19020053
UNITED STATES ENVIRONMENTAL PROTECTION AGENCY
WASHINGTON, D»C. 20460
JUN 3 2005
OFFICE OF THE
CHIEF FINANCIAL OFFICER
MEMORANDUM
SUBJECT: EFAB Report on SRF Combined Operations
FROM:
TO:
Charles E. John
Chief Financial Officer
Stephen L. Johnson
Administrator
I am pleased to transmit the attached Environmental Financial Advisory Board (EFAB)
•report, Combined Operationstoj the Clean Water and Drinking Water State Revolving Loan
Funds (SRFs). •"...-
•This latest SRF report presents the Board's thoughts on improving these two important
and successful environmental infrastructure programs by further combining their financial and
programmatic operations. The Board believes there are real efficiencies and economies to be
gained at both the state and federal levels in such an effort and would be happy to assist EPA as
needed and appropriate.
If you have questions or comments regarding this EFAB report, please call me or have
your staff contact Joseph Dillon of my staff at 564-9673.
Attachment
Recycled/Recyclable . Printed with Vegetable Oil Based Inks on 100% Recycled Paper (20% Postconsumer)
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UNITED STATES ENVIRONMENTAL PROTECTION AGENCY
ENVIRONMENTAL FINANCIAL ADVISORY BOARD
MAY 2 7 2005
Honorable Stephen L. Johnson
Administrator
United States Environmental Protection Agency
1200 Pennsylvania Avenue, NW
Washington, DC 20460
Deair Administrator Johnson:
The Environmental Financial Advisory Board (EFAB) is pleased to submit the
enclosed report, "Combined Operations of the Clean Water and Drinking Water State
Revolving Loan Funds (SRFs)," for EPA's consideration. EFAB strongly supports these
important and successful infrastructure loan programs and has a well-established record
of providing advice to the Agency on ways to further improve them.
This latest report examines the idea of more closely combining the financial and
programmatic operations of these Wastewater and Drinking Water SRF programs. The
report notes that while some states are already moving in this direction, there is
significant room for further progress in this area. EFAB is convinced there are real
• opportunities for achieving efficiencies and economies by moving toward the combined
operations of the two SRF programs at both the state and federal levels.
The Board recognizes that additional information may be needed in order to best
implement combined SRF operations and recommends that EPA undertaken detailed
examination of the two programs to better determine what opportunities and advantages
exist and how they might best be combined. EFAB is prepared to assist in such an effort
in any way consistent with its charter.
Sincerely,
Lyons Gray . « A. Stanley Meiburg
Chair Executive Director
Enclosure
cc: Charles E. Johnson, Chief Financial Officer • * -
Benjamin H. Grumbles, Assistant Administrator for Water ,
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EFAB Report
COMBINED OPERATIONS OF THE CLEAN WATER AND
DRINKING WATER STATE REVOLVING FUNDS
GENERAL CONTEXT
Many studies and reports indicate that the investment needs for clean water and
drinking water facilities are large and growing. EPA itself estimates that capital needs
for clean water will range from $331 billion to $450 billion during the period from 2000
to 2019. For the same timeframe, EPA estimates that capital needs for drinking water
will range from $154 billion to $446 billion. (These figures are taken from the EPA
report, The Clean Water and Drinking Water Gap Analysis, September 2002.)
Obviously, whatever the exact figures may be, very substantial resources will be required
to address the environmental investment needs of clean water and drinking water.
EFAB believes that the states, local governments, and the federal government all
have roles to play in order to successfully address this significant environmental
investment challenge. In particular, the Board has long supported a strong federal
commitment to two important infrastructure loan programs, the Clean Water and
Drinking Water State Revolving Fund (SRF) Programs. This strong commitment
remains very important during this period of growing infrastructure investment needs and
tight government budgets. Having noted this, the Board also believes that all federal
programs should make every possible effort to realize the maximum efficiency and
effectiveness in the use of whatever funds they are appropriated.
OVERVIEW
EFAB is convinced there are real opportunities for achieving efficiencies and
economies by moving toward the combined operations of the two SRF loan programs at
both the state and federal levels. Indeed, a number of states are already demonstrating
efficiencies both in financial and programmatic management through combined operation
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of some aspects of their loan programs including financial management for purposes of
more efficient investment, bond issuance, and programmatic management. Some of these
are described below. Many other states, however, for various reasons, maintain distinctly
separate management structures. And while there are many diverse aspects of SRF
management, including environmental prioritization, watershed planning, community
outreach, and education which each state approaches individually, the essential common
denominator of each SRF program is its financial component.
Each state fund is first and foremost a loan program where the first imperative is
an understanding of the basics of loan financing. Whatever other disciplines may be
involved, the SRF programs are principally banking operations and the capability to
understand the fundamentals of banking and efficient money management are essential to
an effective program. With the maturity of these loan programs, vast amounts of money
are now circulating from loan repayments and fund investments. Annual combined loan
repayments from the two funds now exceed $3 billion dollars and annual earnings from
invested funds exceed $500 million (net of investments of leveraged bond reserves).
EPA, through its own training efforts and through those financed with organizations such
as the Council of Infrastructure Financing Authorities (GIFA), has encouraged states to
improve their financial management capabilities in the loan programs.
This has been salutary, but in the view of this Advisory Committee, a
fundamental restructuring of the program in many states as well as in EPA headquarters,
has the potential to more fully achieve the advantages of efficient financial management.
At a time of budget constraints, a real potential for reduced federal grant support, and
increasing emphasis on achieving economies in the operation of governmental programs,
EFAB believes that many states could achieve economies in SRF management by
merging or more closely combining the operations of their two environmental lending
programs. Moreover, in the opinion of some state program managers we have consulted,
combined Clean Water and Drinking Water SRF operations could achieve economies in
program administration as well, especially with respect to the integration of Intended Use
Plans.
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EFAB Report
Likewise, we are of the opinion that EPA itself could achieve efficiencies in its
own Clean Water and Drinking Water SRF management by combining their operations at
headquarters where two separate SRF operations are maintained within the Office of
Water.
EFAB urges EPA to undertake a comprehensive review of the operations of the
SRF program in terms of its own management at headquarters and in the regions to
determine if moving toward a combined operation of the two loan programs might
achieve a more efficient and effective use of resources, and also encourage individual
state programs to consider combined programs which could lead to improved financial
management techniques. We appreciate that some constraints and limitations exist which
may inhibit the full integration of the two programs, especially with regard to the separate
state and federal enabling legislation implementing the two loan programs. Even so, the
combined or close operation of the two programs in a numbers of states offers instructive
prototypes of how efficiencies can be achieved through more integrated management. In
recommending this action we recognize that the Congress was not prescriptive in telling
the states how to administer the loan programs and that this has been one of the strong
features of the program, allowing states to adapt their loan program implementation to
their own constructs and particular needs. It is not our intent to suggest there is any one
prototype that should be enforced upon the state programs, but rather, to suggest that
there are efficiencies to be achieved by combining some operations which states, with
EPA cooperation, should investigate for application to their own programs.
BACKGROUND
In June 2001, EFAB published a report titled "Environmental State Revolving
Funds: Developing a Model to Expand the Scope of the SRF." The report examined the
idea of providing states the flexibility to expand their Drinking Water and Clean Water
State Revolving Funds to cover projects in all environmental media. The flexibility to
fund all environmental media would, in turn, allow states the flexibility to address all
causes of pollution for the maximum environmental benefit. The Board believes that if
such an environmental SRF is to become a reality, it should be built upon the success of
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EFAB Report
the existing Clean Water and Drinking Water programs through additional funding for a
broader range of projects. As a first step towards identifying the benefits associated with
an environmental SRF, EFAB undertook to identify the benefits that may result from the
combined operation of the Clean Water and Drinking Water SRFs. In addition, EFAB
sought to identify the regulatory, statutory, organizational and programmatic hurdles that
currently prevent the Clean Water and Drinking Water SRFs from operating as a single
entity.
EFAB members held informal discussions with a number of States to identify the
benefits and issues inherent in the combined operation of the Clean Water and Drinking
Water SRFs. Conversations were held with SRF managers from the States of New York,
New Hampshire, Missouri, Maryland, Montana, North Carolina and New Mexico. The
anecdotal information received from these conversations offers insights into the
perceived benefits of jointly operated SRFs. This information can serve as the basis for
an in-depth analysis of the benefits of combined SRF operations across states.
OPPORTUNITIES, CONSTRAINTS AND LIMITATIONS
EFAB explored a number of areas where there may be obvious advantages of
combined operations. These included fund investments, leveraging, administration and
staff expertise, and project funding capacity. As mentioned previously, EFAB also
attempted to identify some of the possible limitations and constraints in implementing
such a major shift. Both benefits and hurdles are described in further detail in the
paragraphs that follow.
Administration
The majority of managers we spoke to believe they would reap significant
administrative benefits if they were able to run the Clean Water and Drinking Water
SRFs as one. Technical project management in most states is split by fund with
coordinators and engineers working on one type of project or the other. Cost savings
would result from having a single SRF with a dedicated technical staff in one, as opposed
to multiple, locations. Furthermore, states mentioned they would be able to benefit from
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EFAB Report
cost savings in the time staff spend on producing separate reports for each of the funds,
namely the Annual Reports and Intended Use Plans. Accounting for the funds would be
greatly simplified, as SRF monies would no longer have to be tracked separately. One
state mentioned that having a single SRF would assist in addressing match requirements
and the accounting challenges that tracking the separate matches involves.
Moreover, moving toward consolidation of the two SRF programs would be
complementary to EPA's efforts over the last several years to approach water pollution
control on a more integrative, watershed basis. Recognizing the need to bring non-point
source controls into the equation has caused the Agency to foster more emphasis on a
watershed approach to planning and implementation of strategies for both point and non-
point control and safe drinking water supply. The closer integration of the two water
infrastructure financing programs at the state level would help facilitate this watershed
approach, allowing states to identify the most efficient and effective use of expenditures
for both control and supply. A fully integrated loan program where available money was
fungible would provide the state with the flexibility to direct loan funds to the most
environmentally strategic projects in a watershed. To fully achieve this objective of a
common pooling arrangement and a common Intended Use Plan, would require some
modest changes in federal statute in both the Clean Water and the Safe Drinking Water
Acts. It would be important to maintain the current categorical appropriations so that the
set-asides for state program administration as well as those for basic drinking water
assessments would be sustained roughly in proportion to the administrative needs of the
two programs.
Cost-of-Funding
Many states that leverage their SRFs already sell a single issue of bonds to fund
both Drinking Water and Clean Water. These bonds are jointly secured or cross-
collateralized by the assets of both SRFs and generally achieve AAA ratings - the highest
rating assigned to municipal bonds. SRF managers are able to sell bonds jointly secured
by the assets of both SRFs by complying with the proportionality or investment
provisions in each Act.
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EFAB Report
Aside from advantageous borrowing levels, which the majority of SRFs enjoy by
virtue of their ratings, most managers view a single pool of funds as a financial advantage
for both the SRF and the projects funded. For instance, a single municipality or entity
applying for both drinking water and clean water loans would be able to receive funding
under a single loan application. This would simplify the legal work that must be
undertaken by both borrower and lender, resulting in lower legal and trustee fees.
Fund Investments
As permitted by EPA, most investment managers treat funds under each SRF as
fungible for investment purposes, although they must separately account for the assets of
each SRF. The ability to account for SRF federal and state contributions in one common
equity fund is an area where benefits can be significant. Several states consulted on this
project jointly manage their own investments, finding it preferable to state investment
pools where returns and flexibility of investment products are often limited. Since
anticipated cash-flow needs for constructions draws, new lending and possible
administrative costs are critical factors of short term fund investing, the capacity to shift
available fund from one category to another is essential to achieving better returns. Quite
simple, returns are generally directly proportionate to the amount and duration of money
invested and the ability to combine available funds in one managed investment pool can
significantly enhance returns.
Barriers to Implementation
The most frequently cited hurdle to combined operations is the different
institutional arrangements that currently exist between the state agencies responsible for
the implementation and oversight of each SRF. Characterized by one state administrator
as "institutional drag" this may also be an issue for EPA, where different divisions have
responsibility for the Clean Water and Drinking Water programs. Even at the
Congressional level, two separate House Committees assert jurisdiction over the
Drinking Water SRF, a complicating factor in achieving any statutory modification.
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Furthermore, there is concern within EPA that combined operations could have a least
common denominator effect, with the loss of flexibilities currently enjoyed by one or the
other fund (e.g., funding for disadvantaged communities or coverage of technical
assistance costs).
While there are legal constraints at the federal level for implementing a jointly
operated SRF, constraints at the state level are tied to how each state is organized to
manage the SRFs. Federal authorization of a common SRF would require states to
review state laws as well as the powers of their current managing institutions. In this
respect, some states have cautioned about the advisability of going to their legislature
with requests for basic legislative change; concerned that opening up the loan program
for legislative modification would unduly expose it to legislative tinkering and possible
mischief and might result is some efforts to expropriate the loan funds for other state
financing needs. They advised that often state legislatures have little understanding of
the SRF program and any invitation for statutory changes could open the funds to
politically motivated actions. However, tightly crafted federal legislation could limit
attempts by state legislatures to divert SRF funds.
EFAB RECOMMENDATIONS
We recommend that EPA, perhaps in cooperation with EFAB, undertake an
examination of the two programs to determine what opportunities and advantages exist
for combined SRF operations. To undertake this in any comprehensive fashion is a big
job and we obviously do not have the resources. But evidence from our observations and
consultation with several state programs indicates wisdom in moving, however
incrementally, toward a more fully integrated program. The question is not whether the
programs could be combined, but rather how best can they be combined and to what
advantage and perhaps at what cost.
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