' ' '' ''''"'dCiL^rton? ! jh-OH,,
                                        ;.,. f-._    r  "' _  ijp3ry
                                     "i*=: .-.:;, to; i DC2040
                                                      e. NW
                                             STATE ACTIVITY
                    Michigan's  Short-Term
                    Cross-Investment  Structure
 l/nder a short-term

  cross investment

structure a state may

    invest funds

   from one SRF

 program to cure a

 default in the other
A    number of states, including New
    York, Michigan, and Colorado, have
already issued bonds to leverage their
Drinking Water State Revolving Fund
(DWSRF) programs. Recent reports
indicate that up to fifteen states are
already leveraging or are planning to
leverage their DWSRF programs. In
designing their leveraged program
structures several states have explored
the use of pooled bond security
enhancements that are new to the  State
Revolving Fund program: cross-
collateralization and short-term cross-
investment. These security
enhancements allow the resources of
one SRF to be used to secure the
repayment of leverage bonds of the
other program.

    Cross-collateralization was
    authorized by the Departments of
Veteran Affairs and Housing and Urban
Development, and Independent
Agencies Appropriations Act, 1999 (PL
105-276). Short-term cross-investment is
allowed under the "permitted
investment provisions" of the Clean
Water Act and the Safe Drinking Water
Act. To date, New Jersey has received
approval for a cross-collateralization
structure and New York and Michigan
have received approval for short-term
cross-investment structures.

    Under a short-term cross-investment
    structure, a state may use available
funds from one SRF program to help
cure a default in the other. In the event
that a borrower fails to repay a CWSRF
or DWSRF loan, the first source to
cover the default is the individual
program debt service reserve. With a
short-term cross-investment structure,
as the debt service reserve is depleted,
the second revolving fund can "invest"
funds to cure the deficiency. The
investment is made by the borrower
SRF selling a bond to the investing SRF
program. The investment is permitted
under Section 603(d){6) of the CWA and
Section 1452(f)(5) of the SDWA.  The
authority for borrowing funds for cross-
investment is found in Section 603{d)(4)
of the CWA and Section 1452(f)(4) of
the SDWA. The bond must be a short-
term investment so that the lending
SRF is repaid after the borrowing SRF
recovers from loan defaults.

    The benefit of the cross-investment
    is that it provides additional
security to bond holders which helps to
improve the bond ratings given to
leveraging bonds and reduce the cost
of borrowing to the SRF program.
These benefits are accomplished even
though the chances of a cross-
investment actually occurring are
remote due to the extraordinary level
of debt service reserves (often 50
percent of bond size) found in many
leveraged SRF programs. This report
describes the Michigan short-term
cross-investment structure.

                           Overview of Michigan's Crhss-Investment Structure
   Michigan's first

 DWSRF bonds funded
$532 million in loans
    to 23 separate

government borrowers

   for 24 different

      Michigan's CWSRF and DWSRF are
      managed jointly by the Michigan
Department of Environmental Quality
and the Michigan Municipal Bond
Authority. The State has used reserve
fund leveraging in the CWSRF since
1992. In  order to finance DWSRF
loans, Michigan amended its existing
master indenture to establish a
combined revolving fund financing
program while continuing to separately
account for all funds associated with
the CWSRF and the DWSRF. The first
DWSRF bonds funded $53.2 million in
loans to 23 separate government
borrowers for 24 different projects.
    Exhibit 1 displays Michigan's master
    indenture flow of funds. The
indenture shows that as principal on
bonds are repaid moneys from the
Reserve Fund are released for other
uses. It is possible to release funds and
reduce the size of the reserve because
as the outstanding bond principal is
reduced, the released funds are no
longer  required to provide security or
to generate interest to subsidize the
repayment of the bonds. Moneys from
the Revenue Fund are also released
once it is determined that they are not
required for debt service payments.
                               Exhibit 1
                      Michigan's Master Indenture
                   Pooled Project Bonds Flow of Funds

                                                                     STATE ACTIVITY
Use of Released Moneys for Cross-Investment
     Once the funds are released from the
     Reserve Fund, Michigan's SRF
management reviews the CWSRF and
DWSRF to determine whether the released
funds are required to cure any fund
deficiency resulting from defaults on SRF
loan repayment. If the funds are not
needed to cure a default, they are then
made available for any authorized SRF
purpose (i.e., new loans). Exhibit 2
displays the priority order in which the
released funds may be applied. The Exhibit
shows that the released funds are first
used to cure defaults within the Fund of
origin before they are made available for
cross investment in the other SRF
                                           Released moneys are supplied by both
                                           SRF programs and are accounted for
                                      separately.  If a cross-investment is
                                      required to cure a default the investment
                                      will be accounted for as a short-term,
                                      temporary investment of one SRF in the
                                      other and will be evidenced by a
                                      subordinate repayment bond. The cross-
                                      investment will be repaid with the first
                                      moneys available to the borrowing fund,
                                      i.e., after payment of debt service on
                                      outstanding bonds.
                                Exhibit 2
                  Priority Use of Released Account Moneys
Repayments &
Investment Income
CWSRF Pooled Project
Bonds Revenue Fund
CWSRF Pooled Project
Bonds Oeht Service Fund
CWSRF Pooled Project
Bonds Reserve Fund
CWSRF Puo ed Project
Bonds Released Account
Any Authorised S8F Purpose
of the Fund

Available in tkr following
. Debt Service Fund for
CWSRF Project Bonds
b. Reserve Fund for CWSRF
Project Bonds
c. Debt Service Fund for CWSRF
Refunding Bonds
d. Reserve Fund for CWSRF
Refunding Bonds
e, Debt Service Fund DWSRF
Project Bonds
f. Reserve Fund for DWSRF
Available in the following
a. Debt Service Fund for
DWSRF Project Bonds
h Kt'-t-rve Fund for OWSRF
Project Bonds
c. Debt Service Fund for CWSRF
Project or Refunding Bonds
tl. Reserve Fund for CWSKF
Project or Refunding Bonds
Repayments &
Investment Income

t t


DWSRF Pooled Project
Bonds Revenue Fund

DWSRF Pooled Project
Bonds Debt Service Fund
DWSRF Pooled Project
Bands Reserve Fund
DWSRF Pooled Project
Bonds Released Account
Any Authorized SRF Purpose
of the Fund
Released funds are first

 used to cure defaults

  within the Fund of

 origin before they are

  made available for
cross-investment in the
                                                                                other SRFJund

                                                                   STATE ACTIVITY
    f  ,"
-: i'v CO
< / -.