EFAB Report: Application of Innovative Finance Techniques in the Transportation Infrastructure and Financial Innovation Act of 1998 to Environmental Finance Issues

i •
UNITED STATES ENVIRONMENTAL PROTECTION AGENCY
" WASHINGTON, D.C. '20460
OFFICE OF THE
CHIEF FINANCIAL OFFICER
. APR 19 2X35

MEMORANDUM

SUBJECT: EFAB Report on Innovative Finance Techniques

FROM:
Charles E. Johnsg
Chief Financial Officer
TO:
Stephen L. Johnson
Acting Administrator
I am pleased to transmit the attached Environmental FinancialAdvisory Board (EFAB)
report, The Application of Innovative Finance Techniques in the Transportation Infrastructure &
Financial Innovation Act of 1998 (TIFIA) to Environmental Finance Issues.

This report presents the Board's thoughts and recommendations on a TIFIA provision
known as "backloading" in which debt repayment is scheduled towards the back-end of a project.
The Board believes that backloading could successfully be used to support brownfields
redevelopment and to address affordability needs in rural infrastructure.development. EFAB
urges EPA to seek TIFIA-like backloading authority as a complement to its infrastructure
assistance programs. The Board offers to provide EPA with additional assistance as needed with
this innovative financing tool.

If you have questions or comments regarding this EFAB paper, please call me or have
your staff contact Joseph Dillon of my staff at 564-9673.

Attachment
Ftecyclod/RacyclaWe . printed with Vegetable Oil Based Inks on 100% Recycled Paper (20% Postconsumer)

-------

-------
UNITED STATES ENVIRONMENTAL PROTECTION AGENCY
ENVIRONMENTAL FINANCIAL ADVISORY BOARD
MAR 1 6 2005
Honorable Stephen L. Johnson
Acting Administrator^ ...
United States Environmental Protection Agency . • -. •- '
1200 Pennsylvania Avenue, NW ,..-••
Washington, DC 20460

Dear Mr. Johnson:

The Environmental Financial Advisory Board (EFAB) is pleased to submit the enclosed
report, "Application of Innovative Finance Techniques in the Transportation
Infrastructure & Financial Innovation Act of 1998 to Environmental Finance Issues," for
the Agency's consideration and use.

EFAB has an established history of providing advice to EPA on innovative ways to pay
for environmental protection. The Board has recently examined the Transportation
Infrastructure & Financial Innovation Act of 1998 (TIFIA) and determined that
innovative financing techniques authorized therein could be of great value to a number of
areas of vital interest to EPA, including: brownfields redevelopment and affordable water
and wastewater infrastructure development in rural areas.

TIFIA contains a provision commonly referred to as "backloading" in which debt
repayment is scheduled towards the back-end of a project. This approach is very useful
for projects which require substantial up-front capjtal, yet the revenues to service the debt
do not materialize for some time. TIFIA has been used successfully in toll road
development where the roadway is built, but traffic and toll revenues grow slowly over
time. With the Federal government providing security as a "patient investor", debt
repayment is scheduled on the back-end of the project as revenues are realized.

EFAB believes that backloading techniques could be successfully used to support
brownfields redevelopment and to address affordability needs in rural infrastructure
development. In both cases, financing is often stymied by the fact that revenues are not
immediately forthcoming. Given a reasonable assurance that revenues will grow over
time to properly service the project debt, a backloaded repayment schedule could help
projects in these areas to proceed. Of course, there may be substantial risk in this
approach; but with the security provided by a "patient investor," and/or a credit worthy
guaranty, the risk could be mitigated to enable the project to proceed.

-------

-------
In the case of brownfields redevelopment, the remediation/rehabilitation of a site must'...".
often occur prior to attracting a substantial user, and/or where the annual income from the
substantial user, is insufficient to sustain the cost of the project. Backloading could be
used in conjunction with other financial techniques (such as Tax Increment Financing) to
fund projects where the capital improvements must take place prior to the attraction of a
major user or users, the revenues from which would, overtime, sustain the financing.

In rural areas, water and waste water projects are often deemed unaffordable because the
required capital investment in new facilities can not be immediately serviced by user
charges. Moreover, the hook-ups/connections to water and wastewater facilities often
proceed slowly. As connections are made and the service area rate'base increases, user
charge revenues grow to support the debt repayment needs. Backloading could be
instrumental in enabling a project to proceed; thus solving an immediate environmental
need, while deferring financial issues of "affordability" of debt repayment to a later time.

We recommend that the Agency, seek to obtain TIFIA-like authority as a complement to
its infrastructure assistance programs. EPA should consider developing the means to
deploy backload repayment schedules and to implement various guaranty mechanisms.
These mechanisms could enable EPA to address immediate environmental needs while
structuring the solutions to financial issues to a later stage of the project. EFAB would be
happy to provide additional assistance with this innovative financing tool.

Sincerely,
Lyons Gray
Chair
A. Stanley Meiburg
Executive Director
Enclosure

cc: Charles E. Johnson, Chief Financial Officer
Benjamin H. Grumbles, Assistant Administrator for Water
Thomas P. Dunne, Acting Assistant Administrator for
Solid Waste and Emergency Response

-------

-------
                      Environmental
              Financial Advisory Board
EFAB
Lyons Gray
Chair

A. Stanley Meiburg
Executive Director
Members

Hon. Pete Domenici
Terry Agriss
A. James Barnes
Julie Bclaga
George Butcher
Michael Curley
Kelly Downard
Mary Francoeur
Hon. Vincent Girardy
Steve Grossman
Stephen Mahfood
Langdon Marsh
John McCarthy
George Raftelis
Andrew Sawyers
James Smith
Sonia Toledo
Jim Tozzi
Billy Turner
John Wise
   The Application of Innovative Finance
      Techniques in the Transportation
 Infrastructure & Financial Innovation Act
  of 1998 to Environmental Finance Issues
This report has not been reviewed for approval by the U.S. Environmental Protection
Agency; and hence, the views and opinions expressed in the report do not necessarily
  represent those of the Agency or any other agencies in the Federal Government.
                                       March 2005

-------

-------
The Application of Innovative Finance Techniques in the
Transportation Infrastructure & Financial Innovation Act of 1998 to
Environmental Finance Issues . ,
Transportation Innovations ' .

The Environmental Financial Advisory Board (EFAB) has examined the
provisions of the Transportation Infrastructure & Financial Innovation Act of 1998
(TIFIA) to determine if any of the innovative financial techniques authorized therein
could be adapted to other statutes to help finance environmental infrastructure. The
TIFIA program provides for a strong federal role to encourage private investment in
transportation facilities. Among the tools used by the program are direct federal loans
and loan guarantees. In effect, the Federal government under TIFIA becomes a "patient
investor" that provides projects with a credit-worthy capital markets platform.

Backloading

The Board has identified an exciting TIFIA innovative.financing technique
commonly referred to as "backloading" which could prove very useful in several
important environmental financing areas. "Back loaded" financing, in the TIFIA context,
recognizes the ramping-up of revenues associated with the introduction of a new service
to be supported by user fees. This ramp-up often occurs with parking garages, toll roads,
and transit services.

For example, an airport authority might decide to build a parking garage in
circumstances where inexpensive, ample, ancillary parking already exists. The airport is
projecting that, over time, the conveniences of the new garage will lure travelers away
from the less costly alternatives. Thus, the garage revenues will be zero until the garage
is built, and then build slowly to levels where they can carry the full debt service. When
a new toll road is built, the community must become accustomed to the tolls and the new
traffic patterns; thus, it may take years for the volume of traffic to build to the point
where revenues are sufficient to repay monies borrowed for construction.

In each of the cases described above, project revenues ramp up over time from
zero to, hopefully, levels able to support operations and service debt. However, these
demand (or revenue) risks are often difficult to forecast, and private investors are often
unwilling to assume the risks associated with the ramp-up or with the potential that actual
revenues may be lower than projected. .

Patient Investor

TIFIA addresses these factors by recognizing an appropriate role for the federal
government as a "patient investor." In particular, the TIFIA program allows the federal

-------
government to be repaid after the private investors. Thus, the debt service schedule can
be skewed over time, and the TIFIA program funds can be used for those segments of the
financing where the projected revenue flows are more problematic.       ...

Environmental Opportunities

       In evaluating the potential applicability and utility of these transportation
financing innovations to the environmental arena, the Board believes that they could
serve well in several important areas: smart growth, brownfields redevelopment, and the  '
development of water and wastewater infrastructure in rural communities.

Smart Growth              ,    '

       In the smart growth area, backloading could be used where the rehabilitation of an
older site must be accomplished prior to attracting a substantial user, or where the annual
income from the substantial user alone, without ancillary users, is insufficient to sustain
the cost of the project.

Brownfields Redevelopment and Land Revitalization

       So, too, in the case of the  redevelopment of brownfields, back-end loading could
be used in conjunction with other creative financial techniques such as Tax Increment
Financing (TIF) to fund projects where the capital improvements must take place prior to
the attraction of a major user or users, the revenues from which would over time sustain
the financing.

       In both the land revitalization and brownfields areas, backloading is warranted
since the increase in property values (and revenues from new site uses) that may be
expected to arise from site mitigation and redevelopment is not likely to occur
immediately, so the capacity of a private owner or a public agency to service a debt in the
early years of such a conversion would be far lower than its capacity in later years.

       Large Projects      _.

       Large scale land revitalization (of factories, mines, railroad yards, shopping malls
and the like) either requires a public agency to remediate the site prior to attracting a
substantial user or master developer or requires that such an investor be prepared to take
on remediation activity prior to redevelopment work.

       If such projects were financed or subsidized by a local government through the
ever-more-frequently used TIF tool, the use of backloading would make it possible for
the public sector participant to raise more capital, since debt servicing capacity would be
higher after the tax increment from the revitalization was realized from the higher
property values. (TIFs, by design, involve no higher tax rates, but just a capture of the
higher value of property.) Those rising property values that could help service a back

-------
loaded bond are likely to occur off-sitCj around the major redevelopment project, and not ••
just from the development itself. . • ,..;,.,,:;-

Small Projects "''."'

In the small scale (under one-half acre) brownfields redevelopment area,
backloading and the use of TIFs could'help make^possible the revitalizatioh of whole
neighborhoods beset with environmental and economic problems. Since such small sites
may account for more total contaminated land area than the large sites in private hands, ...
any advance in attracting investment in this setting would be extremely valuable. '•••

In an area with depressed property values and multiple abandoned, underutilized
and/or contaminated sites, no one reclamation project is likely to significantly raise area.
property values. Thus, the possible use.of a TIP is limited by^the absence of substantial .
off-site impacts. Such impacts maybe attainable only from a series of revitalizations of
problem sites. The cash flow to finance the first site, therefore, may never be available
unless all sites are done simultaneously, which is extremely unlikely.' Back loaded debt
financing through a TIF, however, could attract a developer to begin the series of private
sector investments heeded to turn around a neighborhood and provide the area-wide tax
increments needed to service the debts when higher payments come due.

Affordable Rural Water and Wastewater Infrastructure

In rural and developing areas, back-end loading could be used in financing water
and wastewater projects where hook-up fees and user charges only begin to flow after a
project is completed. Infrastructure projects in such areas are often judged unaffordable
because the debt associated with the capital investment needed for new facilities cannot
be immediately serviced by user charges. In fact, new hook-ups/connections to water and
wastewater facilities often occur slowly. As connections are made and the service area
rate base increases, user charge revenues grow to support debt repayment. Backloading
could enable projects to proceed because it solves immediate environmental needs by
deferring financial issues of "affordability" of debt repayment to a later time.

This approach might be especially valuable along the US-Mexican border, where
the North American Development Bank. (NADBank) could guaranty a bond issue with a
highly skewed amortization schedule that allows for the build-out of the system and the
build-up of operating revenues to sustain long-term debt service. In this case, the new
water/wastewater system would enjoy the very low interest rates provided by the
NADBank guaranty until such time as the system revenues could provide substantial debt
service coverage. :•-..,-

In each of the examples above, it should be noted that, without a NADBank, or
other credit-worthy guaranty, the financings could only be accomplished at speculative
rates which would further compound the problem being addressed. Thus, back-end
loading, coupled with such a guaranty, could prove very valuable indeed.

-------
Recommendation

       We, therefore, recommend that, as the Agency reviews its core legislation and its
action programs in the water, wastewater, brownfields and smart growth areas, it gives
consideration to the use of financial mechanisms such as guaranties and direct loans that
will accommodate back loaded financing. We further recommend that the Agency seek to
obtain TIFIA-like authority as a complement to its infrastructure assistance programs.'
EPA should consider developing the means to deploy backload repayment schedules and
to implement various guaranty mechanisms. These mechanisms could enable EPA to
address immediate environmental needs while structuring the solutions to financial issues
to a later stage of the project, EFAB would be happy to provide additional assistance
with this innovative  financing tool.    -

-------