oEPA
Office of Water (4101)
STATE ACTIVITY
UPDATE
EPA816-N-00-003D
January 2000
Michigan's Short-Term
Cross-Investment Structure
Under 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.
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Overview of Michigan's Cross-Investment Structure
Michigan's first
DWSRF bonds funded
$53.2 million in loans
to 23 separate
government borrowers
for 24 different
Projects
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 7
Michigan's Master Indenture
Pooled Project Bonds Flow of Funds
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STATE ACTIVITY
UPDATE
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
CWSRF Loan
Repayments &
Investment Income
1
CWSRP Poo ed Project
Bonds Revenue Pund
]
f
CWSRP Poo ed Project
Bonds Debt Service Pund
1
CWSRP Poo ed Project
Bonds Reserve Pund
3
r
CWSRF Poo ed Project
Bonds Released Account
Moneys
1
f
Any Authorized SRP Purpose
of the Pund
Available in the following
order:
a. Debt Service Pund for
CWSRP Project Bonds
b. Reserve Pund for CWSRP
Project Bonds
c. Debt Service Pund for CWSRP
Refunding Bonds
d. Reserve Pund for CWSRP
Refunding Bonds
e. Debt Service Pund DWSRP
Project Bonds
f. Reserve Pund for DWSRP
Bonds
Available in the following
order:
a. Debt Service Pund for
DWSRP Project Bonds
b. Reserve Pund for DWSRP
Project Bonds
c. Debt Service Pund for CWSRP
Project or Refunding Bonds
d. Reserve Pund for CWSRP
Project or Refunding Bonds
'f ^
DWSRF Loan
Repayments &
Investment Income
DWSRF Poo ed Project
Bonds Revenue Fund
J
t
DWSRP Poo ed Project
Bonds Debt Service Pund
;
,
DWSRP Poo ed Project
Bonds Reserve Pund
>
f
DWSRF Poo ed Project
Bonds Released Account
Moneys
1
r
Any Authorized SRP Purpose
of the Pund
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 fund
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STATE ACTIVITY
UPDATE
Summary of Key Features
Michigan's structure is designed to be
appealing to bond rating agencies
and investors. The State's approach
enhances the security structure of
Michigan's CWSRF and DWSRF leveraging
bonds while complying with federal
CWSRF and DWSRF program requirements.
The following are key features of
Michigan's short-term cross-investment
structure:
. The CWSRF and DWSRF accounts
remain separate.
• Only moneys released from
reserves or revenue accounts may
be used for short-term cross-
investments.
• Cash draws can not be made for
cross-investment purposes.
• Cross-investments cannot be used
for state match
• The structure allows short-term
cross-investments in either
direction between the State's
CWSRF and DWSRF programs.
• Short-term cross-investments are
made after the borrowing program
has depleted all other sources of
security in that fund.
• Investments are temporary, short-
term bonds that will be repaid with
the first available SRF resources.
• Any investments between the
CWSRF and DWSRF will be recorded
on the SRF balance sheets and
evidenced by a subordinated
Repayment Bond
• If all funds are viable, the released
moneys will immediately be made
available to commit to eligible SRF
projects.
• The state's approach is detailed in
the operating agreements for the
DWSRF and CWSRF between the
region and the state.
• Funds will not be held in one SRF
in anticipation of potential future
cross-investment needs.
States interested in further information
on short-term cross investment should
contact their EPA Regional Office SRF
Coordinator. For information on
Michigan's program contact the state
representatives below.
State Contacts:
Financial-
Janet Hunter-Moore
(517)373-1728
Program-
Thomas L. Kamppinen
(517)373-2161
This update was prepared by
EPA Headquarters
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