
cost (the $375 million revolving contribution) or low cost
(the $300 million in loans repayable at 1 percent),
PENNVEST can loan these funds at low rates of interest.
The Commonwealth's deep capitalization also fa-
cilitates PENNVEST's own revenue bond borrowings.
PENNVEST raised $60 million in November 1990 to
provide a portion of the funds needed to meet $218
million in approved loan commitments. The balance of
the required funds came from the Commonwealth's
contributions. PENNVEST structured its own borrow-
ing to make the loan repayments on the entire $218
million available first to repay its $60 million revenue
bond.
Under this arrangement, PENNVEST's loan repay-
ment income is sufficient-even at the low average inter-
est rate of 2,2 percent to repay its borrowing costs by a
wide margin. PENNVEST pledged for this borrowing
that loan repayment income would never be less than
154 percent of its scheduled bond repayments. That is
enough to coverall scheduled payments on PENNVEST's
borrowings, even in the unlikely event that 35 percent of
PENNVEST's borrowers default on their loans.
Since PENNVEST's could show such high coverage
of its own borrowing costs, and because the number of
borrowers was more than 100, the bond rating agency
Standard & Poor's (S&P) gave the revenue bond sale a
strong AA rating. (This is an unusually high rating for a
borrower with no taxing power.)
The bond pool was large enough to permit S&P to
rate the sale without considering the credit qualities of
PENNVEST's individual borrowers. This allowed
PENNVEST to offer financing without imposing strin-
gent credit-quality screening, which could eliminate
weaker borrowers, including a disproportionate share
of small borrowers.
Summary
PENNVEST's ability to provide tax-exempt financ-
ing for privately owned CWSs is both driven and
limited by the volume of tax-exempt borrowing
by PENNVEST and the Commonwealth of Pennsylva-
nia to meet needs unrelated to the requirements of
privately owned CWSs.
Under State law, any privately owned CWS in Penn-
sylvania is eligible for a PENNVEST loan. The way
PENNVEST generates tax-exempt funds to loan to these
systems avoids the Federal Tax Code restrictions on
what type of privately owned CWS can borrow funds
raised by selling tax-exempt private activity bonds. If
PENNVEST could not obtain the minor portion of Com-
monwealth bond sales, and had to rely on private-
activity bondsinstead,onlyprivatelyowned CWSs whose
rates are regulated by the Commonwealth would be
eligible for loans of tax-exempt funds under the Federal
Tax Code.
PENNVEST has been able to generate very high low
volume and substantial subsidies in its portfolio of pub-
lic- and private-sector loans. As the PENNVEST loan
portfolio grows, the Authority's ability to loan money to
borrowers not considered credit worthy by the custom-
ary market standards also increases. Also, high annual
loan volumes require large PENNVEST revenue bond
sales, which increase the size of the 5 percent minor
portion available for loan to private CWSs. Both these
benefits-access to loans for weak borrowers and access to
Page 19
-------
Pennsylvania Infrastructure Investment Authority
loans for privately owned CWSs-are facilitated by estab-
lishing and continuing a large lending program.
PENNVEST is nearing the end of its first round use
of its initial capitalization funds from the Common-
wealth and from the sale of PENNVEST revenue bonds.
The Authority will require additional Commonwealth
support in the form of bond sale proceeds to continue
providing high loan volumes and deep subsidies. Its
work in this area is supported by the citizens of Pennsyl-
vania. In April 1992, voters authorized an additional
$300 million in capital contributions to PENNVEST. •
For More Information:
Jerry W.Allen, II
Director of Financial Management
Pennsylvania Infrastructure Investment Authority
(PENNVEST)
22 South Third Street
Harrisburg, PA 17101
Paul Marchetu" ,
Executive Director
Pennsylvania Infrastructure Investment Authority
(PENNVEST)
22 South Third Street
Harrisburg, PA 17101
Page 20
-------
Financing a For-Profit Investor-Owned Water Utility in New York
Financing a For-Profit Investor-Owned
Water Utility in New York
The Shorewood Water Corporation is a for-profit
investor-owned CWS on Long Island in New
York State that serves about 5,000 customers.
Although Shorewood is not a small CWS, it lacked access
to the national credit markets, similar to many small
CWSs. A regional investment banking firm headquar-
tered in Albany, New York developed financings for the
Shorewood Water Corporation which illustrate a suc-
cessful approach to overcoming barriers to capital ac-
cess. The financings described here were completed in
November, 1987 and December, 1991.
The regional investment firm arranged tax-exempt
private activity bond financing for Shorewood by enlist-
ing the support of New York State water utility rate
regulators in permitting a "debt service surcharge" on
customer bills to finance the revenue required to repay
the utility's debt. Prior to this financing, Shorewood was
unrated and thus did not haveaccess to the national debt
market. The approach described below enhanced
Shorewood's credit worthiness and resulted in the util-
ity earning a BBB bond rating.
Development of the Shorewood Private Activity
Bond Financing: The Key Components
Shorewood's financial condition did not support an
investment grade bond rating. Without an invest-
ment grade ratingShorewood would be limited to
seeking financing from local financial institutions. Bor-
rowers in Shorewood's situation frequently must agree
to terms that are much less favorable, and generally
more expensive, than those available to stronger bor-
rowers who can finance in the national credit market.
For example, weaker borrowers may be unable to secure
fixed-rate financing or fixed-rate financing may only be
available for a period that is much shorter than the utility
owner(s) desires. Variable-rate financing may introduce
more financial risk than the utility owner(s) is willing to
assume. Another provision may require mat the utility
owner(s) make a personal repayment pledge to secure a
loan. Because of these unfavorable loan terms, the utility
owner(s) may elect not to borrow the necessary funds to
make system improvements which would otherwise
have been completed.
To reassure the lenders that there would be ad-
equate revenue to repay Shorewood's debt over the full
life of the loan, the financing plan designed for Shorewood
created a legal link between Shorewood's rate payers
and the lenders. There were two elements to this ar-
rangement: a "debt service surcharge" and a contractual
pledge between Shorewood and its lenders to repay the
loan.
The debt service surcharge appears as a separately
identified charge on each customer's bill and represents
the customer's share of the debt service payable on
Shorewood's loan. Shorewood was authorized by the
New York State Public Service Commission (NYSPSC)
to collect the debt service surcharge in the amount needed
Page 2\
-------
Financing a For-Profit Investor-Owned Water Utility in New York
to repay the loan over the full life of the loan. Shorewood
obtained this NYSPSC ruling in advance of its bond sale,
so that it would be able to demonstrate to potential
lenders that it had full legal authority to collect sufficient
revenues to repay its loan. This arrangement was then
noted in the loan documents executed for Shorewood's
bond sale. In these documents, Shorewood pledged to
its bondholders to collect and apply the debt service
surcharge only for the purpose of repaying its loan.
Through thedebtservicesurchargeand Shorewood's
pledge in its bond documents the investment firm cre-
ated a new revenue stream dedicated solely to repaying
Shorewood's lenders. Armed with these mechanisms
assuring Shorewood's ability to repay its debt, the in-
vestment firm was able to obtain a letter of credit for
Shorewood's borrowing. The letter of credit pledges
that a financial institution will, for a specified period of
time, advance funds to pay debt service to lenders if the
borrower fails to make scheduled loan payments. With
the letter of credit, Shorewood was able to borrow at
rates that reflected the AAA bond rating of the financial
institution that provided the letter of credit.
Shorewood subsequently borrowed additional tax-
exempt funds using the same combination of a debt
service surcharge and a contractual pledge to its borrow-
ers to use the surcharge revenues only to repay its loan.
In the second financing the letter of credit was elimi-
nated: Shorewood borrowed entirely on the strength of
its own credit and the strength of the NYSPSC-approved
debt service surcharge. Although the letter of credit
allowed Shorewood to sell its bonds with the very favor-
able AAA bond rating, the fees charged for the letter of
credit offset most of the benefits. For the second financ-
ing, Shorewood achieved a BBB (low investment grade)
rating, and successfully borrowed at favorable tax-ex-
empt rates.
The key ingredients in this approach are:
• Collaboration with state water utility rate regulators
to ensure that the water utility can demonstrate to
lenders that it has regulatory approval to impose
rate increases sufficient in size and duration to retire
proposed long term debt. This approach requires
rate regulators to approve a rate increase on a pro-
spective basis, based on forecasts of borrowing costs.
Most rate regulation of water utilities is done on a
retrospective basis, and regulators examine histori-
cal costs only.
• Creation of dedicated income stream, pledged to
repay borrowing costs, which is approved by the
New York Public Service Commission as a "debt
service surcharge".
Issuance of tax-exempt private activity bonds by a
finance agency for the benefit of the water utility.
This mechanism permits private utilities access to
cheaper tax-exempt financing, which is commonly
only available to governmental bodies.
Impact of State Law
AnyfinancingagencyauttiorizedunderNewYork
State law to issue tax-exempt private activity
bonds for the benefit of a privately-owned or-
ganization engaged in the furnishing of water for public
consumption may provide tax-exempt financing under
this approach. It also does not need to be authorized to
serve state-wide: a county or municipal industrial de-
velopment authority or an economic development fi-
nance agency can also use this approach, provided it is
authorized to issue tax-exempt private activity bonds for
water supply purposes.
One constraint in using this approach is that the
finance agency must secure an allocation of private
activity bond volume cap from the state entity that
allocates volume cap. (Thecapisequalto$150millionor
$50 per capita, whichever is larger.) Therefore the fi-
nancing agency must compete with other projects for
tax-exempt financing.
Impact of Federal Tax Code
Federal Tax Code provisions place restrictions on
the types of privately owned CWSs that may
finance with tax-exempt bonds. One restriction,
for example, is that rates must be established or ap-
proved by a governmental body, and not all privately-
owned CWSs meet this requirement.
The National Regulatory Research Institute (NRRI)
periodically surveys state public utility regulators to
determine the extent and manner of regulation of pri-
vately owned water systems. NRRI's latest published
survey results reviewed regulatory practices in the first
quarter of 1989. The survey results indicate that the
NYSPSC regulates rates for all investor-owned CWSs,
regardless of size. In addition, New York regulates rates
for all CWSs organized as private homeowners associa-
tions. New York does not regulate rates for CWSs
operated by mobile home parks. Therefore, only New
York CWSs operated by mobile home parks would be
ineligible for tax-exempt private activity bond financing
under the Federal Tax Code.
Pa«e 22
-------
Financing a For-Profit Investor-Owned Water Utility in New York
Summary
The Shorewood financing used creative financing
mechanisms mat provided financial assurance to
the lender to increase the borrowing capacity of
an unrated for-profit water system. The approach also
did not rely on subsidy funding. The Shorewood
financing is essentially a straightforward tax-exempt
private activity bond financing, but with a critical differ-
ence: the borrower's credit worthiness was enhanced by
the cooperation and support of state public utility rate
regulators. Without the support of the NYSPSC for the
debt service surcharge, and without action by NYSPSC
on a prospective basis, Shorewood would have been
unable to complete its financings.
The financing approach used in the Shorewood case
could be applied to other water systems, provided that
the water systems meet Federal Tax Code eligibility tests
and provided that state utility rate regulators approve
the debt service surcharge on a prospective basis. It is
likely that the debt service surcharge approach will be
more readily accepted by states whose water utility rate
regulators currently use forecast data as a basis for
considering rate increase requests. NRRI's 1989 survey
of 45 states indicates that 17 use either a future test year
in water utility rate cases, or a combination of a historic
test year and forecast data.
The Shorewood approach requires that the state
entity responsible for allocating tax-exempt private ac-
tivity bond volume cap make an allocation to the financ-
ing agency that borrows on behalf of the nongovernmen-
tal CWS. If such allocations are difficult to acquire, the
volume of such financings that can be accomplished will
be limited by the availability of volume cap allocation.
Alternatively, issuers could substitute taxable financing,
using the same mechanisms. •
For More Information:
Paul L. Gioia
Senior Vice President
First Albany Corporation
41 State Street
Albany, NY 12207
-------
Page Intentionally Blank
-------
Rural Development Administration * Rural Water And Waste Disposal Loan Program
Rural Development Administration
Rural Water And Waste Disposal Loan Program
The Rural Development Administration (RDA),
formerly the Farmers Home Administration
(FmH A), operates the Water and Waste Disposal
Loan and Grant Program. This organization provides
financing for rural water systems that cannot afford
loans from conventional sources. These systems may be
run by government or by non-profit associations, coop-
eratives, or non-profit corporations. RDA also can pro-
vide grants of up to 75 percent of the eligible costs of
projects in low-income areas. Regulations prohibit loans
or grants to profit-making organizations, including in-
vestor-owned, for-profit water systems.
An agency of the U.S. Department of Agriculture,
RDA makes loans directly to borrowers. State and
district offices of the FmHA continue to operate the
program at the field level. Prospective borrowers apply
at local FmHA offices; there is no State-level public or
private intermediary. Under a joint policy statement
with the EPA, RDA gives projects required to meet
federal SDWA standards priority when committing avail-
able funds.
The minimum interest rates on RDA loans is 5 per-
cent. The maximum rate is the same as the tax-exempt
borrowing rate of the most credit-worthy States and
municipalities issuing tax-supported bonds. These fa-
vorable terms result in a subsidy to me borrower. For
example, the maximum rate during the first six months
of 1992 was 6.625 percent. Access to tax-exempt financ-
ing is one of the primary benefits of borrowing through
RDA, because these borrowers would often otherwise be
unable to secure reasonable borrowing terms.
Loan Activity
During FY 1991, RDA made 579 loans to water
systems. The loans totaled $316 million and
averaged $546,000 each. About a third of the
loans (close to 200 loans worth at least $100 million) went
to nongovernmental CWSs. RDA also made 283 loans
totaling $184 million for waste disposal, sewer, and
combined water and waste disposal projects.
Also during FY 1991, RDA made 376 grants to do-
mestic water systems totaling $163 million. Another 236
grants worth $145 million were made for waste disposal
and sewage projects, combined water and waste dis-
posal projects, and technical assistance and training.
Again, nongovernmental CWSs received significant RDA
support; nearly one-third of the grant funds, $50 million,
went to these systems.
Almost two-thirds of all loans made to water sys-
tems were accompanied by grants. About one-half of the
200 loans made to nongovernmental CWSs were paired
with a grant. With loans and grants totaling $366 million
in FY 1991, RDA is clearly a major provider of credit to
rural water systems nationwide. It may be the principal
source of credit for such systems in some states.
Pape 25
-------
Rural Development Administration - Rural Water And Waste Disposal Loan Program
RDA uses a formula which incorporates Census
data on rural population and the number of households
in poverty to allocate loan and grant funds to States.
Data from the 1990 Census will be used to compute the
FY 1993 state allocations. The State allocations shown
below reflect the total funding available for both water
and waste disposal projects from the Federal budget for
fiscal year 1991. The total allocation of the top 10 states
averages about $31 million, while the bottom 10 aver-
ages about $2 million.
Basic Program Eligibility Requirements
T
o be eligible for a RDA grant or loan, an appli-
cant must be a rural:
municipality, county, or other political subdivision
of a State (however, the service area of the project
may not include any area in any city or town having
a US Census population greater than 10,000), or
association, cooperative, or corporation operated on
a not-for-profit basis, or
To receive a loan for a water-related project, an applicant
must show that the loan will be used for installation,
repair, improvement, or expansion of a rural water
facility, including treatment plants, distribution lines,
well pumping facilities and related costs. This broad
definition covers the cost of necessary land acquisition,
"soft costs" such as planning and engineering, and con-
struction costs.
In addition to demonstrating that the facility plans
and specifications comply with State and local regula-
tions, eligible applicants must show:
• an inability to self-finance the project, or to secure
conventional commercial financing at reasonable
rates;
• the legal authority to construct, operate, and main-
tain the proposed facility; and
• the legal authority to apply for, secure, and repay the
loan.
Eligibility Criteria for Subsidized Loans
Whether an applicant is eligible for a subsidized
loan depends largely on the median house
hold income of the proposed project's ser-
vice area. Loans at 5 percent interest are available only
for projects that are necessary to meet health or sanita-
tion standards. To be eligible for this interest rate, the
median household income must be below the Federal
poverty level ($13,950 for a family of four in 1992), or less
than 80 percent of the statewide nonmetropolitan me-
dian household income.
Intermediate rate loans (whose interest rate falls
between 5 percentand the "market rate") are available to
applicants who do not qualify for 5 percent loans, if the
median household income of their project's service area
is not more man the State's nonmetropolitan median
household income. The interest rate on these loans is
currently capped at 7 percent.
In 1991, RDA made 40 percent of its loans at the 5
percent interest; 45 percent of its loans at intermediate
rates; and 15 percent at the market rate.
Eligibility Criteria for Grants
Grants to fund construction projects are available
only if they are necessary to bring user charges
to a reasonable level. To determine whether a
user charge is reasonable, RDA compares it to charges in
communities facing similar economic conditions that are
served by established systems constructed at a similar
cost per user. Therefore, a CWS could not use a grant to
reduce its user charges below the level paid by users of
comparable systems.
RDA will consider a grant of up to 75 percent of
eligible project costs only if:
• the portion of the average annual user charge allo-
cated to pay off debt is more than 0.5 percent of the
median household income in the service area, and
• the median household income is either below the
federal poverty line or less than 80 percent of the
State's nonmetropolitan household income (which-
ever is easier to satisfy).
RDA will consider a grant of up to 55 percent of
eligible project costs only if debt service for the project is
more than 1 percent of the median household income,
provided the median household income in the service
area is no more than the State's nonmetropolitan median
household income.
Projects serving areas where household incomes are
higher than these limits are ineligible for RDA grants.
Page ?6
-------
Rural Development Administration - Rural Water And Waste Disposal Loan Program
RDA Water and Waste Disposal Loan and Grant Program
Ten States with Largest Funding Allocations, FY1991
(Dollars in Millions)
State
Puerto Rico
Pennsylvania
N. Carolina
Texas
New York
Ohio
Michigan
Georgia
Kentucky
Tennesse
Total
% Allocation
5.26
5.26
5.15
4.92
4.40
4.16
4.00
3.69
3.44
3.32
43.63%
LoanS
23.766
23.626
23.116
22.101
19.784
18.673
17.997
16.549
15.442
14.909
$195.963
Grant $
13.963
13,881
13.581
12.985
11.623
10.971
10.574
9.723
9.073
8.759
$115.133
Total $
37.729
37.507
36.697
35.086
31.407
29.644
28,571
26.272
24.515
23.668
$311.096
RDA Water and Waste Disposal Loan and Grant Program
Ten States with the Smallest Funding Allocations, FY 1991
(Dollars in Millions)
State
Nevada
Rhode Island
Hawaii
Alaska
Wyoming
Delaware
Utah
Vermont
N. Dakota
Montana
Total
% Allocation
0.16
0.18
0.18
0.20
0,23
0.27
0.33
0.51
0.53
0.58
3.17%
Loan$
0.699
0.792
0.826
0.907
1.018
1.196
1.491
2.276
2.371
2.586
$14.162
Grant $
0.411
0.465
0.485
0.533
0.598
0.702
0.876
1337
1.393
1.519
$8319
Total $
1.110
1.257
1.311
1.440
1.616
1.898
2.367
3.613
3.764
4.105
$22.481
Page 27
-------
Rural Development Administration - Rural Water And Waste Disposal Loan Program
Other Loan Terms
RDA loans are written for the shortest of three
possible terms: 1) the useful life of a facility, 2) a
maximum of 40 years, or 3) a shorter period
required by State law. Provisions to secure RDA's posi-
tion are incorporated in all loans. Standard security
provisions applicable to all loans made to non-profit
borrowers include:
• Theborrower must pledge thatall its revenue will be
made available to repay its RDA loan. This require-
ment, in effect, makes the RDA loan a "general
obligation" of the borrower. In other words, RDA
has first claim on all revenues of the borrower, up to
the amount needed to make the loan payment when
due.
• RDA takes a lien on all assets it finances and on all
related assets of the borrower. This lien is similar
to a home mortgage held by a bank. In either case,
the lender may seize the asset and sell it to pay off
the loan if the borrower defaults on the obligation.
Additional loan security provisions may be required if
RDA determines they are necessary. These additional
provisions may extend beyond the borrower organiza-
tion to personally involve members of the non-profit
organization, or a unit of government in the project's
service area:
• RDA may require members of the borrowing orga-
nization to personally guarantee the loan's repay-
ment through promissory notes or similar docu-
ments, or by pledging members' assets to provide
loan collateral in addition to the assets covered by
RDA's first lien.
• RDA may require a local government to secure a
loan with its revenues—if there are many seasonal
users of the planned facility and RDA concludes that
year-round residents would have to pay higher fees
than RDA considers reasonable.
Borrowers whose loans are not backed by governmental
taxing authority must fund reserves to reduce RDA's
risk that loans will not be repaid, or repaid on time.
These reserves accumulate during the early years of the
loan and can include:
• A debt service reserve to supply funds for scheduled
loan payments if a borrower does not make a timely
payment. The debt service reserve is always re-
quired when a borrower does not pledge its taxing
power to pay off the debt.
• An emergency maintenance reserve to fund unan-
ticipated maintenance needs.
« A facility extension reserve to provide for future
system expansion.
• A replacement reserve to fund the replacement of
components whose useful life is shorter than the
duration of the loan.
The emergency maintenance, facility extension, and
replacement reserves are required on a case by case
basis, depending on RDA's assessment of the borrower.
Nongovernmental CWSs that borrow from RDA are
expected to accumulate enough debt service reserves to
make one scheduled loan payment. RDA expects these
borrowers to accumulate the reserve within 10 years
after the loan is made.
All CWS borrowers must obtain fidelity bond cover-
age (to protect the CWS from the consequences of any
financial impropriety by its employees) and property
insurance. RDA also may require other forms of insur-
ance to protect its position as lender.
RDA will make loans to projects that are partially
funded by other lenders. In fact, RDA encourages joint
financing as a way to stretch its loan funds.
Loan applicants must show evidence of support for
their project by requiring new users of the financed
facility to make a cash contribution to the project. The
amount of the contribution is negotiated by the borrower
and RDA. This requirement serves to test the economic
feasibility of projects that will provide substantial ser-
vice to new users, and it reduces the requirement for
RDA financing. RDA may reduce the required contribu-
tion, or waive it entirely, if it jeopardizes service to low-
income families. A waiver also may be granted if the
financed facility is required by State statute or local
ordinance.
Summary
RDA's Water and Waste Disposal Loan Program
provides a large volume of low-interest loans
and grants nationwide. By making low-cost
loans and grants, RDA in effect subsidizes the construc-
tion projects it supports. And the program explicitly
recognizes SDWA compliance as a priority when mak-
ing financing awards.
The RDA loan program provides a large amount of
loan and grant funds to CWSs organized as customer-
owned, not-for-profit entities. Even more loans are
provided to government-owned CWSs. RDA does not
Page 78
-------
Rural Development Administration - Rural Water And Waste Disposal Loan Program
provide loans or grants to mobile home parks, unless
they are not-for-profit organizations or are served by
water systems which are otherwise eligible for RDA
financing.
The loan program's target organizations—those
unable to borrow independently, or to borrow at reason-
able terms—and the deep subsidies it provides make the
program especially attractive to rural nongovernmental
CWSs facing high compliance capital costs, low cus-
tomer incomes, or both.
In recent years, the RDA program has been able to
make loans in the same year application was made.
Projects that require grant funding may experience
delays until funds become available. •
For More Information:
Laurence G. Bowman
Chief of the Program Development Branch
Water & Waste Disposal Division
Rural Development Administration
USDA South Building
Washington, DC 20250
Page 29
------- |