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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